Executive Summary

Perhaps one of the most pertinent policy questions today, more than ever, is whether to impose increasingly stringent capital liquidity laws in New Zealand or not. The structuring of how much collateral any given lending institution must have as opposed to that which is lent out, underpins our modern domestic economy. It is clear, therefore, that an entire system from regular families with mortgaged houses to New Zealand’s sovereign debt currently rests upon this mechanism of lending. Such a consideration need not be a reason for static policy, but rather, the high stakes at hand should be considered a call to action, a mandate for change. It is from this starting point that a problem is framed. This problem is considered to be one of ‘perverse incentives’ created by the structure of the deregulated financial sector. These perverse incentives lead the financial sector to pursue short term, destabilising gains, over long term stability. Once this problem has been articulated a risk assessment of applying more stringent capital liquidity standards is conducted. This risk assessment shows that regulation can be detrimental if applied incorrectly, but regulation itself is not inherently bad in any given context, rather problems concerning the actual implementation are perceived to be the real risk. A cost-benefit analysis is, therefore, invoked to settle whether capital liquidity standards are the best policy option available. All of the shortlisted alternatives considered, it is found that capital liquidity standards are best used in conjunction with other complementary policy options. The amalgamation of these policy options with the primary method of making capital liquidity standards more stringent ensures the success in solving the problem of perverse incentives, leading to economic instability.