Setting the capital ratio

Setting the capital ratio Presentation to FSO 20 Nov 2018.

2 Our framework 2-step process: • Identify the level of capital that will cap the probability of a crisis. • See if any win -win opportunities remain at the capital target.

3 Our methodology

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5 Sense checks • Other methods for calculating the relationship between capital and the probability of crises (Fed Reserve functions, BoE studies, IMF) • Implied shock losses versus loss experience in crisis countries • Explanatory power re: Ireland’s losses • Input assumptions reflect variety of NZ and external data • IMF, World Bank data on global NPLs • Optimal capital literature methods and findings • NZ stress tests results informed LGD assumptions • Indicators of correlations between asset values and output

6 The key to achieving soundness: the probability of insolvency and capital

7 Recommended Tier 1 target

8 Efficiency: any win-win opportunities at the capital target?

9 Extra slide if any questions about where the targets came from

10 Extra slide if any questions about the impact of changing Lc to 20% of GDP (NPV output lost in a crisis) 0.94 0.95 0.96 0.97 0.98 0.99 1.00 95.0% 96.0% 97.0% 98.0% 99.0% 100.0% Expected output/Qt Stability (probability of solvent system) Relationship between stability and output (NZ base case assumptions, varying Lc) Lc=20% base case and Lc=63% currently: Tier 1 = 7.7% of unweighted assets If R=0.3, recommend 9% to 10% 

11 Extra slide if any questions about the way R interacts with the loss distribution

12 Extra slide if any questions about effect of lower R