Revisiting the case for splitting the Reserve Bank

The Minister of Finance has commissioned a two-stage review of the Reserve Bank Act.  The scope of the first part is pretty clear: it is about monetary policy (goals, transparency, and decisionmaking structures).  What, if anything, is included in the second stage is still up for grabs, with the Minister awaiting advice from the officials (a joint Treasury/Reserve Bank process) and from the Independent Expert Advisory Panel.   It seems likely that the Reserve Bank itself will try to keep any second stage to an absolute minimum –  as someone put it to me last week, the Bank seems happy with any reform that keeps things pretty much just as they are now –  and the arrival of Adrian Orr as Governor next month is likely, based on past performance, to reinforce that resistance.

A few weeks ago, I outlined the case that, as a key component of the second stage, the Reserve Bank should be split in two.  The Reserve Bank itself would remain responsible for monetary policy and associated activities (notes and coins, foreign exchange reserves, interbank settlement etc) while a new Prudential Regulatory Authority would take on responsibility for regulation and/or supervision of banks, non-banks, insurance companies, payments systems (and for the associated AML controls).

In favour of that position is that:

  • it is the more common model in advanced countries today (including Australia),
  • the synergies and overlaps between the various functions of the Reserve Bank are pretty slight (and probably no greater than, say, those between fiscal and monetary policy),
  • structural separation would allow for clearer lines of accountability, and
  • structural separation would allow for the creation of stronger, more effective, cultures  –  with appropriately skilled chief executives –  in each of the two successor institutions.

There hasn’t been a great deal of public commentary about this issue/option, but I noticed that the Shoeshine column in last week’s NBR picked it up.   NBR’s columnist  –  Jenny Ruth –  noted her support for structural separation (“a jolly good thing”).    She has been pretty critical of the Bank’s handling of a number of its prudential responsibilities, and is uneasy about the extent to which she believes the use of LVR limits –  by statutue, in pursuit of financial stability – “has become hopelessly confused with the Reserve Bank’s monetary policy functions”.

But in putting together her column she also talked to Massey banking academic David Tripe who “agrees there is a problem but isn’t so sure separation is the solution”.  He is quoted as saying

“My suspicion is that it wouldn’t improve matters because it would still be the same people doing the supervision”

and arguing

“We’ve got bank capture of the regulator –  the Reserve Bank asks for the data that the banks agree to provide, not the other way round”

On his first point, I guess my response would be that structural separation is not panacea, but that (a) change starts from the top, and (b) it should be materially easier to hold the financial regulator to account when it is responsible for only one main job (unlike today’s Reserve Bank).   And, as I’ve noted above, many of the other considerations also point in the direction of structural separation.  Finding a chief executive and senior management team who care primarily about the prudential regulation of the financial system –  whereas most of the senior management of the Reserve Bank over decades has always been more interested in (and had more background in) monetary policy –  is likely to be significant part of lifting the performance of the regulator.

Perhaps my one real unease is that a standalone regulatory agency could – if it were allowed to – become even more resistant to transparency and public accountability for its actions.  Whether there is a structural split or not, the officials and politicians doing the current review need to take steps to make the regulatory side of the Bank (as it is now) much more open.

(On Tripe’s second point, while I think there is something in what he says –  especially around data –  I rather doubt many of the banks would recognise the “regulatory capture” story.  On that note, I’m looking forward to the forthcoming publication of the New Zealand Initiative’s work on economic regulatory agencies, including the Reserve Bank.)

In her column, Jenny Ruth highlights a number of recent cases where the Reserve Bank’s handling of regulatory issues leaves a lot to be desired (and where, even if the Bank was correct, it has been so untransparent that we couldn’t possibly be confident of that).  I’ve written a bit about one of the cases she mentions –  the Westpac capital models issue.  The Bank has made no attempt to pro-actively disclose the relevant material (and would no doubt staunchly resist OIA requests), and although it claims it discovered the problem, as Ruth notes

“Westpac insiders say that Westpac outed itself. Shoeshine’s money in on Westpac”

Whatever the truth on that point, the whole episode did little to instill confidence in the Reserve Bank’s systems, processes, or accountability.

I haven’t written about the two other episodes Jenny Ruth highlights, both involving Kiwibank (you can read them for yourself).  Neither suggest that the Reserve Bank’s prudential wing has been on top of its game, or that they really have an instinctive handle on the nature of markets and financial institutions.

There are capable people in the regulatory/supervisory side of the institution (and I sat on the relevant internal policy committee for the best part of 20 years) but it is time for some refreshment, and the sort of restructuring that a fresh chief executive, focused on building and maintaining a strong and effective regulatory agency, can bring.  I’m not convinced, by any means, that all the regulatory framework is well-warranted, but if Parliament chooses to regulate, we need the job done excellently, and with considerable transparency and accountability.

NBR appeared on Friday morning.  As it happens, on Friday the Reserve Bank was taking regulatory action.   At 6.37pm an email dropped into my inbox stating that CBL Insurance had been placed in interim liquidation by the High Court, on application from the Reserve Bank.  The Reserve Bank is, of course, now responsible for the prudential regulation of insurance companies.

In time, I hope we see a substantial accounting by the Reserve Bank of its activities in this case, including its exercise of its powers to apply for the appointment of a liquidator.  In the meantime, I was interested in a piece on by David Hargreaves who suggest that, based on what we’ve seen so far, this episode too raises questions about the handling of the Reserve Bank’s supervisory/regulatory role.

From the Hargreaves article

That the RBNZ was interacting, strongly it seems, with CBL Insurance going back as far as July last year was revealed by CBL Corporation to the NZX only as recently as February 5, almost in passing and then more explicitly on February 7.

Key parts of the February 7 revelation for me were that the RBNZ had done an independent review on CBL insurance, that it had, as long ago as July 27, 2017 issued a minimum solvency recommendation, and then – most crucially from my perspective – that on November 22, according to the statement from CBL Corp, RBNZ had issued directions to CBL Insurance, CBL Corporation and its subsidiaries, requiring them to consult on any non-business-as-usual transactions greater than $5m.

That last one, as far as I’m concerned is a biggie. Essentially a publicly listed company with a sharemarket value of three quarters of a billion dollars was put on the leash by the regulator three months ago. And yet nobody was told publicly.

The CBL February 7 statement went on to say that “these directions and discussions that CBL Insurance has had with RBNZ have been occurring under strict confidentiality orders prohibiting CBL from making any announcement to the market while those orders remained in place. These orders have now been lifted.”

Neither confirm nor deny

The RBNZ refuses to either confirm or deny that it had placed confidentiality orders on its interactions with CBL Insurance last year.

He goes on

I actually think the RBNZ had some obligation to let the public know it was engaging with this company.

I do not like the idea of regulation behind closed doors because it is suggestive, at least, whether that is the reality or not, of a holier than thou attitude. It is to me, the regulator putting themselves above the public.

I’m not sure how well prepared the RBNZ was for getting itself into a situation like this with a publicly listed entity like an insurance company.

I’m not so sure about “holier than thou”, but it is an example of just the sort of thing the Reserve Bank always used to worry about: if it had private information (especially about significant regulatory interventions) and customers were nonetheless allowed to carry on trading with regulated entity, doesn’t that then create at least some moral risk, some moral exposure, if the regulated entity subsequently failed?  It seems extraordinary, if true, that the Reserve Bank could ban a regulated entity talking about a regulatory intervention.

Hargreaves’ solution isn’t one I’d agree with

Personally, I would suggest creation of a separate authority to regulate and supervise the insurance sector. Yes, it would be more money, it would arguably be more bureaucracy, but sometimes that’s what you’ve got to do for the best results.

Frankly, I’ve never been quite sure that the case for prudential regulation of general insurance is particularly strong anyway, and would be very reluctant to see a standalone insurance regulator. But I take the Hargreaves story as reinforcing the case for a strong standalone prudential regulatory agency, led by people whose sole job is prudential regulation and supervision, and within governance and accountability structures that help ensure serious and effective scrutiny of how the regulatory agency does its job.

I gather that Treasury and the Reserve Bank have been consulting this week with private sector representatives on the possible prudential regulatory aspects of the Stage 2 review.  I hope that the idea of structural separation –  with all it could entail –  isn’t lost in the desire of Reserve Bank management to keep things just as they have (not overly effectively) been.

4 thoughts on “Revisiting the case for splitting the Reserve Bank

  1. I do not think that a separation of duties would do much difference. What needs to be topmost is jobs and a robust and growing economy.


  2. …. “I gather that Treasury and the Reserve Bank have been consulting this week with private sector representatives”

    Who would those private sector representatives be?

    Wouldn’t be the NZBA by any chance?


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