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Geof Mortlock argues the prudential regulation of banks, insurers and non-bank deposit-takers should be moved from the RBNZ to a new regulatory agency

Geof Mortlock argues the prudential regulation of banks, insurers and non-bank deposit-takers should be moved from the RBNZ to a new regulatory agency

By Geof Mortlock*

In a recent article published on I argued that there are significant deficiencies in the way the Reserve Bank regulates and supervises banks, insurers and non-bank deposit-takers (NBDTs). I argued that major changes are needed, including much-strengthened governance, transparency and accountability, regulatory effectiveness, cost/benefit analysis of policies and robust consultation practices. 

I concluded by noting that I am sceptical of the Reserve Bank’s willingness to make the changes needed or that it has the culture and skills to actually do the job well. I suggested that the better course would be to move the regulatory functions out of the Reserve Bank and into a new, separate agency. Others have also argued for this. In this article, I want to put the case for this change.

In many countries - including Australia, Canada, Japan, Sweden and Switzerland - the prudential supervision authority is separate from the central bank, often having been moved out of the central bank following a comprehensive review of regulatory institutional arrangements. 

Typically, the supervisory agencies are overseen by the country’s Ministry of Finance and report to the Minister of Finance or equivalent. In some countries, such as France and the United Kingdom, the prudential supervision authority is a separate agency, but under the oversight of the central bank.

In New Zealand, there has never been a serious consideration of the benefits and costs of separation of the prudential regulatory function from the Reserve Bank. In contrast, Australia and many other countries have had comprehensive, independent assessments of this and other aspects of regulatory arrangements that resulted in major changes to regulatory architecture. Some of these reviews, as in the United Kingdom, occurred in part because of regulatory failures.

In that regard, New Zealand has had more than its fair share of financial institution failures or regulatory compliance breaches which would, in any other country, raise serious questions about the suitability of the regulatory arrangements. New Zealand has never had such an assessment, despite these failures. A fresh assessment of the adequacy of regulatory architecture is well overdue.  The current review of the Reserve Bank Act provides just this opportunity.

The Reserve Bank assessment being led by the Treasury should evaluate the benefits and costs of three regulatory architecture options:

  • Retaining the regulatory function in the Reserve Bank, but under much-strengthened governance, accountability and transparency arrangements, including policy objectives and performance metrics established by the Minister of Finance, backed by robust external monitoring of the Bank’s performance.
  • Establishing a new agency to conduct prudential regulation, with its own statute, governance and accountability arrangements, but where it is under the overview of the Reserve Bank, similar to the arrangement in the United Kingdom.
  • Establishing a completely separate government agency – a New Zealand Prudential Regulation Authority – under its own statute, governance and accountability arrangements, reporting to the Minister of Finance, and unconnected with the Reserve Bank.

Of these options, I favour the third one – the creation of a new government agency that is completely separate from the Reserve Bank. This is the Australian and Canadian model, and one that is prevalent in many countries in the OECD. In my assessment, there are several persuasive reasons for adopting this model:

  • It would reduce the concentration of excessive power in one government agency. Currently, the Reserve Bank has a very wide range of powers compared to most central banks in the OECD. It has responsibility for monetary policy, foreign exchange reserves management, currency intervention, operating significant parts of the payment system and securities settlement system, prudential regulation of banks, insurers and NBDTs, regulation of money laundering, regulation of the payment system, financial stability oversight, macro-prudential regulation and currency management. I will stop there. The sentence is already too long!  So is the range of functions under one agency. This concentrates excessive power in the Reserve Bank. It also creates potential and actual conflicts of interest, as I argue later in this article. A narrower span of functions would reduce this concentration of power and avoid conflicts of interest.
  • Removing regulatory functions from the Reserve Bank would enable the supervisory agency to focus on the job at hand without being distracted by the other central bank tasks, particularly monetary policy. Under the current arrangement – and ever since the inception of banking supervision in 1987 – the prudential regulatory function has been the poor cousin to monetary policy. The Reserve Bank of New Zealand Act makes this almost inevitable when it states in section 8: “The primary function of the Bank is to formulate and implement monetary policy …”.  The financial regulatory functions of the Reserve Bank are treated in the Act as an ‘added extra’, rather than a core responsibility of equal importance to monetary policy. In keeping with this, the Reserve Bank has tended over the years to accord much greater emphasis, attention, management oversight, resourcing and public reporting to the monetary policy function than to its regulatory responsibilities. The Reserve Bank Board, likewise, has generally paid much greater attention to the monetary policy function than to financial sector regulation. (That said, the Board has performed very poorly in all of its monitoring roles. Sadly, it has been little more than a compliant rubber stamp and cheer leader for senior management).
  • Separation of the regulatory functions would also enable the Reserve Bank to focus on its core role of monetary policy and related functions, undistracted by the many regulatory issues which it currently oversees. This would likely be conducive to a more focused and effective central bank. It would help the central bank to lift its game in monetary policy – i.e. to keep inflation broadly around the mid-point of the inflation target range; something that it has consistently failed to achieve in recent years.
  • Separation of the regulatory functions would enable a senior management team to be appointed with the skills, knowledge and experience to perform the role effectively – i.e. people with deep knowledge of, and practical experience in, banking, insurance and financial regulatory issues. The current senior management team – and its predecessors – generally lack the skills, knowledge and experience required for the role.  Mostly, the senior management team with responsibility for policy functions has, over the years, been dominated by economists. For all their talents, they know little about banking and even less about insurance. For example, not one member of the current senior management team has had a career involving practical experience of banking or insurance. Compare that to the situation in the Australian and Canadian regulatory agencies, and in many other countries, where the senior management teams bring much more relevant skill sets and practical industry experience to the job than is the case in New Zealand.
  • It would enable the regulatory agency to build the depth of knowledge and skills in its staff to perform the functions required of them. Currently, although the Reserve Bank has able people in the supervisory area, it lacks the depth and breadth of knowledge and industry experience to do the job as effectively as it should. For example, the staff generally lack the knowledge needed to conduct in-depth reviews of bank and insurer risk management systems. Similarly, if the Bank were tasked with conducting an asset quality review of a bank to assess its capital adequacy, the Bank would lack the capacity to do this. In contrast, the Australian regulator – the Australian Prudential Regulation Authority (APRA) – has much greater technical capacity in these areas.

In short, the Reserve Bank lacks sufficient capacity to do the job entrusted to it. The answer is not – as argued by Adrian Orr recently – to simply increase staff numbers. That misses the point.  We do not want or need a bloated regulator filled with more bureaucrats. Rather, what we need is a supervisory agency with the organisational focus, culture, systems, skills and practical knowledge to do the job – and do it well. This is far more likely to occur in a dedicated supervision agency, with robust governance, accountability and transparency, than in the Reserve Bank, and especially in a central bank whose DNA has always been relatively hostile to the notion of financial sector regulation.

  • Separation of the supervisory function from the Reserve Bank would also remove potential conflicts of interest between the Bank’s functions. For example, there is a conflict of interest between the Reserve Bank’s role as owner and operator of core parts of the payment and settlement systems, and its supervisory responsibilities in these areas. It is rather like the referee of a rugby game also being an active player on the field. Even worse, this referee gets to write the rules of the game!
  • It would ensure that macro-prudential supervision policy is directed at the promotion of financial system stability rather than being used as a de facto monetary policy instrument or for other nefarious purposes that do not necessarily anchor to financial stability. Reflecting this, I very much doubt that, had the responsibility for macro-prudential policy been allocated to a separate prudential regulator, and not the Reserve Bank, the macro-prudential policy tools would have been used as aggressively and relatively clumsily as has been the case under the Bank.
  • Separation of regulatory functions from the Reserve Bank would also remove the potential conflict of interest that can arise in the conduct of monetary policy – for example, where a tightening of monetary policy might be justified on price stability grounds but could potentially weaken banking sector stability. In such a situation, the central bank is in an awkward position, with a risk that policy settings will be compromised rather than targeted to a clear policy objective. Separation of monetary policy and financial stability functions avoids this potential tension.

Taking into account these factors, a strong case can be argued for separation of the regulatory function from the Reserve Bank, as has been done in so many other countries. Likewise, the responsibility for resolving failed banks and insurers should also be removed from the Reserve Bank and placed in a separate regulatory agency. This would help to reduce potential conflicts of interest that can arise between a central bank’s role as lender of last resort and the role of managing a bank distress or failure situation. 

Removing failure resolution responsibility from the central bank also helps to reduce moral hazard risks, given the risk of depositors and others thinking that the Reserve Bank might use its deep pockets to fund a bank rescue. It is far better that the resolution authority be a separate agency and that any resolution funding – whether it be deposit insurance or systemic resolution funding – be from specific, dedicated sources under separate statutory authority.

But what of the arguments for retaining the regulatory function in the Reserve Bank? The argument generally advanced by the Bank in favour of retaining prudential regulation is the alleged synergy between the prudential function and the other functions of the central bank. For example, it has been argued that the Bank is better equipped to perform the regulatory function because of its payment system operations, financial market functions and monetary policy operations. This argument is fragile at best. The insights gained by the Reserve Bank from these other functions have little bearing on its role as prudential regulator. 

The skill sets between these areas of the Bank are very different from those needed in prudential regulation. The movement of staff between departments within the Bank is limited for that reason.  Moreover, at least in my many years at the Bank, there was little practical interaction between the different departments in ways that enriched the performance of prudential regulation and supervision. It might have increased in more recent times, but I very much doubt that there is any substantive and truly useful input from these other parts of the Reserve Bank to the regulatory function.

Therefore, the synergies in locating the banking regulation function in the Reserve Bank are questionable at best. And what of the synergies between insurance regulation and the Bank’s other (non-regulatory) functions? None at all, is the answer. The same argument applies to AML regulation – there are no synergies with the Bank’s other non-regulatory functions.

If one looks at our near neighbour, Australia, the separation of prudential regulation from the Reserve Bank Australia (RBA) had no obvious adverse effect on the ability of APRA to regulate the financial sector. If anything, it enhanced it by enabling APRA to focus on its key functions without the distraction of the other functions of the RBA. APRA is now widely regarded as one of the most effective prudential regulators in the world.

To the extent that central bank insights have a useful role to play in informing prudential supervision, they can be harnessed efficiently and effectively through well-structured coordination between the supervision authority and the central bank. This happens regularly in Australia through the Council of Financial Regulators and bilaterally between APRA and the RBA. Much the same is true in the other countries where there is a separation of prudential regulation from the central bank.

I therefore believe that the Government should seriously consider separating all of the prudential and anti-money laundering regulatory functions, together with responsibility for bank and insurer failure resolution, from the Reserve Bank and transferring them to a separate, new government agency. The prudential supervision of NBDTs should also be brought directly under the new supervisory agency, rather than continuing the current arrangement where the Reserve Bank is the regulator of NBDTs but supervision is conducted by trustees. The new agency would be established by an Act of Parliament with a clearly defined mandate, objectives, powers, transparency obligations and accountabilities. It would be subject to robust governance, probably including a board appointed by the Minister of Finance and an executive decision-making committee.

The new structure would strengthen New Zealand’s financial regulatory architecture and enhance the effectiveness of financial sector regulation. In contrast, retaining the status quo will perpetuate all of the current inadequacies and leave the Reserve Bank with far too many disparate functions and way too much power. The time for a fundamental change is now.

*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

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When you see things like OBR - which seems to favour bank shareholders rather than depositers - coming out of RBNZ, you have to wonder about conflicts of interest and whether they are up to the job.

This comment is completely wrong. Bank shareholders get wiped out if OBR is used. Please do some simple research before making wild, unfounded claims.

Yes, if OBR is used, shareholder funds are used, but the banks managers probably continue on, and history suggests those jokers always ensure they get paid handsomely whatever the outcome.
Also, even the RBNZ has said that OBR might justify a lower level of capitalisation, a view which does favour shareholders at the risk of depositors. This is a crazy view, but nonetheless expressed by the RBNZ.

Yes that's right Peri. It does appear to lighten capital requirements on shareholders at the risk of depositers.

With covered bonds introduced in 2013, then subsequently OBR, you now have large pools of assets cordoned off for those bonds that would have previously been available for depositers in the event of a bank failure. Higher ability to secure lending should reduce costs of capital.

In support of Geof Mortlock's advocacy for a separate regulator, I have personally observed the differing perspectives within the insurance industry, on APRA vs the RBNZ. My perception is that aussie insurance executives have a healthy regard, if not at times outright fear, of APRA's extensive powers and its detailed sector expertise, whereas the RBNZ is viewed as a much more benign, almost avuncular, institution.

CHCh revealed serious inadequacy in reinsurance programs purchased by insurers. No accountability for those errors and little examination of the validity of guidance on solvency provided to the market by insurers in the post EQ period, has occurred. The RBNZ self policing approach on solvency ratios and risk management was exposed as ineffective. Which perhaps explains the apparent lack of appetite to pursue enquiry to any great extent. The CHCH experience alone should be enough to highlight the significant weakness in the RBNZ's 'supervision' of the insurance industry.

Because of the close interdependence of NZ's insurance market on Australian parents, especially in respect of the adequacy of reinsurance programs negotiated by the Aussies for NZ policyholders, I would go further than Geof and suggest that his proposed NZ regulatory body should also be closely aligned operationally, with APRA.

You tend to forget that when the Christchurch EQ sequence started there was no prudential supervision for insurers except credit ratings and the 500k at the public trust.

The RBNZ rules came into force later. The AMI shambles was on normal company solvency issues not prudential regs.

You tend to forget that when the Christchurch EQ sequence started there was no prudential supervision for insurers except credit ratings and the 500k at the public trust.

The RBNZ rules came into force later. The AMI shambles was on normal company solvency issues not prudential regs.

Mr. Mortlock makes a very compelling case to separate the functions of the RBNZ. I wonder if the regulatory parts of the RBNZ would be better transferred to the FMA rather than another government agency.

Fair comment as mentioned the Reserve Bank has many other functions and this may not be their number one priority. Australia has a separate authority and it found significant "please explain" issues. We need this authority and agree the FMA could be the home for it.

nz is too small for a multitude of regulatory oversight. we don't necessarily have the scale, or complexity that exist in foreign jurisdictions to warrant such overkill. Besides we had/have trustees which are independent of the rbnz that carry out certain functions as agents of the rbnz. And how well did that turn out?

A leaner, focussed RBNZ (on monetary policy, exchange rates, employment, economy) and another meaner, tougher Regulatory Agency, tasked with supervising full time the Banks and Finance Industry as suggested in this article is worth considering. With the change of government and with Winston talking about RBNZ reforms, can this happen soon ?

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Days to the General Election: 39
See Party Policies here. Party Lists here.