In a speech today to the Business New Zealand CEO Forum in Auckland, Reserve bank Governor Adrian Orr said that a banking system is sound only if it operates well in almost all circumstances and if the public is still confident in the system even when a bank fails.

“The most important tool in our kit is ensuring banks hold sufficient capital (equity) to be able to absorb unanticipated events. The level of capital reflects the bank owners’ commitment – or skin in the game - to ensure they can operate in all business conditions, bringing public confidence,” he said.

“The Reserve Bank needs to ensure there is sufficient capital in the banking “system” to match the public’s “risk tolerance”. This is because it is the New Zealand public – both current and future citizens - who would bear the brunt of a banking mess.”

Relatively higher levels of capital make a bank safer because it provides a buffer to cope with unexpected events and meet financial commitments. But capital comes at a cost to owners and long-term investors, who invariably want to reduce the risk to their own money while still generating good profits.

The Reserve Bank has been assessing the capital level in the banking sector that minimises the cost to society of a bank failure, while ensuring the banking system remains profitable, Mr Orr said.

“We have calibrated our ‘sweet spot’ thinking about economic ‘output’ and financial stability benefits. Our assessment is that we can improve the soundness of the New Zealand banking system with additional capital with no trade-off to efficiency.”

The Reserve Bank will be releasing a final consultation paper on bank capital requirements in mid-December, with an emphasis on the need to take a broad perspective for all New Zealanders and not just bank owners and investors.