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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