Less dogma, more flexibility needed in Reserve Bank's risk management strategy

Less dogma, more flexibility needed in Reserve Bank's risk management strategy

By Gareth Vaughan

Discussing potential bank failure is a frightening topic at the best of times.

Although thankfully none of New Zealand's banks fell over during the Global Financial Crisis, the TV images of customers queuing to get their money out of Northern Rock, and memories of the chaos that hit global financial markets when Lehman Brothers went belly up, remain etched in my mind.

But although our banks survived intact, with the help of both the Crown retail deposit guarantee scheme and the Crown wholesale funding guarantee scheme, New Zealand as a society has experienced the recent pain of dozens of finance companies crumbling with individual investors in some cases losing the shirts off their backs and taxpayers carrying the can for the thick end of $1 billion, largely due to South Canterbury Finance. And insurer AMI also met its Waterloo after the big Canterbury earthquakes.

Many of us are old enough to remember the Government's bailing out of BNZ with hundreds of millions of dollars of taxpayers' money in 1989 and 1990.

So when the Reserve Bank's Head of Prudential Supervision Toby Fiennes speaks about the prudential regulator's approach to risk management, it's worth listening. Fiennes did this last week in a speech to the NZ Society of Risk Management, which I covered here.

However, I found some of the what he said stuck in the craw with the overall impression of a regulator too set in an ideological mindset and not adopting a pragmatic enough approach.

No on-site reviews

Firstly, there was Fiennes' comment that, in a move unusual for international regulators, the Reserve Bank doesn't conduct on-site reviews.


Frankly that comment sounds like butt covering.

I heard recently from a senior New Zealand bank executive about a visit to their bank from Australian Prudential Regulation Authority staff. The Aussies were escorted by uncomfortable looking Reserve Bank staff, as those from across the Ditch asked their questions.

Now, I'm not suggesting on-site visits are the be all and end all of bank, insurer or non-bank deposit taker regulation. And as demonstrated above at least some Reserve Bank staff set foot inside bank HQs from time to time. But it strikes me that simply visiting say, ASB's state of the art Auckland headquarters to have a look around and see how banks are operating in the digital age and asking a few questions, can't hurt.

At the very least it may give some idea of what the culture inside the bank is like.

No favours for the big boys? Pull the other one

Fiennes was also at pains to say a punch drunk big financial institution wouldn't necessarily receive favourable treatment over an on the canvas minnow. Financial intermediaries "can and will be allowed to fail," he said.

With my taxpayer's hat on I like the sound of that. But I also realise that as tough as the Reserve Bank wants to talk now, should the proverbial hit the fan events will probably be taken out of its control.

Witness the hasty implementation of the Crown retail deposit guarantee scheme in 2008. In 2012 Michael Cullen, Finance Minister when the Scheme was introduced, told me New Zealand had been forced into a much more comprehensive, open ended scheme than had been under consideration by the "panicky" actions of Australian Prime Minister Kevin Rudd.

What that emphasises is the political pressures that would weigh down on number 2, The Terrace in a time of crisis from both sides of the Tasman.

Because if one of our big four banks is in serious trouble, it's likely its Aussie parent will be too, and potentially the whole financial system given how dominant the big four banks are with their interconnectedness on both sides of the Tasman.

The Reserve Bank may be allowed by the Government to apply haircuts to savers' deposits via its Open Bank Resolution Policy if one of the country's smaller banks goes under. But it's simply not believable that a government would stand aside and let it do this to a big bank holding tens of billions of dollars worth of voters' deposits.

Competition is there but makes few major inroads

Fiennes also made much of the efficiency of our financial system, saying this efficiency helps create opportunities for new entrants, products and services.

"Within an overall stable financial system in New Zealand, there is ample scope for new entrants. Over the last six years the number of banks registered has increased by 50%, from 16 to 24. And in just the last 12 months since the insurance legislation came fully into effect, we have welcomed two new insurers to the market," Fiennes said.

Although I'm not disputing the numbers in terms of new entrants, and I do see real retail banking alternatives to the big four banks through the likes of locally owned Kiwibank, the Co-operative Bank, TSB, SBS and Heartland, the reality is the big four still own this market. The big four hold in the vicinity of 90% of total system assets. And as the Reserve Bank itself pointed out in May; "The New Zealand banking system is highly profitable in an international sense."

Questions to pose here include although there are realistic alternatives to the big banks, why are the big boys able to maintain their combined dominance year after year? Can this last? And is it good for New Zealand?

As prudential regulator the Reserve Bank focuses on maintaining financial stability rather than helping foster competition. In theory the latter issue is the Commerce Commission's job. But it allowed a deal earlier this year that gave IAG 66% of the home and contents and vehicle insurance market, which doesn't send consumers an encouraging message about competition. 

Lastly I'd suggest that using a quote from the CEO of Goldman Sachs as an exemplar in a speech on financial markets risk management is probably something best avoided.

"In a recent report by Credit Suisse, Lloyd Blankfein, CEO of Goldman Sachs, emphasised the importance of focusing on real risk adjusted returns in banking, highlighting that it is not possible to shoot from the hip and generate sustainable returns," Fiennes said in his speech.

See Fiennes' full speech here.

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The NZ banking customer environment must be the most profitable in the developed world. 
With the Kiwi 'she'll be right' national attitude, and the highest interest rates for borrowers for a stable Western country we provide a lucrative environment.  
Perhaps the solution is, since we can seem to. Supervise our banks adequately, we join the Australian currency and have one tran Tasman banking system.  Maybe that is the intention anyway.   

The cost of any regulator failing to do the tasked job always falls back on the people.....hence my absolute loathing of regulators.......if any business were as incompetent as a regulator they simply fall over and that is a great way of weeding out the poor performers.......how many regulators fall on the sword?......they tend to get a handshake and thankyou for their time and effort.......and depart through the rear entrance door.
Any bank failure is ultimately a regulator failure!!!!   I have absolutely no time for the nasty sods at the RBNZ who think they can conveniently side-step their duties using invented mechanisms under the banner of policy called an OBR......the invention of the OBR should be screaming a message to all NZ'ers that the regulators are incompetent and that their money is not safe.
The RBNZ should perhaps read the governing legislation......they might like to think they are off the hook in an OBR event.........but......people have the right to take court action against the RBNZ......so while the RBNZ thinks it can get itself off the hook via policy which is all smoke and mirrors........there is nothing to stop depositors from taking legal action against the RBNZ for failing to regulate which causes loss......then there are the banks themselves......who could take action against the RBNZ for failing to regulate appropriately and ensure that the bank/s were stable etc.
if any bank fails in NZ there will be legal ramifications for the RBNZ.... are they really that stupid in Wellington that they think they can make cop-out public statements in which they try to remove themselves from the responsibility they are tasked with?.....given that they have publicly stated they do not undertake on-site inspections as part of regulatory good/best practice........
If there is an OBR or bank failure type event.......depositors have had most of their rights taken away by the regulator who has had supreme authority......firstly the existence of a regulator removed the rights of depositors to be in a normal contractural position with the banks......and secondly the regulator has policy which further removes the right to access or control your own cash asset.......people aren't going to sue a failed  bank so they will sue the next best thing being the regulator.........
Good article Gareth!!

Sue them with what recourse exactly?

I wouldn't go so far as to say "incompetent", unless by "competent" you mean "incapable of making any error of judgement, ever".  We should certainly all be aware that regulators, like everybody in every profession that ever was and ever will be, are capable of making mistakes.  If we are relying on a system that will only work if everybody in it does their job to perfection at all times, then we are on shaky ground indeed.
So yes, certainly there should be a "screaming message" to all New Zealanders, as there should be to every citizen that ever was and ever will be, that neither they nor their money nor their families are "safe"; and that no regulatory system can ever make them so.  It would be irresponsible to encourage consumers of any good or service to believe that the fact that there's a regulator means that they can sit back and relax because somebody else will make sure everything is all right.  And it would be dangerous to encourage suppliers of any good or service to believe that if the regulator has looked at it and hasn't said anything, then it's either all right or not the supplier's fault/not the supplier's problem, if it isn't.

If I sell any goods or services then I have to guarantee that the goods and services I sell are suitable for purpose......I have to provide a refund or replacement goods or service if what I  sell is faulty, damaged or not fit for purpose etc
What is sauce for the Goose is sauce for the Gander........ it is the Golden Rule of Ethics and Reciprocity.........just because you are the regulator you should not be expempted from the same rules and ethics of business...........in fact the RBNZ as regulator should have the highest of morals and ethic as the are in a priviledged position!!!   If they can't maintain or hold to the same standards that is expected of all other business then I would suggest they are incompetent..........
When the banks can distribute heir profits to shareholders in a financial year without having any restrictions on the following years trading results......the normal business risk has been transferred onto unsecured depositors.......I believe this is incompetence.......and not an error in judgement.......the reasons that the RBNZ have provisioned NZ with in regards to the OBR simply do not stack up in way or form to fit the mandate of financial stability.

"images of customers queuing to get their money out of Northern Rock"
I got 900 quid back out of 10ksterling....it would have been over 1k until the bastards took out their management fees on top of the huge loss.
If it gets really rough and ppl lose everything I think Kunstler has the right view of these bankers future.

"And insurer AMI also met its Waterloo after the big Canterbury earthquakes."
Not so sure I would put them in the same boat?
I mean AMI appear to have done considerable due dilegence meeting all the requirements asked of them but got caught out. Or not?

Did they reinsure adequately, overpay the executives, invest the float in an approriate manner?

I would be interested to know which bank govt ministers and senior RB people use and how they determined its financial stability given they expect lay people to do so.
Also if they can give an assurance that if they become aware of their bank facing difficulties  neither they or their family will withdraw their money and accept an OBR bail-in like everyone else.
Because there won't be a public warning - that would guarantee the thing they hope to avoid. Probably those in the know selling their shares and crashing the share price will be the best signal to depositors.

The stuff of a banana republic eh?

A question you should consider in this
The banking system in Australia is bigger than the new zealand system, and the goernment has deemed it necessary to seperate the powers of prudential regulation and administration of monetary control ie RBA and APRA. Seperate entities. Different responsibilities. Obviously APRA take their responsibilities more seriously, even getting in a plane and flying over the Tasman. Howzat
Have you ever wondered why?

Maybe we should out-source the prudential regulation to APRA