A description of New Zealandâ€™s internationally unique approach to banking supervision to the Centre for the Study of Financial Innovation in London
Thank you for inviting me to speak to you today.
The subject of my address today is the new approach which New Zealand has adopted to the supervision of its banking system. As some of you may be aware, this has attracted considerable interest around the world, not least for the emphasis it places on market disciplines as a means of promoting a robust banking system.
Before I outline the new approach to banking supervision, I think it would be useful to put the supervision reforms into a broader context.
As you probably know, New Zealand is no stranger to financial innovation. Over the last decade or so, the New Zealand financial sector has undergone a sweeping set of reforms. Briefly, these have included:
These reforms have played an important part in the broader restructuring of the New Zealand economy. And they have resulted in New Zealand having one of the least regulated financial sectors in the world.
It is not surprising, given this background, that sooner or later, banking supervision policy would be reassessed. Indeed, the recent reforms to banking supervision very much complement the general pattern of financial sector liberalisation in New Zealand.
In order to understand the new approach to banking supervision in New Zealand, it is helpful to know a little of our former supervision framework.
For most of the period from 1987 to 1995, New Zealand's approach to banking supervision was relatively orthodox. It involved:
However, the former system of banking supervision differed in some important respects from the approaches adopted in many other countries. In particular, New Zealand's supervisory framework:
These distinguishing features continue to apply under the new supervisory framework.
So, why did we review our approach to banking supervision? The review was motivated by a number of concerns. I will briefly outline the more important of these.
After a lengthy period of review and consultation, the new banking supervision arrangements came into force on 1 January this year. The new arrangements seek to address the concerns just outlined, by increasing the role of market disciplines in New Zealand's financial system.
Under the new approach, New Zealand's banking supervision objectives remain essentially unchanged. Supervision seeks to maintain a sound and efficient banking system and to minimise damage to the system that could result from a bank failure. We remain of the view that it is unnecessary and inappropriate to protect depositors or to provide deposit insurance. However, the way the Reserve Bank seeks to meet those objectives has indeed changed.
Probably the most important feature of the new banking supervision framework is the public disclosure regime under which all banks in New Zealand now operate. This requires all banks to publish quarterly disclosure statements, containing comprehensive financial and risk-related information.
The disclosure framework has a number of features. I will not mention them all, but some are worth highlighting.
- An important feature of the new framework is the quarterly Key Information Summary. This is aimed principally at depositors and contains a short summary of key information on the bank, including:
- The Key Information Summary must be displayed prominently in every bank branch. We are hopeful that it will provide depositors and others with more focused and timely information than has previously been the case.
- Banks must also publish a larger disclosure document quarterly, which is aimed principally at professional analysts and the financial news media. It contains detailed information on the bank and its banking group, including:
- The disclosure statements must be externally audited twice a year, although the half year audit is only required to be of a limited review nature.
- Perhaps one of the most important features of the disclosure framework is the role it accords bank directors. The directors are required to make certain attestations in the disclosure statements, including whether:
- In addition, the directors (or their appointed agents) must sign the disclosure statements as being not false or misleading. Directors face severe criminal and civil penalties (including up to three years' jail and personal liability for creditors' losses) if a disclosure statement is held to be false or misleading.
The disclosure regime has enabled the Reserve Bank to remove a number of prudential regulations. These include the limits on banks' lending to individual customers and on open foreign exchange positions, and the Reserve Bank's former external audit requirements in relation to banks' control systems. We believe that the market disciplines created by enhanced disclosure have obviated the need for these types of regulation.
While the emphasis on market disciplines through disclosure lies at the core of the new approach, it is important to note that the Reserve Bank continues to have responsibility for supervising the banking system. In that regard, a number of the Bank's core functions have not been significantly altered.
We believe the new approach to banking supervision offers some important advantages over the former system.
In contrast, substantial reliance on conventional supervision can create serious impediments to financial market innovation and efficiency, can reduce the incentives for banks' directors and managers to take responsibility for the management of their banks, and can increase the risk of moral hazard.
Before concluding this address, I think it would be useful to make a few comments on some of the reactions we have had to the banking supervision changes.
All in all, I believe that the new approach has been relatively well accepted, both in New Zealand and internationally. But it has taken time for that acceptance to be achieved. It is fair to say that, during the review process, reservations about the new approach were expressed from a number of quarters.
One of the observations made has been that New Zealand is "free riding" on the efforts of the home supervisors - ie the supervisors of the parent banks of the banks operating in New Zealand. We firmly reject this notion. It is certainly true that any host supervisor will - inevitably - rely to some extent on the global supervision of the home supervisor. After all, this is an intrinsic part of the Basle Concordat. No matter what supervisory arrangements a host supervisor puts in place, the host supervisor is very limited in the extent to which it can meaningfully influence the financial soundness of an international bank, particularly where the local operation is a branch of the overseas bank. But it can ensure that the local operation is adequately supervised within these constraints. Indeed, this is the host supervisor's obligation under the Basle Concordat. I have no doubt that the New Zealand supervisory framework is just as effective - and probably more so - at promoting sound management practices in the New Zealand operations of international banks, as the more conventional supervisory approaches.
Another observation frequently made is that New Zealand would not have adopted the new supervisory framework had a substantial part of its banking system been domestically owned. I cannot prove that our approach would have been politically feasible with a different ownership structure. But it is my firmly-held conviction that we would be adopting this approach even if most of our banks had been locally-owned, because we believe, quite strongly, that the regime is actually more likely to promote prudent banking behaviour than the conventional approach. In this context, I should note that, at the time we commenced our review of banking supervision, in late 1991, a significant part of the New Zealand banking system was still domestically owned.
Some observers have suggested that our approach places an excessive emphasis on the role of bank directors - that we are asking too much of them. To illustrate this point, some months ago, I had a visit from the chief executive of one major international bank with an operation in New Zealand. He had come to protest strongly at the requirement that bank directors would have to sign the disclosure statements every quarter, and attest to the appropriateness of their risk control systems. When I asked why, he said "... bank directors understand absolutely nothing about banking...". This comment is quite unfair about many bank directors, of course, but there is an uncomfortable element of truth in it in some cases. The blame for this situation almost certainly lies in part on a supervision regime which has assumed too much of the responsibility for the viability of banks. We very much hope that a regime which will continue to have some key regulations, but which is based primarily around market disclosure and director attestations, will improve that situation.
Another area of concern was the effect our disclosure regime might have on the parent banks of the banks operating in New Zealand. Some banks were concerned that quarterly disclosure in New Zealand might effectively force parent banks to also issue quarterly disclosure statements. We are not actually aware of any such pressures, although of course it is still early days under the disclosure framework. But I must say that we would feel no discomfort if parent banks do come under pressure to issue quarterly statements in their home countries. From a supervisor's perspective, and from the perspective of depositors and others, more frequent and higher quality financial disclosures by parent banks would be thoroughly welcome.
Overall, I am confident that the new supervisory framework - with its partnership between supervision and market disciplines - will serve New Zealand well in the future. I have no doubt that it will make a significant contribution to the ongoing soundness and efficiency of New Zealand's financial system.