RBNZ makes 'in-principle' decision for ANZ, ASB, BNZ & Westpac to be required to report credit risk through both their current internal models approach and the standardised approach

The Reserve Bank says ANZ NZ, ASB, BNZ and Westpac NZ will have to start reporting their risk weighted assets (RWA) and associated credit ratios using both the internal models approach they currently use, and the standardised approach other New Zealand banks use.

The prudential regulator details this in a response to submissions on the calculation of risk weighted assets, which is part of its biggest ever review of bank capital adequacy requirements.

The decision confirms what the Reserve Bank proposed in a consultation paper late last year, as reported by interest.co.nz here. Not surprisingly, all of ANZ, ASB, BNZ and Westpac argued for the status quo to be retained, that they just keep using internal models, in submissions to the Reserve Bank.

Nonetheless the Reserve Bank has revealed five "in-principle" decisions. They are:

- the capital framework will continue to permit qualifying banks to use internal models to estimate credit-risk related RWA (the IRB or internal ratings based approach), although there will be more restrictions on modelling;

- the IRB approach will not be permitted for any credit exposure with an external rating (for example, sovereigns, banks, some large corporates);

- there will be a RWA floor imposed on IRB models. This floor will be a proportion of the equivalent standardised calculation RWA value;

- all banks will calculate the RWA arising from operational risk in the same way, using the Basel Standardised Measurement Approach; and,

- IRB banks will be required to report RWA (and associated credit ratios) calculated using the standardised approach alongside those arising from the IRB approach (‘dual reporting’).

The big four banks using the internal models approach means credit risk weights calculated using it account for about 90% of NZ banking sector exposures. All other NZ banks use the so-called standardised approach for credit risk, through which their credit risk weights are prescribed by the Reserve Bank and are typically higher than those of the big four banks, who set their own models which they must get approved by the Reserve Bank.

Simplicity and clarity demanded in times of stress

The Reserve Bank says it'll consult stakeholders next year on the details of its decisions. And the next stage in the capital review will be a quantitative impact study to shape the central bank's analysis of the potential costs and benefits of its in-principle decisions. Additionally submissions will be sought on the minimum capital ratio settings, likely in the fourth quarter of 2018.

"We continue to believe that credit risk models need to be constrained more in the light of our experience with the IRB framework. This is consistent with the view about internal models held by the Basel Committee and many overseas regulators," the Reserve Bank says.

"On balance, the Reserve Bank prefers an approach that retains IRB models in the New Zealand framework, while putting in place restraints on IRB modelling to mitigate the disadvantages of internal modelling (competitive neutrality and the opaqueness of internal models)."

It goes on to point out it's not clear to external parties how IRB banks arrive at their model RWA values, with this lack of transparency reducing the effectiveness of market discipline, which is one of the three pillars of the Reserve Bank's regulatory regime.

"The recent example of the Global Financial Crisis also provided strong evidence that in times of stress, market participants and other stakeholders quickly demand simplicity and clarity about the measurement of capital, which is a clear advantage the standardised framework has over the IRB approach," the Reserve Bank adds.

The Reserve Bank doesn't believe compliance with dual reporting will be onerous for ANZ NZ, ASB, BNZ and Westpac NZ. However, it acknowledges it hasn't yet calculated the costs and benefits, but suggests private costs to banks should be balanced against potential net social benefits.

APRA watch

The Reserve Bank notes the Australian Prudential Regulation Authority (APRA) is considering making changes to the standardised approach. For example, it points out APRA has identified four characteristics of residential mortgages associated historically with relatively high probabilities of loss being interest-only loans, poorly documented loans, high debt-to-income loans, and investment property loans. APRA is proposing to classify mortgages with one or more of these characteristics as non-standard, which means they'll have a 100% risk weight, versus 25% normally.

APRA's expected to finalise its policy next year. The Reserve Bank says it'll then assess whether or not to adopt the same approach in New Zealand, and may seek submissions.

"...there may be compliance efficiencies for the large four banks if some aspects of New Zealand's standardised approach are modified in order to facilitate dual reporting," the Reserve Bank says.

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