IMF calls for a more intensive approach to bank supervision from the RBNZ, deposit insurance and a debt-to-income cap tool in its Financial Sector Assessment Program report on NZ

By Alex Tarrant & Gareth Vaughan

New Zealand’s financial system is resilient to severe shocks, although further enhancements to banking, insurance and securities markets regulation and supervision are recommended in a long-awaited independent report.

The International Monetary Fund on Tuesday morning issued its much-anticipated Financial Sector Assessment Program (FSAP) report on New Zealand. The Reserve Bank, Financial Markets Authority and Finance Minister Steven Joyce all welcomed the findings, saying the recommendations will be reviewed.

Read their reactions further below, along with the IMF's executive summary.

Speaking to media in Parliament Tuesday morning, Joyce said changes being considered included tweaking the Reserve Bank's Open Bank Resolution framework. This could be along the lines of adopting a 'de minimis exemption' from freezing and haircutting deposits under the OBR as an alternative to a deposit insurance scheme, which the government is not in favour of. See his full comments in the video above.

Banking system

The IMF noted New Zealand’s banking sector had significant exposure to the housing and dairy sectors. This was a key financial vulnerability along with a high reliance on offshore wholesale funding markets. Credit has resumed strong growth during the last few years, putting pressure on funding and increasing concerns with the housing sector, the IMF said.

While bank stress tests indicated the financial system could weather severe shocks, these needed to be interpreted with caution, the IMF said. Authorities could still strengthen financial sector oversight and crisis preparedness frameworks, it said.

Specifically, the IMF again recommended the Reserve Bank be given the ability to limit debt-to-income ratios (DTIs), a tool the Bank has been calling for. The Fund noted the RBNZ’s loan-to-value ratio (LVR) limits have had a limited effect given rising house prices, although it did say LVRs had strengthened banks’ portfolios.

Joyce earlier this year kicked the DTI discussion into touch until after the 23 September election by requesting an in-depth analysis of how the tool would affect borrowers. The move was widely read as National being concerned about the impact DTIs would have on first home buyers in the run-up to the election.

The Reserve Bank has maintained DTIs would be complementary to LVRs, and that they would best be used in tandem.

The IMF also encouraged the Reserve Bank to issue enforceable supervisory standards on key risks, review the enforcement regime to promote preventive action, and initiate on-site programs targeted on areas of high risk.

It said New Zealand’s Open Bank Resolution framework – by which the government hopes to avoid having to use public funds to bail out a troubled financial institution – was a step in the right direction for a crisis resolution framework. However, the IMF again recommended the addition of a deposit insurance scheme, or at least a “de minimis exemption from freezing and haircutting deposits in OBR” at an appropriate level.

The IMF also recommends a more intensive approach to supervision by the RBNZ. The central bank and prudential regulator ought to "issue enforceable supervisory standards on key risks, review the enforcement regime to promote preventive action, and initiate on-site programs targeted on areas of high risk."

NZ advised to reduce incentives for leveraged real estate investments

Elsewhere the IMF suggests tax measures, such as a broader taxation of capital gains in real estate and limitations to subtract negative gearing losses from other income sources, would reduce incentives for leveraged real estate investments by households and help redirect saving incentives to other, potentially more productive investments.

"Further tax measures related to housing could be considered to reduce incentives for leveraged real estate investments by households. Such measures could help redirect savings to other, potentially more productive, investments and, thereby, support deeper capital markets," the IMF says.

"Measures to lift potential growth should focus on leveraging the benefits from high net migration and interconnectedness. Implementing productivity-enhancing tax reforms and ensuring additional support for innovation could provide a basis for further diversification."

Securities markets

Meanwhile, the IMF said enhancements to New Zealand securities markets regulation had been significantly improved with the introduction of the Financial Markets Authority (FMA). However, further work was required, it said.

“The regulatory perimeter could be reviewed to include wholesale asset managers and custodians, whose activities will become more relevant as the asset management industry matures, bringing potential new risks. There is also a need to enhance conduct regulation in the insurance sector."

Commerce and Consumer Affairs Jacqui Dean, who has responsibility for the Financial Markets Authority, told Interest.co.nz in Parliament Buildings Tuesday morning that she had not yet read the recommendations as she had just yesterday returned from an overseas trip.

Here's the IMF's executive summary:

Imbalances in the housing market, banks’ concentrated exposures to the dairy sector, and their high reliance on wholesale offshore funding are the key macro financial vulnerabilities in New Zealand. The banking sector has significant exposures to real estate and agriculture, is relatively dependent on foreign funding and is dominated by four Australian subsidiaries. A sharp decline in the real estate market, a reversal of the recent recovery in dairy prices, a deterioration in global economic conditions, and a tightening in financial markets would adversely impact the system. The key risks faced by the insurance sector relate to New Zealand’s vulnerability to natural catastrophes. 

Despite these vulnerabilities, the banking system is resilient to severe shocks. Results of stress tests and sensitivity analysis across all relevant risk factors indicate that the solvency and liquidity of the banking system can withstand adverse and severe shocks. In addition, there is a limited impact of solvency and liquidity contagion from direct exposures to banks and nonbank financial institutions, common holdings of securities, and market contagion. That said, the results from stress tests, although a useful supervisory tool, need to be interpreted with caution and the authorities can strengthen the financial sector oversight and crisis preparedness frameworks to further improve the resilience of the system.

Strengthening the macroprudential framework is important. The financial system is dominated by four major banks with similar business models in which the majority of assets are associated with housing loans. Direct exposures among them are relatively limited, but the potential for spillovers is elevated. Credit has resumed strong growth during the last few years, putting pressure on funding and increasing concerns with the housing sector. So far, the authorities have applied exposure limits to loans with high loan-to-value ratios (LVR) which, while strengthening the profile of banks’ portfolios, have had limited effects given rising housing prices. Adding a debt-to-income cap to the macroprudential toolkit would enhance systemic resilience by limiting the risks from growing household indebtedness. Imposing additional loss-absorbency requirements for domestic systemic banks, and allowing an effective accountability of the RBNZ without jeopardizing the integrity and independence of its macroprudential decision-making process are also recommended.

The approach of the RBNZ to supervision should be strengthened by increasing the weight of regulatory discipline in its three-pillar framework. The RBNZ approach to supervision relies on three pillars: self, market, and regulatory discipline. The authorities have strengthened regulatory discipline since the last FSAP, but the three-pillar framework should be improved by adopting a more intensive approach to supervision. This would increase the ability of supervisors to be proactive to exercise regulatory discipline and obtain reliable information to enforce self- and market-discipline. The RBNZ is encouraged to issue enforceable supervisory standards on key risks, review the enforcement regime to promote preventive action, and initiate on-site programs targeted on areas of high risk. In addition, clarifying the responsibilities of the Treasury and RBNZ on financial sector issues and reinforcing the role and autonomy of the RBNZ as prudential regulator and supervisor would enhance the ability of the RBNZ to respond swiftly to ongoing and emerging risks.

Increasing supervisory resources for all financial sectors is key. This would support the highly qualified RBNZ staff in improving the effectiveness of the supervisory process, enhancing their knowledge of financial institutions’ operations, and deepening risk assessment of supervised entities—and strengthening their ability for early preventive action. 

The proposed reforms to the regulatory and oversight framework for Financial Market Infrastructures (FMIs) will get New Zealand broadly on par with international standards. The proposed regime will provide the authorities with the legal basis for the oversight of systemically important FMIs, and with a graduated range of enforcement, crisis management, and regulatory powers. The authorities are encouraged to adopt international principles for FMIs in secondary legislation to provide for a transparent set of requirements to the industry and allow a consistent implementation of international standards among all systemically important FMIs. 

The reform of securities market regulation significantly improved the framework, but further enhancements are required. The review of the regulatory framework was instrumental in implementing key reforms, including the establishment of the FMA as conduct regulator. The new regime governs how financial products are offered, promoted, issued and sold, and introduces licensing for providers of certain products, including managers of retail funds. The regulatory perimeter could be reviewed to include wholesale asset managers and custodians, whose activities will become more relevant as the asset management industry matures, bringing potential new risks. There is also a need to enhance conduct regulation in the insurance sector.

The crisis resolution framework needs to be enhanced further. The Open Bank Resolution (OBR) framework, which aims to avoid the use of public funds when resolving systemically important banks, is a step in the right direction. To enhance its credibility and strengthen the financial safety net, the introduction of deposit insurance would be the best option. Absent support for deposit insurance, a second option is to legally establish a de minimis exemption from freezing and haircutting deposits in OBR, set at an appropriate level. The decision-making process in a crisis and the exercise of resolution powers need to be clarified. The RBNZ should be the sole resolution authority, with clear mandates and responsibilities, requiring the approval of the Minister of Finance (MoF) only for resolutions with fiscal or systemic implications.

The home-host relationships between Australia and New Zealand are well above international practice, but stronger collaboration would enhance synergies. The RBNZ could take a more proactive role in collaborative supervision. The scope of the Memorandum of Cooperation on TransTasman Bank Distress Management (MOC) could be extended to include insurance companies and FMIs. Moreover, further work on the trans-Tasman framework for assessing systemic importance and discussing possible coordinated responses would support timely and effective decision-making in an actual crisis. 

The full report is here.

The Reserve Bank of New Zealand acknowledged the report:

The International Monetary Fund (IMF) has declared New Zealand’s banking system to be resilient, but nevertheless recommended ways to improve the strength of the country’s financial sector and the regulatory framework.

In releasing the findings from its Financial Sector Assessment Programme (FSAP) overnight, the IMF said that the banking system is well-placed to manage risks and vulnerabilities associated with current developments in the housing sector, the high level of household debt, and low dairy prices. The FSAP included a range of ‘stress tests’ of the large New Zealand banks.

The report states that New Zealand has a good institutional framework for macroprudential policy and that LVR restrictions have generated financial stability benefits, although it could be strengthened further. They also recognise a number of important positive features about the Reserve Bank’s supervisory framework, including the strong Trans-Tasman relationships.

Recommendations for improvements include increasing the intensity of supervision for both the banking and insurance sectors, within the Reserve Bank’s “three-pillar” approach to prudential regulation that is based on self, market and regulatory discipline.

The IMF has endorsed the Reserve Bank’s current legislative proposal to improve the regulation and oversight of financial market infrastructures, as well as the importance of reviewing the bank capital framework.

The Reserve Bank is considering the FSAP findings and recommendations in its areas of responsibility and the degree to which these might further its statutory purpose of promoting a sound and efficient financial system.

A forthcoming article in the Reserve Bank Bulletin will explain the 2016 FSAP process and its findings and recommendations in more detail.

Finance Minister Steven Joyce:

Finance Minister Steven Joyce has welcomed the International Monetary Fund’s positive assessment of New Zealand’s economy and its financial system, as contained in two reports released this morning.

“The 2017 IMF report on the New Zealand economy endorses New Zealand’s strong economic plan. It notes New Zealand has enjoyed a solid expansion since 2011, and it expects further solid growth in the near to medium term,” Mr Joyce says.

The report is positive about the country’s economic outlook and endorses New Zealand’s macro-economic and fiscal policy settings.

“The IMF notes that the New Zealand economy is more resilient than in the past, specifically referencing our lower current account deficits than in previous periods of expansion. It also notes that New Zealand is benefiting economically from its current growth in population,” Mr Joyce says.

The IMF also released its Financial System Assessment Programme (FSAP) report on New Zealand this morning.

Mr Joyce welcomed the IMF’s recognition that New Zealand’s financial system is sound and resilient to shocks.

“The IMF assessed New Zealand’s resilience to four key vulnerabilities, the housing market, debt levels in the agricultural sector, the banking system’s dependence on overseas funding, and our ongoing vulnerability to natural disasters. They found New Zealand has the capacity to withstand any adverse events brought on by those risks.

“We will continue to work to increase resilience, through ongoing regulatory actions by the Reserve Bank and the Government’s work to increase housing supply, reduce public debt and prepare for natural disasters.”

“I’m pleased the IMF has recognised the significant progress that New Zealand has made in developing its regulatory system since the last FSAP in 2003/04, including the introduction of a prudential regime for the insurance sector, the creation of the Financial Markets Authority (FMA) and the introduction of the Financial Markets Conduct Act 2013,” Mr Joyce says.

Mr Joyce said both reports highlight the IMF’s view that the biggest area of policy work for New Zealand to complete is in the prudential policy area.

“The Reserve Bank and other agencies have significant work in progress on a number of matters that the IMF raises, including the proposed Debt to Income lending ratios, the Bank’s current review of bank capital requirements, its review of the Insurance (Prudential Supervision) Act, and MBIE’s review of the Financial Advisors Act.

“The IMF acknowledges the progress being made on developing a regulatory framework for Financial Market Infrastructure and the extension of the anti-money laundering regime to other sectors.”

The Financial Markets Authority:

The FMA today welcomes the publication of the International Monetary Fund’s Financial Sector Stability Assessment (FSSA) for New Zealand.

The FSSA is the IMF’s headline report from their 2016 review of New Zealand’s financial system. This review is known as a Financial Sector Assessment Program (FSAP) and included two IMF missions in August and November 2016. Detailed documentation was examined and meetings held with the FMA, the Reserve Bank, MBIE and the Treasury. The IMF teams also met with industry participants and trade associations.

Alongside the FSSA, the IMF is intending to publish several supporting documents from the FSAP covering the specific areas that the review focused on - banking, insurance, securities regulation, crisis management, financial markets infrastructure and macro-prudential policy.

The IMF notes that securities regulation in New Zealand has undergone a “major overhaul” with the establishment of the FMA and the introduction of the Financial Markets Conduct Act 2013 (FMCA). The FMA now has a much broader mandate than the previous regime under the Securities Commission, including the licensing or supervision of a number of new sectors. In addition, the FMA has a range of new powers [and responsibilities] under the FMC Act. They also noted the review of the Financial Advisers Act.

The previous FSAP in 2003/2004 identified a number of material deficiencies in New Zealand’s framework for securities regulation.

Rob Everett, Chief Executive of the FMA said: “The regulation of NZ’s financial markets has been significantly enhanced over the last decade and this has required significant work from the industry, the FMA and MBIE. It is good to see the IMF’s assessment clearly reflects that.”

The IMF has, as expected, put forward some recommendations for further enhancement of the regulatory regime for consideration. These recommendations touch on a number of areas including supervisors, custodians, the wholesale asset management sector and issues around conduct in the insurance industry.

The FMA is considering these proposals alongside its fellow regulators, the Reserve Bank, MBIE and the Treasury.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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26 Comments

Here is an interesting article to read , in regards to financial stability

Overall, the results suggest that financial stability policies must carefully consider network effects, since the emergence of instability arises from the structure of the network and not from any criteria related to individual banks. Policies that focus solely on the stability of individual banks without accounting for network effects may end up doing exactly the opposite of what they intended.

Read more at: https://phys.org/news/2017-04-policies-believed-stabilize-financial.html...

I have no confidence in our banks. Depositors are completely unprotected because of the OBR and the fact there aren't even any minimum exemptions stipulated to this rule. The government will not take the advice of the IMF as of course they are only interested in protecting the banks and corporations. Just listen to Bill English, its your own fault if you buy a house and interest rates go up, what he is not saying is that their attitude is that it is your own fault for depositing money in a bank and end up losing all your savings, that wouldn't go down too well would it, but that is exactly their policy or lack of. Is this what you call a catch 22 situation. At the first sign of mortgagee sales I am withdrawing all my money and buying gold, physical that is.
Edit - or Bitcoin or Etherium , I have already set us up with an exchange, just trying to figure out how to set up a wallet. It is a pretty sad state of affairs when you trust gambling with Bitcoin a safer bet than leaving your money in a bank.

Things have changed. I used to rest east with term deposits but with this cluster "gathering" housing market, I don't feel safe having them any more.

It's sad indeed that banks should be able to take from those who are lending them money, just because they themselves have lent injudiciously. Inconsisten pseudo-capitalists who want to privatise their profits but socialise their losses.

We should at least do what Iceland did and demand equity in return for bailouts, rather than the free bailout the USA gave its banks.

Be nice to clarify what an OBR would mean,exactly how it would be implemented: I really don't think the RBNZ has a clue.

That is not correct. They have detailed implimentation plans. See here.

We have no idea what the "de minimus" would be, we don't know if all of, or only a percentage of the balance above the "de minimus" would be stolen; and we don't know if any or which govt would have political will to rob the savers .
A "de minimus" of $5000 has been suggested, not good if you have most of your life's savings in term deposits, going on the adage that low return = low risk.

I am certain the RBNZ has a proforma de minimus in mind. But they are best not to declare it in advance for two reasons. Firstly, it would be gamed (just like deposit insurance is in other jurisdictions, leading to unmanageable moral hazards), and secondly, the appropriate de minimus should be set in the circumstances of the crisis. Guessing that now is not necessary from the regulators point of view. And it could well send a false signal that would be corrosive at the time the real level needed to be set.

A hard and fast de minimus would be used in the computer program to define how severely the proportion of funds deposited over and above that level, are cut back. The new 30 day notice period for term deposit early withdrawal will apply. And in fact the bank may not even accept early withdrawals.
And even worse than this, if the bank run continues, because it would be an evolving situation, the haircut may be made more severe with the passage of time.
From a personal perspective I don't think its absolutely they need to say what the de minimus is because we can all make up our own minds on how we spread our money around. Obviously it is not prudent to put all your eggs in the one basket.
The covered bond holders would get their pound of flesh first and foremost you can guarantee that!
If the run on the bank was severe enough, the bank would not be able to pay out the de minimus sums to everybody. (Only those who got in first, probably by having money on call).
The Kiwibank (NZ post) guarantee has gone away now, but there still are the Kiwibonds out there. You certainly pay for the security though! (Via the low interest rates payable in this rising inflation environment).
Those who read sites such as this one should be financially literate, so should not be faced with ruin if just one bank experiences OBR. But unfortunately there will be many out there who are overly loyal or have no concept of diversity who would be affected disproportionately.
Diversifying would have been prudent regardless of the National Party politicians setting up the OBR regime in the first place.

Joyce earlier this year kicked the DTI discussion into touch until after the 23 September election by requesting an in-depth analysis of how the tool would affect borrowers. The move was widely read as National being concerned about the impact DTIs would have on first home buyers in the run-up to the election.

Hmmmmm.....

Though singing the same popular and parsimonious refrain as his predecessor, Steven Joyce's big announcement on cutting debt blithely ignored the country’s real debt problem, which lies conveniently off the Government’s books.

The problem with Joyce’s announcement is that he’s not looking at the right debt, a point made by ACT, whose leader and only MP, David Seymour said of the announcement:

"When private debt is more than four times' worse [than public debt], the emphasis needs to be on returning Government surpluses to households and businesses."

Private debt has ballooned under this Government, fuelled by rising house prices and slow wage and productivity growth. [my emphasis]

National’s disregard for the ticking time bomb at the heart of its ‘rockstar economy’ is reminiscent of another crisis in a similarly lauded boom. In 2008, over the space of a few short months, Ireland found its model ‘Celtic Tiger’ economy brutally refashioned into one of the PIIGS, (Portugal, Italy, Ireland, Greece and Spain), pariah economies and poster children of fiscal indiscipline. Read more

Anyone seeking reassurance should read the IMF financial stability report and staff update for Ireland August 2006.

..good one. Wriiten in Aug 06, crash was in 07. Will NZ be as 'orderly' I wonder?

"While much of the growth in housing construction, and the extended boom in house
prices, can be explained by fundamental factors of catch-up and immigration, there
are concerns that house prices are now becoming overvalued; real estate prices have
risen by about 10 percent per year on average since 2000, consistently faster than
household average income (Figures 4 and 5). The central expectation is for an orderly
slowing in the housing market"

I have written it many times before, and I’ll do so again; the recovery is at this point purely political. Given the past few months and the hopes that the elections here and elsewhere have inspired it hasn’t been nearly political enough even in theory. Until that changes we are Japan, an ultimately bleak and dangerous future where economists debate R* and confer at conferences about what might they be able to do during the “next” one even though the last one still clings to every macro variable and populist uprising; while more and more adults live as a financial burden in the homes of their increasingly angry parents, here and all across the world. Read more

Nice one Kate, eerily similar to recent NZ assessments

Until Ireland beat us in a rugby test, I don't believe we will suffer the same fate.
Oh, hang on a second........

So how do we minions strategise to deal with the threat of OBR?

Is there a limit they don't touch i.e. small deposits of $5 k all over the place?

Or do we open accounts in AUS where they are guaranteed up to $250K from Govt?

Safety deposit box......

There is no de minimis under the OBR at the moment. I think it was Joyce (standing in for Bill English) who was asked this in Parliament a few years ago and rather than answering the question he accused his opponent of fear-mongering. Minions are best advised to stash at least some of their loot in a safety deposit box and some in Kiwi bonds, which aren't formally govt guaranteed but have an implicit guarantee, if only because while a bank can be wound up, the Crown can't and the debt endures (and the Crown can always raise money through taxation or printing it).

Yes, the banks have not be regulated enough for too long and the longer it goes on the greater the threat to society they become. The American fought them for a while in the 30's and 40's (I think) and lost. No pollie these days will have the balls, or the support to achieve much. Still it needs to be done.

Could the IMF or someone on here please advise me of what is potentially a more productive investment than property?

Residential property is not 'productive'. It is just rent-seeking. Productive enterprises produce goods or services that others (customers) use to further their economic goals - that is, they get 'benefits'. Residential property on the other hand only advantages the seller; for 'buyers' property is only a cost with low 'benefit' levels. There may or may not be utility (comfort, for example) but no real benefits. (The story is more complicated for commercial property which may give real 'benefits' to the buyer.)

Bonds and shares.

These recommendations just push NZ'ers into losing more of their rights as they are handed over to the likes of the RBNZ and other can't vote the blighters out sorts!!! I for one don't won't anymore of my rights handed to international organisations (or local for that matter) unless they are prepared and willing to pay me for the loss of that right!!

There is far too much emphasis placed on financial instability from a declining market price and NO emphasis placed upon the financial instability that gets created from restrictive measures that come from these types of policies. If one cannot borrow to build then less houses get built does the IMF not understand this basis fact? Or do they have a different plan that is not published?

There is no right to easy credit

It is a RIGHT to do business, and if that business is borrowing money from someone else then that has nothing to do with anyone else other than the parties directly concerned.

It is not a RIGHT to interfere in other people's business!!

It is not a RIGHT for Governments or their Agencies to have enormous running costs and run up enormous debts and place countries and economies and the people in them into hardship paying off those expenses
and debts.