A short note on the outcome of the RBNZ capital plans

Today, the RBNZ posted its final capital plans – well, they still need to be finalised, but for the Christmas holidays this will do.

In fairness, I see no reason not to commend the RBNZ for their decisions on capital. See the summary cheat sheet below:

The Reserve Bank incorporated most of the suggestions that I wrote down in my submission to the 4th Capital Review Paper some months ago. First and foremost is the acceptance of Additional Tier 1 capital. The significance of this decision on hybrids got lost on the reporters at the press conference and the radio today. At least Banking expert Claire Matthews from Massey University missed this one entirely in RNZ’s The Panel. The banks can now issue AT1 capital instead of growing retained earnings organically or issue shares.

In the war on capital, the battle on Additional Tier 1 is decisive. The Reserve Bank has lost this battle: it now allows banks to print 250 basis points of Tier 1 hybrids, which is 1 percent more than Basel III requires.

Smaller battles that the sector has won: i) two percent capital relief for banks that are not systemically important, up from one percent. ii) a longer phase-in, which could help smaller banks and non-joint-stock banks to grow capital.

No small fry

The 2.5 percent allowance for AT1 lowers the need for equity capital by an estimated $9bn, which is half of the total amount of extra capital that banks need. This is a significant win for the large banks, which can now ask their Ozzie parents to print AT1 at low cost. A major win also for the investment banks that advise the Big 4, they will happily support the issuing banks.

So, yes, when Adrian Orr mentions that the Reserve Bank has listened, then he certainly has a point. He listened to the sector in particular. Not so much to others, in particular the three expert academics. For example, Ross Levine was not in favour of hybrid Tier 1, and I am sure the other experts have only been selectively heard.

Still not finished

As expected, this proposal is not really final. For example, the RBNZ will consult on the management of the conservation buffer, now named: Escalating Supervisory Response policy or ESR.

Lastly, and this is me nitpicking: the Basel Committee does not like it when instruments are called ‘Additional Tier 1’ and ‘Tier 2’ if they are not fully Basel III compliant. As far as I know, but I may be wrong, Basel III includes this document, which requires all non-common Tier 1 and Tier 2 instruments issued by internationally active banks to have a loss absorption mechanism that can be triggered.

Apart from that, the RBNZ has presented a proposal that is acceptable and much more in line with Basel (and my suggestions) than before.