Shamubeel Eaqub: A balancing act for banks
The RBNZ predictably left the policy interest rate at a historic low of 1.75 per cent. The RBNZ is unlikely to raise interest rates for some time because there is little inflation and there is little prospect of any for some time.
Inflation and interest rates are a distraction. The evils that will stalk New Zealand for the next two decades are banks and too much debt.
The risks to New Zealand's economic and financial stability will come from too much borrowing, borrowing for housing rather than enterprise, and overly expensive house prices. We can skirt around the issues, but the core issue is too much lending by banks.
The focus of the RBNZ and the next governor – due to be in place in March 2018 – must be on banking regulation and taking away their largely unfettered control over credit and money creation.
The RBNZ has a dual mandate of economic and financial stability.
Controlling inflation in a low but positive range is to ensure economic stability. It was a vast improvement on previous methods of money's supply control and frequent political manipulation.
But the RBNZ's interpretation of financial stability has been too narrow: that banks do not fail and require a costly taxpayer funded bailout.
While preventing failure of banks is a good idea, it is not enough. Banks have been responsible for excessive amounts of borrowing in the economy. And this borrowing is increasingly going towards buying houses from each other, rather than financing enterprise which creates a future stream of jobs and income.
Borrowing growth has been spectacular for decades. Indeed, we are borrowing faster than the economy is growing. It seems we need ever larger amounts of debt to grow the economy. But history shows that our economic growth with debt gorging has not been faster than previous periods. Debt is a useful tool, but its unfettered growth has been socially useless.
Worse, if we look what the lending has been used for, it has been socially corrosive. More and more of bank lending has gone to buying existing houses, rather than enterprise.
More money chasing existing houses has contributed to house prices becoming extremely unaffordable. It is not the only cause, but a large and entirely controllable source. Unaffordable housing is one of the largest sources of inequality – a social cost – in New Zealand.
By regulation, mortgages are deemed to be half as risky as corporate loans, a clear signal to lend more in that area. As a result, an increasing share of bank lending now goes to mortgages, both in New Zealand and internationally. In New Zealand the mortgage share of bank lending rose from 10 per cent in 1970 to 20 per cent in 1980, and just over 50 per cent now.
The difference between lending to existing houses and lending to enterprise is that the latter is an engine of continued growth in jobs and incomes. Of course, not in every instance, but more likely than not.
As a country, we need to realise that debt is useful. But too much debt, and misallocation of that debt, is socially and economically caustic. The evidence from around the world and history, is that left to themselves, banks inevitably create debt in excessive quantities and that debt is more likely to chase real estate rather than real investments.
Individually, the banks and home owners are making rational and good decisions. The evil of banking and too much debt are not their profit motives, nor their individual actions. Rather, the collective impact of their behaviour is instability in society and the economy.
The RBNZ is right not to want to impose too much regulation on banks. We don't want regulation to stifle competition, innovation and progress. But it is wrong to have too little, when all the evidence points to financial markets everywhere being imperfect markets.
As a country, we are still in the thrall of the 1980s thinking that regulation is bad, and markets are good. But that is far too simplistic. Markets are not perfect, and to deal with these imperfections and to curb socially useless behaviour we need to have the right regulatory interventions.
Banks should be required to hold more capital to curb too much lending in the economy. We should remove artificial incentives to lend to mortgages. But we should leave enough room for banks to lend as they see fit. It's a delicate balance.
Debt and banks is the coming crusade for the RBNZ and the new governor.