Grant Spencer: Taking stock of financial sector regulation
Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to the
New Zealand Banker's Association, Auckland 22 July 2014.
* * *
Introduction
Thank you for the opportunity to meet with you this afternoon.
I want to talk today about an important initiative at the Reserve Bank- to undertake a
stocktake of our regulatory framework for banks and non-bank deposit takers.
There has been a considerable amount of financial sector regulation in recent years, both
globally and locally in New Zealand. In large part this has been a response to the major
financial and economic costs of the global financial crisis.
While the New Zealand banking system fared relatively well in the GFC, the unprecedented
severity and scope of the financial shocks made it clear that the prudential regulatory regime
needed to be strengthened, and that this should be coordinated on a global front.
Five years on from the GFC, with most of the Basel III regime in place, we now have a
considerably stronger prudential regime which we are broadly happy with. But it is also more
complex and it has expanded at a rapid pace.
We feel it is now opportune to take a step back and review where we have got to. We want to
make sure that the reforms meet their intended objectives, are efficient and do not create
misplaced incentives or impose large compliance costs that could outweigh the broader
benefits of the reforms to society.
Our aim here is not to fundamentally change or roll back the regulatory framework. We want
to shape and thin the stock of regulation, not undertake a major reformulation of the system.
I will set out the context and motivation for the review and then discuss how we will go about
it. But first we should remind ourselves why we have financial sector regulation.
The role of financial sector regulation
The Reserve Bank's prudential framework plays an important role in New Zealand's
economy. Its objective is to promote the maintenance of a sound and efficient financial
system. In the case of the insurance regime, the objective is a sound and efficient insurance
sector. Prudential regulation is necessary to achieve these objectives because of the
existence of significant externalities in the financial system.
The externalities are costs to the broader economy and society that are not taken into
account in the commercial decisions of financial institutions. The interests of banks and
NBDTs can differ from those of society at large. For example, they may face incentives to
increase leverage and risks in the expectation of achieving higher returns, without bearing all
the costs if things turn out badly. Banks in particular sit at the heart of the payment system so
a bank failure can quickly spread and affect people and businesses who are not direct
customers of the failed bank. These externalities can be significant- we estimate the
potential cost of a serious financial crisis to be between 10 and 20 percent of GDP.1
The international expansion of regulation
The concerted effort of the major economies to bolster the global banking regulatory regime
post-GFC has been coordinated within the G20 and associated bodies - specifically the
Basel Committee on banking supervision (BCBS) and the Financial Stability Board (FSB).
The emphasis of the reforms has been focussed on the large internationally active banks
based in the G-20 economies. However, the reforms have been broadly implemented across
most domestic banking systems. The growth in Basel Committee publications since the GFC
is shown in Chart 1.
New regulation under the broad banner of Basel III has generally been prescriptive in order
to maximise international consistency and minimise the scope for regulatory arbitrage. This
has contributed to an increasing complexity in financial regulation as new regulations have
attempted to accommodate differences between the major banking systems. For example,
Basel I (the first international capital standard in 1987) was 30 pages in length, the Basel II
standard 347 pages, and the new Basel III standard 616 pages.2
Further complicating the international regulatory environment have been the extensive
"domestic" reforms of the US and EU3 which have major extra-territorial implications for
international banks based in the US/EU and, importantly, for banks dealing with US/EU
banks.
New Zealand's approach to the evolving international framework
New Zealand is not a member of the Basel Committee or the FSB/G20 and as such is not
obliged to follow the Basel rule book. However, we agree with the underlying rationale of the
international reforms. New Zealand banks did not suffer a serious credit shock in the GFC
but we saw how quickly bank capital could be eroded in global financial institutions. And our
banks experienced real difficulties in funding and liquidity management that required official
support. We have therefore acknowledged the need to increase the safety of the financial
system by enhancing the prudential regulatory regime.
Given that Australia is a member of the G20 and BCBS, the parents of our major banks are
required to comply with Basel Committee standards. Further, New Zealand is a debtor
country that has relied on the major banks to fund its current account deficits over many
years. The access of the banks to the international capital markets could be hindered if they
were seen to be non-compliant with the key Basel and FSB standards.
In short, as a small debtor country hosting foreign banks and reliant on international capital
markets, we cannot afford to be too far removed from the Basel tent. I note that the current
Australian Financial System Inquiry has recently reaffirmed this same position for Australia4.
Over the past five years we have reviewed the emerging Basel III reforms and shaped our
financial regulations to suit New Zealand circumstances. This has been something of a
balancing act. We have not adopted all the Basel reforms (for example we have not adopted
the leverage ratio) and we have introduced some policies that differ from the Basel standards
(for example the Reserve Bank's liquidity standard, BS13), in order to better reflect New
Zealand conditions.
In doing this, our general approach to prudential standards has been relatively conservative,
and we have tended to be early rather than late adopters of the new standards.
A conservative approach to standard setting is consistent with our governance based
approach to supervision. Under the New Zealand model, the responsibility for implementing
the standards is very much sheeted home to the directors and executives of the regulated
institutions. The Reserve Bank's supervisory engagement with the banks is focussed on
governance, strategic direction and risk management. It is not based on in-house reviews to
check compliance with the standards.
Non-bank regulatory frameworks
Outside of the banking sector, the Reserve Bank's role as prudential supervisor has
expanded into new areas, largely due to domestic rather than international considerations.
New Zealand suffered a major series of failures in the finance company sector, with
45 finance companies entering into liquidation, receivership or moratorium between 2006
and 2011. Legislation providing for the prudential regulation of non-bank deposit takers
(NBDTs) was first passed in 2008, and substantially came into effect in 2010. More recently,
additional legislation was passed last year providing for the licensing of NBDTs by the
Reserve Bank.
Our broad approach to NBDT regulation is based upon a version of the regime for registered
banks, with generally less demanding standards that are tailored to the circumstances of the
NBDT sector. Trustees are responsible for the day-to-day supervision of NBDTs, while the
Reserve Bank regulates the sector, and sets and enforces prudential requirements.
New Zealand's insurance sector was also very lightly regulated until legislation was passed
in 2010. The goal of the new regulatory framework was to reduce the potential impacts on
policyholders of an insurer failing, and diminish the broader impact on the economy in the
event of more widespread problems in the insurance sector.
We have since licensed 100 insurers, and are developing a framework for the day to day
supervision of licensed insurers. Our regulatory approach is based upon the three pillars of
self, market and regulatory discipline, and seeks to combine international standards and the
particular characteristics of the New Zealand insurance sector.
While the NBDT regime is in the scope of the regulatory stocktake, we feel the insurance
regime is too recent to be included. We are however, reviewing insurance solvency
standards as a separate exercise.
Motivation for the stocktake
In light of the international trends and the approach we have taken in New Zealand to
financial sector reform, why do we need to undertake a review?
First, it is sound practice to review a regulatory regime from time to time, particularly where it
has been subject to rapid change. We need to review whether the regulation and the
processes we follow are as rigorous, transparent and fair as they should be.
Second, the burst of post-GFC regulation, particularly around capital adequacy, has
produced a layering of requirements on top of the Basel II reforms that were finalised in
2008. A fresh look at the body of regulation in each key area should offer scope for
simplifying the framework, including the removal of redundant regulations.
Third, we need to step back and look at the consistency and coherence of the whole
regulatory regime. For example, do the changes to capital and liquidity requirements have
implications for the prudential policies in other areas such as disclosure or governance? Is
our alignment with international standards appropriate? Do we have a consistent approach
between banks and non-banks?
Improving the efficiency, clarity and consistency of prudential standards
In reviewing the specific prudential requirements applying to banks and NBDTs, our objective
is to improve the efficiency, clarity and consistency of these requirements.
Efficiently designed regulatory requirements should achieve their objectives while minimising
compliance costs as far as possible. Some of the questions we will be asking about the
efficiency of existing requirements include:
• Are all of the prudential requirements necessary to maintain a sound and efficient
financial system?
• Do the requirements serve their original purpose? Should they be cut back,
removed, or replaced?
• Does alignment with international standards or the requirements of other
jurisdictions help to improve efficiency by avoiding the need for banks with foreign
parents to comply with multiple sets of rules?
We also want to make sure that the prudential requirements applying to banks and NBDTs
are as clearly presented as possible. In particular, the Banking Supervision Handbook has
evolved organically over time and this has inevitably resulted in some aspects of the
Handbook not being presented as logically and coherently as we would like.
The scope of the review
Included in the scope of the review will be the regulatory documents, regulations and
legislative provisions containing the prudential requirements for banks and NBDTs.
For banks, this means all of the standard conditions of registration, guidance and Orders in
Council that make up the Banking Supervision Handbook, and that contain requirements
relating to everything from capital to OBR pre-positioning.
For NBDTs, it means the regulations and legislative provisions that establish their specific
prudential requirements.
The project will not be looking at changes to the Reserve Bank Act itself, or the recently
enacted Non-bank Deposit Takers Act 20135. As such, it will not be looking at the
supervisory approach adopted in the two sectors, or the matters that were considered as part
of the review of the prudential regime for NBDTs that we undertook last year, such as the
role of trustees in NBDT supervision.
The key planks of the prudential framework will not be revisited, including the need for banks
and non-banks to: hold sufficient capital; maintain sufficient liquidity; implement robust risk
management systems and policies; and have strong governance regimes.
A full list of the key planks is included in the terms of reference for the project that were
published on the Reserve Bank's website this afternoon.
As noted earlier, the stocktake will also exclude the insurance regime, although a separate
review of the insurance solvency standards is currently underway and will consider many of
the same themes around efficiency, clarity and consistency. The broader insurance regime is
too young to include in the review.
The process for developing prudential regulations
The second part of the stocktake will review the processes we use for developing prudential
regulations. This will extend to how we identify potential threats to financial stability, how we
assess actual versus intended effects of policies, and our approach to communications. I
know that many of you will have views on these matters.
Consultation periods are another matter that we will be looking at closely. Over the last three
years we have carried out approximately 25 consultations relating to the banking sector, with
the average consultation period being four to six weeks (although the shortest consultation
period was three weeks and the longest six months).
We want our general approach to the length and nature of industry consultation to be
consistent and transparent, although there may still be occasional instances where the need
to move quickly may force us to shorten the timeline.
Co-ordination of policies with other government departments and agencies with an interest in
the banking or NBDT sectors is clearly important.
Many of you here will be aware that the Reserve Bank is a member of the Council of
Financial Regulators (along with Treasury, MBIE and the FMA) that meets quarterly to
discuss work programs and emerging issues.
The Council has recently established a subcommittee, called the banking forum, which is
intended to help ensure that government agencies see the big picture of regulatory initiatives
affecting the banking sector at any given time. The exchange of information at the forum will
help agencies to sequence regulatory reforms and consultations so that pressures from
bunching are avoided.
Process for carrying out the stocktake
We are enthusiastic about the stocktake project, and believe it can lead to positive outcomes
for the public, the Reserve Bank, banks and NBDTs, and other stakeholders.
We anticipate that the project will take about 12 months, and involve several stages as set
out in the indicative timetable below:
Indicative timetable
Stage 1 Initial Scoping
Industry workshop / discussions with industry bodies/ Establishment of Late July 2014 - Early August
expert panel 2014
Stage 2 Formulation of draft proposals
RBNZ and expert panel analyse bank and NBDT prudential
August 2014 - February 2015
requirements
Industry workshop / discussions with industry bodies October 2014
Industry workshop / discussions with industry bodies February 2015
Stage 3 Public Consultation and Conclusion
Discussion document prepared March 2015 - April 2015
Discussion document out for comment May-June 2015
Industry workshop / discussion with industry bodies May 2015
Analysis of submissions and formulation of draft proposals July 2015 - August 2015
Industry workshop / discussions with industry bodies Late August 2015
Conclusions finalised, Summary of submissions and report on
September 2015
conclusions published
The first stage will scope ideas that should be considered as part of the stocktake. As part of
this process, we will shortly be holding a workshop with industry participants.
The second stage will be the detailed formulation of draft proposals. This will last from
August through to March next year. As part of this stage of the project, we are proposing to
hold two further workshops with industry around October and February. We will also be
assembling a small panel of financial regulation experts (from outside the banks themselves)
to help formulate draft proposals.
The third stage of the project will involve a public consultation on the proposals. It will seek
input from all stakeholders, after which specific changes will be agreed upon. We expect to
hold workshops with industry during this stage.
Ahead of the workshops, one thing I would like industry to think carefully about is how they
assess regulatory costs. Different banks and people within banks give us different
perspectives. For some the impact on directors work programmes is the main issue; for
others it is the cost of capital; for others it is the resources tied up in consulting on and
implementing regulatory change.
Keeping in mind that the fundamental building blocks of conservative capital, liquidity, risk
management and governance are taken as given, we would be interested in industry views
on what one or two big things would really increase the efficiency and effectiveness of the
regulatory regime.
Conclusion
To sum up, the Reserve Bank is committed to delivering a world-class regulatory framework.
That means one that fully supports the soundness and efficiency of the New Zealand
financial system, and is lean, easy to use and as cost-effective as possible.
The non-bank sector had serious issues earlier on which led to a strengthening of regulation
in that sector. However, the banking sector came through the Global Financial Crisis in very
good shape by international standards, which is a testament to the industry and to the
regulatory environment. It is important though that we work to continuously improve the
regulatory framework. We look forward to working with you all towards that end.
Thank you.