Prudential regulationi Relationship with the prudential regulator
The Reserve Bank's approach to bank supervision is based on three pillars: self-discipline, market discipline and regulatory discipline.
The self-discipline pillar involves the Reserve Bank creating incentives for banks to maintain the systems and capacity to identify, measure, monitor and control their risks and maintain prudent operations. This is achieved by:
- requiring high-quality, regular and timely financial public disclosure by banks in the form of disclosure statements;
- requiring directors to sign attestations in their bank's public disclosure statements;
- not creating an impression that the Reserve Bank (rather than the banks themselves) has primary responsibility for the prudent management of banking risks; and
- the Reserve Bank avoiding explicit or implicit government support for banks.
The market discipline pillar attempts to use market forces to reinforce the incentives for the prudent management of banks. This second pillar is based on the premise that an efficient and well-informed market will reward well-run banks, for example through lower funding costs and better access to funding. This is principally achieved by the Reserve Bank maintaining a contestable and competitive banking system, and ensuring the market is well informed about a bank's financial performance and condition.
The regulatory discipline pillar involves the Reserve Bank using regulatory and supervisory tools to reinforce incentives for banks to manage their risks prudently. The Reserve Bank has deliberately sought to keep its regulatory interventions to a minimum.
The Reserve Bank monitors all banks on an ongoing basis. Monitoring occurs principally through banks' twice-yearly disclosure statements. The RBNZ Act provides the Reserve Bank with extensive powers to obtain additional information, to have that information audited if required and to have a bank's affairs investigated.
The Reserve Bank meets with the boards of directors of the larger banks on a regular basis. The Reserve Bank does not conduct on-site examinations of banks in its capacity as the prudential regulator of banks.ii Management of banks
When considering an application for registration as a bank, the Reserve Bank will consider the suitability for their positions of the directors and senior managers of the bank. This policy applies in the case of locally incorporated applicants, to existing or proposed directors, the existing or proposed chief executive officer (CEO) and existing or proposed executives who report directly to the CEO; and, in the case of overseas-incorporated applicants, to existing directors and the existing or proposed chief executive of the New Zealand operations.
If a proposed director or senior manager has already passed a foreign banking regulator's suitability assessment, the Reserve Bank will usually accept that assessment as evidence of suitability.
A locally incorporated bank will be required to maintain adequate separation between the bank and its owners. This will require:
- putting in place policies to monitor and limit exposures to related parties;
- the company having a constitution that does not permit the directors to act in the interests of its holding company;
- the size and composition of the board being such that it does not give rise to concerns about the bank's ability to pursue its own interests when those interests conflict with those of its shareholders; and
- the bank having an audit committee (or other committee whose mandate includes audit matters) comprising non-executive and otherwise independent directors.
The Reserve Bank generally will require a locally incorporated bank to have at least five directors. The majority of the directors must be non-executive, and at least half are required to be independent. At least half of the independent directors must be ordinarily resident in New Zealand. The chairperson must also be independent. The Reserve Bank's criteria for a director to be independent are set out in the Reserve Bank's Corporate Governance (BS14) document.
The Reserve Bank must be supplied with a copy of the curriculum vitae of any potential director, CEO or executive who reports to the CEO of a locally incorporated bank, and the appointment of such a director, CEO or executive can only be made if the Reserve Bank has advised that it has no objection to the appointment.
Directors of banks (and the New Zealand CEO of an overseas bank) are required to sign bank disclosure statements (published twice yearly), which include certain attestations by the directors. Attestations include that the directors believe, after due enquiry by them, that:
- the bank has systems in place to monitor and adequately control the banking group's material risks, including credit risk, concentration of credit risk, interest rate risk, currency risk, equity risk, liquidity risk and other business risks, and that those systems are being properly applied;
- exposures to connected persons have not been contrary to the interests of the banking group (this applies to locally incorporated banks only); and
- the bank has been complying with its conditions of registration.
In the full-year disclosure statement, a bank must also disclose the following (and address any changes to the composition of the bank's board in the half-year disclosure statement):
- details of each director (including name, occupation, technical or professional qualifications, whether he or she is executive or independent, other directorships and any details of transactions that could materially influence a director in carrying out his or her duties); this information must also be disclosed in respect of the New Zealand CEO of an overseas bank;
- whether there is a board audit committee (locally incorporated banks are required to have an audit committee or other committee that considers audit matters), and certain details of that committee; and
- the board's policy for avoiding or handling conflicts of interest that may arise from directors' personal, professional or business interests.
In addition to the disclosure statements that are published twice-yearly by banks, the Reserve Bank publishes selected financial information for New Zealand banks side by side on what is known as the Dashboard. The Dashboard is updated quarterly with financial information that banks privately report to the Reserve Bank. The Dashboard approach aims to enhance market discipline by aggregating financial information in an accessible format that facilitates side-by-side comparison of banks based on key metrics.
Banks whose New Zealand liabilities, net of amounts due to related parties, exceed NZ$10 billion, will also be subject to outsourcing conditions of registration:
- The bank must comply with the Reserve Bank's Outsourcing Policy (BS11). The Outsourcing Policy requires the bank to have the legal and practical ability to control and execute outsourced functions. The policy is intended to minimise the impact of the failure of a large bank, or a service provider to a large bank, on the wider economy, and to preserve the available options if there is a large bank failure. The current version of the policy was issued in 2017, and affected banks have a transition period of five years to be fully compliant with the Outsourcing Policy.
- The bank must ensure that:
- the business and affairs of the bank are managed by, or are under the direction or supervision of, the board of the bank;
- the employment contract of the CEO or person in an equivalent position with the bank and the terms and conditions of the employment contract are determined by the board of the bank, and any decisions relating to the employment or termination of employment of that person are made by the board of the bank; and
- all staff employed by the bank have their remuneration determined by the board or the CEO of the bank, and are accountable (directly or indirectly) to the CEO of the bank.
No restrictions have been imposed by the Reserve Bank on bonus payments to management and employees of banks.iii Regulatory capital and liquidity
A bank's capital requirements must be calculated under one of two approaches available under the Reserve Bank's capital adequacy framework. The first is the standardised approach and is set out in the Reserve Bank's Capital Adequacy Framework (Standardised Approach) (BS2A). This approach uses external credit assessments produced by approved credit rating agencies and is the default approach. The second permits a bank that has been accredited by the Reserve Bank to use its internal models to measure the risks of the bank's business and is set out in Capital Adequacy Framework (Internal Models Approach) (BS2B). The Reserve Bank's capital adequacy framework aligns with the Basel III global standards in almost all areas, but some departures were made to reflect New Zealand's circumstances: for example, the Reserve Bank did not support the introduction of a leverage ratio for New Zealand banks, relying instead on its liquidity policy (which is discussed below).
The Reserve Bank implemented the Basel III capital requirements in stages. Transitional relief for regulatory instruments that no longer meet the applicable criteria for recognition as Tier 1 or Tier 2 capital was removed on 1 January 2018.
A bank must have a capital policy. The capital policy must take into account any constraints on the bank's access to further capital, for instance if required in relation to an increase in business or an unexpected loss. In addition, a bank must satisfy the Reserve Bank that it has the capacity to implement and manage an internal capital adequacy assessment process that meets the Reserve Bank's Guidelines on a Bank's Internal Capital Adequacy Assessment Process (BS12).
A branch of a bank incorporated overseas will have to demonstrate to the Reserve Bank that the global bank complies with adequate capital standards that are at least broadly comparable with those in New Zealand, and that it is subject to adequate supervision by the bank's home supervisor.
Minimum levels of capital must be held on both a solo and group basis. Capital is divided into Common Equity Tier 1 capital, Additional Tier 1 capital and Tier 2 capital, consistent with Basel III. Locally incorporated banks generally need to comply with the following capital requirements:
- the total capital ratio of the banking group is at least 8 per cent;
- the Tier 1 capital ratio of the banking group is at least 6 per cent;
- the Common Equity Tier 1 capital ratio is at least 4.5 per cent; and
- the capital of the banking group is at least NZ$30 million.
Since 1 January 2014, most locally incorporated banks have been required to maintain a conservation buffer of 2.5 per cent above the minimum ratios or face restrictions on distributions. The Reserve Bank has the discretion to apply a countercyclical buffer of common equity of between zero and 2.5 per cent, although there is no formal upper limit. The purpose of the buffer is to protect the financial system during the downturns that follow periods of excessive credit growth. If a bank does not maintain its capital ratios above the buffer, the bank's ability to make distributions will be restricted.
Capital ratios are calculated by reference to risk-weighted on-balance and off-balance sheet credit exposures, a capital charge for market risk exposures and a capital requirement for operational risk. Locally incorporated banks must obtain a notice of non-objection before treating a capital instrument as regulatory capital, and must receive approval for certain repayments of instruments.
The Reserve Bank has been undertaking a review of the capital requirements for locally incorporated banks since 2017. In the most recent phase of the review, the Reserve Bank proposed a substantial increase to locally incorporated banks' capital requirements. The review is expected to conclude in 2019, and if any changes are implemented, the Reserve Bank has indicated that they will be phased in over a five-year transition period.
Banks must also comply with the Reserve Bank's Liquidity Policy (BS13). The Liquidity Policy requires banks to meet a minimum core-funding ratio of 75 per cent, ensuring that a greater proportion of bank funding is met through retail deposits and term wholesale funding. This has led to increased competition among banks and non-bank deposit takers for retail deposits. Basel III proposes a leverage ratio, which the Reserve Bank considers very similar to the intent of BS13. The Reserve Bank considers, however, that certain aspects of the new leverage standards are not suitable for adoption in New Zealand: for example, the requirement that government securities comprise the bulk of high-quality liquid assets held by banks is not suitable because New Zealand does not have a sufficient volume of government debt on issue.iv Recovery and resolution
The Reserve Bank's Open Bank Resolution (OBR) Pre-positioning Requirements Policy (BS17) applies to locally incorporated banks holding retail deposits in excess of NZ$1 billion (although other registered banks may opt in). The OBR is a tool for responding to a bank failure, allowing the bank to be open for full-scale or limited business on the next business day after being placed under statutory management. It is intended to provide an immediate and practical tool for responding to a bank failure and to reduce the moral hazard associated with implicit government support of banks (those that are too big to fail).
The OBR policy places the cost of a failure in the first instance on shareholders, but also provides flexibility to assign losses to creditors without causing unnecessary disruption to the banking system and wider economy. If a statutory manager is appointed to a bank, the bank must close, and all accounts must be frozen to enable the bank's net asset deficiency to be determined. A haircut reflecting the bank's net asset deficiency plus a buffer is applied to all creditors' accounts, and funds equal to the amount of the haircut are frozen. The non-frozen funds are guaranteed by the government, and the bank is able to reopen for core transactions business. On the following day, haircuts are applied to other non-time sensitive liabilities to enable those liabilities also to be partially satisfied. If sufficient funds become available, the frozen funds can be released during the course of the statutory management.
Banks subject to the OBR policy must pre-position for OBR; this means having IT, payments, resource and process functionality in place ahead of a crisis so that, if a statutory manager is appointed, access channels can be closed, funds can be frozen and access channels can be reopened for business by no later than 9am the next business day.