Geoff Bascand: The effect of daylight - disclosure and market
discipline
Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of
New Zealand, to members of the NZ Bankers' Association, Auckland, 28 February 2018.
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Introduction
Thank you for coming today and giving me the opportunity to share the Reserve Bank's views on
disclosure. I'm going to cover how we use a disclosure regime to support a sound and efficient
financial system and the beneficial impact of more informed stakeholders.
The Reserve Bank's prudential framework emphasises the importance of disclosure of
information from the entities we have responsibility for regulating and supervising - registered
banks, licensed insurers and licensed non-bank deposit takers (NBDTs). It's a key part of market
discipline, one of the three pillars of our prudential framework. It reflects the influence investors
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and other stakeholders can have on an institution's behaviour and risk profile. By potentially
influencing the business' behaviour, stakeholders can contribute to its long term viability, and the
health of our financial system more generally.
One of the Reserve Bank's key statutory purposes is a sound and efficient financial system. So
our interests are well aligned with stakeholders who want information on a financial institution's
performance, strength, and risk profile. Indeed the demand for meaningful market information is
broad, ranging from depositors, policyholders, shareholders, creditors, through to rating
agencies, credit and market analysts, and the financial media.
The Reserve Bank as the prudential regulator is also a 'user' of such information - it informs our
policy settings (e.g. capital ratios) and information may inform a range of specific supervisory
actions to address any concerns about an entity we might have (e.g. to assess solvency and
associated risks).
I should note, however, the information set we have includes the same information that is
provided to the public, as well as other 'private' information that institutions report to us,
sometimes under compulsion of statutory powers. This latter set might be more granular,
detailed or proprietary. Information may also be kept confidential to the Reserve Bank to avoid
market disruption or because it may have a detrimental impact on an individual financial
institution's competitive position. In addition, there are constraints on public disclosure contained
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in our governing legislation which prevent public disclosure of that information except in
prescribed circumstances. Those provisions allow regulated entities and the Bank to discuss
sensitive commercial information in candour, which is a necessary element for prudential
supervision.
There are some limits to what is sensible to disclose and when; such judgements can be quite
contentious. Moreover, we recognise that disclosure is not without cost. While mindful of these
considerations, the Reserve Bank is disposed towards openness and enhancing disclosures.
I'm going to touch on attributes that make information relevant and useful for external
stakeholders including that it is reliable, accessible and comparable. I'll also highlight some key
initiatives to improve our disclosure regime including the Bank Financial Strength Dashboard,
follow-ups to the bank director attestation review, and related initiatives in the insurance sector.
Why is disclosure important?
In general terms the disclosure of information is a response to the inherent issues when two
economic agents enter into a transaction. Typically one party has greater information than the
other - a situation termed 'asymmetric information'.
Disclosure helps resolve a number of potential conflicts. These can be internal - for example
between an institution's senior management and directors who are monitoring performance on
behalf of owners. And external - between the institution and a range of other stakeholders.
In short, managers have better firm-specific information than directors, shareholders and other
stakeholders, and don't necessarily have an incentive to fully report information that may be
detrimental to their self-interests, or the interests of the institution as a whole.
Therefore both board directors and external stakeholders demand information from a firm's
managers so they can carry out their respective monitoring roles. There is a well-established
literature on corporate governance that focusses on the various mechanisms designed to
address the internal informational advantage between management and the Board. Hence,
disclosure also supports an entity's internal monitoring or 'self-discipline' - a second pillar of our
prudential framework. I'll return to the topic of corporate governance when I cover the Reserve
Bank's bank director attestation review.
Public disclosure can be challenging. There may be weak incentives for a financial institution to
produce and share information. While market participants may demand information, what's
produced may not meet their needs, be ad hoc and/or not based on generally accepted and
comparable accounting standards, for example. And there may be few ways of being sure the
information being provided is reliable and gives a fair picture of the institution's financial position -
something that otherwise may only emerge once an institution comes under stress or evidence
of fraud is made public.
There is a clear role for professional bodies and regulatory authorities to set minimum
requirements attached to publicly disclosed information in order to help ensure its integrity, and to
make it ultimately useful for stakeholders. These include auditors, accounting standards boards,
stock market exchanges, financial market conduct authorities and prudential authorities.
There are a number of local and international examples that illustrate the importance of public
disclosure - or more to the point, the failings of poor disclosure:
In the United States a number of financial and accounting scandals in the early 2000s
associated with Enron and WorldCom, prompted a major overhaul of regulation which
included a focus on increased financial disclosure. These scandals also highlighted another
aspect of public disclosure tied to the necessary independence of auditors and their role in
attesting to the veracity of financial reporting. Serious conflict of interest issues can arise in
the relationship between a financial institution and the auditors/accounting firms it hires.
Here in New Zealand, the finance company sector experienced a wave of failures prior to the
Reserve Bank assuming responsibility for the regulation of 'non-bank deposit takers' in 2008.
The failures featured inadequate risk management, including over-exposure to certain
sectors and related-party lending. The poor quality of information disclosed to 'mum and dad'
investors was another key failing.TV advertisements with well-known New Zealand
personalities painted a misleading picture of the risk-reward profile for their potential
investments. Compounding the problem was the advice potential investors were receiving
from financial advisers during this period.
Internationally the demand for public disclosure and transparency has increased since the
global financial crisis (GFC). The crisis highlighted the difficulty of evaluating complex
financial products and deficiencies in public disclosure across a number of jurisdictions.
The complexities served to heighten uncertainties about the financial strength of some
individual banks, and undermined confidence in the banking system as a whole.
Good public disclosure
It is clear that there are real benefits from public disclosure of information - provided that
information is trustworthy. It helps to:
Build stakeholder confidence that the institution is presenting an accurate and reliable picture
of its financial position, and complying with all relevant laws, regulations and rules. It helps
avoid both the perception and/or realisation of financial malfeasance on the part of the
institution. The old adage that 'sunlight is the best disinfectant' is relevant here.
Enable diverse private sector stakeholders to monitor the institution and make appropriate
and well-informed decisions on whether to invest in the institution as a potential shareholder,
bondholder or depositor, or to enter into an insurance contract in the case of insurers.
Create a well-informed market, which is a precondition for improving the efficiency of the
financial system by helping to better allocate society's scarce resources. Welfare is
enhanced when funds flow freely between more and less risky investment opportunities,
provided those risks can be discerned and priced adequately. This applies to investments in
financial institutions as much as it does to the businesses and financial products that they
lend to or invest in. For example, riskier financial institutions should face commensurately
higher funding costs.
There is some evidence, mostly from the United States and Europe, that market information
affects the pricing, risk and behaviour of financial institutions. The Reserve Bank has recently
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undertaken some analytical work that finds similar, albeit tentative, results for New Zealand.
This analysis also suggests that the more visibility disclosures get, the more impact they have.
This work is informing our evolving approach to disclosures, set out below.
The disclosure of information, by itself, will not achieve the benefits described above. Too much
information, and the wrong sort, can obfuscate, confuse and detract from market participants'
ability to monitor and exert discipline over financial institutions. Too much information may also,
paradoxically, be used to hide evidence of poor practice or wrong-doing. Most importantly, the
information itself needs to be trustworthy and meet a number of attributes to be effective.
International standards identify a number of characteristics of public information that can
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enhance the benefits of disclosure and market discipline:
Decision-useful and accessible: That means presented in a way that is appropriate for
the information and distributed in ways market participants can easily access.
Timely: Information should be of sufficient frequency and timeliness to be useful.
Comprehensive and meaningful: Information should be sufficiently comprehensive so
market participants can form a well-rounded view, including the risks faced. It should be
sufficiently aggregated to provide a proper overall picture, and sufficiently disaggregated so
distinct material items can be clearly identified.
Information should accurately reflect what it purports to describe. Note, there is
Reliable:
some potential trade-off between reliability (getting the numbers 100 percent right) and
timeliness.
Comparable: The methods and assumptions used in the preparation of information
(particularly for financial reporting based on accounting standards which allow a degree of
flexibility) should be transparent.. More explicit standardisation of reporting requirements
(both financial and other information) would enhance comparability and the identification of
how banks differ by financial performance, business activities, various prudential metrics,
risk profile and risk management processes/practices.
Consistent over time: Disclosure should enable trends to be identified in the institution's
balance sheet position, performance and risk profile over time.
Taken together, these criteria provide a useful framework for benchmarking disclosure
requirements and outcomes across different financial sectors.
Global efforts to enhance and improve financial institution disclosure
Following the GFC there has been a global and ongoing effort to improve public disclosure and
consequently market discipline. For example, the international standards for supervision of banks
produced by the Basel Committee were revised in 2012. They now include two new core
principles on Financial reporting and external audit (BCP 27) and Disclosure and
transparency (BCP 28) which replaced a single core principle on Accounting and
disclosure from the earlier 2006 standards.
The Basel standards are used by the IMF in their Financial Sector Assessment Programme
(FSAP) which evaluates a member country's approach to banking supervision. The IMF recently
conducted an FSAP for New Zealand and I'll touch on the results of their assessment
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shortly. While the Reserve Bank's mandate is prudential (i.e. financial soundness), disclosure is
also very important from a market conduct and consumer and investor protection perspective.
These latter objectives generally sit with other entities, but equally demand high quality disclosure
of information. Regulation has also evolved significantly in the conduct dimension, in New
Zealand through the Financial Markets Conduct Act (2013) and the establishment of the Financial
Markets Authority in 2011.
For the insurance sector, the International Association of Insurance Supervisors (IAIS) is the
global standard setter, with core principles first issued in 2011. The IAIS' principles are also used
by the IMF for FSAP purposes. ICP 20 is on Public disclosure and requires the supervisor to set
requirements for insurers to disclose relevant, comprehensive and adequate information. It
needs to be timely and give policyholders and market participants a clear view of their business
activities, performance and financial position.
The Reserve Bank's approach to registered bank disclosure
Public disclosure has been a cornerstone of the Reserve Bank's approach to prudential
regulation and supervision, particularly since 1996 when the disclosure regime for registered
banks was introduced. The Reserve Bank has periodically reviewed the disclosure regime and
made changes that underscore the Reserve Bank's commitment to effective disclosure. It's an
ongoing process and there are further improvements we are making.
A brief overview of the bank disclosure regime
Currently all registered banks are required to produce disclosure statements on a quarterly
basis. The required content varies depending on whether it is a full year, half year or 'off-quarter'
disclosure statement, and whether the bank is locally incorporated or a branch of an overseas
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incorporated bank. The disclosure statements include financial reporting and other
supplementary information, such as a bank's capital adequacy position and asset quality.
The Reserve Bank's disclosure requirements for banks are overlaid on top of financial reporting
obligations in the Financial Markets Conduct (FMC) Act 2013 and Financial Reporting Act 2013,
which are enforced by the Financial Markets Authority (FMA). Under those Acts banks must
prepare annual financial statements in accordance with generally accepted accounting practices.
The Act also requires that the annual financial statements are audited by a qualified
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auditor. Banks are exempt from many of the product disclosure requirements of the FMC Act by
virtue of the separate disclosure regime imposed under the RBNZ Act.
RBNZ disclosure statements must be signed by bank directors, attesting to the veracity of the
information provided (for branches, the NZ CEO also signs). Banks must publish their quarterly
disclosure statements on their websites and make hard copies available on request. The
attestation links a bank's internal governance processes and practices (thereby aligning the
interests of senior management and the Board) to the supply of public information.
Reserve Bank additional requirements include the preparation of off-quarter and half year
disclosure statements based on interim financial reporting standards, a requirement for the full
year disclosure statement to include the auditor's report, including an opinion on the
supplementary information that is provided, and penalties for false or misleading director
attestation. Reserve Bank supervisors also meet annually with the audit firms of registered
banks.
IMF FSAP evaluation of the Reserve Bank's approach to bank disclosure
The IMF assessed the Reserve Bank's disclosure framework for registered banks against the
core principles developed by the Basel Committee. For BCP 27 Financial reporting and external
audit the New Zealand regime was assessed as 'largely compliant' - effectively a pass mark.
The New Zealand legal framework provides for financial statements to be prepared in
accordance with New Zealand equivalents to internationally recognised accounting standards,
and to be audited by a qualified external auditor in accordance with equivalent standards to
international auditing standards.
One specific area where New Zealand was marked down was because the Reserve Bank does
not determine or verify that banks use valuation practices consistent with New Zealand
accounting standards, relying instead on the existing auditing process and director attestation.
The IMF recommended that the Reserve Bank engage in a more focussed way with external
auditors to discuss valuation practices of banks in their financial reporting. We will add this to the
list of issues that we explore in our engagement with auditors.
For BCP 28 Disclosure and transparency, the Reserve Bank received the highest grade, being
assessed as 'compliant'. The IMF noted that the Reserve Bank is committed to achieving
highquality disclosure by banks in line with international standards. There were no specific
recommendations; however we were encouraged to extend disclosure to include information on
bank staff remuneration. We don't currently require that and see remuneration frameworks as
the responsibility of directors.
The Bank Financial Strength Dashboard - improving the accessibility and comparability
of bank information
The Reserve Bank regularly reviews the specific requirements it imposes on banks to ensure the
disclosure regime remains fit for purpose. A major review over 2009-11 streamlined
requirements, resulting in cost savings for banks without weakening market information. More
recently the Reserve Bank undertook a Regulatory Stocktake over 2014-15. The objective was to
enhance the efficiency, clarity and consistency of the prudential requirements for banks and
nonbank deposit takers. Reviewing bank disclosure requirements was a key part of the Stocktake
and in particular whether off-quarter disclosure requirements continued to deliver clear benefits,
relative to the costs imposed on banks to prepare.
The Stocktake concluded that there was little merit in continuing to impose off-quarter disclosure
requirements on branches, but some form of continued disclosure for locally incorporated banks
was warranted.
The Stocktake also highlighted issues with accessing and comparing disclosure statements.
Differences in how information is presented reduce the ability of non-expert users to review and
understand disclosure information. It also imposes costs on more experienced users in their
efforts to compare across registered banks.
Currently the Reserve Bank provides a summary table on its website of individual bank data. This
is based on the non-templated bank disclosure statement data (i.e. non-standardised) and
therefore suffers from the same issues noted above. In addition, the summary table does not
hold a prominent place on the website, nor is the data particularly timely.
As a consequence the Reserve Bank has developed and consulted on a Bank Financial Strength
Dashboard concept that will be a big step forward in reporting of bank information. The
Dashboard will be a user-friendly interactive online tool that will provide a central repository of key
information about the prudential and financial condition of New Zealand incorporated banks. The
underlying data will be updated quarterly and hosted on the Reserve Bank's website. The
information will be drawn from data that banks provide to the Reserve Bank and presented in an
accessible and user-friendly format. Importantly, the new Dashboard will allow users to make
side-by-side comparisons of banks in an 'apples-with-apples' scenario on key subject areas.
They are likely to include: credit ratings, capital adequacy, asset quality, profitability, the balance
sheet, and liquidity.
The main benefits of the Dashboard are the material enhancement to market discipline by
improving the accessibilityand comparability of information available to market participants.
This will significantly reduce the costs for existing users of disclosure statements to digest and
analyse bank-specific information and conduct comparative analysis. In addition, the Reserve
Bank expects that the Dashboard will widen the range of stakeholders who will use publicly
disclosed bank information, extending the points of influence and avenues of market discipline.
Ordinary depositors are one group who arguably only exert a fairly weak level of influence over
banks at the moment. While retaining the Reserve Bank's prudential focus, the Dashboard will
also contribute to the wider public policy objectives for informed investor/consumer
decisionmaking.
The Dashboard information will be aim to be comprehensive with a high-level summary of key
metrics, and the ability to drill down to more detailed information. Simple text will accompany the
data to help explain it to users. Additional content is expected to be added over time as
experience with the Dashboard builds and we receive feedback from users. The quarterly
standardised and comparable data will enable users to readily identify trends in data, and hence
be consistent over time.
It is expected that the publication lag will also be somewhat shorter as data would be updated on
the Reserve Bank's website within two months compared to four months at present -therefore
improving the timeliness of the data.
While the Dashboard information will not be subject to the same formal director attestation
requirements, the of the information provided by banks will be ensured by the due
reliability
diligence that the Reserve Bank expects banks to add to their internal processes tied to private
reporting. Banks will have the opportunity to review their own Dashboard data prior to publication,
as well as providing commentary. The Reserve Bank will process all corrections to private
reporting before publication of the Dashboard. In addition, banks will be able to correct their
Dashboard data after publication has occurred. These revisions will be made transparent in
order to support market discipline.
We are finalising web page development for the Dashboard and release is currently planned for
late May using banks' data for Q1 2018. There will be an awareness campaign to promote the
Dashboard as a user-friendly, authoritative and reliable source of information.
All banks, including branches will still be subject to half and full year disclosure requirements and
the associated director attestation process. The Reserve Bank will be making technical
amendments to the half and full year disclosure requirements so they align with the quarterly
information provided in the Dashboard.
Improving bank reporting of regulatory capital
Current disclosure requirements include information on regulatory capital. Banks must provide
information on their capital ratio which includes a risk-adjusted measure of banks' assets
(riskweighted assets). New Zealand banks use either a standardised approach to risk-weights
(prescribed by the Reserve Bank), or an approach based on internal modelling and various
regulatory formula (currently used by the big-4 banks). The calculations are crucial to
understanding banks' exposures and financial strength but can be difficult to evaluate.
The standardised approach for the calculation of risk-weights is inherently more transparent to
the public than the customisation of internal models. Even for the Reserve Bank, which has
access to banks' modelling documentation and regularly meets with the big-4 banks' modelling
teams, it is sometimes unclear how risk-weights have been arrived at.
The Reserve Bank is currently reviewing capital requirements for locally incorporated banks,
including the disclosure of risk-weighted asset data. It is our view that improvements to their
transparency can be made, and we are consulting on this and any associated costs that may
arise.
In the December 2017 consultation document (PDF 1MB), and broadly consistent with recent
Basel guidance, the Reserve Bank is proposing an option that would require the big-4 banks to
disclose capital ratios under both the internal models and standardised approaches - so-called
'dual reporting'. The Reserve Bank hopes that as a result of dual reporting internal models banks
will provide more public explanation of the reason for any marked variation between their internal
models measure and the standardised calculation, as well as their modelling assumptions and
methods in general.
Bank director attestation review
As I discussed earlier, the bank disclosure regime is supported by a requirement for bank
directors to attest to (i.e. sign-off on) the accuracy of information contained in the disclosure
statements. This is a crucial aspect of New Zealand's regulatory regime. Directors are
responsible and accountable for the integrity of bank reporting. Due diligence helps support the
internal governance processes of the bank, driving responsibilities, systems and processes to
generate and scrutinise management information.
The question arises as to how confident users can be in the robustness of attestation
statements. Directors and users of disclosure statements are aided by the reporting of external
auditors, but to what extent should the Reserve Bank review the information directors have relied
on, or independently test and challenge their assurances?
Currently, the Reserve Bank evaluates the reliability of directors' attestations and compliance
with RBNZ guidelines through reviews of documentation such as risk appetite statements,
financial information, reports submitted to bank management, and meetings with bank
management and directors.
The IMF (in its 2017 FSAP report), while not contesting the attestation regime, urged the Reserve
Bank to more rigorously test attestations through specific reviews, especially for locally-owned
banks. For example, they expressed a concern that the Reserve Bank did not undertake much
independent verification of banks' internal risk management practices or Board effectiveness.
Last year, and partly in response to the IMF's FSAP, the Reserve Bank undertook a thematic
review of the attestation process across 15 locally-incorporated banks. The review was carried
out by Deloitte on behalf of the Reserve Bank. Deloitte determined the attestation regime as
'largely effective' based on a weighted average of scores using their methodology, with some
variation across individual banks. Deloitte noted a number of a general issues that potentially limit
the effectiveness of the regime:
A reliance on high-quality directors to make the regime work. The number of directorships
held by directors, length of tenure, lack of banking experience, risk of capture by
management and lack of diverse skills on the Board all potentially affect the effectiveness of
the regime.
There is a correlation between the effectiveness of the attestation regime and an open and
honest culture within the bank. Sign-off from directors is only appropriate if they believe that
staff at all levels will communicate 'bad news' upwards.
In the absence of Reserve Bank guidance, banks could be applying different processes to
verify attestations; applying different materiality thresholds, and; applying some policies
differently. There may be a role for the Reserve Bank to provide more specific guidance on
specific policies, and to independently verify an individual bank's attestation process.
The Reserve Bank has begun considering both the findings from the IMF FSAP (which were
released in April last year), and those from the more recent attestation review.
In relation to FSAP, the Reserve Bank is closely examining the recommendations that, taken
together, may further enhance the three pillar approach to regulation and supervision.
Particularly key are the recommendations about independent verification by the Reserve Bank of
banks' internal policies and processes, and the provision of more explicit guidance to help
provide a better benchmark to support bank director attestation. Our view is that rather than a
fundamental shift to a more intrusive supervisory regime such as checking an individual
institution's reporting via on-site inspections, our verification is likely to be undertaken through
greater use of thematic reviews (i.e. reviewing policies and practices across the banking
sector). We continue to see directors and auditors owning the primary verification role.
The Reserve Bank will be considering the findings of the attestation review in the context of how
it might better support banks' internal governance processes (i.e. self-discipline). No final policy
decisions have been made, but some elements of this enhanced approach may include:
More frequent engagement with bank Board of directors. This will provide a greater
opportunity for the Reserve Bank to communicate any concerns with directors, and help to
address the information asymmetry between senior management and directors described
earlier. The Reserve Bank will also gain a potentially better insight into the effectiveness of
the Board and how it is discharging its oversight duties.
The Reserve Bank will also consider how to support directors in understanding their duties,
via induction sessions for new independent directors.
The development of guidance on the Reserve Bank's expectations around risk
management. This will help provide a clearer and more consistent benchmark for bank
directors to attest whether they believe their institution is adequately managing risks.
Formally embedding a 'positive assurance' process for attestation sign-off. The review
highlighted that most banks adopt a limited or 'negative' assurance process whereby
management states to directors that they are not aware of any compliance or risk appetite
breaches. The Reserve Bank would prefer to see senior management actively
demonstrating or providing evidence of compliance to directors.
Reviewing requirements in the Reserve Bank's corporate governance policy (BS14) related
to, for example, tenure limits for independent directors, limits on directorships and
requirements on banking experience.
Reviewing BS10 to require banks to undertake on-going suitability assessments of their
directors and senior managers. The Reserve Bank will also be providing greater clarity on
the definition of 'senior manager' for the purposes of the current non-objection process.
Insurer disclosure
Overview of disclosure regime
Public disclosure of information also forms an important part of the market discipline pillar for the
insurance sector - a sector the Reserve Bank assumed responsibility for in 2010 under the
Insurance (Prudential) Supervision Act (IPSA). Section 4(e) of IPSA defines disclosure in the
public interest: "the desirability of providing to the public adequate information to enable the public
to make [their own] decisions".
The insurer public disclosure regime is based on accounting and audit standards (enforced by
the FMA as is the case for registered banks). For example, the Financial Reporting Act requires
all insurers to produce audited financial statements within four months of the financial year-end.
These financial statements are available from the Companies Office website, while some
insurers also publish them on their own website.
Licensed insurers are also subject to additional disclosure requirements imposed by IPSA and
Reserve Bank standards and guidelines.
Under IPSA most licensed insurers must have, and disclose on its website, a financial
strength rating prepared by an approved rating agency to policyholders before issuing and
renewing insurance policies. The Reserve Bank also publishes these financial strength
ratings on its website. Overseas insurers must disclose the existence of any overseas
policyholder preference if one exists.
Licensed Insurers must also disclose their financial strength ratings to policyholders before
entering into or renewing a contract of insurance.
As part of Reserve Bank solvency standards, insurers are required to disclose solvency
positions and regulatory capital information in their financial statements and on their website.
IPSA requires that actuarial information contained in financial statements is reviewed by the
licensed insurer's appointed actuary and subject to a separate report which is included in the
financial stateme