Orr challenges trading banks over their profits

: Reserve Bank Governor Adrian Orr at the Finance and Expenditure Select Committee
 

The Reserve Bank Governor Adrian Orr has come out fighting against what he argues is the excessive profitability of the country's trading banks.

“The banks are among the most profitable in the world,” he told a media briefing at the launch of the Bank’s Financial Stability Report yesterday.

“They sit there at about three in the world,” he said.

In fact, they are fourth after Korea, Israel and Estonia; and Australia, which hosts the parent of most New Zealand banks, is seventh.

Orr is fighting off a concerted attack from the Bankers’ Association against Reserve Bank proposals that the banks hold much greater reserve capital to cope with any future financial or other crises.

The Bank has proposed that trading banks hold up to 16 per cent of their risk-weighted assets – essentially their loans --- in capital.

The former Treasury Secretary, `Dr Graham Scott, in a report commissioned by the NZ Bankers Association, has argued that the expected economic costs of the policy would exceed the expected economic benefits by about $1.8 billion per annum.

The move was originally prompted by the GFC and consideration of how the Reserve Bank might handle a future crisis.

Asked what had changed since the GFC, Orr said “not enough”.

“What has changed is not sufficient which is why we want higher capital,” he said.


 The Finance and Expenditure Select Committee hearing

The Finance and Expenditure Select Committee hearing

“When you think that since the GFC household debts have actually increased; Government debts have increased; interest rates globally have fallen so the room and ability to go and survive through another global financial crisis is tighter.

“Insufficient change has happened.

“In New Zealand we have made some very good changes, but still insufficient.”

Orr said we were still exposed to the same risks we were during the GFC  “and in some cases from a more heightened position.”

An hour later, in front of Parliament’s Finance and Expenditure Committee he returned to the same themes.

And once again the banks were the target.

“It (banking in New Zealand) is a very very profitable business,” he said.

“Part of that is privatising profits and socialising losses; where is that risk-free rate really set."

Orr said that if risk was reduced for bank investors then so should return on capital be reduced.

"A non-competitive business can set a return at whatever they feel like,” he said.

Orr rejected the idea that New Zealand’s banks had “sailed” through the GFC.

“The Government of New Zealand put a $133 billion guarantee, almost overnight, to help the banks," he said. 

“The Reserve Bank cut interest rates by 575 basis points; we had a wholesale lending guarantee of $10 billion and the Bank itself had to buy $8 billion of debt off the banks to provide them with liquidity just to survive.

“That is outside of all the other economic and unemployment displacement and economic chaos that went on during that period.”

Orr said it was critically important to the development of a small open economy that we had one of the best-capitalised banking systems in the world.

But Orr is not only concerned about how the trading banks might cope with another GFC, he also pointed up problems in the insurance sector whose solvency, the Bank said in its report, has fallen over the past year.

The Bank is currently reviewing the failure last year of CBL insurance with a possible loss of up to $344 million.

A review of the life insurance industry that the Bank published in January showed the sector “in a poor light”.

However there are potential problems in the general insurance market too.

As a consequence of the Canterbury and Kaikoura earthquakes, and the failure of successive governments to raise the proportion of property insurance covered by the EQC,  the New Zealand insurance industry is moving towards more specific risk-based pricing for insurance.

The Chief Executive of the New Zealand Insurance Council, Tim Grafton, recently said that it might be time to ask just how much risk got shared across government, private insurers and the insured and how much effort should be put into reducing property risks “given Lloyd’s ranks New Zealand as the second most exposed country to natural catastrophe losses.”

“Currently, it is expected that a small proportion of insurance customers will face materially higher prices, and very few will be unable to obtain full insurance cover,” the Bank’s report said.

“But the precise impact on the overall availability and price of insurance is uncertain, reflecting limited information on reinsurance costs for New Zealand and insurer strategies.

“The Reserve Bank is engaging with insurers and reinsurers to better understand the evolving position in more detail.

“It is likely that risk-based pricing will become more widespread in New Zealand over time. Owners of particularly high-risk assets should be aware that their insurance costs are likely to rise, and the level of cover that they can obtain may become more limited in the future.”

There are anecdotal reports that some apartment blocks, particularly in Wellington, may find insurance either prohibitively expensive or even impossible to obtain.

Reserve Bank Deputy Governor, Geoff Bascand; Governor, Adrian Orr; Manager Financial Systems Analysis, Chris Bloor at the Finance and Expenditure Select Committee yesterday.

Reserve Bank Deputy Governor, Geoff Bascand; Governor, Adrian Orr; Manager Financial Systems Analysis, Chris Bloor at the Finance and Expenditure Select Committee yesterday.

The concerns have been heightened this week with the announcement that the Allianz company was going to pull out of the New Zealand market.

The Bank’s Manager, Financial Systems Analysis, Chris Bloor, told the Select Committee that the New Zealand insurance market was tightly concentrated; the top three insurers had 85% of the residential market and 65% of the commercial.

“In the Wellington market at the moment we are seeing that in general insurance is available but some are having more difficulty obtaining it,” he said.

“Where there is particularly high risk; if it is a body corporate; if it is prone to liquefaction or tsunami damage.

“There are fewer players in WEellignton to write the insurance but the insurance is still there at a price, but we are watching it closely.”

Orr said that the Bank’s concerns over climate change were “multi”.

“Better pricing needs to evolve; people need price signals to make their decisions for a smooth transition.

But ultimately it was the Banks that were the focus of much of what Orr and his team wanted to talk about.

Orr reminded the media briefing that the new capital requirements would not be imposed overnight.

“We are not asking for this transition to happen tomorrow,” he said.

“We are asking for it to happen through time.

“if banks are choosing to use this as an excuse to change their current business behaviours, then that becomes a customer decisionwhether to remain or ask questions about that.

He said that if some banks chose not to be in a sector like agriculture, then they needed to be upfront and honest that that was their business choice and not hide behind potential future outcomes.

Orr is known for his propensity for blunt talk --- but it is new for the Reserve Bank, and from the sound of things yesterday, there will be more of it whether the banks like it or not.

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