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  1. \nonstopmode
  2.  
  3. \documentclass[a4paper]{article}
  4.  
  5. %% Sets page size and margins
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  8. \usepackage{hyperref}
  9. \hypersetup{
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  14. \urlstyle{same}
  15.  
  16. %% Language and font encodings %%
  17. \usepackage[utf8]{inputenc}
  18. \usepackage[english]{babel}
  19. \usepackage{epigraph}
  20.  
  21. \title{RBNZ Proposition Review}
  22.  
  23. \date{}
  24. %\author{Ainsleigh Hall\\Guy Nankivell\\David Colwil\\Calum Jacobs}
  25. \author{}
  26.  
  27. \begin{document}
  28. \maketitle
  29.  
  30. \iffalse
  31. \section*{Introduction}
  32. Preface, at the time of writing I had only covered the first 20 pages. But it
  33. slighly changed my mindset on the stance that we should take. I thought
  34. initially that it was a good thing; more regulation = good and more buffers
  35. is a happy thought. However, there is low visibility over what the banks
  36. already maintain and the potential cost that this could have to the economy
  37. if they increase their already high levels of capital requirements.
  38. I thought this quote was a good summation of the potential risk;
  39. \fi
  40. %
  41. %
  42. \epigraph{Because the level of a bank’s capital can have an impact on the
  43. interest rate it charges on its loans, it is possible that higher capital
  44. requirements could make it more expensive for New Zealanders to borrow money
  45. from a bank. While we certainly take this into account, we
  46. think this impact should be minimal.}{\textit{RBNZ \\ Capital Review Consultation}}
  47. %
  48. %
  49. \iffalse
  50. Also, in an economy as small as New Zealand, we cannot ignore the implications
  51. of banks taking more capital upon themselves which lowers the leverage and
  52. potentially making them less efficient. So to me, the flow on effects have been
  53. downplayed; primarlily the lesser efficiency making borrowing more expensive
  54. and the fact that this could cause a slow down in the economy.
  55. \fi
  56. \section*{Introduction}
  57. Our position centres on how the Reserve Bank of New Zealand (henceforth, "RBNZ")
  58. has downplayed the ramifications of the change to capital requirements in NZ.
  59. %On all accounts, the change outlined is not so risky to cause
  60. A regulated financial industry is necessary to allow all participants to
  61. transact with confidence; however, the very information asymmetry the RBNZ
  62. seeks to reduce is what has been predated upon here to potentially push through
  63. reforms that are of arguable value, at substantial cost.
  64. \section*{Advantages}
  65. \begin{itemize}
  66. \item Lowers inherent risk of financial institutions failing: The primary advantage
  67. of increasing the capital ratio is that the risk of banks failing is reduced.
  68. This is because banks are required to hold a higher proportion of capital which
  69. can be used if there is a sudden withdrawal from the financial institution
  70. %
  71. %
  72. \item Reduces likelihood of Government bailout: A derivative advantage of
  73. this is that the government is less likely to have to bail out failing financial
  74. institutions as there is simply less chance of them failing. This reduces the
  75. risk the government bears and in turn allows funds to be allocated more
  76. efficiently by the government
  77. %
  78. %
  79. \item Reflection of global standards: Specifically looking at the types of
  80. buffer planned to be introduced by the RBNZ the counter-cyclical buffer is a
  81. new addition. This appears to be a direct reflection of the global trends towards
  82. prevention of another financial crisis through prudential financial regulation.
  83. The introduction of the counter-cyclical buffer is also seen in Basel III. While
  84. New Zealand is not a signatory it is a useful indication of global expectations and trends
  85. %
  86. %
  87. \item Macroeconomic susceptibility of New Zealand: Finally, New Zealand has a
  88. number of macroeconomic features which may require us to have a higher ratio of
  89. capital stored in financial institutions. These include a reliance on a single
  90. sector (agriculture/dairy), which is funded by a large amount of debt and high
  91. levels of household debt. Both of these are vulnerable to exogenous economic
  92. shocks which may lead to a sudden withdrawal from banks. This makes it
  93. prudential to have a higher ratio of capital
  94.  
  95. \end{itemize}
  96. \section*{Disadvantages}
  97.  
  98. \iffalse
  99. \section*{Notation}
  100. $p$ denotes the page of the article that I am referring to, and $s$ refers to
  101. what I believe to be the paragraph number, but what I call a section.
  102.  
  103. \section*{Comments}
  104. These were the points that I thought would be good to document or draw
  105. attention to.
  106. \fi
  107. \begin{itemize}
  108.  
  109. %\item Focus is on guarding against the impact of systemic events but
  110. %no comment on the probability of such, or the potential exposure. \\
  111. %
  112. %
  113. %\item This has an insurance principle about it; loss mitigation in tough
  114. %times, however at the expense of borrowers in the economy. Risk v cost?
  115. %Does this match with our financial system? \\
  116. %
  117. %
  118. %\item Principle around purpose of RBNZ centres around soundness and
  119. %efficiency. This potentially makes banks actively utilise their capital less
  120. %effectively.\\
  121.  
  122. \item It is noted on page 12, paragraph 4,
  123. that average Tier 1 capital ratio across all locally
  124. incorporated banks was 13.4\%. Tier one capital requirements are 8.5\%. The
  125. proposed change is for Tier one capital requirements to be 16\%. This means
  126. that on average, banks only must procure 2.5\% extra to meet the change in
  127. requirements. Whilst this may seem an insignificant sum, there is insufficient
  128. consultation to suggest that a bank shall 'die' at 13.5, and 'live' at 16.
  129. It may be argued that retaining more capital in this case cannot do any harm
  130. as preparation for systemic shock, however, without grounds to suggest why this
  131. particular amount is going to provide palpable benefits, the cost is very large
  132. as banks must actively reduce their efficiency (and thereby the
  133. inherent value) to incorporate the changes. \\
  134.  
  135. %\item $p13 s20$ This formalises the relationship between capital and
  136. %efficiency of banking operations and weighs cost vs benefit. \\
  137.  
  138. %\item $p13 s22$ This defines their idea of how they facilitate efficiency
  139. %in the economy under this proposal.
  140. %This can be conferred with the purpose of financial institutions; allocation
  141. %of capital to its most productive usage. \\
  142.  
  143. \item Figure 3 on page 14 discusses the optimal combination of reserved capital and
  144. risk, in perpetuity. This builds the argument that if financial institutions
  145. have higher capital requirements to a point, they may 'bounce back' from
  146. systemic shock more rapidly and on average provide better economic performance.
  147. This is somewhat disingenuous as the point at which they document there as the
  148. benchmark suggests that this is where financial institutions in NZ already
  149. operate at. However, as prior noted, this is certainly not the case. In
  150. reality, most banks are above this point and on the curve of an optimal
  151. combination of retained capital. We opine that an equilibrium could have been
  152. found already by banks operating locally and that reflects the risk associated
  153. with our financial sector. \\
  154.  
  155. \iffalse
  156. \item This was a point which I don't know if it is true or not but we should
  157. equally investigate. Our lectures on the Basel requirement criticised them
  158. by saying that in the event of a systemic shock, the banks will spend more time
  159. 'hoarding capital' to maintain their compliance instead of utilising this
  160. capital when it is arguably needed most to restart the economy. In this case,
  161. our current model, where our retained capital for most of the banks is
  162. fractionally below what the proposed value is, will be slightly better
  163. as the banks need not hoard the capital to keep compliance, they may
  164. temporarily scale back their capital requirements to encourage transacting
  165. and then rebuild their buffers over time. \\
  166. \fi
  167.  
  168. \item A criticism of the Basel Accords has been that in the event of a systemic
  169. shock, the mandated capital requirements induce financial institutions to
  170. 'hoard' capital.
  171. This suggests that instead of allocating capital to their most productive usage;
  172. they are instead forced to slowly build up their reserves, at the cost of the
  173. restarting the economy effectively.
  174. The current model, where our retained capital for most of the banks is
  175. fractionally below what the proposed value is, will be better
  176. as the banks need not hoard the capital to keep compliance, they may
  177. temporarily scale back their capital requirements to encourage transacting
  178. and then rebuild their buffers over time. \\
  179.  
  180.  
  181. %\item $p16, s33$ Suggests that NZ is operating on a higher RWA to asset ratio. \\
  182.  
  183. \iffalse
  184. \item $p16, s34$ Important notes on how they have modelled the risk factors
  185. to banks. Centre around the types of loans in NZ, historic record of bank
  186. losses, operational \& trading risks for which NZ banks are exposed to.
  187. One must also consider the legal framework that these banks operate under and
  188. that due to the highly progressive
  189. % Work on the above
  190. \fi
  191.  
  192. \item We are comfortable in assuming that there is a rough proportionality
  193. relationship;
  194. greater capital requirements $\propto$ less risk of crisis. In that notion,
  195. table 2 (from Brooke et al. 2015, on page 18) suggests that 14\%,
  196. (within half a percent
  197. of our current average bank holdings) suggests banking crisis will occur once
  198. in every 200 years. This fact is the goal of the RBNZ's reform in the first
  199. place, potentially suggesting that it need not formalise this. This figure is
  200. also based upon the implied systemic risk of the global economy which they
  201. concede that NZ carries less risk internally and is insulated from some of
  202. the global turbulence. \\
  203.  
  204. \end{itemize}
  205.  
  206. \section*{Conclusion}
  207. Our focus has been one of cost-value analysis;
  208. whether the potential risk that we decrease
  209. is palpable and will foreseeably generate an economic benefit in perpetuity
  210. against the cost which is ultimately borne by borrowers as increasing the capital
  211. requirements will make borrowing more expensive. The notion of encouraging more
  212. capital is admirable, however, careful thought must be applied to the framework
  213. in which you operate before any claims can be made as to its effectiveness.
  214. Whilst the benefits are unknown, and speculative, the disadvantages are
  215. increases to interest rates and making the cost of debt more expensive in
  216. NZ--a nation which has high levels of debt.
  217.  
  218.  
  219. \end{document}
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