Geof Mortlock makes the case for a shake-up to RBNZ governance and a fundamental, independent review of the regulatory framework for NZ's financial system

By Geof Mortlock*

The Reserve Bank of New Zealand Act is well overdue for a major overhaul. It was enacted in 1989. Aside from some limited-scope changes to the Act since 1989, and the amendments made last year to establish a Monetary Policy Committee, there has been no substantial review of the governance and accountability framework of the Reserve Bank since 1989. 

Given the powers entrusted to the Reserve Bank and its importance to the economy and financial system, robust governance, transparency and accountability are critical. I therefore welcome the current review of the Reserve Bank Act. I hope it will lead to a fundamental strengthening of the governance and accountability arrangements for the Reserve Bank.

There are several problems with the current arrangements. A key one is that too much power is vested in the Governor as a ‘single decision-maker’ for the Bank. This has always been an unusual and questionable feature of the Bank’s governance. There is little precedent for it in central banks and financial regulators in other countries, where decision-making generally rests with a board of directors or a committee comprising a combination of internal and external members. It also sits at odds with the decision-making structure of the other main financial regulator in New Zealand – the Financial Markets Authority – where decision-making is vested in a board. And it has no parallel in the private sector, where governance lies in a board, which in turn delegates decision-making to the CEO, subject to close oversight from the Board.

The recent amendment to the Reserve Bank Act has changed this structure in respect of monetary policy by establishing a new Monetary Policy Committee (MPC) as the decision-making body on monetary policy. It is chaired by the Governor and comprises staff appointees and external appointees. The amendment to the Act requires a majority of the MPC to be Reserve Bank staff. That was a pity in my view, as it still leaves in place the likelihood of excessive dominance by the Governor.  Nonetheless, the establishment of the MPC is a step in the right direction.

No changes have yet been made to the wider governance and accountability arrangements of the Reserve Bank. These are matters subject to the broader review of the Reserve Bank currently under way.

Change to prudential policy decision-making structure

Under the current arrangements, the Governor is the sole decision-maker in the Reserve Bank for all prudential matters. This has the same kinds of risks as did the single decision-maker model for monetary policy. It concentrates too much power in one person. It creates the risk of poor-quality decision-making and is especially problematic if the person who occupies the office of Governor is prone to erratic decision-making, lacks in-depth understanding of prudential issues and is not tolerant of others’ views. I think a strong case can be argued for a major change to the Reserve Bank’s existing decision-making structure for prudential regulation matters.

Actually, my preference would be something more fundamental – the removal of all prudential functions from the Reserve Bank to a new Prudential Regulation Authority.  However, that is a topic for another article. For so long as the Reserve Bank has responsibility for prudential regulation, there is a need to remove the current single decision-maker arrangement in favour of a committee-based decision-making model. This would reduce the risks associated with the dominance by one person. A committee arrangement would help to bring a more balanced consideration of issues, drawing on the knowledge, skills and experience of its members. This is likely to assist in promoting better quality decision-making than is the case under the existing Governor-dominated model.

I would favour the establishment of a Prudential Policy Committee (PPC) as the decision-making body in the Reserve Bank on all matters relating to the regulation and supervision of banks, insurers, non-bank deposit-takers (NBDTs) and payment system operators, including micro and macro-prudential supervision. It would appropriately be chaired by the Governor and comprise the Deputy Governor and up to two other staff appointed by the Reserve Bank Board on the recommendation of the Governor.  In addition, the committee should include at least four external persons appointed by the Minister of Finance, having regard to (but not being bound by) the recommendations of the Governor and the Board. Desirably, the committee would comprise a majority of external appointees so as to reduce the risk of Governor dominance and Reserve Bank ‘group think’. 

Therefore, if three internal members are appointed, then there should be four external members. If four internal members are appointed, there should be five external members. Like the MPC, the Prudential Policy Committee would have a charter, established by the Minister, setting out its purpose, modus operandi and related matters. Decisions made by the PPC should be published so as to ensure transparency and accountability.

As I will argue in another article, I think a strong case can be made for removing the prudential functions from the Reserve Bank altogether.

On matters outside of monetary policy and prudential policy, such as the general administration of the Reserve Bank, the management of foreign exchange reserves, the management of currency, etc, my suggestion is that decision-making authority be vested in an executive committee comprising the Governor, Deputy Governor and at least two other staff appointed by the Board on the recommendation of the Governor.

Accountability and transparency for prudential regulation

There is also a need to fundamentally strengthen the prudential regulation accountability and transparency arrangements for the Reserve Bank. Under current arrangements, the Reserve Bank sets prudential policy with only broad reference to very high-level statutory objectives. The government has no say on the specific policy objectives of prudential policy, unlike the case with monetary policy. This needs to change. While it is appropriate for the Reserve Bank to have operational independence in making policy decisions (via the proposed committee structure), it is not appropriate that it should be free to set policy objectives. 

Just as monetary policy objectives are set by the government under the new framework, so should prudential policy objectives. This will reduce the risk of the Reserve Bank going in odd directions on policy, as it is currently prone to do. It will strengthen the accountability of the Reserve Bank. And it will be provide a more structured anchor to decision-making.

I therefore recommend that the Reserve Bank Act be amended to make provision for the government (via the Minister of Finance) to issue, following consultation with the PPC, a Statement of Prudential Policy for the Reserve Bank which the PPC would be required to adhere to in its decisions. The Statement of Prudential Policy would be published and would become a key element in an enhanced accountability framework. The Statement would elaborate on policy objectives set out in the Act (which should anchor to financial stability, promotion of sound risk management in financial institutions, promotion of depositor/policyholder confidence and minimisation of damage to the financial system and economy in a failure, tempered with the need to avoid excessive compliance costs and to avoid adverse regulatory impacts on financial system efficiency). The policy objectives in the Statement would mainly be qualitatively expressed, but consideration could be given to some quantitative targets, subject to the practicality of any such targets.

The Statement of Prudential Policy would also set out performance criteria relating to the policy objectives. These would help to guide the PPC in the design and implementation of prudential policy. They would also provide a framework for assessing the Reserve Bank’s and PPC’s performance.

The Act should be amended to require the PPC to report at least six monthly on its activities and on matters relating to the performance against the Statement of Policy Objectives.  Reports should be public in much the same way as Monetary Policy Statements. In addition, the Minister should be empowered to require such further reports from the PPC as he requires from time to time.

Members of the PPC should be required to appear before Parliament’s Finance and Expenditure Committee (or its equivalent) as required by the Committee.  This would include an obligation on any and all members of the PPC to appear before the Committee if required by the Committee. It is important that Parliament does not just question the Governor or other Reserve Bank staff on prudential policy. It should equally question and seek the views of non-executive PPC members and have the capacity to do so without any Reserve Bank staff being present. The same point applies in respect of the MPC.

Who should appoint the Governor and Deputy Governor?

Under the current structure, the Governor is appointed by the Minister of Finance on the recommendation of the Board. The Deputy Governor is appointed by the Board on the recommendation of the Governor.

I believe this is a flawed model of governance. It places too much influence in the hands of the Board, the members of which are unelected. The process the Board adopts for identifying potential candidates for Governor is non-transparent, as is the process they apply in selecting the candidate to be recommended to the Minister.  There is no accountability in the current appointment process. It has no precedent in other countries to my knowledge. Probably for good reason.

The appointment of the Governor should be made by the Minister having regard to the views of the Board, but the Minister should not be constrained in appointing someone recommended by the Board. Ultimately, it is the government of the day that needs to take responsibility for the appointment of the CEO of one of the most powerful government agencies. This is especially important given the degree of operational autonomy given to the Reserve Bank.

The Deputy Governor should also be appointed by the Minister of Finance and not by the Board on the recommendation of the Governor. The Deputy Governor is the person who runs the Reserve Bank in the absence of the Governor. He or she exercises considerable powers in that situation and in their own right. It is therefore appropriate that the government of the day makes the appointment, rather than vesting that power in unelected officials.

Reserve Bank Board

There is a need to fundamentally strengthen the role of the Reserve Bank Board. It has always been an oddity in the governance structure. It is essentially a performance assessment board; it has no decision-making functions other than in the appointment process for the Governor and the Deputy Governor. It is one of the weak links in the governance arrangements. It has never performed its role effectively. In my time at the Reserve Bank, the Board was a passive presence and rarely made any meaningful enquiries on prudential matters. I doubt that has changed much. Its annual reports are tucked into the Reserve Bank annual reports and are notable for their blandness. 

The Board’s reports say nothing, in substance, on how the Board went about its monitoring business. And they contain little meaningful assessment of the performance of the Bank. It is striking that the Board’s annual reports never make criticisms of the Bank’s performance, notwithstanding that there are many examples of inadequacy in the Bank’s performance of its monetary policy and prudential policy roles. Sadly, this is not really surprising. Since its inception, the Reserve Bank Board has been ineffectual as a performance monitoring body. It has badly failed in its role. Rather than being the passive, well-trained lapdog of the Governor, the Board needs to become a real watchdog with teeth.

In the first 15 years or so after the enactment of the Act, the Board was – astonishingly – chaired by the Governor. This was always an absurd arrangement, given that the Board is charged with monitoring the performance of the Governor. That was partially addressed in the early 2000s when the Act was finally amended to remove the Governor as chairman. A non-executive director selected by the other non-executive directors now chairs the Board. That is a far better arrangement. 

However, it still falls well short of the mark. The Governor still sits on the Board. He shouldn’t. He has no place on the Board given that it is a purely performance assessment board. The Act should be amended to remove the Governor from the Board. It should also be amended to make provision for the Minister to appoint the chairman of the Board. The chairman needs to be directly accountable to the Minister.

I think several other things need to be done to make the Board an effective part of the governance arrangement. These include:

  • The Board should be required to report at least six monthly to the Minister on the performance of the Reserve Bank in respect of all of its functions, and more frequently if required by the Minister. All reports to the Minister should be tabled in Parliament within one month following the receipt of the report by the Minister and thereby publicly disclosed. The Board’s annual report should be completely separate from the Reserve Bank’s annual report.
  • The Board should be required to meet with Treasury as and when required by Treasury for the purpose of enabling the Treasury to better assess the performance of the Board.
  • The Board should be given funding to employ at least one full-time senior staffer to service the Board, and given funding to engage consultants and other experts as necessary. It should not be dependent on advice from Reserve Bank staff or dependent on the Governor to obtain funding for external resourcing.
  • The Minister should set performance criteria against which he would require the Board to monitor the performance of the Reserve Bank and its committees (in addition to any other criteria the Board may choose to apply).
  • The Board should be empowered to recommend to the Minister that the Governor or Deputy Governor be removed from office if it is satisfied that any of the statutory criteria for removal are satisfied. Likewise, it should be empowered to make recommendations to the Minister for any changes it believes are necessary to any aspect of the Reserve Bank’s governance and staffing, or on other matters, where it is satisfied that such changes are appropriate to address deficiencies in the Reserve Bank’s or its decision-making committees’ performance.

Administration of the Reserve Bank Act and other legislation governing the Reserve Bank

A further issue that requires fundamental change is the responsibility for administering the Reserve Bank Act and other legislation governing the Reserve Bank’s statutory powers, such as the Insurance (Prudential Supervision) Act. Oddly – and wrongly – these Acts are administered by the Reserve Bank. This means that the Reserve Bank has responsibility for undertaking reviews of these laws. This is an absurd situation. No other regulatory body has such carte blanche ability to so heavily influence the reviews of their own laws. For example, the Financial Markets Authority does not administer the laws under which it operates. The Ministry of Business, Innovation & Employment does that.  Likewise, the Commerce Commission. And in Australia, Canada, United Kingdom and almost all other advanced countries, the regulator/central bank does not administer its own laws. Typically, this is done by a finance ministry, treasury department or justice department.

The current situation needs to change. It is fundamentally flawed. It creates a severe conflict of interest. The Reserve Bank will only ever undertake reviews of the laws affecting it in a self-interested and biased manner. This has proven to be the case time and time again in the past. And I should know. I was the lead Reserve Bank staffer in many changes to the Reserve Bank Act. It was never a truly objective process driven by the good of the country.  It was always tempered by governors wanting to ensure that reforms to the Reserve Bank were done in a manner that did not upset the comfortable status quo.

The Reserve Bank Act, Insurance (Prudential Supervision) Act, and all other legislation currently administered by the Reserve Bank should be passed permanently to Treasury for administration. In future, all legislative reviews – major or minor – should be led by, and the ultimate responsibility of, Treasury. The Reserve Bank should obviously be closely consulted in any such review. But the pen must be held by Treasury.

Performance reviews of regulators and broader things

Finally, in this article, I want to commend to the government the idea that the Reserve Bank and other financial sector regulatory agencies should be subject to periodic independent performance assessments. This has never happened in New Zealand, yet it is a fairly common practice in many countries. In Australia, for example, there have been many government-initiated reviews of the financial system – most recently the Royal Commission enquiry into market conduct issues.  Before that, there was the Financial System Inquiry, the Wallis review and the Campbell review, among others. All of these reviews included assessments of the regulatory authorities. They all led to major changes – for the better.

The Australian Royal Commission has recommended that a separate government agency be established to undertake performance reviews of the financial regulators and that the regulators be subject to capability assessments every four years. The Australian government has just announced that the Australian Prudential Regulation Authority (APRA) will shortly undergo a capability review.

And what about New Zealand? What kind of reviews have occurred here? None, is the answer, aside from the current review of the Reserve Bank. And that review – oddly – is being co-led by Treasury and Reserve Bank. It is not a truly independent review.

Despite decades of regulatory failures or periodic financial institution failures, successive New Zealand governments have rested on their posteriors. No action has been taken of any truly independent nature. The closest we have had to independent assessments of the financial sector regulatory arrangements is by the International Monetary Fund through the Financial Sector Assessment Program assessment in 2003 and 2017.

What is needed is a fundamental, independent review of the financial system regulatory framework once the current review of the Reserve Bank has been completed.  It should be a broad-based review that freshly assesses the financial sector regulatory architecture in New Zealand, the allocation of regulatory responsibilities, the adequacy of prudential regulation, the adequacy of market conduct regulation, and the framework for regular assessments of regulator performance. In parallel, I would recommend that the government take a leaf out of the Australian book and require the financial regulators in New Zealand to be subject to regular capability and performance assessments by independent reviewers appointed by the government.


*Geof Mortlock, of Mortlock Consultants Limited, is an international financial consultant who undertakes extensive assignments for the International Monetary Fund, World Bank and other organisations globally, dealing with a wide range of financial sector policy issues. He formerly worked at senior levels in the Australian Prudential Regulation Authority and Reserve Bank of New Zealand.

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48 Comments

Or how about we just have sound money and let people determine their outcomes rather than a overly complex centralised authority?

I can’t help but feel that particularly in the western world “the emperor’s new clothes” are about to be pointed out for what they are.

Isn't a 2% inflation target just Modern Marxism dressed up in nice clothes? Designed to transfer wealth and power to politicians and bureaucrats in government for the purposes of their pay and pensions? They know best?

As Keynes himself put it:
Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

https://www.pbs.org/wgbh/commandingheights/shared/minitext/ess_inflation...

2% for the 1% in my opinion if you catch my drift.
Not quite how central banks were sold to pollies and the public though. They whispered in politicians ears that they could create money that wouldn’t cost them anything for them to buy votes with - they told the public they could prevent boom and bust cycles. Genius really, evil genius and here we are trapped on a path to nowhere while “experts” continually justify their actions and make out they are achieving their objectives.
As for the politicians pay and pensions, they clearly understand how the game works seeing how their pay seems to rise all the time to account for inflation.

I'm not convinced the politicians are as much to blame as we think. They have less freedom of action than might appear and have to deal with the effects of past mistakes. Very few have any grasp of double entry bookeeping, and without that, how can they hope to understand finance? You have to use the appropriate mathematics, and Pacioli's seems to work.

Interestingly, economists seem to fawn over Newton's calculus but ignore his insight into the necessity of a system of measurement that is as independent of manipulation as possible when it comes to money. Calculus makes their equations look clever and the transformation of those equations as deeply meaningful and scientific. A bunch of integrals will do that, but the equation is only as good as the assumptions on which it rests. Newton devised a monetary system designed to provide a consistent measure of value based on NOT CHEATING.

I guess for economists like most people, if the look hard enough the will see what they want to see not what is really there. Simple common sense tells us that a measurement system should be free from manipulation but hey, how else are certain people going to rent seek.

Interesting about our pollies not knowing how our money system works but your probably on to something. If most of the general public doesn’t know then why would I expect people elected to.

How’s about a change in the way monetary policy is set? I.e from interest rate targeting, to either setting policy over the exchange rate (yes I’ve heard the Singapore argument), or a switch to targeting the monetary aggregates.

How about just printing 3% more notes each year and let the market work out the appropriate interest rate rather than it being artificially set by an organisation that seems less and less in tune with the economy every day.

Perhaps there should be an investigation into why the OCR is being operated at an emergency level when there's no emergency?

If anything, the OCR should be lower. The RBNZ have failed to hit even the mid-point of their legislated inflation target for 7+ years. In addition, the exchange rate is as important as the OCR and 1.05 against the A$ is historically very strong.

Perhaps lowering it simply has not achieved that aim. Will repeating the same act but even more achieve it, or only inflate bubbles further? We've seen asset bubbles being blown, but not a great investment in productive business or this recycling into growth in the economy.

That's why it's not lower, but by far and away the biggest determinant of a mortgage rate is the banks credit charge and that has been widening. The OCR will be cut, it's inevitable.

If it ain't broke don't fix it. If anything halve the number of staff at the RBNZ and have the OCR set by a simple programme:

If CPI > 2.5% increase OCR 0.25%; If CPI < 1.5% decrease OCR by 0.25%

Job done.

why can't the market set interest rates?

Because inflation is not a primary target for the market. However it is for the Government.

I don't see how that matters.
Interest rates in a free market sense are primarily determined by the demand for money.

we are being driven off a cliff.

'Being An Economist Means Never Having To Say Deflation'

https://www.alhambrapartners.com/2019/02/11/being-an-economist-means-nev...

Being a Neo-Keynesian economist means never saying deflation.

Hyper inflation and deflation are not good. Current Governments don't like it. Start up your own party if you want.

Yes. But andrew specifically said "why can't the market set interest rates".
That would imply that inflation is largely an arbitrary consideration as price increases and decreases are underpinned by production.

Which I answered.

Okay. You don't understand the point.
Seems that 'fact checking' brain of you needs to read up on the implications of andrew's original comment.

More yapping. You're like the village idiot who buts into a conversation with nothing to contribute and everyone nods their head until you go away. You must see this in your daily life or are you as clueless there as here?

If me, the village idiot, got Andrew's point, and you couldn't understand it... What does that make you?
#justsaying

I know you are you said you are but what am I!... Village idiot status confirmed.

Seriously, you are probably an awkward person in social settings in the real world. You can get help with that which may make your life better. You might be able to find a partner and get some friends. You should look into finding some help and support.

I don't need to go out for two reasons:
1 - The graphics are shit outside.
2 - It's so much more fun and intellectually satisfying to stay inside and fact check the self proclaimed fact checker.

Angry, bitter a dumb... You have my pity.

Even a small amount of inflation compounds into a big deal. Deflation just corrects past mal-investment, asset bubbles etc. The government has been a disaster at setting rates.

In the EU ZIRP is driving them off a cliff, as growth stalls and starts to reverse.

https://northmantrader.com/2019/02/11/rant-alert/

That is an epic rant, I must say.

And worth the read, Thanks AndrewJ

Oh god, not northman. Last time I checked he got short US stocks in 2011 and rode bull market all the way up.

The whole process of monetary policy is to smooth output volatility. Your solution would increase it and be reactive 18 months too late. You need forward looking mechanisms that lie somewhere between reactionary and speculative toward future developments.

All the staff and so called professionals at RBNZ failed to hit the target more often than not so I will back my simple programme

Yea. You would fail.
Miserably. Utterly embarrassingly.

You aren't as smart as you think.

From the person who just replies to other peoples comments with snide redundant remarks. Quite sad really.

I just thought you'd appreciate the 'fact checking'.

The RBNZ is probably the best central bank in the world. The country is indebted to everyone who works there imo

They have guided a small open trading economy through some pretty treacherous waters over the last few decades. They are very well respected internationally with good reason.

From March 2014 RBNZ jumped the gun and increased OCR from 2.5% to 3.5%. Took them 9 months to admit they were premature in calling an end to the GFC when they finally started dropping the OCR down to in June 2015 until the current historic low of 1.75% was hit in November 16.

My programme would've done a better job and not prematurely added 1% to the OCR thereby avoiding a lot of pain and suffering imposed on borrowers and the economy in general.

Anyone singing RBNZ's praises obviously wasn't a borrower at that time.

Wait. So you are saying that the RBNZ jumped the gun in 2014?

But you are advocating your 'programme' which would have raised the OCR in 2011 when headline CPI was ~4%?

See an issue here, or do I have to spell it out?

Spell it out. I need a good laugh.

Well, HG.
Integers are countably infinite and follow successively from one another. i.e. the higher the number, the more it's value.
When we say 2011, it implies that all numbers to the right of it on the number line are greater than it. This implies that 2011 is less than 2014. Or, it the case of time, 2011 occured before 2014.

Now you said the RBNZ were premature in raising the OCR and that your algorithm wouldn't have at the same point in time. However, your algorithm would have triggered an OCR raise before the (premature) RBNZ in 2011 when the headline CPI was above your threshold.

Put simply logic would imply that your algorithm is shit, by even your own standards.

Wrong. Try again.

You sound like a sad Panda.

Cheer up. I'll give you as many chances as you want to put forward an argument.

Yawn. I was. Also it is not uncommon for a central bank to purposefully tighten a cycle, before an easing cycle begins.

Nah man.
Not by a long shot.
But they will be the best once they adopt HeavyG's retrospective binary approach to inflation targeting.

The reserve bank is reading his comments with their hands trembling at his raw power.

It is broke. Paying half your 2 salary household income to the bank for 30 years is usury whether it seems like it or not. Doesn't really matter if the interest rate is 4% a house that costs 10x income or 20% on a house that costs 3x income. Either way we're giving banks a license to steal by creating debt from a computer.
Also the LVR regulations are a joke when you essentially let the banks' best mates (valuers) arbitrarily determine the value of 'V'. Imagine a game of doubles tennis where the front player pushes down the net every time the bank serves a debt ball.

.