Building a balance
sheet to support
financial stability

Speech delivered to UBS Australasia Conference
in Sydney, Australia

By Karen Silk, Reserve Bank Assistant Governor

14 November 2023

A ~ Reserve Bank
of New Zealand

Te Putea Matua

Introduction
E nga mana, e nga reo. E nga karanga maha 0 te wa.

Téna koutou, téna koutou, téna koutou katoa,

Good morning. It's wonderful to be here in Sydney representing Te Putea Matua, the Reserve Bank

of New Zealand. I want to thank UBS for hosting th

As an Assistant Governor with responsibility for fi
thinking about the RBNZ's balance sheet, its si
and that is what I would like to talk about today.
he RBNZ's balance sheet, following

trilogy on

Rayner's in 2021.

Central ba
given their

policy pos

form of moneta

It is correc
profit and
will be in s

is not the exclusi

nk balance sheets are garnering sig

GFC, any change in central banks'
y easing or "quantitative tigh

that a central bank's balance shee
herefore any time there is a chang
upport of policy. When we conside
ve domai

Today my

outline some of
purpose. In parti

Central ba

business supporti
system and et
the FX swap marke

close to th

The functioning of

dysfunctio

via the financ

Financial stability is often
he stability o

n their traditiona
ent against g
individual entities.

OCUS

growth in size. With increases in size la

n of monetary policy.

ial

T
on

ial

a
n

ba
eni

isa
ein

ze, composition and

ficant interest these days, which is u

is event and fo

ancial markets, I
h

r

is speech m
om Christia

igh
nH

inviting me to speak.

spend a fair amount of time
the risks associated wi
t be considered the thi
awkesby's in 2020 and

th it -
dina
Vanessa

gely due to their use as tools of
nce sheets are commonly viewed

"

g.

n instrument of policy, not an ins
he size or composition of the ba

will be on the RBNZ's balance sheet as a tool to support financial s

the recent steps we've taken

"lender-of-last-resor

ood collateral, and typica

nks also play a critical role in
ng objectives related
ive mone

to ensure that the

ffec

e OCR.

inancia
confide
em to

rodes
ial sys

ne

he real economy.

hought about in terms of prudential regu
individual deposit takers which in turn strengthens

"role, central banks can a
ly at penalty rates of interes

the provision of market liq
0 efficient payments and se
he RBNZ regularly transacts in

implied NZD overnight interest rates in that market remain

ary policy transmission. For instance, t

markets more broadly is also importa
nce, impedes transmission of monetary policy, and can quickly transmit

poli

mone

andable

ary
as either a

nders

rument of
ance sheet, it

cy, however, this includes financial stability and

The role of the central bank balance sheet in financial stability

lation - which a
he financial syste

, to support the

ui

tlements across

ability and I will

0 strengthen the RBNZ's balance sheet for that
cular in the area of foreign reserves.

ims to support

m.

so provide funding or liquidity,

stability of

dity in the normal course of

the financial

nt for financial stability. Market

Central banks in this context can also play a role as "market-maker-of-last-resort", providing
market liquidity through facilities designed to provide targeted and temporary liquidity where it
might otherwise be absent, largely in times of stress or crisis. For example, the RBNZ has a Bond
Market Liquidity Support (BMLS) facility which we can use to make outright purchases of
government bonds during periods of market stress - something we did during the most acute
phase of the COVID-19 crisis.

Figure 1
Bond Market Liquidity Support

NZ$m bps
100 12

~
a
(Xe)

50 6

25 3
0 ree 0
Jan 20 Feb 20 Mar 20 Apr 20 May 20

Ms NZGB Purchases (LHS)
LGFA purchases (LHS)
Average bid-ask spread of Nominal NZGBs (RHS)

Source: Bloomberg; RBNZ

The role of market-maker-of-last-resort is largely an unavoidable one given the importance of
market functioning, both for financial stability and as a channel for the transmission of monetary
policy.

But that doesn't mean there aren't important questions to ask about how and when central banks
should play this role. How dysfunctional do markets need to be before central banks step in, who
should have access to central bank facilities and on what terms, are live policy issues across many
jurisdictions today. The Bank of England has recently announced its intention to provide liquidity
acilities to non-banks' and the Federal Reserve's response to banking stress earlier this year
included a facility which took collateral at par, rather than at market value'.

+

While circumstances at a given point in time may dictate variation in response to crises, guidelines
or the provision of support can also support appropriate expectations of self-sufficiency with
market participants. To that end, as part of our current internal Liquidity Management Framework
Review, we are developing our crisis "playbook" to support a clear understanding of the purpose,
scope and entry and exit conditions for crisis facilities between ourselves and market participants.

ankofer co.uk/s

amb

mon:
Bank Term Funding
program.htm

am. (2023, September 11). Retrieved from www.federalreserve.gov website: https://www.federalreserve.gov/financial-stability/bank-term-funding-


Foreign Reserves Coordination Framework

n

Cc

5D

The introduc
ag
expectatio

re

published i

The in
exchange
commi
decisioning

For examp

M

occur with
exceptiona

fu

obj

ervene in the fo
jectives. This cou
or when the leve
damentals and

he case of the R
inister of Finance
ion o
oO a new 'Fo
S aroun
oles of

ee

spective

ion oO
erven

roduc

in

anuary 2023.

Like most central banks, RBNZ ho

eign exchange

of the exchang
ereby working

BNZ, the level a
under ad hoc

eign Rese
d the ma

e RBNZ and M

the new f
ions. Periods o

tted to main

e,
Po
a

onetary

ndamenta

aining a free-fl

ameworks we apply.

in assessing the appropriateness of FX intervention
licy Committee (MPC) utilise four key criteria that se
four required to be met. These include: 1) Exceptio
ly high or low 2) Unjustified - the exchange rate should
s 3) Consistent - intervention should be consistent wi

amework does not fundamentally c

ds foreign reserves on its balance sheet

e rate is at extreme and unjustified levels

inister of Finance. The FRCF was

f intervention are still expec
cating exchange rate, with this bei

a hig
al-t

th ou

against the desired stance of monetary poli

elative
cy.

id use of foreign reserves had historically been ag
emoranda of Understanding, with the last one ag
the new Reserve Bank Act 2021 required the RBNZ and
ves Management and Co-ordination
agement and use of foreign rese

inister

Framework' (FRC
ves in New Zealand a

agreed in December 20

ange the approach to
ed to be rare, and we
ng reflected in the i

hat can be used to
market to support both financial stability and mo
d include intervening when market functioning is impaired, and liqui

etary policy
dity is limited
to economic

eed with the
eed in 2007.
of Finance to
F) setting out
d the
22 and

oreign
emain
ternal

or monetary policy purposes, the
h hurdle for intervention to
e exchange rate should be
be unjustified by economic
monetary policy objectives

4) Opportune - market conditions should be opportune and allow intervention a reasonable chance
of success.

Figure 2
NZDTWI and RBNZ Foreign Exchange Activity
Monthly data to June 2023

1,

NZ$m
000

500

-1,000

*Includes all RBNZ activity in the foreign exchange market including business as usual operations

Index

2018 2020 2022

Gl Net purchases of NZD (LHS)* «==NZDTWI Exchange Rate (RHS)

Source: RBNZ

80

A well-functio
every day by

oreign assets
RBNZ

addressed by

Unde

here

Figure 3
Foreign Cur
Monthly data

NZ$b
20

2004

2006

will consi

the new

ning foreign exchange market is crit
it may also be necessary for the R
dity and confidence to the market.
which requires a prepositioning of
der whether market dysfunction

intervention.

exporters, importers, borrowers, and inves
inancial crises,
providing liqui

ical to
ors.
BNZ to i
In orde

he RBNZ ba

is sustained,

FRCF, agreement was reached wit

rency Intervention Capacity
to September 2023

2008 2010

h the Mi
holdings of foreign reserves for this purpose. The agreemen
eview, growth in size of the economy and scale of FX markets in the intervening period and
ore the need for increased capacity to support intervention.

2018

niste

2020

ew Zealand's economy and

Average 2007-.

is relied on
n extreme circumstances, such as

ntervene for financial stability purposes,
r to do so the RBNZ must al

eady hold
ations, the
easonably

ance sheet. In these situ
systemic and could be

of Finance to increase the RBNZ's
acknowledges the time since last

2022

2022

*Foreign reserves that are readily liquefiable less foreign currency liabilities that fall due in the next 12 months.

Source: RBNZ

As episodes of intervention are rare there is no clear answer as to what the right level of foreign

reserves is. In determining what an appropriate level of foreign reserves for
we considered a range of metrics, including import volumes, deb
well as international central bank comparisons, and scenarios including p
New Zealand and overseas. We will not be commenting on the
that information is considered market sensitive but will note that
occur over a number of years. This is because we seek to avoid u

our actions in

Increasing the level of foreign reserves - all else equal - results in t

reaching agreed levels.

ew Zealand might be,
ing and FX turnover, as
evious interventions in
arget level of reserves agreed as
achieving it is a process that will
ndue risk to market liquidity from

outstand

he size of the RBNZ balance sheet

increasing. The raising of reserves, and their subsequent investment in foreign currency assets, is

funded through the RBNZ increasing the level of settlement cash i
the initial cost of funding the foreign reserves reflects the Official C
settlement cash within the system is remunerated by the RBNZ. 1

n the system. This also means that
ash Rate (OCR) - the rate at which
This cost of carry is partially offset


by the return generated on the investment of the foreign reserves into assets such as foreign

currency government bonds.

The RBNZ holds two main portfolios of foreign reserves, hedged and unhedged, with the distinction
between the two simply reflecting how the NZD is converted into a foreign currency.

Unhedged reserves are raised by selling NZD in exchange for foreign currency in the spot foreign
exchange market. This transaction results in us owning foreign currency, and the value of these
assets will fluctuate in line with increases or decreases in the exchange rate.

The hedged reserves are raised by lending NZD in exchange for foreign currency, generally in the
cross-currency basis swap market. We effectively borrow foreign currency under long term contracts
and are not exposed to movements in the exchange rate, because all the foreign exchange rates

are agreed at the start of the contract.

Under the Foreign Reserves Managemen

primary considerations when looking to inves
when they are needed our reserves mainta

incorporating sustainability considerations i

and

esponsible for managing the investment of the
t our reserves are safety and liquidity. This ensures that
in their value and can be easily converted into cash.
Subject to satisfying safety and liquidity requiremen
ike other central banks around the globe, the

nm our

climate change will impact upon those over
investment opportunities.

A Review of Financial Resources

Historically the RBNZ has chosen to hold a mix of both unhedged and hedged reserves. In addition
0 the different exchange rate exposures, there are other considerations taken into account when
determining the mix. These include the relative costs, risk appetite, refinancing risk and intervention
needs. While we will not comment on what the composition will look like in the future, we expect
he mix of portfolios to carry flexibility and be influe

nced by market conditions over time.

Co-ordination Framework the RBNZ is also
oreign reserves. Like most central banks, the

s, return is then considered and optimised and
RBNZ is also evaluating alternatives for the
investment criteria. While the purpose of the

eserves will always require safety and liquidity as primary criteria, risks such as those posed by
ime and transition and mitigation likewise may add to

Central banks, including the RBNZ, are unique in that they can operate under negative equity -

the value of thei

5

iabilities can exceed the value of their assets - without impinging on their ability

to fulfil their policy objectives. However, there is a risk that periods of deep and persistent negative

equity could erode confidence in a central bank and therefore its ability to fulfil its' policy
objectives. The RBNZ has a legislatively manda
manner and aims to have sufficient financial resources to support its core operations, manage
exposure to financial risks associated with its balance sheet activities, and enable a reasonable
range of policy interventions for financial stabili

future.

ity and monetary policy that may be needed in the

ed obligation to operate in a financially responsible

Holding and using foreign reserves, for example, exposes the RBNZ balance sheet to a range of

financial risks, including market, credit, liqui

dity and counterparty risks. In the normal course of

operations, this would require access to an appropriate level of financial resource, i.e. capital or like
instruments, to accommodate exposure to those risks on their balance sheet.

positioned financial resources.

exposure to financial risk well in advance

and support the RBNZ's operational independence, which is critical for ou

our objectives.

RBNZ, together with the NZ Treasury, have reviewed the RBNZ's financial
determined that in addition to those req
holdings, there are current and potential future balance sheet activities (su
inancial stability) that carry a degree of financial risk and would also bene

esources and

ch as interventions

quick action in a cr

uired to support the agreed increase in foreign reserves

for

it from additional pre-

Pre-positioned financial resources, in this case capital and indemnities, provide several benefits
beyond mitigation of risks to credibility. It can support the Crown's ability to manage overall Crown
of a crisis, support fiscal and monetary policy

coordination, provide clarity around decision-making structures to enable

isis,

credibility in achieving

Following the review, the RBNZ has received an additional $1.8 billion in capital plus additional

indemnities from the Crown.

Indemnities provide financial backing for the RBNZ and transfer financial risk to the Crown in
relation to specific activities undertaken by the RBNZ. Unlike capital, indemnities are not fungible -

they can't be exchanged for anything else - and can

volatility.

ot be used to support general balance sheet

An example of an indemnity that you may be familiar with is the indemnity the RBNZ received for

around the world are publicly owned and their balance sheets are co

government balance sheets, the overall effect on gove

Since the RBNZ balance sheet is a subset of the Crown balance sheet, accounting

stance.

in instances of market dysfunctio

profitable.

purchased under LSAP that remain on our balance sheet).

has now been terminated for new purchases (although it remains in effect

Central banks around the world have taken varied approaches to address

Following the review two new indemnities have been provided. The first indemnity speci
supports foreign exchange interventions related to the FRCF. The second i
osses that may be incurred on bond purchase programmes, in the future. As discussed
bond purchase programmes, which can be useful in supporting financial stability, may be needed
, such as that we encountered at the onset of COVID-
important to note that interventions will not necessarily lead to losses, and in some cases, can be

potential losses on the Large Scale Asset Purchase Programme (LSAP) deployed in response to
COVID-19. Provision of this indemnity has meant tha
programme have not impacted the RBNZ's capital position. As part of the

accounting losses from the LSAP
review this indemni

for existing bonds

accounting losses fi

bond purchase programs undertaken during and before COVID. Some central banks (like the
RBNZ) have opted for indemnities while others have gone into negative equity. Since central

solidated within overall

ty

banks

nment balance sheets remains the same.

osses on LSAP
have to some extent been offset by fiscal benefits to the rest of the Crown. The IMF has explored
he net benefits of the LSAP programme in New Zealand as part of their independent Article

eport, and has found that the LSAP programme had favourable effects on the Crown's fiscal

IV

ically

ndemnity relates to

previously

9. It is

Larger risks, fo
policy stimulus

RBNZ also reta

Conclusion

and not profit.

The foreign exc

beyond that cu

interventions oO

policy interventi

this scale. We have a Memor.
onetary Policy (AMP) tools with the Ministe
indemnity beyond our existing financial resou
with a role in promoting

ange marke

example for bond purchase programmes intended to provide ongoing monetary
on the scale of the COVID-19 LSAP, may require additional financial resources,
rrently provided. However, we expect that in such situations, there would be more
ime to formulate policy and seek additional financial resources once immed
have been alleviated. As such, we have not sought pre-positioned financial resources to enable
andum of Understanding (MOU) on Additional

of Finance which lays out a process for seeking an
rces if needed. This MOU further provides the Crown

iate crisis concerns

fiscal and monetary policy coordination. As previously discussed, the

ns the ability to operate under negative equity.

conjunction with Treasury and the Minister of Finance, the RBNZ determined

Risks related to

Reserves Coordi
We are building towards

nation Framewor

his highe

hat now.

orm of capital and indemnities, which enable us to

support if required, and like other central banks retain the ability to operate u

Central banks are sometimes accu

n conclusion, central banks can use their balance sheets to support not just monetary policy, but
also financial stability objectives. In all cases though, the balance sheet is an instrument of policy
nterventions for financial stability might happen at the same time as monetary

ons, for example during COVID-19, or they may occur independently, in fixed
income or currency markets.

is very important for New Zealand, as a small open economy. In

hrough the Foreign

that a higher level of foreign reserves holdings was appropriate.

evel of foreign reserves holdings, combined with risks associated with
other current and possible future balance sheet activities in pursuit of our obj

necessitated a higher level of financial resources. We now have a greater level of pre-positioned
inancial resources in the

© support financial stability, if and when needed. We have agreed processes

ectives have

intervene in markets
'o seek additional
der negative equity.

sed of fighting the last crisis. Our aim in undertaking reviews of

our reserves, resources and intervention playbooks is to not continue to fight the last crisis, but to
learn from it, and position ourselves to be prepared (as far as one can be) for the next one.

Thank you.

References

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website: httos://www.federalreserve.gov/financial-stability/bank-term-funding-program.htm

Bolt, W., Frost, J., Shin, H. S., & Wierts, P. (2023). The Bank of Amsterdam and the limits of fiat
money. In www.bis.org. Basel: BIS. Retrieved from BIS website:

httos://www.bis.org/publ/work1065.htm

Carstens, A. (2023, February). Central banks are not here to make profits [Speech]. Presented at the
Op-ed by Mr Agustin Carstens, General Manager of the BIS. Retrieved from
httos://www.bis.org/speeches/sp230209.htm

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httos://www.rbnz.govt.nz/financial-markets/foreign-reserves

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he-european-central-bank-conference-on-money-markets

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awkesby, C. (2020, August). COVID-19 and the Reserve Bank's Balance Sheet [Speech]. Presented
at the 2020 KangaNews New Zealand Capital Markets Forum. Retrieved from
httos://www.rbnz.govt.nz/hub/publications/speech/2020/speech2020-08-20

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website:_httos://www.ronz.govt.nz/hub/publications/bulletin/2023/how-the-reserve-bank-
implements-monetary-policy

F. (2023, August). New Zealand: 2023 Article IV Consultation-Press Release; Staff Report; and
Statement by the Executive Director for New Zealand. Retrieved from
httos://www.imf.org/en/Publications/CR/Issues/2023/08/24/New-Zealand-2023-Article-IV-
Consultation-Press-Release-Staff-Report-and-Statement-by-the-538455

Jordan, T. (2011). Does the Swiss National Bank need equity? In www.snb.ch. Basel: Swiss National
Bank. Retrieved from Swiss National Bank website:
httos://www.snb.ch/en/publications/communication/speeches/2011/ref_ 20110928 tin

Logan, L. (2023, March). Preventing and responding to dysfunction in core markets [Speech].
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httos://www.dallasfed.org/news/speeches/logan/2023/Ikl230303

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he ANZ-KangaNews New Zealand Capital Markets Forum 2021. Retrieved from
httos://www.rbnz.govt.nz/hub/publications/speech/2021/speech2021-06-02


RBNZ. (2013). Foreign currency reserves: wh
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media/2bea3a4070f64a47a84ce5875bfbcd

yy we

old them influences how we

m https:/Avww.rbnz.govt.nz/-

6a.as

hx?sc_lang=en

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