a) Systemic risk
The point of implementing a more stringent capital liquidity standard is to curtail the perverse interests, which cause systemic risk to begin with (Rodriguez, 2003: 67-80). It would be rather counterproductive then if the policy solution itself caused systemic risk, rather than assuaging it. What must be ascertained is whether the regulation stabilises the financial sector more than it destabilises it. It would be prudent to mention here if the policy solution is to be implemented successfully, it will mean change, and change is typically not conducive to stability in the short term. The RBNZ must, therefore, trade off short term stability for long term stability if it wishes to address the problems previously mentioned. Certainly, this point comes down to balance. The RBNZ should not increase capital liquidity standards in way a way that freezes the financial markets, or a way that causes little to no change whatsoever. What is recommended is a gradual increase in the stringency of capital liquidity rates. Whilst, financial markets may still react to the news of capital liquidity rates increasing in the future, the gradual change in ratio, and ratio makeup will give the RBNZ time to assess the impact of its policy overtime. This gradual building up of capital liquidity standards coupled with the typical RBNZ consultation process, means that the risk of a catastrophic financial freeze will be minimized.
Regulation as considered by some economic schools of thought is inherently a policy failure, but regulation in this instance is a response to a market failure (Maxfield, 1998: 41-49). Regulation by no means is a perfect policy solution. The present context, however, is far from ideal and requires a nonideal solution to realign perverse incentives. The perverse incentives in this instance (as demonstrated earlier) are correlated with the increasing liberty given to the financial sector through the era of deregulation (Reinhart, 2009: 74-75). In this particular policy decision, the RBNZ must, therefore weigh the liberty to engage in unwise financial practices against the long term instability a large amount of these decisions creates. The former liberty is, perhaps not particularly valuable as the liberty to lose money is, most likely not valued by most. Furthermore, the ability to lose money in lucrative ventures is not lost. Capital liquidity rates simply stem high leverage rates, and stop those inclined to make unwise financial investments in conducting such business through large financial institutions. In this way the market mechanism is largely maintained. The market would indeed find a new equilibrium with a ceiling of capital regulation. This regulation largely enforces decisions, which are already known to be imprudent, and therefore not rational to make. The marginal losses, from the inefficiencies associated with such regulations are demonstrably far lower than those losses associated with large financial bubbles created by the lack of regulation (Bank for International Settlements, 2011: 20-32). It is unlikely that leverage rates of around seventy percent, would ever be in a macroeconomic sense a good mechanism to maintain. This begs the question why would someone need the market to tell them that being able to leverage seventy percent of one’s house without any collateral would be a bad decision? Any risk of associated with regulation per se, therefore is mitigated as actors decisions should be largely consistent with the regulation imposed.