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NZ OCR has raised 25 basis point to 7.5% March 8, 2007

Posted by riskopedia in Basel II, Economy, LGD, Regulator, Retail Risk.
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The New Zealand Reserve bank has raised the Official Cash rate (OCR), which is used as a tool to control the monetary policy, by 25 basis point to 7.5% this morning. You can refer to http://www.nzherald.co.nz/section/3/story.cfm?c_id=3&objectid=10427700, as well as http://www.rbnz.govt.nz/news/2007/2960402.html

I am not going to analysis in any more depth or facts whether Alan Bollard should increase the long lasted rate to 7.5%. There are already enough commentators and news out there who will do this job.  

What interested me is the one thing I have picked up from the article:

  • The bank has struggled to get inflation under control despite a sluggish economy over the last two years and Dr Bollard signalled his frustration by revealing it, and other government agencies, are looking at other measures to support the OCR. These include enforcing existing capital gains tax rules applying to housing investment and changes to bank capital adequacy requirements “to help moderate the amplifying effect of credit on the housing cycle”.

I have done a little search and find another article, a RBNZ letter to NZ Minister of Finance.

http://www.rbnz.govt.nz/monpol/about/2505127.html

Again, one paragraph in here said:

  • The Reserve Bank is currently implementing a new capital adequacy regime for banks (Basel II) designed to better align capital requirements with the underlying risks that banks take. An important part of implementing that framework will be working with banks to ensure that the risk models they are using appropriately reflect risk profiles through the business cycle as a whole (and avoid generating incentives to assume larger and riskier loans near the peak of the cycle). The Reserve Bank will also be exploring the extent to which capital requirements under this regime may be designed to provide counter-cyclical macroeconomic benefits, consistent with the paramount consideration of promoting financial stability.

Now, relate back to the APRA 20% LGD floor, and the comment made by RBNZ. In the old days, Regulator has the “power” to control the monetary policy, by the way of changing interest rate, without too much concern about Bank’s capital (or RWA) since they are a static calculation (fix factor) which Reserve bank can “forecast”. With Basel II comes along, all the sudden the Banks now have the control of what the Capital should be like based on the IRB estimates, which this is now a variable factor, and RB can no longer limit the credit flow by simply changing the rate. A bank can now “adjust” the estimates to alter the credit flow to stay competitive, regardless of what the OCR said. 

Often retail banks include large proportion of loan as Housing Loan. It is not a good sign to the Reserve bank, if, most banks come up with RWA less than Basel I rule. With the housing market bubble and the beign economic environment, there is no room for comfort in anything less than what Regulator has traditionally understand (Basel I). And this will lead down to a IRB Standardised approach, i.e. the banks can have whatever they come up with, but sorry, they have to set a floor because the Regulators can understand better, until 3-4 years down the track when we do hit a downturn. I would bet that if we are now doing all these models back in 1997 (Asian crisis) or 1990/1 (Recession time), I don’t even think the Regulators would set any limit when they wouldn’t be as freak out as now.

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