Media reported the other day that the new local subsidiary of the large Chinese bank ICBC had been issued a notice for breaching one of the Reserve Bank’s regulatory requirements. It looks like a fair call. Registered banks have to comply with the rules (the “conditions of registration”) from the start. And it is prudent that the Reserve Bank should keep a particularly sharp eye on state-dominated banks – whether from New Zealand, China (and, as is well-recognised, whatever the legal form, the Party ultimately calls the shots in each of the major banks), or elsewhere. Government banks around the world have a pretty poor track record, misallocating capital and too often ending badly, whether because of weak market disciplines, or because the pursuit of other public policy objectives over time undermines the soundness of the bank. As I noted the other day, that happened to the US agencies.
This episode must be a bit embarrassing for ICBC itself, and for its chair, the former Reserve Bank Governor, Don Brash. Rules are rules. But sometimes rules are silly rules, with no very obvious public policy foundation. Then it is time for those who hold regulatory agencies to account to ask questions about whether those rules should be in place at all.
What exactly did ICBC do? They did not obtain prior approval from the Reserve Bank before appointing a compliance officer, one of the CEO’s direct reports.
Under Reserve Bank rules (outlined here):
no appointment of any director, chief executive officer, or executive who reports to, or is accountable directly to, the chief executive officer, may be made in respect of the registered bank, and no person may be appointed as chairperson of the board of the bank, unless the Reserve Bank has been supplied with a copy of the curriculum vitae of the proposed appointee and has advised that it has no objection to that appointment.
Under the current Reserve Bank Act, the Bank must have regard to the suitability of directors and senior managers in determining whether to register a bank in the first place. If we are going to have a bank registration regime that seems a sensible enough provision, on entry. But the ongoing conditions of registration for established banks are a matter of choice for the Bank.
“Fit and proper” requirements are pretty common internationally. But citizens should reasonably ask “to what end, and with what evidence that the requirements make a useful difference?”
The Reserve Bank’s prudential regulatory powers have to be used to promote the soundness and efficiency of the financial system (sec 68 of the Act). The focus of the suitability (“fit and proper”) tests is presumably on the soundness limb of that provision. Prior Reserve Bank “non-approval” must be expected to reduce the threat to the soundness of the financial system (not just the individual institution, but the system itself). How might it do that? The Reserve Bank says it focuses on integrity, skills and experience.
At the (deliberately absurd) extreme, if the Reserve Bank were blessed with the divine quality of omniscience, they could see into the soul of each potential appointee, and discern accurately how those individuals would respond to the sorts of threats, risks, shocks ,and opportunities they would face while serving with a New Zealand registered bank. No one prone to deceive under stress, to breach internal risk limits, or to take “excessive” risk would get appointed. That sort of insight would be very helpful. But it isn’t on offer.
Instead, the Reserve Bank’s document suggests a backward-looking focus – checking out past appointments, past criminal convictions, and the like. All of which is fine, but all of that information is known (or knowable) to those at registered bank concerned who are making the appointment. And most of the stuff that is really interesting, and telling, is likely to be about character. That isn’t knowable in advance, and certainly not by Reserve Bank officials. What expertise do Bank economists and lawyers – many very able people – have in second-guessing the judgement of the banks themselves in making such appointments? And what incentive do they have to get it right? The model looks like one that favours the appointment of grey colourless accountants and lawyers, who have not yet blotted their copybooks – perhaps never having taken any risk – with a bias against anyone who has learned banking, and what it is to lose shareholders’ money, the hard way.
Banking regulators worry about the risks to depositors and taxpayers if widespread or large banking failures occur. But the first people to lose money as a result of mistakes, misjudgements, or worse are usually the shareholders in the bank concerned. They might reasonably be assumed to have more at stake from bad appointments of directors or senior managers than central bank regulatory officials do. New Zealand has in place pretty demanding bank capital requirements.
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 a 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. Perhaps conviction for an offence involving dishonesty in the previous  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. 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.
Perhaps too there might be 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.
But the current fit and proper tests seem to be an additional compliance cost, for no obvious public policy benefit. It has the feel of something they feel the need to be seen to be doing, to be a “proper supervisor”, and get ticks in the right boxes when the next IMF FSAP comes through, rather than something where there is evidence that the rules have advanced financial system soundness in New Zealand.
The Reserve Bank is currently undertaking a “regulatory stocktake”. But that stocktake ruled out from the start reviewing almost anything very interesting and fundamental in the supervisory regime. It seems to be a tidying-up exercise, not bad in itself, but not focused on the real issues.
One of features of the New Zealand banking regulatory system is that the Bank is both operational regulator/supervisor, and responsible for the policy framework and legislation around banking supervision. But those with responsibility for monitoring the Bank – its Board, the Treasury, the Minister of Finance, and Parliament’s Finance and Expenditure Committee – might want to ask just what value is being added by these fit and proper requirements. Perhaps the Minister of Finance could raise it in one of his “letters of expectation” to the Governor?
Provisions of this sort cost money, both to banks to comply with and to taxpayers to administer the provisions, and impede business flexibility. Individually, the amounts involved and the degrees of inconvenience, are probably not large, but the old line remains true “take care of the pennies and the pounds will take care of themselves”. There should be a general presumption against regulatory burdens – particularly where they impinge directly on the lives and professional careers of individuals – and an onus on the regulators to show that their provisions are making a material net difference to worthwhile public policy objectives.
2 thoughts on “Fit and proper people”
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