RBNZ Bank Capital Story

The RBNZ "bank capital requirement" review has become contentious. Yesterday, Michael Reddell (https://croakingcassandra.com/) showed three convincing graphs to debunk the RBNZ claim that the main reason for wanting to raise bank capital requirements is that our macro volatility is high.

Grant Spencer spoke about the process to review bank capital in October 2017. You could find his speech online. It is a nice speech. Thus, this is not something the new Governor invented for sure. The RBNZ thought about it earlier.

Here, I want to add one more graph to Reddell's three graphs to show that New Zealand's macro volatility is not significantly different from Australia's, not at all.

I decompose the real interest rate differentials r-r*, where r is New Zealand's real interest rate and r*is the U.S. real interest rate to Country Risk and a Currency Risk.

r-r* = (i - i*-f)  + [(f-ds) + dq]

The first term is the Country Risk; the second and the third are the Currency Risk.

i is New Zealand's 3-month nominal interest rate; i* is the U.S. 3-month T-Bill interest rate; and f is the forward exchange rate of the NZD-USD. ds is the nominal exchange rate depreciation rate, which is zero under perfect foresight. dq is the expected real exchange rate depreciation rate. I do not have actual data for f  so I proxy it by s(t) - s(t-12). I do the same for Australia and focus on the Country Risk - the first term in the equation because the currency risk is almost the same for both the Kiwi dollar and the AUD.

The country risk for Australia and New Zealand are almost identical. The Standard Deviations are 11.4 for Australia and 11.9 for New Zealand.

There is no convincing macro indicator to use as a reason to raise bank capital. 

Maybe the RBNZ has other reasons, not macro ones.

The IMF newly published World Economic Outlook increased our growth rate forecast. Our banks withstood the massive Global Financial Crisis. Reddell also mentioned that we do not even have data for banking crisis that occurred once in 200 years.

The RBNZ must come up with a more reasonable story for its capital level review.