What is the Reserve Bank's role in relation to prudential supervision of banks?

In a recent Herald article1, Governor of the Reserve Bank Dr Alan Bollard discussed the Reserve Bank's broader banking regulation and supervision goals and processes.

Registration and supervision regime

Dr Bollard considers that there are three main ways in which the Reserve Bank implements its registration and supervision regime:

• Self regulation
  
  Responsibility for risk management is placed on each bank's board and senior management as this is where risks are best identified and dealt with. This is achieved through compulsory disclosures and director attestations as to the bank's financial position, capital adequacy and risk management, complemented by an external audit.
  
  
• Disclosure
  
  Because banks rely on public confidence, the Reserve Bank requires disclosures that ensure the public has access to relevant information about the health of New Zealand banks, including their credit ratings.
  
  
• Capital adequacy and other specific rules
  
  Specific prudential requirements, including minimum capital ratios, limits on credit exposures and some corporate governance rules.

Reserve Bank consent now required to purchase a significant stake in a New Zealand bank

A regular consultation regime is in place, with powers to obtain information, give directions and, where necessary, appoint a statutory manager or de-register a bank. Dr Bollard accepts that experience around the world indicates that no country is immune from banking failures and notes that the Reserve Bank must be prepared to deal with a bank failure in order to avoid significant damage to the financial system.

Under the Reserve Bank of New Zealand Amendment Act, prospective purchasers of 10 per cent or more of a registered bank are required to obtain the written consent of the Reserve Bank. Significantly, the Reserve Bank has the power to impose conditions on any consent granted and it has recently been developing its policy in this regard. It has considered the following factors:

• In order to ensure additional strength from a local board of directors and greater certainty about location of assets and liabilities, implementing a requirement that systemically important banks must be locally incorporated.
  
  
• A systemically important bank must be able to operate as a going concern if its parent, or another of its service providers, fails. The Reserve Bank is working on how best to achieve a situation where the board or a statutory manager will have access to sufficient management resources to be able to operate the bank independently in this situation. It may be that director attestations, third-party independent reviews and disclosure requirements will achieve this.
  
  
• Investigating ways of ensuring that taxpayers' funds are not resorted to in the event that a systemically important bank makes large losses and exhausts its capital – one option includes “haircutting” its creditors (including depositors).
  
  
• Ways of reducing the probability of failure by further enhancing the strength of New Zealand banks – one option noted would be to impose higher capital requirements.

The concerns reflect the fact that all but two of New Zealand's registered banks are owned offshore and, in the event of a failure, the Reserve Bank may have little ability to influence a restructuring process (for example, if the information systems for the bank are managed offshore).

The Australian Banking Act provides that, if an Australian incorporated bank fails, its assets must be allocated to the bank's deposit liabilities in Australia in priority to all other liabilities. Dr Bollard notes that this could put a New Zealand depositor at such a bank, or at a New Zealand branch of the bank, in a less favourable position. The Reserve Bank is managing this issue in the following ways:

• Systemically important banks must be locally incorporated.
  
  
• Investigation of an “enhanced branch” structure, that might replicate the protections provided by local incorporation.
  
  
• Discussions with Australian officials concerning the relatively recent closer integration of Australia and New Zealand's financial sectors and the implications for each country's regulatory frameworks. Dr Bollard considers that there is a possibility that a more integrated trans-Tasman approach to banking supervision and crisis management may emerge, but notes that, in the meantime, the Reserve Bank is continuing to progress New Zealand's own options.

1. The New Zealand Herald, 2 October 2003

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