Ex-RBNZ and APRA official, Geof Mortlock, argues the RBNZ's regulation of the financial sector is so inadequate this responsibility should be passed on to a new agency

"The regulatory discipline leg is weak. Some would say it's broken."

By Geof Mortlock*

The Government is currently undertaking a review of the Reserve Bank. The review is not confined to monetary policy; it extends to all of the Reserve Bank’s functions, including financial regulation. It provides a well-overdue opportunity to fundamentally assess the performance of the Reserve Bank and make the changes that are needed to improve its effectiveness and accountability. 

One of these areas is the Reserve Bank’s role as the regulator of banks, insurers and non-bank deposit takers (NBDTs).

Role of the Reserve Bank as financial regulator

The Reserve Bank is responsible for the prudential regulation and supervision of all banks and insurers in New Zealand. It also regulates, but does not supervise, NBDTs (such as building societies, credit unions and some finance companies). This is an important responsibility. Banks are central to the functioning of our economy. They provide the bulk of lending to the private sector and hold the lion’s share of deposits. They operate the payment system that handles all of our day-to-day transactions. Equally, insurers are of major importance to the economy. They protect businesses and households against major risks, including to property, life, earnings and health, and are big investors in the economy. Without healthy banks and insurers the economy would be imperilled and the living standards of all New Zealanders would be at severe risk.

The regulation of banks and insurers in most countries is intended to promote a healthy financial system and protect depositors, policyholders and other users of financial services. It seeks to promote the prudent management of risks in financial institutions and achieve a very low (but not necessarily zero) probability of bank and insurer failure.

In New Zealand, the objectives of financial regulation are similar. The Reserve Bank is charged by Parliament to supervise banks and insurers to promote a sound and efficient financial system and insurance sector. Notably, however, there is no explicit statutory objective to protect depositors or policyholders, unlike the case with most financial sector regulators globally. This is an omission that should be rectified in the Reserve Bank review.

How effective is the Reserve Bank as financial regulator?

Given the importance of the financial regulation role, it is important to ask the question – how effective is the Reserve Bank in its performance as financial regulator?  The answer is mixed. In some respects, it has done a reasonably good job – such as establishing broadly sensible capital and liquidity requirements, and promoting financial disclosures by banks and insurers.

However, there are major inadequacies in the Reserve Bank’s approach to financial regulation which, if left unchecked, create significant risks for our financial system and economy, and for depositors and policyholders. There are also deficiencies in the way it behaves as a regulator, such as inadequate consultation over regulatory proposals and the poor standard of regulatory cost-benefit assessments.

Let’s take a closer look at these.

The ‘three pillars’ of regulation – a wobbly three-legged stool

The Reserve Bank has long maintained a so-called ‘three pillar’ approach to supervision. These pillars are:

  • ‘market discipline’ - the influence of financial markets on banks and insurers;
  • ‘self-discipline’ - bank and insurer corporate governance and risk management; and
  • ‘regulatory discipline’ - regulation and supervision by the Reserve Bank.

The Reserve Bank makes much of market discipline and self-discipline. It places much less emphasis on regulatory discipline. The framework is unbalanced. It is a bit like a three-legged stool, but where each leg is of a different length. And one leg – the regulatory discipline leg – is weak. Some would say it is broken. The result is a stool that wobbles precariously and is not a safe place to sit. As a result, the stability of our financial system is seriously compromised.

The Wobbly Stool of the Reserve Bank’s three pillars: Not a good foundation for financial stability

Image result for photo of wobbly stool

A strengthening and rebalancing of the three legs of the stool need to be achieved to provide a robust foundation on which financial system stability can be achieved.  I see a number of things that need attention.

Market discipline needs to be strengthened

The market discipline pillar needs to be strengthened. This can be done by modifying bank disclosure requirements to focus on more risk-based disclosures, reverting to quarterly disclosures and promoting disclosure of comparative data across banks. The Reserve Bank has made progress in some of this, such as through the disclosure ‘dashboard’ initiative. However, in other respects the Reserve Bank has reduced the effectiveness of bank disclosures – e.g. by abandoning quarterly disclosures in favour of six monthly and by dropping the Key Information Summaries that were intended to be accessible to the ordinary depositor. Moreover, the disclosure arrangements for insurers and NBDTs falls well behind that of banks and therefore reduce the effectiveness of market discipline.

Financial literacy needs to be improved. For financial disclosure to be effective, at least for households, the disclosure statements need to be understandable by ordinary depositors and policyholders. Currently, they are not. More emphasis needs to be placed on financial literacy to enable ordinary depositors and policyholders to understand key disclosures. This is a major gap at present. The Reserve Bank needs to lift its game in this area, as does the Financial Markets Authority, working collaboratively together with the Commission for Financial Capability and the Ministry of Education. Much more can and should be done to improve financial literacy so that depositors and policyholders are better placed to understand financial disclosures and make well-informed financial decisions.

The effectiveness of disclosure also depends, crucially, on the accuracy of the information being disclosed. The Reserve Bank is poorly placed to verify the accuracy of these disclosures, given that it does not seek to assess in any detail banks’ or insurers’ capital, asset quality, provisioning or other information that are key to the veracity of the disclosures. Instead, the Reserve Bank relies solely on director sign-offs and external audit. This leaves depositors and policyholders quite vulnerable.

Financial institution self-discipline needs to be strengthened

The Reserve Bank makes much of the self-discipline pillar yet does relatively little to support it. Its main effort in this regard is the director attestation requirement under which directors must sign public disclosure statements, including as to the accuracy of the disclosures and adequacy of the risk management arrangements of the financial institution. In itself, the director attestation is a very useful tool and helps to promote sound governance and risk management in banks and insurers.  However, it is not supported by other relevant requirements. Regulators in other countries are much more effective in this space. The Australian Prudential Regulation Authority (APRA) is a good example of this, with its comprehensive regulatory standards on, and supervisory assessments of, bank and insurer governance and risk management.

The self-discipline pillar should be strengthened by introducing more comprehensive corporate governance and risk management requirements for banks, insurers and NBDTs. These need not be overly intrusive in a regulatory sense; indeed, they should not be. But they should raise the bar on minimum requirements for governance and risk management systems and controls, together with strengthened audit of these matters.

The regulatory/supervisory pillar is the shortest and weakest leg in this wobbly stool 

The Reserve Bank has long been a ‘light-handed’ supervisor. This reflects a long-standing Reserve Bank scepticism about the efficacy of prudential supervision; it has always been the ‘reluctant regulator’. Since it first acquired the supervisory role for banks – in 1986 – the culture of the Reserve Bank – from the Governor down – has been unsupportive of financial regulation. As a result, it has a poorly developed approach to prudential supervision, with too few staff for the job at hand, and a fundamental lack of the skills, knowledge and experience to be effective.

The Reserve Bank has not developed a supervisory framework that is world class; it falls well behind accepted international practice. For example, the Reserve Bank does not conduct in-depth assessments of banks’ and insurers’ business operations, governance or risk management, in contrast to the approach taken by most prudential regulators in the OECD. They do not have comprehensive requirements in place for governance or risk management, or the capacity to assess the adequacy of banks and insurers in these areas.

The Reserve Bank is also poorly placed to detect non-compliance with regulatory requirements, as was seen recently when a major bank (Westpac) apparently drew to the Reserve Bank’s attention its own non-compliance with regulatory rules. The Reserve Bank is also not well placed to proactively identify and resolve emerging problems before they become obvious or the financial institution is about to fail. The recent failure of CBL Insurance is an example of this. In earlier years, the Reserve Bank was slow to detect and respond to problems in DFC (which failed in 1989) and BNZ (which came close to failing in 1990).

The Reserve Bank lacks the ability to perform asset quality reviews and therefore to assess the accuracy of banks’ and insurers’ capital adequacy. This creates an unwarranted reliance on the market discipline and self-discipline legs of the stool, which are themselves already relatively weak.

In short, the current arrangement leaves the Reserve Bank ill-equipped to do the job Parliament has given it and creates a considerable risk that New Zealand could face serious bank and insurance distress and failure situations in the future. This risk would be much greater were it not for the fact that the bulk of our banking system, and a large part of our insurance sector, are operated by Australian financial institutions and are therefore supervised by APRA. In effect, APRA is doing much of the ‘heavy lifting’ for the Reserve Bank, even though APRA’s sole responsibility is to look after the Australian financial system, not the New Zealand financial system. And what of the banks and insurers that are domestically owned, where there is no parent supervisory authority overseeing them? Therein lies an even greater vulnerability.

These problems were pointed out by the International Monetary Fund (IMF) in its comprehensive assessment of the New Zealand financial system in 2017. For example, in its assessment of the Reserve Bank’s banking supervision arrangements, the IMF concluded that the Reserve Bank was ‘materially non-compliant’ with 13 of the 29 ‘Basel Core Principles’ – the international standard on banking supervision. This is a ‘fail’ by any standard. Notwithstanding what the Reserve Bank might argue, the failure of its banking supervision framework is not, in any material way, counter-balanced by the market discipline and self-discipline pillars. The stool is very wobbly indeed.

A major reform of the Reserve Bank’s approach to financial regulation is needed. I am not suggesting that the Reserve Bank become a ‘heavy-handed’ regulator and supervisor. However, I do see a need for a significant strengthening of the regulatory/supervisory pillar to better align it to international principles and practice, and a strengthening of the market and self-discipline pillars. This suggests the need for the Reserve Bank to buy in staff with greater expertise in banking and insurance risks, replacing staff who lack the skills and knowledge to do the job. It also suggests the need for an intelligently designed, risk-based approach to supervision that includes regular thematic and occasional deep-drill assessments of banks and insurers. The Reserve Bank also needs to strengthen its capacity to detect emerging stress at an early stage and to strengthen their prompt corrective action framework and introduce recovery planning requirements for banks. Closer collaboration with APRA is needed; the current level of collaboration is inadequate, especially in the approach to planning for bank distress or failure. 

Reserve Bank policy formulation and consultation is deficient

The Reserve Bank’s approach to policy formulation and consultation on regulatory initiatives is deficient. Too often, the Bank has allowed far too short a period for affected parties to make submissions on regulatory proposals. All too often the Bank has often given the strong impression that it has little interest in the submissions it receives – i.e. that it is consulting for the sake of appearance and has no intention of modifying its approach in light of submissions. It generally provides inadequate responses to submissions and insufficient justifications for any decision to reject points raised in submissions. The argumentation for policy proposals is often poorly developed. Cost/benefit analysis is typically provided to justify the Reserve Bank’s preferred option, rather than being objectively and rigorously developed at an early stage in the policy formulation process. There is very little substantive independent assessment of the Reserve Bank’s cost/benefit analysis. In stark contrast, the Australian system provides for much more rigorous independent assessment of all regulatory proposals.

All of these deficiencies need to be rectified by imposing on the Reserve Bank much stricter requirements on consultation and cost/benefits analysis, and by bringing much stronger external scrutiny to the process. Similar arguments can be made for other regulatory agencies.

The Reserve Bank’s governance and accountability need to be improved

Underpinning all of this is the need for a major shake-up in the governance of the Reserve Bank, its organisational culture and its accountability. The Governor should no longer be the sole decision-maker; that should fall to a small decision-making committee, including external persons appointed by the Minister of Finance. The Reserve Bank Board should be required to do its job properly and provide close scrutiny of the Reserve Bank’s performance in all of its functions; it has failed miserably in this regard. The Minister of Finance should set a financial regulatory policy target (largely in the form of qualitative factors) for which the Reserve Bank should be held accountable. Performance metrics should be developed by Treasury to assess the Reserve Bank’s performance.

A fundamental review of the Reserve Bank’s approach to supervision is needed to strike the right balance and make the improvements needed. This review should be led by Treasury and involve external, independent experts. In my assessment, the best way to achieve the needed changes is to remove the financial regulation functions from the Reserve Bank and move them to a new, separate agency. I am sceptical of the willingness or ability of the Reserve Bank to change its cultural DNA.  Moving financial regulation out of the central bank was done in Australia with great success. Likewise, this has been done in many other countries, such as Canada, Germany, Japan, Sweden and Switzerland. But that is a topic for another article.

Geof Mortlock is a former senior official from the Reserve Bank of New Zealand and the Australian Prudential Regulation Authority and is now an international financial consultant based in Wellington. He undertakes regular consultancy assignments for the International Monetary Fund, World Bank, Financial Stability Institute and KPMG internationally. See www.mortlock.co.nz

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?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.


Excellent article thanks Geoff. Very timely for NZ.

He does not want a 'heavy handed' regulator. Why not ? Maybe that's the only way it can make a difference, otherwise it just becomes lost in this quite arcane sector.

Superb analysis. To excerpt just one point for emphasis, it's astonishing to learn that the IMF concluded in 2017 that the Reserve Bank was ‘materially non-compliant’ with 13 of the 29 ‘Basel Core Principles’ – the international standard on banking supervision. As you say, 'a fail by any standard'.

In a world defined by increasing geopolitical and financial risk - a world on which our property economy/bubble is afloat - it is imperative we get our house in order.

I wouldn't place as much credence on the IMF conclusions workingman.

The NZ regulator came out looking rosy after the gfc compared to most international counterparts.

You couldn't heap the same praise on most countries that the imf presides over. Most of which are either only just recovering now, or are still looking decidedly sick.

A similar argument was levelled by the USA, in terms of accounting standard’s pre gfc. The rest of the world international financial standards were always considered inferior by the USA to US GAAP. Look how that turned out

Don't believe everything you read

Isn't it about time we became the East Island of United Australia and sacked all the pencil pushers. Useless RBNZ. Useless councils. Useless Commerce Commission. Useless NZQA. Corrupt Immigration staff.


I liked the changes suggested around protections for depositors and policy holders of banks and insurers. What a breathe of fresh air. In NZ we have gone in the other direction with things like OBR which end out providing shareholders more protection and depositors less.

The OBR is a shocker. Banking is an essential service. RB's rationale for it must be a lie. They dont want deposit insurance cause it's expensive & risky...look at Canterbury Finance. I bet they have their savings spread around the banks and the globe.

"I bet they have their savings spread around the banks and the globe."

Quite likely. Mind you, everyone else can, and perhaps should, do the same...

Good article. Much the same could be said about the Commerce Commission.

Splitting the functions would align NZ and Australian approaches. Sensible under CER.