By Gareth Vaughan
The Reserve Bank says only a small number of macro-prudential tools could play a role in boosting New Zealand's financial stability, and their use should be limited to periods of exceptional financial imbalances such as unusually strong credit growth and asset prices.
The central bank’s comments, in its November Financial Stability report out yesterday, come with the G-20 expected to rubber stamp proposed global banking regulatory reforms, the so-called Basel III put together in the wake of the global financial crisis, at this week’s meeting in Seoul.
In the stability report Governor Alan Bollard reiterated that the Reserve Bank generally supports the new global standards but will fully assess their potential impact on the financial system before initiating any changes to the New Zealand supervisory framework. The Basel III proposals include requirements for banks to increase stable funding and liquid asset holdings.
The Reserve Bank says that although a large number of macro-prudential tools are under discussion internationally, it believes only a relatively small number of tools could have a future role in New Zealand.
“These include adjustments to the core funding ratio (CFR), the use of counter-cyclical capital requirements broadly along the lines of the Basel III proposals, adjustments to capital risk weights for particular sectors, and measures targeted specifically at the housing market such as restrictions on loan-to-value ratios.”
Introduced on April 1, the CFR sets out that banks must obtain at least 65% of their funding from retail deposits or wholesale sources of more than 12 months duration. In the stability report, the Reserve Bank says it plans to lift the CFR to 75% over the next two years, a slightly later timeframe than its previous guidance of lifting the CFR to 75% by mid-2012.
Meanwhile, the central bank says in principle macro-prudential tools can help promote financial stability in two ways; Instruments such as capital or funding requirements can help to build financial system resilience by increasing financial buffers available to financial institutions to absorb shocks. Or some macro-prudential tools may also directly influence the credit cycle, generally by their effect on the price or availability of credit, thereby dampening down the build-up of financial system risk due to excessive credit growth.
“However, considerable caution is needed in respect of the effectiveness of macro-prudential tools, especially their capacity to directly influence the credit cycle,” the Reserve Bank says. “Most tools have not been used widely in other countries and there is considerable debate about how well they might work.”
The central bank’s own analysis suggests the effectiveness of some tools on constraining credit growth could vary considerably depending on global financial market conditions.
“For example, raising capital or core funding requirements may be of limited effectiveness in constraining credit growth in an environment in which the cost of capital or funding was cheap.”
“However, use of such tools could still be appropriate to build the future resilience of the financial system.”
The Reserve Bank says it envisages a “horses for courses” approach to macro-prudential tool use. Given this, it’s unlikely it’ll ever be feasible to devise fixed policy rules for assorted macro-prudential instruments. Instead, it would be a case of choosing the right policy tool for the right occasion.
“Overall, we believe that if New Zealand were to deploy macro-prudential instruments in the future, their use is likely to be best limited to periods of exceptional financial imbalances, such as unusually strong credit growth and asset prices,” the Reserve Bank says.
“This appears to be broadly in line with the intention of the Basel III proposal for counter-cyclical capital requirements, which the Basel Committee on Banking Supervision envisage might be applied infrequently in most jurisdictions, perhaps just once every 10 to 20 years.”
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