Readers will be familiar with that exasperating feeling of looking for something and not finding it. You know it should be there, but it is missing.
This feeling may ring a bell with anyone reading the Reserve Bank’s consultation paper, Capital Review Paper 4. Released on 14 December, the paper contains radical proposals to almost double bank capital requirements. The objective is to reduce the risk of bank failure to once every 200 years.
The proposals are unprecedented in the developed world. And they will have profound implications for all New Zealanders. UBS, a global investment bank, suggests the proposals could increase borrowing costs for New Zealanders by 80 to 125 basis points – or cause rationing of credit. The Reserve Bank itself acknowledges the changes will adversely affect GDP.
The consultation document is long – 59 pages in total. But reading the paper, something critical is missing. Despite the adverse consequences of the proposals, nowhere in the paper is a detailed evaluation of the costs and benefits of the proposed 1-in-200-year target.
Indeed, the closest the paper comes to providing any evidence for the target is a footnote explaining that a 0.5% annual risk tolerance is embedded in insurance solvency standards across Europe. But that hardly justifies imposing the costs of the Reserve Bank’s proposals on New Zealanders.
Cost-benefit analysis is a critical tool for regulatory decision-making. And it is enshrined in the Cabinet Manual. The Government Statement on Regulation states that government agencies must satisfy themselves that the benefits of proposed action not only exceed the costs but also deliver the highest net benefit of all practical regulatory options.
Yet, it appears our central bank does not think it needs a cost-benefit justification for its new target. But if 1-in-200 years is less risky than the status quo, why not 1-in-400? Or 1-in-1000? Alternatively, why not only 1-in-50?
The arbitrary target demonstrates the Reserve Bank has overlooked something. It cannot sensibly assess appropriate risk tolerances without assessing the impacts – both costs and benefits.
The Bank’s statutory duty is to “promote and maintain a sound and efficient financial system”. Soundness and efficiency are related. But soundness is an attribute of an efficient financial system, not an objective to be pursued at any cost. Like other forms of safety, it should only be pursued to the extent the benefits exceed the costs.
Before its proposals harm us all, the Reserve Bank needs to rediscover what it has overlooked – its own efficiency objective.
You can read our submission on Phase 2 of the Reserve Bank of New Zealand Act Review here.