Banking risk is not often talked about or discussed in mainstream media and this in part is a man-aged form of media spin designed to ensure the public that all is OK in the world of banking. Whenever a banking CEO or Treasury Minister faces the media the narrative is very predictable in that promotion of certainty in the banking sector is a given. No one wants to undermine faith in the banking system for fear of upsetting the delicate balance of trust that banking relies on. Behind the scenes however the Reserve Bank of New Zealand (RBNZ) have been very aware of high risk levels in the banking sector can threaten a functional economy. A position paper in 2018 identified the failure of systemically important banks around the western banking system that imposed huge bail out costs on tax payers and signalled the need for an increase in Tier 1 capital requirements as a means of reducing such risk. Tier 1 capital is a key measure to ensure a bank’s financial strength and provides a buffer to protect bank clients and the wider economy in times of economic stress.
The Reserve Bank of New Zealand Bill is currently making its way through the New Zealand Par-liament processes. This is the culmination of a review process begun in 2017 by the RBNZ to as-certain appropriate capital reserves needed to strengthen banks and reduce banking risk. Capital reserves is the amount of money invested by the bank owners or the equity base upon which their lending occurs, usually calculated as a percentage called the capital ratio. This is usually about 10% but in the past has been much lower in reality. Admati & Hellwig in their book “The Bankers New Clothes” show that major banking institutions worldwide equity levels were 2-3% of their total assets. This was also enabled by inadequate statutory body supervision and creative moves by the banks to hide financial obligations through subsidiaries and keeping derivative obligations off the balance sheets. The seriousness of keeping such low levels of capital reserves meant that major big player banks worldwide faced liquidity problems which nearly collapsed the global fi-nancial system.
A hidden component of risk posed by the big four Australian banks which includes ANZ, CBA, NAB (who own BNZ) and Westpac are derivatives which according to Martin North of Digital Finance Analytics are no longer tangible assets but are highly speculative gambling positions bet-ting on movements in exchange rates and interest rates. Exposure to derivative gambling is an enormous risk for the big four banks who have exposure to several trillions of these very risky speculative instruments. Under the Glass Steagall legislation introduced into the American bank-ing system after the Great Depression such high risk investments were outlawed for deposit taking banks. Unfortunately the protective legislative frame was dismantled by successive governments spurred on by neo liberal philosophy and free market deregulation. This ideology has systemically failed as the system is now being propped up by waves of quantitative easing preventing firstly systemic collapse and secondly the market corrections that should take place in a capitalist system.
The proposal in New Zealand is to increase this ratio from 10.5% to 18% for the Australian owned banks as they are seen as riskier institutions compared to local NZ owned banks. The Capital re-serve for the smaller New Zealand owned banks is 16%. Part of this risk is the growing awareness that these institutions are now so large (often referred to as too big to fail) that their collapse or fail-ure will impose serious risk to the New Zealand economy. Commentators also promote the con-cept of bank owners and shareholders having “more skin in the game”. This means their capital reserves need to be higher so that they have more to lose if the bank is mismanaged. Admati & Hellwig propose reserves in the 20-30% range are necessary to secure the current levels of risk in the banking industry.
What has become apparent over the last few decades is that ‘too big to fail’ banks have been able to shift shareholder and owner risk onto the general public manifest by the huge bail outs that oc-curred post the Global Financial Collapse and other bail outs prior to 2007. This has been de-scribed as privatising profits and socialising losses or another apt description: socialism for the owners and rugged capitalism for the general public. This has also exacerbated the shift in wealth to the top 10% of the population in unprecedented ways moving the bulk of the population to what Yanis Varoufakis the former Greek finance minister calls “a new form of feudalism”.
The bail-in legislation in Australia and the Bank Resolution Processes in NZ have again shifted risk to the people who save their surplus cash in banks. This type of legislation forced on Western banks by the International Monetary Fund and The Bank of International Settlement was imple-mented in both Australia and New Zealand to shift more risk to savers. What this means is that a failing bank can take your deposits and term investments.
The 2007-2008 global financial crisis exposed systemic risk in the banking sector despite assuranc-es from banking risk assessors and rating agencies that everything was OK. The collapse of Leh-man Brothers Investment Bank in the USA and Northern Rock in the UK exposed these risk anal-ysis systems as totally inadequate. Part of this legislative agenda is to increase the Tier 1 capital re-quirements of all banks and to strengthen risks related to the big four ‘too big to fail’ Australian Banks.
The notion of ‘too big to fail’ has implications for viable capitalism. When banks get too big they impose more risk to the economy and to economic efficiency. Moral hazard is exacerbated in that CEOs knowing that they are too big to fail will take more risks to maximise profits. There are ar-guments that the size of these banks creates inefficiencies including management arrogance cou-pled with excessive renumeration packages that further distort risk taking behaviour and ‘group think’ cultures that ignore genuine risk assessment.
Australian banks control 85% of the New Zealand banking market. This must be one of the great tragedies of the neo-liberal revolution instituted under a Labour government by Roger Douglas in New Zealand during the 1980s. Such a situation increases the risk levels to New Zealanders espe-cially in the light of another housing bubble in Australia and attempts to yet again make lending easier. The so-called responsible lending legislation on the books in Australia will increase debt levels which are at historic highs further exposing Australian banks to the inevitable correction that are likely to occur in the housing market.
Record levels of public and government debt are signalling the collapse of current banking and fi-nancial systems. Steve Keen (economist) says that the 2018 housing debt in Australia has reached 90% of GDP. This has been promoted by both the Morrison Government and the banking industry and of course is still being promoted by Frydenberg’s attempts to relax lending criteria to keep this housing bubble afloat. Keen warns that mainstream economists ignore private debt, but it is this debt that will drive a significant crash in the Australian housing market. The combination of very low interest rates, negative gearing for investors and first home buyer incentives are all fuelling this debt bubble. In NZ disincentives have already been implemented to take heat out of the housing market. One of the more significant interventions is the rapid phasing out of negative gearing for investors and a red line test for the sale of a speculative housing asset within 5 years, which in ef-fect is a capital gains tax.
In relation to this situation the only way an investor or homeowner can protect themselves is to de-liver (reduce debt) as quickly as possible. Keen claims we can expect corrections of up to 40% when the crash finally comes. Such a scenario has significant risk for New Zealand, whose 85% exposure to the Australian banking system is of serious concern. Coupled with this is the effect of a very large credit crunch which will see a rapid rise in unemployment creating an economic storm.
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Maurice Vaughan is a contributor to elocal Magazine.