New Zealand’s Reserve Bank is creating waves on both sides of the Tasman. Just before Christmas, it surprised the banking sector with proposals to almost double banks’ capital ratios.

The RBNZ estimates the new capital requirements are equivalent to about 70 per cent of the banking sector’s profits over the proposed five-year transition period. With New Zealand’s four major trading banks all Australian-owned, this news will have been as much a shock on Collins Street as it was on Queen Street.

The proposals are undeniably controversial. They set a risk appetite for reducing the frequency of bank failure to once every 200 years. Remarkably, this figure is unsupported by a rigorous cost- benefit analysis from the central bank. And the proposals look past the regular stress-testing the RBNZ has performed on the banking sector in New Zealand. Yet, without fail, New Zealand’s banks have come with flying colours.

Market commentary suggests the proposals will significantly increase costs for borrowers or lead to a contraction in the availability of credit, or both. Analysis by investment bank UBS predicts the proposals could see borrowing costs increase by 80 to 120 basis points. Even the Reserve Bank’s own assessments suggest the proposals could trim New Zealand’s GDP by $NZ1.5 billion ($1.42 billion) to $NZ2 billion a year, making the proposals a very costly insurance policy.

Yet nowhere in the RBNZ’s consultation documents does the bank undertake a proper cost-benefit analysis, modelling whether the benefits of the proposals actually outweigh the costs. Without this analysis, the bank cannot assess whether the value of the proposed insurance is worth its price.

Faced with a barrage of criticism, the RBNZ has promised it will now undertake this analysis – and have it independently reviewed. Yet a modelling exercise conducted after the consultation period has closed hardly helps inform discussion about the advantages and disadvantages of the bank’s proposals.

The RBNZ’s proposals are also controversial because they can be implemented on the say-so of one man – RBNZ governor Adrian Orr. A charismatic figure, Orr was appointed in March last year by Grant Robertson, Finance Minister of New Zealand’s (then) new Labour-led, coalition government. Since then, Orr has set about transforming the image of the RBNZ, likening the organisation to the Maori forest god Tane Mahuta to try to bring greater understanding of the RBNZ’s role in the New Zealand economy.

In May last year Orr also joined forces with the Financial Markets Authority, its sister regulator, to conduct a ‘‘mini- Hayne’’ inquiry into behaviour in the banking and insurance sectors. This notwithstanding, the central bank has no statutory authority to regulate the conduct of financial markets participants. Perhaps unsurprisingly, no bank or insurance company challenged the RBNZ’s extra- legal inquiry. It can be unwise to bite the hand that regulates you.

Understanding Orr’s immense power requires an understanding of the RBNZ itself. At least to Australian eyes, the RBNZ is twice the institution the Reserve Bank of Australia is. Like the RBA, the RBNZ is responsible for conducting monetary policy. But the RBNZ is also New Zealand’s prudential regulator of financial market participants (the same role as the Australian Prudential Regulation Authority).

While the bank has a board, the governor is not accountable to his directors. This is because Orr’s powers do not derive from the board. Instead, they are vested directly in him by the Reserve Bank of New Zealand Act.

Until this year, implementing monetary policy was also the sole responsibility of the governor. However, from April 1 the governor has shared responsibility with a newly appointed Monetary Policy Committee. The change follows ‘‘Phase 1’’ of Finance Minister Robertson’s review of the RBNZ Act.

Currently, the governor still enjoys sole power to determine the prudential requirements for all registered banks. Consequently, he can implement his proposals to double banks’ capital without answering to any other body. This is a remarkable concentration of power in a single individual.

All the signs are, however, that the governor’s sole charge may soon change. ‘‘Phase 2’’ of the Finance Minister’s review of the RBNZ is under way. Among other matters, this phase focuses on the governance and structure of the RBNZ’s prudential regulatory role.

As has already happened with monetary policy, the likely outcome of the review will see the governor share decision-making responsibility with others. Most likely this will involve a different arrangement from the committee-based approach adopted for monetary policy decision-making. A board governance model is the preferred approach for independent regulatory agencies in New Zealand. As the RBNZ already has a board, it would be a simple step to arm it with responsibility for holding the governor to account for prudential regulatory decision-making.

Change to the RBNZ’s governance cannot come soon enough. Had the governor been accountable to a board, it is inconceivable his current capital proposal would have left the RBNZ’s offices without full cost-benefit analysis.

As for the proposals themselves, the consultation period closed on May 3. The RBNZ says it will take time to consider submissions. In the meantime, the best outcome for New Zealand borrowers is that Phase 2 of the RBNZ review leads the Minister of Finance to change the bank’s governance arrangements. And that governor Orr’s proposals are subject to some independent oversight before they inadvertently capsize the New Zealand economy.