In an extreme scenario he hopes never arises, Reserve Bank Director of Prudential Supervision Scott McKinnon says New Zealand's big four banks could cast off their Australian parents and operate independently given they now meet their prudential regulator's revised outsourcing requirements.
Speaking to interest.co.nz, McKinnon says ANZ NZ, ASB, BNZ, Westpac NZ and Kiwibank are all in compliance with the policy. This follows six years of work at the four Aussie owned banks involving thousands of staff and costing hundreds of millions of dollars, as previously reported by interest.co.nz.
Outsourcing occurs when a bank uses another party to perform business functions that would traditionally have been done by the bank itself. For example, IT (information technology) processing, accounting and call centre work. The major banks are required to have the legal and practical ability to control and execute outsourced functions.
Whilst outsourcing is a common area of focus for bank regulators around the world, McKinnon says the Reserve Bank's focus on related parties is unique. This focus is there because NZ's banking system is about 90% foreign owned by entities from one jurisdiction, Australia.
"We've got a unique banking system in New Zealand and this [policy] gives us a protection that was not there properly [before] and has now gone live. It has been a long journey to get there," says McKinnon.
'Divergence of interest between a commercial entity & the prudential regulator'
Acknowledging "significant pushback" from the banks during the policy development period, McKinnon hopes the bank bosses can now see the fruits of their efforts. At one point the Westpac Banking Corporation reviewed its ownership of Westpac NZ citing, among other things, the Reserve Bank's requirement to structurally separate Westpac’s NZ business operations from Westpac's operations in Australia. And ANZ NZ CEO Antonia Watson said she'd have preferred to spend the money on customer propositions.
"I would hope that all of the bank CEOs would say that now they've gone through this process, their banks are more resilient than before they started. Because they have had to do a lot of work around this, and we want it to be a positive outcome for everyone," McKinnon says.
"This policy's a good example of divergence of the interest between a commercial entity with a shareholder and appropriately focused on shareholder returns, and the prudential regulator who has got to be thinking about New Zealand Inc and what's best for the country."
"At times of crisis those interests diverge quite materially," he says.
In terms of stepping in to separate the NZ subsidiary from its Aussie parent, McKinnon acknowledges it would have to be an extreme scenario he hopes never eventuates.
"But at the end of the day our focus is on what's best for the New Zealand financial system from a stability perspective. We have to prepare for these worst case scenarios and that might involve either the parent entity being in financial difficulty to the point where it was going to fail, or potentially the subsidiary going into statutory management. And in that case you would assume the parent was unable to support the subsidiary."
McKinnon cites the example of Britain's Northern Rock, and the queues of customers snaking around the block seeking to take their money out in the first run on a British bank in 150 years before it was nationalised in 2008.
Although there have been no bank failures in NZ in recent years, there have been banking crises in the past, and much of the finance company sector dissolved between 2006 and 2012.
More hands-on regulator gets prescriptive
Initially introduced in 2006, the Reserve Bank announced the revised outsourcing policy in 2017 after two years of consultation. This followed it determining in a 2014 review that the policy was being inconsistently applied, compromising the stability of the financial system in stress situations, and potentially undermining the viability of the Reserve Bank's Open Bank Resolution bank failure policy.
As the Reserve Bank's then-Deputy Governor Grant Spencer put it in 2017: "The [outsourcing] policy ensures that a failed bank will be able to continue to provide liquidity and a basic level of banking services to customers. This means that wider systemic effects from a bank failure can be kept to a minimum."
In 2019 it emerged the directors of NZ's big banks had told the Reserve Bank quarterly for years that their banks were fully compliant with their regulator's outsourcing policy when they may not have been, albeit the banks individually played this down.
McKinnon says the revised outsourcing policy is much more prescriptive, placing the Reserve Bank "firmly in the process."
"It reflects our shift away from [being] a regulator who relied very heavily on self discipline [via the director attestation regime], to one with much more of a focus on orthodox regulatory discipline."
Each bank was required to have a path to compliance plan, which was tested annually by an external reviewer, such as Deloitte or KPMG, who would report on progress to both the bank and Reserve Bank. Each bank must also have a compendium setting out everything it outsources, and a separation plan so it can separate from its parent if required.
"If a statutory manager's ever appointed they could pick this [compendium] up and know this is where it's all done, these are the parties who do the service and functions for that bank," says McKinnon.
"They had to do a full separation test and the directors had to confirm to us that it would work. [And] they have to get the external auditor to go in every three years to review it and confirm that it's still working and everything's compliant."
"Every year we'll be meeting with them to talk about how they are complying with the outsourcing policy...We've lifted the hood a lot more on the entities we supervise. That's very much a show us, don't tell us world for us," McKinnon adds.
Big money
ANZ NZ, the country's biggest bank, says implementing the revised outsourcing policy was the biggest regulatory project in the history of the ANZ Banking Group, involving 700 staff across NZ, Australia, Singapore and India, costing more than $580 million. ASB puts the cost to it at about $150 million, and BNZ at around $160 million. Westpac NZ hasn't disclosed its cost.
In 2017 the Reserve Bank estimated implementing the revised policy would cost the banks a gross $550 million, and produce a net benefit of $2.2 billion.
"The banks would suggest that figure [$550 million] was under what they actually spent. We sought information from them when we were putting this together. The question is, how much of that over and above the $500 million was more discretionary? So if they were looking to modernise and so forth there might have been additional cost on top of that," says McKinnon.
"Banks could look at this opportunity and think 'is this an opportunity for us to modernise certain systems or processes'."
In terms of the cost variation across the banks, McKinnon suggests that probably reflects their different starting points, in that some were more integrated to their parent bank than others. The four banks have also chosen different paths to meet their regulator's requirement.
CEO Catherine McGrath says Westpac NZ "onshored" some jobs as it moved to meet the requirements.
"There are some scenarios where banks have insourced and the New Zealand subsidiary has started providing services to the Australian parent as well, which I guess is probably a reflection of lower labour costs [in NZ]," McKinnon says.
In May 2018 BNZ customers suffered a weekend service loss with most banking, online banking, EFTPOS and ATM services hit after power was lost by parent National Australia Bank in Melbourne. At the time the Reserve Bank told interest.co.nz NZ's major banks should have systems in place to prevent such a scenario reoccurring, once they'd implemented the revised outsourcing policy.
Much easier for Kiwibank
McKinnon says introducing the revised outsourcing policy has been the biggest project from a banking supervision perspective ever undertaken by the Reserve Bank, and it included 1500 meetings with staff from the banks.
Meanwhile he says the Reserve Bank is "very neutral" on outsourcing per se, with the policy not preventing it and not give guidance to what should or shouldn't be outsourced.
"For instance it's absolutely neutral on the cloud. So if someone wanted to put the whole system in the cloud they could arguably do that."
The outsourcing policy applies to banks with liabilities, net of amounts owed to related parties, of $10 billion or more. In addition to the big four, this also includes Kiwibank. However, given Kiwibank hasn't been required to separate operations from a parent, complying is much simpler.
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