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Gareth Vaughan delves into the detail of sweeping new powers proposed for the Reserve Bank, and explains why the Government wants to move regulation of deposit takers in this direction

Gareth Vaughan delves into the detail of sweeping new powers proposed for the Reserve Bank, and explains why the Government wants to move regulation of deposit takers in this direction
Picture: Lee Winder via Flickr.

By Gareth Vaughan

The latest announcements in the Government's long running review of 1989's Reserve Bank of New Zealand (RBNZ) Act make one thing very clear. For better or worse the days of our idiosyncratic, light handed, financial regulator appear numbered. The RBNZ is being moved into the international regulatory mainstream.

The catalyst for this move was the 2016 International Monetary Fund (IMF) Financial Sector Assessment Program report on New Zealand, published in 2017. It was the IMF's first such report on NZ in 12 years and highlighted just how far from the Western World regulatory mainstream the RBNZ was, with it not ticking several of the IMF's boxes.

In fact the IMF judged the RBNZ to be "materially non-compliant" in 13 of 29 international bank regulatory and supervision framework standards, or Basel core principles. I detailed this in a 2017 article here, with areas of material non-compliance said to include corporate governance, risk management, problem assets, provisions and reserves, concentration risk and large exposures, plus transactions with related parties.

The IMF noted the RBNZ's three pillar approach to regulation being self, market, and regulatory discipline. The IMF's questioning of the self-discipline pillar relying on directors’ attestations to the fact a bank has adequate risk management systems in place led to a review of the attestation regime. The review, by Deloitte, called for a more prescriptive approach to oversight of bank risk management. Interest.co.nz obtained a copy of the review in 2019, but only after a complaint to the Office of the Ombudsman following a fruitless Official Information Act request.

The IMF also pointed to the bizarre scenario whereby the Australian Prudential Regulation Authority undertakes on-site visits of NZ's four Australian owned banks ANZ, ASB, BNZ and Westpac, with RBNZ staffers tagging along merely in an observer capacity. Additionally the IMF said an important precondition for effective banking supervision is the willingness to act, and noted the RBNZ was resource constrained.

A regulatory impact statement released by the Government alongside its plans for the incoming Deposit Takers Act last week highlights some of the key points the IMF made.

Among things the IMF advised were: an increase in the RBNZ’s resources for supervision and regulation, enhancements to the crisis management framework, steps to strengthen cooperation with Australian authorities, clarifications of responsibilities to reinforce the role and autonomy of the RBNZ as prudential regulator and supervisor, and NZ strengthening the financial safety net by introducing deposit insurance.

Details of the deposit insurance scheme were the centre piece of last week's government announcement. With NZ an outlier among OECD countries in not having deposit insurance, the RBNZ long opposed deposit insurance. Primarily the RBNZ argued deposit insurance would increase moral hazard, making banks more susceptible to failure, bringing a need for more, costly regulation. Former Prime Minister John Key also opposed deposit insurance, arguing it would prove too costly for consumers because banks would pass on the cost of any deposit insurance levy to them.

The dogmatic RBNZ opposition softened, however, with then new RBNZ Governor Adrian Orr telling me in April 2018 that deposit insurance was "something that's going to be here in the future." But it hasn't gone entirely. The regulatory impact statement says the RBNZ wanted a $50,000 limit on the deposit insurance scheme and it was Treasury that pushed for the $100,000 limit ultimately adopted.

"The Reserve Bank places substantial weight on the moral hazard risks that arise from protecting depositors from loss at higher coverage limits, and the greater reliance on costly and imperfect mitigation tools that this creates," the regulatory impact statement says.

Meanwhile, new initiatives for financial institution crisis management, including statutory bail-in are being added to the RBNZ's toolkit. Bail-in is very much an overseas initiative in contrast to the RBNZ's idiosyncratic open bank resolution policy

And proposals to incentivise good behaviour from directors of banks and other deposit takers, are also included. Interestingly a requirement is proposed for directors to take out personal insurance against potential penalties for breaches of duties. The financial institution they represent wouldn't itself be able insure or indemnify the director. This, the Government says, is to ensure the incentive appropriately lies on the director personally, rather than the company.

The RBNZ will also be empowered to set "fit and proper" requirements for directors and senior managers of deposit takers, as it already does for insurers.

The regulatory impact statement points out that "the trans-Tasman dimension," and cooperation with Australian authorities is especially important given Australian banking groups own about 85% of NZ’s banking system assets, and about 60% of NZ’s insurance market is Australian-owned.

"The Australian prudential regulator – the Australian Prudential Regulation Authority (APRA) – is therefore the ‘home’ regulator for a large part of the New Zealand financial system," the regulatory impact statement says.

"Both the Reserve Bank Bill and the Deposit Takers Act recognise the significant Australian ownership of the New Zealand financial system and the deposit taking sector in particular, and the importance of the home-host relationship between the Reserve Bank and Australian authorities. The Reserve Bank Bill contains a new generic function around cooperation which includes a requirement to cooperate with overseas bodies that perform similar functions to the Reserve Bank. The Deposit Takers Act will carry over the current explicit reciprocal obligation tied to trans-Tasman cooperation from the Reserve Bank Act, and there will be other parts of the new legislative framework that recognise the importance of regulatory cooperation between the Reserve Bank and its international counterparts."

Last June Finance Minister Grant Robertson unveiled a new five-year funding agreement with the RBNZ giving it an annual average budget of $115 million, a $35 million increase, with staff levels expected to rise by 172, or 58%, to 468.

Last week's announcements also noted the RBNZ will be shifting to standards from conditions of bank registration, as the primary tool for imposing prudential requirements on deposit takers. This mimics Australia where APRA issues prudential and reporting standards. The scope of these standards is set to be broad enough to enable the RBNZ to set standards in relation to the full range of matters covered by the Basel Committee on Banking Supervision’s Core Principles, should it choose to do so.

Robertson is also proposing that the RBNZ receives a suite of powers to enable it to effectively monitor and supervise the financial sector in the interests of financial stability. This would include: powers to request information from deposit takers; a requirement on licensed entities to report breaches of their obligations to the RBNZ; a power to require a deposit taker to produce a report on a particular matter; a search power that would require a warrant; and the power to undertake on-site inspections.

"The Reserve Bank would also have a power to enter and remain on the premises of licensed entities, including insurers [on top of banks and non-bank deposit takers], for the purpose of an on-site inspection. This will not require advance notice, or a warrant. When undertaking an on-site inspection, the Reserve Bank will be able to ask questions, and to see documents. This will provide assurance that firms are meeting their obligations, and allow the Reserve Bank to proactively verify information provided by licensed entities. This power would not function as a ‘search and seizure power.’ The use of these powers would be subject to appropriate limitations, such as restrictions on compelling privileged or self-incriminatory information," Robertson says.

"To the extent possible, the powers that the Reserve Bank would use to collect information and supervise, such as its information gathering and on-site inspection powers, would be consolidated within the RBNZ Bill along with related provisions."

All this highlights a significant shift in the way banks, building societies, credit unions, deposit taking finance companies, and to some extent insurers, can be supervised by the RBNZ. According to the regulatory impact statement there is "good, but not conclusive, evidence to support the proposed reforms." 

What is clear is that if the reforms are enacted largely as proposed, the RBNZ and subsequently NZ should receive more ticks in boxes next time it's reviewed by the IMF than it did in 2016-17. But what is less clear is the extent to which attitudes within the RBNZ shift to meet the more proactive, internationally mainstream regime.

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29 Comments

11
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Pretty sure the Australian banks are creaming it here in New Zealand and could cover the insurance without passing on the costs. I'm sure a relatively small slice of the hundreds of millions of dollars each of the big four take from Kiwi's each year in profits would cover it. Really its just greedy banks where enough is never enough that is the problem. I have a big TD coming out in August and for the first time ever I think that I need to sit down and seriously think about what I can do with it besides leaving it in the bank.

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RBNZ have always come across as toothless to me. Seeing Mr. Orr’s performance the last 3 years, I doubt his attitude to shift to be more proactive and engaging. Perhaps RBNZ needs a ‘working culture’ cleanse.

RBNZ is proactive and engaging when it wants to and when it relates to their vested interest and knowingly or unknowingly have exposed their mindset : Least Regret approach when suits otherwise Wait and Watch.

Now as soon as they say Wait and Watch, will stand exposed.

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"Least Regret approach when suits otherwise Wait and Watch" - perfectly said, as clearly the RBNZ actions have been aggressively targeted at keeping the NZ housing Ponzi alive as long as possible.

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The ability to restrict lending on the speculative housing market and redirect it towards the productive sector would really help tidy up this mess we are in now. Yes it would hurt, but I don’t have any sympathy for the greedy lot who went all in on housing like it was a one way bet.

Conflict of interest prevents them. So to expect any meaningful change is.....

I agree - we need the RB to direct lending away from the speculative activities towards the productive sector.

"Redirect lending towards the productive sector"

Interested if you could give some examples
If you had $1 million where would you put it

Are you looking for active management, or do you want to just see a return. Small business run right can lead to very good returns, both active and invest only.

Passive investment in a small business. Not interested in Angel Investing.

It isnt angel investing. You buy the business as a managed going concern. The only issue is multiples have been heading north, like every other asset.

I would look to a variety of ETFs, with a smaller proportion on individual stocks. That's the approach I'm taking with my sub $1m figure

Then universal land tax and reduced personal and company tax is the only option.

I agree, but hell will freeze over before any politician (of any major party) will even consider it. Too many vested interests in the unproductive part of the economy.

Seems like Hell is freezing over across The Ditch..
https://www.macrobusiness.com.au/2021/04/federal-government-must-incenti...

Of course they have the added incentive of needing to do away with Stamp Duty.

A regulatory impact statement released by the Government alongside its plans for the incoming Deposit Takers Act. last week highlights some of the key points the IMF made. [my emphasis]

Can someone point to a reference on the RBNZ's website where a record of banks' deposit taking actions can be viewed as opposed to deposit creation actions?

Because banks don't take deposits and they never lend money. They are in the business of purchasing securities. When one gets a bank loan, the loan contract is a promissory note. The bank purchases that contract from the borrower. Now the bank owes the borrower money and it creates a record of the money it owes, which we call deposits - source.

Same principle as central bank QE.

Demand deposits referred to by the public as “cash in bank” is recorded and reported by monetary financial institutions (MFI) in units of account by double-entry bookkeeping in a process which the MFIs call “lending ” — but which is effectively a nullity — by debiting loans receivable and crediting demand deposits.

These so created units of account are then denominated at will in dollars, pound sterling, euros, etc., depending on the terms of the documentation or underlying promissory note, or whatever is the legal document giving rise to this type of “lending,” using whatever is the name of the currency in the jurisdiction in which it takes place, but legal tender the “demand deposits” are not.

Banks do not have pre-existing funds in the form of legal tender to lend, except in miniscule amounts relative to the size of their loan portfolios.1 In other words, banks create demand deposits out of nothing, and it therefore remains a nothing. The malpractice continues because public accountants as auditors sanctify the aforementioned practice by “certifying” the banks’ financial statements, provoking credit expansion, moral hazard, asset bubbles, liquidity-stressed financial markets, bank runs, and eventually global financial crises. Link-pdf

They may never "Lend money" but the repayments on their loans and hence their profits is real money. Thats the way it works in our system of money creation, its technically an unlimited resource to create BUT your simply trading your real time working to pay what you borrow back again. Your time is the limited resource and the system doesn't like the people that float around in it debt free.

but the repayments on their loans and hence their profits is real money

These repayments and profits are not legal tender - see my extended comment above - evidence.

Well its more real than Bitcoin and people are throwing money into that, how real do you want it to get ? Short of everyone going back to using Gold coins I don't see a better system. The world population is going exponential, not sure if we can dig gold out of the ground at an exponential rate. Look its a confidence system, Bitcoin or Fiat it doesn't matter, what matters is the masses openly adopting it and using it for trade. Ultimately it doesn't matter if a couple of individuals think otherwise, its the system we have currently.

It's this real, but it is not deposit taking:

But from the point of view of the bank, it has acquired the security without giving up any cash; the counterpart, in its balance-sheet, is an increase in its liabilities. There is expansion, from its point of view, on each side of its balance-sheet. But from the point of view of the rest of the economy, the bank has ‘created’ money. This is not to be denied. Hicks (1989, 58)

We start with the idea of credit creation, specifically a swap of IOUs between a bank and myself involving a bank loan that is my IOU and a bank deposit that is the bank’s IOU. Nothing could be simpler, and yet the mind rebels, especially the well-trained economist’s mind, because this simple operation increases my purchasing power without decreasing anyone else’s. It seems like alchemy, or anyway a violation of some deep conservation law. Real productive resources are the same as they were before, and the swap doesn’t change that, does it?

Spending of the new purchasing power adds another layer of perplexity. If spending increases but real resources do not, then it seems logical that the increased spending must exhaust itself in higher prices—that is the intuitive appeal of the quantity theory of money. My purchasing power may increase, but everyone else’s decreases because their money balances buy less. From this point of view, the alchemy of banking seems like a kind of theft, something to be deplored in the name of economic science and if possible outlawed in the name of the general good. Link

Hardly a robust foundation to bail-in so called "bank depositors' savings" in the event of a bank solvency crisis.

More regulation has made most industries worse off. As a business operator, there needs to be a balance of common sense shown. Many, particularly small businesses are being choked to a slow death by idiotic and poorly thought out compliance.
If you take AML as an example the cost of compliance has far exceeded the savings. The biggest offenders of AML are governments.
The last thing we need is this governments medalling in an area they have little to no understanding.
RBNZ must remain independent from government.

Pretty generalised comment. What business are you in ? I import/wholesale goods. Over the last 12 months we are 33% up, many I know are in a similar position. My wife is(was) in travel. Not so good for that industry.

AML...the above doesn't seem to match NZ's experience of money flowing in when it was easy. Or through our casinos. Nothing wrong with people being asked to show where their money has come from. I've done it, wasn't difficult.

What exactly is the moral risk in protecting depositors identfied By RBNZ? Is it something thats even more immoral than protecting specuvestors by mugging depositors?

Unfortunately the bad overshadows some the the good that Orr initially started out on only to be interrupted by Covids where protecting the banking system has taken priority. Let's see some of the good. Raising the banks capital requirements before suspending it because of Covids. In my opinion gave the banks too much time to achieve this. Blocking bank dividend repatriation. Calling out Westpac and ANZ for not managing their risk properly. I would be quite OK with OBR with both increased capital requirements now and a conservative risk profile set by RBNZ. I think both Westpac and ANZ are now on the default risk profile, not their own in house one. There are other measures I'm sure he and certainly with Grant Robertson could have done more to curb investor/speculator investment before this new round of regs,, 10year brightline and interest tax deductions come into operation.

RBNZ announcement next week - Entire RE machinerary will be active to put pressure on rbnz/government :

https://www.nzherald.co.nz/business/landlords-retreat-from-market-but-so...

Many a time, surveys can be framed / worded in a way to get the desired end result as will be required to hide behind when presenting an argument and to justify their stand.

I think this is good for politicians. In the event something happens, the government wouldn't need to be seen as using taxpayers money to bail out banks like how the Americans does it.

Instead, banks can use depositors money to bail itself out (hence the term "Bail-in"). In ordinary circumstances, depositors would be up in arms screaming "robbery", but because the government now mandates depositor insurances, the politicians can safely reassure the public their money is safe.

The truth is, with insurances, someone has to pay. In this case, it's the depositor in the form of ultra-low interest rates. If anyone notices, the interest rates across Tasman over the last few years had been consistently inferior to NZ for that reason- something has to give.

To avoid banks using your hard earned money to bail out themselves, investors should consider investing in properties. By investing in properties, you turn the table on who do the most bail out.

Without the bothersome math behind the rationale, for example, if you're on a loan to ratio (LVR) 80%, in simple terms, it means you are taking on 20% of the risk while the bank takes on 80%.

So you see, by investing in properties, you just turn the table on the banks who're after your money to guarantee their own safe voyage.

Be quick, opportunities don't present themselves often- winter is the best time of the year to grab a bargain!

Remind me, what proportions of the major banks profits are made from mortgage lending? And how has that proportion changed over the last 20-30 years?

“Regulatory discipline”. I assume this means officers from RBNZ coming into banks and doing reviews?
It should be part of the supervisor’s armoury, but is not a panacea.
In my experience of being involved in APRA reviews of both deposit-taking and superannuation entities, the main issue is the relative competence and experience of the reviewed and the reviewers. If the financial institutions are paying their staff multiples of what the Regulator is paying, you will always get an uneven contest in which the reviewed can relatively easily bamboozle the reviewer.
Add to that the fact that the junior reviewers would love a career with the financial institution and you will tend to get insipid regulation.
And if the answer is seen to be to appoint one of the Big Four to do the reviews you have similar, if not worse conflicts. Who pays whom the big fees?