Alan Bollard: Supervising overseas-owned banks: New Zealand's experience
Address by Dr Alan Bollard, Governor of the Reserve Bank of New Zealand, to the Trans-Tasman
Business Circle, Sydney, 11 August 2004.
* * *
In many respects the Australian and New Zealand economies are similar. With banking, however,
there is a big difference - the New Zealand banking system comprises banks owned overwhelmingly
from abroad, whereas in Australia the banks are mainly Australian-owned.
Of course, the main overseas-owned banks in New Zealand are Australian-owned banks and, in this
sense, it might be said that banking is another thing we have in common. But that would be to
overlook that banking authorities in countries with predominantly overseas-owned banks face some
additional, and different, issues from those in which the banks are mainly locally-owned.
These differences include different roles in the supervision of banks, depending on whether one is the
supervisor of the "home" country parent bank, or, as is predominantly the role of the RBNZ, a "host"
supervisor of overseas-owned banks.
More broadly, and more importantly, for a country whose banking system comprises predominantly
overseas-owned banks, there are different issues concerning the capacity of its banking system to
weather a crisis. In this regard, overseas ownership can be both an undoubted strength, but also a
potential risk.
There are also issues concerning the depth and breadth of financial services that overseas-owned
banks provide to the local economy. In New Zealand we are a very welcoming host of
overseasowned banks, but we also look for our "guests" to be good guests, and to make a positive contribution
to the New Zealand economy.
A number of things have happened recently to raise interest in these issues. First, there has been the
take-over by the ANZ of the National Bank of New Zealand, previously owned by the British bank,
Lloyds TSB. This means that about 85 per cent of New Zealand's banks, measured by total assets,
are now Australian-owned. Australia and New Zealand also now share the same "big four" banks. The
ANZ owns the merged ANZ National in New Zealand; NAB owns the BNZ; the Commonwealth owns
ASB; and Westpac in New Zealand trades as a branch operation.
Second, early this year the New Zealand Minister of Finance and the Australian Treasurer put
trans-Tasman banking supervision on the initial agenda of issues for working towards a single
trans-Tasman economic market. The other issues identified for consideration were accounting
standards and competition policy. On banking supervision, Ministers commissioned New Zealand and
Australian officials to report jointly on trans-Tasman mutual recognition and harmonisation possibilities.
This process is now well advanced, with a report currently before Ministers. I expect that Ministers will
be indicating soon the direction to be taken.
Third, there have been issues in New Zealand in relation to the seemingly small amount of tax the
banks have been paying.
And this has all been happening at a time when the RBNZ has been seeking to reinvigorate the
regulatory arrangements for New Zealand's banking system, to give it more resilience in times of
financial stress. This has been behind our policies to require systemically-important banks (and some
others) in New Zealand to be incorporated in New Zealand, that better ensure effective banking sector
corporate governance, and that place some constraints on banks out-sourcing key operations.
I will say more on these policies, and on our approach to banking supervision in New Zealand more
generally, in a moment, but before doing that I would like to provide some context. Banking
supervision policy needs to be viewed against the backdrop of the importance of the role of the
banking system in the economy.
Why the banking system matters
Banks play a key role in mobilising and allocating the economy's resources - mobilising from those
who, for the meantime, have surplus resources, and allocating to where resources can be put to best
use. This role is particularly important for meeting the funding requirements of growing small- and
medium-sized firms, given that these firms have limited abilities to access funding directly from the
securities markets, or from abroad. With SMEs comprising a large share of the New Zealand
economy, as is also the case in Australia, this makes the banking system important for the economy's
growth prospects.
Equally as critical is the role banks play in the payments system. The overwhelmingly-used means of
payment these days is the bank deposit, whether it be to pay for the groceries, to pay wages, to make
settlement on a property transaction, or to settle dealings in the wholesale financial markets. And we
use a number of bank-provided systems to make these payments. These include EFTPOS, cheques,
telephone banking, and internet banking.
If it were not for the fact that a small number of banks dominate the banking system, bank failures
might not be so much of a problem. But to shut down a bank with a 20 per cent plus market share, and
thus to shut down the ability of perhaps 20 percent of the economy to access working capital and to
make payments, is quite another thing - to say nothing of the risk that one bank failure can precipitate
others, and wider financial system collapse.
Banks therefore play a critical role, but at the same time they are potentially fragile organisations. They
are different from most other firms, because their ability to operate is so dependent on maintenance of
market confidence in their financial soundness. If a manufacturing firm's solvency is in doubt, the
public generally does not suddenly stop buying the product. But if there is material doubt in the
market-place about a bank's ability to meet its financial obligations, without official intervention to
restore public confidence, it can no longer operate.
This fragility is inherent in what banks do. Their business is to take deposits and make loans, which
means that, necessarily, they are very highly geared. No other industry operates with a capital ratio as
low as 8 per cent.
And for deposit liabilities to serve as a means of payment, they need to be liquid. Hence, banks
generally have a balance sheet structure also characterised by borrowing short and lending long. With
this financial structure, the margins for error are fine and, in an uncertain and competitive
marketplace, there are always risks.
Indeed, banks on occasion do get into trouble, and probably more often than is commonly thought.
Recently in Australia, there have been some high profile incidents at the NAB. In the late 1980s and
early 1990s, both Australia and New Zealand had much more serious incidents to deal with. There
was the failure of state banks and the parlous condition of Westpac in Australia, and similar problems
at the BNZ and DFC in New Zealand. Before that, in 1979, there was the problem at Bank of Adelaide,
and both countries have experienced fringe financial institution failures.
None of this makes Australia and New Zealand unique. It is easy to find other countries that have
experienced banking system difficulties that were even more serious. Sweden, Finland and Norway all
experienced systemic banking collapses in the early 1990s, which required fiscal support in the vicinity
of 5-10 per cent of GDP. In the Asian financial crisis later in the 1990s, Indonesia, Korea and Thailand
all needed to provide fiscal support to their banking systems in excess of 30 per cent of GDP. Other
cases include Japan (8 per cent of GDP), Spain (16 per cent) and the United States saving and loan
crisis (3.2 per cent).1
And these are just the fiscal costs. The cost of bank failures is not limited to the cost of rescuing banks
or bailing out depositors. The real economy costs can be greater and longer term, including weakened
investor and consumer confidence, higher borrowing costs, potentially protracted credit contractions
and, in consequence, lower economic growth.
Given this combination of critical importance and potential fragility, no country can afford to view its
banking system with indifference. The banking system is something that is central to a nation's
economy. And that applies whether the banks are locally- or foreign-owned. Indeed, some countries,
including Australia, appear to see banks - at least the large, systemically-important, ones - as being so
central to their economy as to preclude them from being foreign-controlled.
By contrast, in New Zealand, as a matter of policy, we don't restrict foreign ownership in banks, and all
our systemically-important banks are foreign-owned. But, while we have seen no need to restrict
foreign ownership, we do see a need for regulation of overseas-owned banks so as to provide
reasonable assurance that the New Zealand banking system could weather a period of banking stress.
Sometimes it is suggested that having banks that are owned by substantial foreign-owned banks is
actually an advantage, because the foreign owners can be relied on to mount a bail out if the need
arises. While this may often be true, I think it would be imprudent to rely on such an assumption.
To be sure, experience indicates that, usually, parent banks do stand behind their overseas
operations, since not to do so could seriously undermine market confidence in the parent's own
financial position, and would involve writing off the franchise value embedded in their overseas
investment. But there will be occasions when an overseas owner is either unable, because of its own
financial weakness, or because of home country regulatory constraints, to provide that support.
These cross-border issues are something that many countries, particularly the growing number with a
significant foreign bank presence, are having to come to grips with. Increasingly we are being
confronted with the fact that shareholders, customers, and taxpayers, not only have different interests
in the banking system, but increasingly reside in different jurisdictions.
The international framework for supervision of multi-national banks
The internationally-agreed framework for the supervision of multinational banks, as devised by the
Basel Committee on Banking Supervision, is known as the Basel Concordat (not to be confused with
Basel Accord
the on capital standards for banks). The Concordat assigns clear, and deliberately
overlapping, roles to the supervisors of multinational banks in those banks' "home" and "host"
countries.
The home country supervisor is responsible for consolidated supervision of the global bank. It sets
standards to be met on a group consolidated basis, for example, that group capital is sufficient to
support the global business. (Some home country supervisors additionally set standards to be met by
the bank in its home country alone - so-called "solo" standards.) Host supervisors, that is, the
authorities in the other countries where the bank operates, are charged with supervising the bank in
their individual jurisdictions. This framework recognises the reciprocal and over-lapping, though not
identical, interests of the respective authorities, and the importance of sharing information.
As mainly a host supervisor, the prime role of the RBNZ is to promote sound banking by the
overseas-owned banks operating in "our patch". We do this mainly for our own purposes, in
recognition of the vital role of our banking system to the New Zealand economy, but there is also a
significant element of contributing to the effective supervision of the multinational banking groups of
which the overseas-owned New Zealand banks are a part.
In return, we have a close, reciprocal interest in the parents of the overseas-owned banks in New
Zealand, and in the supervision of those banks by the relevant overseas authorities. With New
Zealand's banks almost entirely foreign-owned, there is at least as large a probability that shocks to
the New Zealand banking system will originate from abroad as from within New Zealand.
RBNZ supervision for promoting banking soundness
The Reserve Bank of New Zealand, as the New Zealand banking supervisor, conducts its supervision
of New Zealand banks that are overseas-owned within this internationally-agreed framework. (In New
Zealand, unlike in Australia, the central bank is also the bank supervisor.)
The RBNZ's responsibility to supervise banks in New Zealand is prescribed in the Reserve Bank of
New Zealand Act. This Act requires us to use the powers it gives to the Bank to promote the
soundness and efficiency of the New Zealand financial system, and to avoid significant damage to the
financial system that could be caused by the failure of a registered bank.
There are three central pillars to how we promote sound prudential management by banks, including
by overseas-owned banks, in New Zealand.
First, we look to the banks themselves for self-regulation. This is about policies and structures that
promote effective governance by banks' boards of directors, including effective oversight by local
boards of the local banks' managements. We expect high standards of corporate governance from the
boards of New Zealand banks, and this expectation is reinforced by some quite severe penalties that
could apply should a bank's directors fail to properly discharge their responsibilities.
In these regards, we have observed a trend for overseas-owned banks in New Zealand increasingly to
adopt "matrix management" arrangements, under which the reporting and accountability lines of local
managements to their local boards may be weakened by direct reporting lines to overseas head-office
managements. Hence, we took the opportunity when approving the amalgamation of the ANZ and
National banks, to reinforce that the board of the merged bank must carry prime responsibility for
oversight of the bank in New Zealand. Consistent with this, we have required that the chief executive
of the bank must be appointed by, and be primarily accountable to, the New Zealand board.
We will be consulting with other systemically-important banks about the application of similar
requirements to them. We are also reviewing more generally the governance arrangements in banks
to ensure that bank boards are sufficiently empowered to oversee the management of their bank in
New Zealand and that they bear the appropriate accountabilities in performing their responsibilities.
A second pillar is market discipline. For many years, banks in New Zealand have been subject to
obligations to make quite comprehensive quarterly financial and prudential disclosures to the
marketplace. These disclosures, combined with a policy of not bailing out failed institutions, help to
strengthen market scrutiny of banks, and the market disciplines that go with that.
This is an area of policy where the RBNZ has played a leading role, although other countries' banking
authorities too are now seeing an important place for disclosure by banks as a means of reinforcing
prudential discipline. Globally, banks are making much fuller disclosures to the market than used to be
the case, and that trend will be reinforced by new international disclosure requirements being
introduced as part of the new Basel 2 capital requirements, on which I will say a little more in a
moment.
Third, we have some regulatory and supervisory requirements. Although our regulatory framework is
somewhat less intrusive than that of many countries, it nonetheless contains most of the standard
features. The IMF in its Financial Sector Assessment Programme (FSAP) review of the New Zealand
financial system last year confirmed that we have a good model for host country supervision.
The centre-piece of the regulatory requirements is a requirement that banks in New Zealand be
adequately capitalised. We apply the standard Basel I capital accord in much the same way as do
other supervisors. In the case of overseas-owned banks, we require the bank in New Zealand to be
sufficiently capitalised in its own right, with not less than 8 per cent capital. This serves two purposes.
It reinforces the responsibilities of the local board and management, since they have a balance sheet
for which they are clearly responsible. And it provides a financial buffer should the bank incur losses in
New Zealand, or should the parent bank fail and its New Zealand subsidiary have to be "cut loose".
Banking supervision and failure management
This brings me to the second element of our statutory responsibilities - to avoid significant damage to
the financial system that could be caused by the failure of a registered bank. Absolutely critical in this
situation would be that the New Zealand authorities have the ability to take control of the failed bank in
New Zealand. Without that ability to take control, and to take control quickly, we could not manage the
situation.
And in the case of a systemically-important bank, just shutting the doors generally would not be an
acceptable response. In most cases, our objective would be to maintain the provision of critical
banking services, but without resorting to a bail-out; certainly not a bail-out of existing shareholders,
and desirably not of depositors and creditors, who could expect to bear some of the losses. To
achieve those outcomes, the New Zealand authorities would need to have access to the critical
operating and information systems necessary to operate the bank, and more or less immediately on
the failure occurring.
I should hasten to add that none of this means that, in the event of a bank crisis involving an
overseas-owned bank, the RBNZ's first preference would be to act unilaterally. In most situations a
co-ordinated response involving home and host country authorities would be much preferred - from
both authorities' points of view.
But a co-ordinated response requires that both authorities have a capacity to manage the situation in
their jurisdiction. It would also be unrealistic to assume that co-ordination would always be readily
achievable, as there would be a risk that the interests of the different regulatory authorities would
diverge. This could occur if, for example, an economic shock places stress on the financial system in
one country, but not the other; or the respective regulators in the two jurisdictions have different
priorities in terms of the future of the failed bank.
This is why we focus on ensuring that we have an effective failure-management capacity in respect of
banks operating in New Zealand, including those that are owned from abroad. That in turn requires
those banks, at least those that are systemically-important, to have key systems and key management
available, either on the ground, or at least within our jurisdictional reach. This is another issue we
addressed with the ANZ in the context of the ANZ-National Bank amalgamation, and intend also to
take up with the other systemically-important banks.
Another key requirement, if local authorities are to be able to manage a bank failure, is that there is
clarity about the local bank's balance sheet, that is, clarity on what its financial obligations are, and on
what assets it has to meet those obligations. That clarity is not readily achievable for a bank that is a
branch of an overseas bank because, legally, the assets and liabilities of a branch are inseparable
from those of the overseas parent or head office. This is the main reasoning behind most countries'
requirements that systemically-important banks be incorporated locally, a requirement that now also
applies in New Zealand.
All systemically-important banks in New Zealand currently comply with the requirement to be
incorporated locally, except for Westpac. Westpac has always been a branch bank in New Zealand. It
has been engaged in discussions with us on this issue for some time, and currently has before us a
proposal under which it would "buttress" its present branch structure, in ways it believes would deliver
the policy outcomes we are seeking. However, as the proposal is still under our consideration, it would
be inappropriate for me to comment further on that alternative structure at this time.
Are these RBNZ banking supervision requirements burdensome?
Our requirements of overseas-owned banks in New Zealand are not onerous or costly for those banks.
Let me explain why not.
First, there is nothing in what we require that APRA would not require of an overseas-owned bank that
was systemically important to Australia. I say "would not" because Australian policy to date has
precluded systemically-important overseas-owned banks in Australia.
Second, the Reserve Bank of New Zealand Act requires that we promote the efficiency as well as the
soundness of the New Zealand financial system. This is a responsibility we take seriously, and it is
reflected in what we do in a number of ways. Not least, we see retaining the openness of the New
Zealand banking system to overseas ownership as important for promoting competition and innovation
in the New Zealand banking market.
Another feature of our approach to banking regulation, as it applies to all banks in New Zealand, not
just overseas-owned banks, is that it is largely "principles" based, and relatively light on "black-letter"
regulation.
Our approach to banking supervision is sometimes described as "light-handed". That is a description
that may give the wrong impression, at least if it gives the impression that we are not serious about our
role. We are serious about the principles we apply, and in seeing to it that they are applied. But we
endeavour to supervise in a way that not only is effective, but also is cost-efficient, including for the
banks. The way to achieve that, we think, is to get the basic structures and incentives right -
particularly the incentives for directors to monitor and to exercise effective oversight so as to avoid
having to disclose bad news.
Also, as already outlined, our supervision of overseas-owned banks is conducted very much within the
internationally-agreed framework of "home-host" supervision. We seek to ensure that our requirements
do not cut against home-country requirements and, consistent with meeting our own responsibilities,
dovetail as much as possible with those requirements.
My more general point here is that avoiding unnecessary compliance costs is something we attach
importance to. On the whole, I think we have been quite successful in achieving that. And, as part of
the effort to enhance trans-Tasman co-ordination, we will be reviewing our requirements to see where
we could achieve better alignment.
It also bears stating that our requirements do not deny the many overseas-owned banks operating in
New Zealand the benefits of large overseas-bank parentage, nor overseas banks the benefits of a
New Zealand presence.
New Zealand banks with overseas parentage benefit a lot from that parentage. Parent banks generally
are a source of capital, a source of rating strength, which helps to lower New Zealand bank funding
costs, as well as a source of risk management and systems expertise.
For overseas banks, New Zealand is an open and welcoming market, with a level playing field for local
and overseas participants. And for the Australian-owned banks, New Zealand has provided a
significant addition to their home market, and one that, in recent years, has been very profitable. With
operations on both sides of the Tasman, the Australian banks are well placed to service trans-Tasman
customers, and our banking supervision requirements place few, if any, impediments in the way of
that.
Next steps
Having said all that, the recent report to Ministers that I mentioned in my opening remarks has usefully
sharpened the focus on achieving increased coordination of trans-Tasman banking supervision. We
already have a formal Memorandum of Understanding with APRA2 and we will be looking to work with
APRA on how best the two organisations can coordinate, both in terms of day-to-day prudential
supervision and crisis management. New Zealand certainly will be prepared to carry its share of the
regulatory burden under such co-ordinated arrangements.
At the same time, co-ordination need not mean that our requirements need always be identical to
those of APRA. On some matters we may adopt different approaches. One that is starting to receive
some publicity concerns the implementation of new Basel 2 capital adequacy standards for banks.
Under Basel 2, national authorities will have a choice between adopting a more sophisticated, internal
model-based, approach to calculating capital requirements, or a simpler methodology that is closer to
the existing Basel 1 regime.
APRA has indicated that it proposes to apply the internal model-based regime in its consolidated
supervision of Australian banks' global operations, which, of course, encompass their operations in
New Zealand. In considering this issue, we will be looking to ensure that the adoption of Basel 2 does
not result in a general weakening in the capital adequacy of New Zealand banks, and our general
preference is for a simpler rather than more complex approach, in part to keep compliance costs
down. But we are also aware that if our and APRA's requirements are not reasonably well-aligned,
that could increase compliance costs, and we will be seeking to avoid that.
More generally, given the high degree of integration of the New Zealand banking system with the
Australian banking system, there may well be an opportunity to develop arrangements for
transTasman banking supervision into a world-class model of "home-host" supervision. One area where
more coordination may be possible is banks' disclosure requirements, where international
developments in accounting and disclosure standards will have implications for both countries.
Another area where more structured co-ordination obviously would be useful is in crisis management.
Concluding remarks
By way of conclusion let me recap on what I see as the main points.
First, the banking system matters. For any country, the banking system is one of the most critical
elements of its economic infrastructure. This is as true for a country whose banking system comprises
mainly overseas-owned banks, as it is for one whose banks are predominantly locally-owned. In that
sense, while almost all the banks in New Zealand are overseas-owned, the banking system as a
whole must still meet New Zealand's needs - in fair weather and foul.
Second, it is essential that the New Zealand authorities can supervise the New Zealand banking
system and can respond quickly, decisively and effectively to a banking crisis. All countries need to
shoulder the responsibility for the sound functioning of their banking systems. This is why we require
systemically-important banks in New Zealand to be incorporated locally. And it is why we require such
banks to maintain the capacity to function on a stand-alone basis, if required. Without that capacity,
there is a material risk of the banking system becoming dysfunctional in a banking crisis. Avoiding that
risk we see as being fundamental to the soundness of the New Zealand financial system. The
measures we are introducing to counter that risk recently have been affirmed by Standard and Poors,
who have noted that they "could well enhance the strength of the New Zealand banking sector and its
ability to withstand a period of financial stress".3
Third, the Reserve Bank is concerned to ensure that its supervision is efficient as well as effective.
This is reflected in our emphasis on principles, and structures that emphasise incentives and
accountabilities, rather than detailed prescriptive, or "black-letter", regulation. It is also reflected in the
internationally-agreed framework for the supervision of international banking groups, within which we
operate. This sets up a basis for co-ordination amongst home and host country authorities, and avoids
unnecessary duplication.
With regard to the supervision of trans-Tasman banks, we already have a formal arrangement with
APRA which provides, mainly, for information sharing. In the period ahead we will be looking to build
on that arrangement, in a way that ensures that our supervision of Australian-owned banks in New
Zealand is both effective and cost-efficient. Indeed, with the New Zealand banking system now
comprising predominantly Australian-owned banks, there exists an opportunity to develop
arrangements for the supervision of trans-Tasman banks that would be a world-class model of
crossborder banking supervision.