Mr Brash gives an address on the
development of international standards
Opening address given by Dr Donald T Brash, Governor of the Reserve Bank of New Zealand, to the
SEANZA Forum of Banking Supervisors' conference, held in Auckland on 11 November 1999.
* * *
It's a great pleasure to welcome you all to New Zealand and to the SEANZA Forum of Banking
Supervisors' Conference.
I would especially like to welcome our guest speakers: William Coen from the Basel Committee
Secretariat, Roland Raskopf from the Financial Stability Institute, and Clive Briault from the Financial
Services Authority. We very much appreciate their giving up valuable time to be with us, particularly
given the long distances they have had to travel to get here. I am sure that they will make a very
valuable contribution to our discussions over the next two days.
I would also like to extend a special welcome to the delegate from Macau. In the past, Macau has been
an observer at these conferences. However, since the last meeting of the Forum it has become a full
member of SEANZA.
As some of you will know, the SEANZA Group has a long history. It originally grew out of a 1956
meeting of central bank governors from British Commonwealth countries in the Asia Pacific region.
The governors decided that the central banks in the region should pool their resources to provide an
intensive and systematic training course for promising central bank staff. The first such course was
held in Australia in 1957. These courses continue to be held once every two years. The last course was
held in New Zealand last year, while the next one will be held next year in Sri Lanka.
The SEANZA Forum of Banking Supervisors was established in 1984 as an offshoot of the main
SEANZA group. The objective was to provide a means for banking supervisors from the region to
establish contact with each other, in order to exchange information on issues and problems of common
interest. Initially only central banks were represented at the Forum. More recently, special purpose
regulatory bodies like the Korean Financial Supervisory Service and APRA in Australia have joined.
Since SEANZA was first established, the number of countries in the SEANZA group has gradually
expanded, to the extent that each country now gets the opportunity to host these conferences only once
every 40 years. That probably means I won't get the chance to give the opening address at one of these
conferences again, and that none of us here today will attend the next New Zealand conference! No
doubt the issues under discussion at that conference will be quite a bit different from those being
considered here, and the financial system will look radically different from the way it does today.
Already we are seeing rapid change in the financial sector. Over recent years, advances in computer
and communications technology, and financial market liberalisation, have led to increasing
globalisation of financial markets. At the same time, banks are under pressure to keep their costs
down. As a result, many banks that operate in a number of different countries are choosing to
centralise activities in one regional centre rather than duplicate services in each country. We are
particularly aware of this trend in New Zealand as all of our banks except one are foreign owned. We
are increasingly finding that these banks are using computer systems located in another country, or
that parts of their New Zealand business are not in fact being conducted here at all. For example, a
phone call to a bank's treasury may be answered by someone located in Sydney rather than in
Wellington or Auckland. Or we find that particular types of transactions entered into with New
Zealand-based customers are being booked through another jurisdiction and do not appear on the New
Zealand balance sheet.
These trends make it more important than ever for supervisors in the region to get together and talk
about matters of common interest, both in groups like this and on a one-to-one basis.
At the same time, boundaries between different types of financial institution are becoming
increasingly blurred. Financial conglomerates offering a wide range of financial services are becoming
increasingly common.
These developments are reflected in the three main themes of this conference: international standards,
supervisory structures (and by that I mean the question of whether supervision is best conducted
through a so-called "mega regulator" or through more traditional, functionally-based, supervisory
structures), and the supervision of conglomerates. These are all very important and topical issues.
I would like to talk a little about one of these themes - the development of international standards.
There are two main points I would like to make. First, while there is a definite role for international
standards, it is very important that they are implemented in a way that takes into account the individual
circumstances of each country. Secondly, it is possible to have too much of a good thing in this area.
We will not necessarily be able to achieve our overall objective - a sound and efficient financial
system - by adding further layers of complexity to our supervisory rule books. In fact we may weaken
rather than strengthen the financial infrastructure if we go down this route.
The Basel Committee on Banking Supervision has been instrumental in producing a number of
important international standards on the supervision of banks, including the Capital Accord and
minimum standards governing the supervision of banks' cross-border establishments. Similarly, other
supervisors such as IOSCO and the International Association of Insurance Supervisors have pursued
co-operation in their areas of responsibility. And in the early 1990s, in recognition of the emergence
and growth of financial conglomerates, banking, securities and insurance supervisors from G10
countries began to work together to identify the problems that conglomerates can cause, and to
consider ways to overcome them.
The Mexican crisis in 1995, in particular, and the widespread incidence and high cost of banking
problems recently in this region have prompted calls for concerted international action to promote the
soundness of financial systems. These calls have strengthened over the last couple of years, with the
G7 countries calling for the adoption of strong prudential standards in emerging countries and
encouraging the international financial institutions to increase their efforts to promote effective
supervisory structures in those countries. The Basel Committee has been at the forefront of this effort
with the release of the Core Principles. The IMF and the World Bank are also involved. The IMF is
making evaluation of financial supervision and regulation part of its annual country reviews, and the
World Bank is emphasising the strengthening of financial infrastructure as an important part of its
structural assistance programmes.
These initiatives have many positive aspects. International harmonisation and co-operation are very
important in what is rapidly becoming a "borderless" global financial system. Also, it is important that
the risks that supervisors should take into account in their supervision are identified, and that
benchmarks are established whereby countries can measure their progress in establishing appropriate
supervisory regimes. As supervisors, we can derive a great deal of benefit from such an approach.
Bank customers and banks themselves also benefit from the international comparability made possible
by the use of common measurement and disclosure frameworks.
Nevertheless, I believe it is important not to assume that supervisory arrangements should be, or can
be, the same in every country. In my view, they must be tailored to the individual circumstances of
each country. What is appropriate for a small country like New Zealand may be totally inappropriate
for a large country like the United States, and vice versa. To give just one example, non-bank financial
institutions need not be licensed or supervised in order to take deposits in New Zealand. Here that does
not cause any problems because the non-bank sector is tiny relative to the bank sector, and people are
generally aware of the differences between banks and non-banks, and of the fact that non-banks may
be more risky than banks. However, I would be the first to acknowledge that such an approach would
not necessarily be the best for all other countries. In many countries, retail depositors typically use
non-bank financial institutions rather than banks and it may therefore be important that those
institutions are licensed and supervised. Similarly, in some countries where there are perhaps
thousands of licensed financial institutions and a very large population - and generous deposit
insurance or a strong implicit government guarantee of bank deposits - it may well be desirable for the
supervisor to check the bona fides of bank management. In New Zealand, with its relatively small
population and absence of deposit insurance, we are satisfied that the public is well able to make its
own assessment of the quality of bank management and has an incentive to do so, and in these
circumstances there is no need for the supervisor to take on this role. Thus, while we strongly support
the introduction of international standards in principle, we would not like to see a one-size-fits-all or
checklist, tick-the-boxes, approach. International standards need to be interpreted with an appropriate
degree of flexibility in order to adequately cater for the individual circumstances of each country.
Further, when devising supervisory policies we need to bear in mind not only the individual
circumstances of our own countries but also the need to ensure that policies harness market forces to
the extent possible, rather than undermine them. As Alan Greenspan said in 1997:
"As financial transactions become increasingly rapid and complex, I believe we have no choice but to
harness market forces, as best we can, to reinforce our supervisory objectives. The appeal of
market-led discipline lies not only in its cost effectiveness and flexibility but also in its limited
intrusiveness and its greater adaptability to changing financial environments. Measures to enhance
market discipline involve providing private investors the incentives and the means to reward good
bank performance and penalise poor performance. Expanded risk management disclosures by financial
institutions is a significant step in this direction."1
Indeed, Mr Greenspan made the same point again exactly one month ago, when addressing the
American Bankers Association in Phoenix, Arizona. In that speech he said:
"A one-size-fits-all approach to regulation and supervision is inefficient and, frankly, untenable in a
world in which banks vary dramatically in terms of size, business mix, and appetite for risk
... Policymakers must be sensitive to the tradeoffs between more detailed supervision and regulation,
on the one hand, and moral hazard and the smothering of innovation and competitive response, on the
other. Heavier supervision and regulation designed to reduce systemic risk would likely lead to the
virtual abdication of risk evaluation by creditors of such entities, who could - in such an environment
- rely almost totally on the authorities to discipline and protect the bank. The resultant reduction in
market discipline would, in turn, increase the risks in the banking system, quite the opposite of what is
intended ... Supervisors have little choice but to try to rely more - not less - on market discipline
- augmented by more effective public disclosures - to carry an increasing share of the oversight
load ... The potential for oversight through market discipline is significant, and success in this area
may well reduce the need to rely on more stringent governmental supervision and regulation."2
I am pleased that the profound truth of this view is being recognised more widely and that
international standards are increasingly reflective of this. The use of banks' own models in the
measurement of market risk is one example. Increased emphasis on the role of disclosure is another.
These developments recognise that, as banks' activities become increasingly complex and change
occurs with ever greater rapidity, it becomes more and more difficult to place reliance on detailed
rules. Often supervisors are dealing with yesterday's problem rather than the one that is emerging
today. What we should aim to do is to harness and reinforce market disciplines to achieve the outcome
we are seeking - a sound and efficient financial system. Bank directors and management have a
detailed knowledge of their bank's business. We need to make sure that this knowledge is used in the
measurement and management of risk. We also need to make sure that supervision is not carried out in
a way that will reduce incentives for bank customers to monitor the performance and risk profile of
their bank. To the extent that supervisors ensure that these things happen, we can expect banks to
operate more prudently.
As supervisors, we need to be realistic about what supervision can achieve. It is certainly clear from
the record that there have been significant weaknesses in some countries' banking systems, and that
these weaknesses have both contributed to the emergence and severity of financial crises and
complicated the task of resolving them. However, I am myself somewhat dubious about the
proposition that "poor supervision" was the primary cause of these weaknesses. There has been a
tendency to give supervision the blame for problems that have originated elsewhere, or to seek
supervisory remedies for problems that might be better solved in other ways. I would also note that
supervision can sometimes be part of the "problem" rather than part of the solution - particularly when
there has been excessive regulatory forbearance and/or excessive reliance on the public safety net.
I believe that supervision should be seen as only one of the factors influencing the health of the
financial system. In this regard I am pleased to note that the Basel Core Principles recognise this by
identifying the preconditions for effective banking supervision, including sound and sustainable
macro-economic policies, a well developed public infrastructure, and effective market disciplines. I
am sure that we can all agree that all of these factors are vital to the development of a sound financial
system.
In conclusion, as financial markets become increasingly globalised, supervisory co-operation and
harmonisation become increasingly important. Groups such as SEANZA play an important role in
achieving these objectives, as do international supervisory standards. But I believe it is important that
we don't assume that international standards are the holy grail and that their adoption will necessarily
lead to a sounder financial system. Supervision is only one of a number of factors impacting on the
performance of the financial sector. It is important that we have good supervision, but we should not
over-emphasise its importance.
I hope that you will find this conference stimulating and that you will enjoy your time in New
Zealand.