Setting the capital ratio

Setting the capital ratio
Presentation to FSO 20 Nov 2018.

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.

Our methodology

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

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

Recommended Tier 1 target

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

Extra slide if any questions about where the targets came from

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% 

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

Extra slide if any questions about effect of lower R