The Reserve Bank has had out for consultation a document described as a “regulatory stocktake of the prudential requirements applying to registered banks”.  In fact, it covers only a limited range of issues, as most of the more important issues were ruled out in the terms of reference.   Submissions close tomorrow.

I hadn’t really planned to make a submission, but some discussions got me thinking a bit more about disclosure requirements and the way in which this document seemed to risk leading to less information being available to depositors and creditors, while more information was provided confidentially to the Reserve Bank itself.  That seems wrongheaded, when the focus of the regulatory regime has long been intended to be to support a framework in which creditors carry the risks if things go wrong, not the government or the Reserve Bank.

So I have written a brief submission, which is available here.

Submission to RBNZ regulatory stocktake Sept 2015

I focused on only two aspects.  The first is around the “fit and proper” tests the Reserve Bank imposes for directors and senior managers.  There is no evidence that this process is adding any value in promoting the soundness of the New Zealand financial system.  I raised some questions, and proposed a much less discretionary, disclosure-focused, alternative approach to the issue:

No doubt there will be people (and perhaps there already have been) who were employed by failed finance companies coming up for Reserve Bank approval in the next few years.  In some cases, those people will have had no responsibility for the failure, and in others there may have been some culpability.  But business failures happen, and they aren’t always a bad thing (indeed, unlike some systems, our banking regulatory system is explicitly designed not to avoid all failures).  Why is the Reserve Bank better placed than the registered bank concerned to reach a judgement on whether any previous involvement with a failed finance company should disqualify someone from a future senior position in a bank (or other regulated financial institution)?

In a similar vein, I wonder if the Reserve Bank has done any sort of retrospective exercise and asked itself how likely it is that, with the information available at the time, it would have rejected any (or any reasonable number) of those responsible for the 1980s failures of the DFC and the BNZ.  Done in a suitably sceptical way, it would be an interesting exercise

I’m not suggesting there be no rules at all.  My two specific proposals would be as follows:

• conviction for an offence involving dishonesty in the previous 10 years should be an automatic basis for disqualification from such senior positions.   It wouldn’t be a perfect test, but it is certain and predictable, and probably better than a “we don’t like the cut of your jib” sort of discretionary judgement exercised by regulatory officials.  And it doesn’t hold the false promise of regulators being able to sift out in advance people who might, in the wrong circumstances, later be partly responsible for a bank failure.
• a requirement that a summary CV for each director and key officer be shown on the registered bank’s website.  Those summary CVs might be required to list all previous employers or directorships, and any previous criminal convictions and formal regulatory actions against the individual.

By contrast, the current fit and proper tests seem to be an additional compliance cost, for no obvious (or demonstrated) public policy benefit in safeguarding or promoting the soundness of the New Zealand financial system.

And the second area I commented on was around financial disclosure requirements.  I noted that if the disclosure statements were not providing the information the Reserve Bank needed (as they state), they clearly couldn’t be providing the information that a prudent creditor/depositor would find useful in evaluating his or her bank.  Accordingly, I proposed changes that would materially reduce compliance costs and materially increase the availability of rather more timely data to creditors/depositors –  those, that is, whose money is at risk.

In the consultative document, the Reserve Bank canvasses the possibility of further reducing the amount of information made public, while potentially further increasing the amount of private information the Reserve Bank itself obtains from banks.  That seems a wrong-headed approach, and quite inconsistent with the desire to promote  (a) market discipline and (b) an expectation that government bailouts are not the option of first resort if a bank runs into difficulty.  If the Reserve Bank has revealing private information not available to depositors, and the Bank subsequently  fails, why would a reasonable small depositor not argue with some force that the responsibility for her loss of money rested, proximately, with the Reserve Bank?  Such arguments, correct or not in some narrow economic sense, will strengthen the (already high) likelihood of government bailouts.

My alternative proposal is to reshape disclosure requirements so that depositors and creditors are given the same information that the Reserve Bank considers necessary for it to be able to monitor the health, and emerging risks, in individual banks.

In other words, scrap the existing disclosure requirements completely (which would, no doubt, materially reduce compliance costs), and require instead that all regulatory returns that banks provide to the Reserve Bank be published on the relevant bank’s website within, say, an hour of the information being sent to the Reserve Bank.  If the private information is valuable to the Reserve Bank it would also be valuable (at least in principle) to depositors/creditors and those in the private sector monitoring banks on their behalf.  It is, after all , the money of the depositors and creditors that is at stake,  not that of the government or the Reserve Bank.    And private readers have rather more incentive to use the information well than officials at the Reserve Bank do (however able or well-intentioned the latter may be).

Moving in the direction discussed just above would, of course, represent a substantial change in approach.  Timely statistical returns of the sort banks supply to the Reserve Bank can’t first go through a full audit sign-off and director attestation, but the Reserve Bank itself –  by its own revealed preferences –  clearly thinks that in terms of knowing what is going on on a timely basis, those protections are less important than getting timely information.  If things are very timely there will almost inevitably be the occasional error, but that is not an argument against the idea.  After all, even Statistics New Zealand (perhaps even the Reserve Bank) occasionally finds mistakes in its data.  The concern shouldn’t be errors –  people are human and will err –  but about the risk of being deceived.  But adequate protections against deliberate attempts to deceive either the Reserve Bank or creditors (by deliberately supplying erroneous or misleading information) surely either already exist in statute or common law, or could be legislated separately.  And the fact that the Reserve Bank’s own analysts would be reliant on the same data that were going public would provide an additional layer of comfort –  since the Bank is readily able to ask, and require answers to, probing follow-up questions.

…..

I am also not suggesting an absolutist approach to this issue.  I have no problem with the answers to ad hoc inquiries by the Reserve Bank of an individual bank not being published.  And in times when an individual institution may be approaching crisis, there probably needs to be greater confidentiality around the handling of the detailed information involved in crisis management (although such material should probably still be discoverable after the event).  Indeed, protecting that sort of information was a part of the justification for the (now abused) section 105 secrecy provisions in the Reserve Bank Act.  There is no foolproof dividing line, but I would suggest as a starting point that any statistical returns which are (a) regular, and (b) required of all (or a significant subset of) banks should be subject to my immediate disclosure rule.  And perhaps the Reserve Bank Board could offer an attestation in its Annual Report that it has satisfied itself that staff and management are operating the system in a way that ensures all regular supervisory information is being made available to depositors and other creditors.