variations in these rates from forecast levels impact earnings. the interest rate risk on unhedged foreign reserves is managed through strategic decisions and periodic review of asset allocation ( i. e. our duration target for foreign currency bis central bankers ’ speeches reserve portfolios is managed strategically through the business cycle ). the rbnz also incurs interest rate risk from its holdings of government bonds, but in this case there is a corresponding impact within the treasury, and this has no net impact on the crown ’ s overall balance. capital adequacy notwithstanding a conservative financial strategy and investment policies that limit financial risk, the bank ’ s income and balance sheet remain subject to some volatility. in order to manage this variation in annual financial performance and avoid the credibility risks associated with low levels of equity, the bank has adopted a policy for holding a prudent level of capital and developed a framework for determining the appropriate level of capital. the rbnz chooses to hold capital in line with both normal commercial practice and standard public sector arrangements in new zealand. the bank is not subject to regulatory capital requirements and thus determines its capital adequacy in agreement with its owner ( the government ), reflecting its balance sheet and business risks. having capital is explicit recognition by the government that income from the bank ’ s business will be volatile, and a buffer is required to absorb that volatility. it also supports the credibility of the central bank as regulator and supervisor of financial institutions. assessment of the potential financial consequences of the risks facing the bank determines the appropriate amount of capital the bank should hold. also relevant is the dividend policy. the act requires the bank to recommend an annual dividend to be paid in line with the principles set out in the bank ’ s annual soi, and the minister of finance decides upon the final dividend figure. the dividend principles state that the bank should maintain sufficient equity for the financial risks it faces, and that excess equity should be returned to the crown. they are also tempered by the requirement that unrealised gains on investments should be retained until they are realised in new zealand dollars. thus surplus capital is returned as dividends, while the onus is on the bank to determine the appropriate amount to be held to maintain sound capital adequacy. the bank consults closely with the treasury on these matters, with the intention of coming to an agreed recommendation that is submitted to the minister for decision. if ultimately the bank disagrees with the minister ’ s determination of

bank on foreign exchange operations4. even though with a pure floating rate currency, foreign exchange reserves conceptually may not be required, foreign reserves are held in the event that the bank may be required to intervene in foreign exchange markets, for example where there is disorder in the currency markets or the currency is materially out of line with fair value. foreign exchange intervention has been infrequent. liquidity provision to troubled banks and lender of last resort functions are at the discretion of the bank, including the terms and cost of borrowing. in the gfc, liquidity was provided by the rbnz at the cost of the official cash rate ( ocr ) and with interest rates falling, the bank made positive returns from its lending. ostensibly, the bank incurs credit risk in these circumstances, mitigated through collateralisation. however, the major cost of financial stability support does not fall upon the bank, but instead upon the fiscal authority ( the treasury ). whilst the bank has responsibility as prudential supervisor to recommend the appropriate action if a financial institution fails, critical decisions on statutory management, capital injections or guarantee schemes are ultimately for the minister of finance to make, and would be expected to take the form of fiscal measures. accountability is accomplished through public and parliamentary reporting requirements and monitoring via the bank ’ s board as agent of the minister of finance and on financial matters by the treasury. the bank must publish a statement of intent on its strategic and performance objectives for the coming three years, and publish an audited annual report for the previous year that includes information on policy, operational and financial performance. the soi and the annual report are both tabled in parliament and subject to the scrutiny of parliament ’ s finance and expenditure select committee. the bank observes the accounting standards imposed by the external reporting board ( a statutory body ). from this financial year, the bank is required to apply new zealand equivalents to international public sector accounting standards ( nz - ipsas ) rather than international financial reporting standards ( ifrs ). the change in financial reporting framework will not have a significant impact on the bank ’ s financial reporting, although nzipsas and ifrs could diverge over time. the bank also has responsibilities for the operation of payments and settlements systems that earn income and incur mostly operational risks, with financial risks defrayed in various ways. the mou establishes that the primary purpose of reserves management and intervention activity is : extreme disorder in foreign exchange markets – to ensure continued functioning