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- \documentclass[a4paper]{article}
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- %% Language and font encodings %%
- \usepackage[utf8]{inputenc}
- \usepackage[english]{babel}
- \usepackage{epigraph}
- \title{RBNZ Proposition Review}
- \date{}
- %\author{Ainsleigh Hall\\Guy Nankivell\\David Colwil\\Calum Jacobs}
- \author{}
- \begin{document}
- \maketitle
- \iffalse
- \section*{Introduction}
- Preface, at the time of writing I had only covered the first 20 pages. But it
- slighly changed my mindset on the stance that we should take. I thought
- initially that it was a good thing; more regulation = good and more buffers
- is a happy thought. However, there is low visibility over what the banks
- already maintain and the potential cost that this could have to the economy
- if they increase their already high levels of capital requirements.
- I thought this quote was a good summation of the potential risk;
- \fi
- %
- %
- \epigraph{Because the level of a bank’s capital can have an impact on the
- interest rate it charges on its loans, it is possible that higher capital
- requirements could make it more expensive for New Zealanders to borrow money
- from a bank. While we certainly take this into account, we
- think this impact should be minimal.}{\textit{RBNZ \\ Capital Review Consultation}}
- %
- %
- \iffalse
- Also, in an economy as small as New Zealand, we cannot ignore the implications
- of banks taking more capital upon themselves which lowers the leverage and
- potentially making them less efficient. So to me, the flow on effects have been
- downplayed; primarlily the lesser efficiency making borrowing more expensive
- and the fact that this could cause a slow down in the economy.
- \fi
- \section*{Introduction}
- Our position centres on how the Reserve Bank of New Zealand (henceforth, "RBNZ")
- has downplayed the ramifications of the change to capital requirements in NZ.
- %On all accounts, the change outlined is not so risky to cause
- A regulated financial industry is necessary to allow all participants to
- transact with confidence; however, the very information asymmetry the RBNZ
- seeks to reduce is what has been predated upon here to potentially push through
- reforms that are of arguable value, at substantial cost.
- \section*{Advantages}
- \begin{itemize}
- \item Lowers inherent risk of financial institutions failing: The primary advantage
- of increasing the capital ratio is that the risk of banks failing is reduced.
- This is because banks are required to hold a higher proportion of capital which
- can be used if there is a sudden withdrawal from the financial institution
- %
- %
- \item Reduces likelihood of Government bailout: A derivative advantage of
- this is that the government is less likely to have to bail out failing financial
- institutions as there is simply less chance of them failing. This reduces the
- risk the government bears and in turn allows funds to be allocated more
- efficiently by the government
- %
- %
- \item Reflection of global standards: Specifically looking at the types of
- buffer planned to be introduced by the RBNZ the counter-cyclical buffer is a
- new addition. This appears to be a direct reflection of the global trends towards
- prevention of another financial crisis through prudential financial regulation.
- The introduction of the counter-cyclical buffer is also seen in Basel III. While
- New Zealand is not a signatory it is a useful indication of global expectations and trends
- %
- %
- \item Macroeconomic susceptibility of New Zealand: Finally, New Zealand has a
- number of macroeconomic features which may require us to have a higher ratio of
- capital stored in financial institutions. These include a reliance on a single
- sector (agriculture/dairy), which is funded by a large amount of debt and high
- levels of household debt. Both of these are vulnerable to exogenous economic
- shocks which may lead to a sudden withdrawal from banks. This makes it
- prudential to have a higher ratio of capital
- \end{itemize}
- \section*{Disadvantages}
- \iffalse
- \section*{Notation}
- $p$ denotes the page of the article that I am referring to, and $s$ refers to
- what I believe to be the paragraph number, but what I call a section.
- \section*{Comments}
- These were the points that I thought would be good to document or draw
- attention to.
- \fi
- \begin{itemize}
- %\item Focus is on guarding against the impact of systemic events but
- %no comment on the probability of such, or the potential exposure. \\
- %
- %
- %\item This has an insurance principle about it; loss mitigation in tough
- %times, however at the expense of borrowers in the economy. Risk v cost?
- %Does this match with our financial system? \\
- %
- %
- %\item Principle around purpose of RBNZ centres around soundness and
- %efficiency. This potentially makes banks actively utilise their capital less
- %effectively.\\
- \item It is noted on page 12, paragraph 4,
- that average Tier 1 capital ratio across all locally
- incorporated banks was 13.4\%. Tier one capital requirements are 8.5\%. The
- proposed change is for Tier one capital requirements to be 16\%. This means
- that on average, banks only must procure 2.5\% extra to meet the change in
- requirements. Whilst this may seem an insignificant sum, there is insufficient
- consultation to suggest that a bank shall 'die' at 13.5, and 'live' at 16.
- It may be argued that retaining more capital in this case cannot do any harm
- as preparation for systemic shock, however, without grounds to suggest why this
- particular amount is going to provide palpable benefits, the cost is very large
- as banks must actively reduce their efficiency (and thereby the
- inherent value) to incorporate the changes. \\
- %\item $p13 s20$ This formalises the relationship between capital and
- %efficiency of banking operations and weighs cost vs benefit. \\
- %\item $p13 s22$ This defines their idea of how they facilitate efficiency
- %in the economy under this proposal.
- %This can be conferred with the purpose of financial institutions; allocation
- %of capital to its most productive usage. \\
- \item Figure 3 on page 14 discusses the optimal combination of reserved capital and
- risk, in perpetuity. This builds the argument that if financial institutions
- have higher capital requirements to a point, they may 'bounce back' from
- systemic shock more rapidly and on average provide better economic performance.
- This is somewhat disingenuous as the point at which they document there as the
- benchmark suggests that this is where financial institutions in NZ already
- operate at. However, as prior noted, this is certainly not the case. In
- reality, most banks are above this point and on the curve of an optimal
- combination of retained capital. We opine that an equilibrium could have been
- found already by banks operating locally and that reflects the risk associated
- with our financial sector. \\
- \iffalse
- \item This was a point which I don't know if it is true or not but we should
- equally investigate. Our lectures on the Basel requirement criticised them
- by saying that in the event of a systemic shock, the banks will spend more time
- 'hoarding capital' to maintain their compliance instead of utilising this
- capital when it is arguably needed most to restart the economy. In this case,
- our current model, where our retained capital for most of the banks is
- fractionally below what the proposed value is, will be slightly better
- as the banks need not hoard the capital to keep compliance, they may
- temporarily scale back their capital requirements to encourage transacting
- and then rebuild their buffers over time. \\
- \fi
- \item A criticism of the Basel Accords has been that in the event of a systemic
- shock, the mandated capital requirements induce financial institutions to
- 'hoard' capital.
- This suggests that instead of allocating capital to their most productive usage;
- they are instead forced to slowly build up their reserves, at the cost of the
- restarting the economy effectively.
- The current model, where our retained capital for most of the banks is
- fractionally below what the proposed value is, will be better
- as the banks need not hoard the capital to keep compliance, they may
- temporarily scale back their capital requirements to encourage transacting
- and then rebuild their buffers over time. \\
- %\item $p16, s33$ Suggests that NZ is operating on a higher RWA to asset ratio. \\
- \iffalse
- \item $p16, s34$ Important notes on how they have modelled the risk factors
- to banks. Centre around the types of loans in NZ, historic record of bank
- losses, operational \& trading risks for which NZ banks are exposed to.
- One must also consider the legal framework that these banks operate under and
- that due to the highly progressive
- % Work on the above
- \fi
- \item We are comfortable in assuming that there is a rough proportionality
- relationship;
- greater capital requirements $\propto$ less risk of crisis. In that notion,
- table 2 (from Brooke et al. 2015, on page 18) suggests that 14\%,
- (within half a percent
- of our current average bank holdings) suggests banking crisis will occur once
- in every 200 years. This fact is the goal of the RBNZ's reform in the first
- place, potentially suggesting that it need not formalise this. This figure is
- also based upon the implied systemic risk of the global economy which they
- concede that NZ carries less risk internally and is insulated from some of
- the global turbulence. \\
- \end{itemize}
- \section*{Conclusion}
- Our focus has been one of cost-value analysis;
- whether the potential risk that we decrease
- is palpable and will foreseeably generate an economic benefit in perpetuity
- against the cost which is ultimately borne by borrowers as increasing the capital
- requirements will make borrowing more expensive. The notion of encouraging more
- capital is admirable, however, careful thought must be applied to the framework
- in which you operate before any claims can be made as to its effectiveness.
- Whilst the benefits are unknown, and speculative, the disadvantages are
- increases to interest rates and making the cost of debt more expensive in
- NZ--a nation which has high levels of debt.
- \end{document}
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