In the last few months, I’ve run a couple of posts making the case for splitting the prudential regulatory/supervisory functions of the Reserve Bank out into a standalone prudential regulatory agency.  The main post was here, with some follow-up comments here.  The case for structural reform has been further strengthened, in my view, by the results of the recent New Zealand Initiative survey on regulated entities, in which it is clear that most respondents have little or no respect or regard for the Reserve Bank in its supervisory roles (as distinct from the inevitable disagreements with a regulator that should be expected/encouraged).   There are good arguments in principle for structural separation, and there is no sign (say) that despite those in-principle arguments the Reserve Bank has been doing a superlative job anyway.

As I noted in the earlier post, in most OECD countries (outside the euro-area, where central banks no longer have a monetary policy job to do), banking regulation and supervision is done by a body other than the central bank.

But if we look at advanced countries that do have their own monetary policies, I could find only three others –  Czech Republic, Israel, and the United Kingdom –  in which the same agency is responsible for monetary policy as for prudential supervision.   The US is –  in this area as so many –  a curious hybrid system, in which the Federal Reserve has some –  but not remotely all – responsibility for prudential supervision.  But as far as I could tell, the following OECD countries have monetary policy and prudential supervision conducted by separate agencies:

Canada, Australia, Norway, Sweden, Korea, Japan, Poland, Chile, Turkey, Mexico, Switzerland, and Iceland

I’m not sure that Turkey or Mexico offer models of governance for New Zealand, but the presence on that list of small well-governed countries like Norway, Sweden and Switzerland –  as well as tiny Iceland –   gave me pause for thought.

Perhaps of most direct relevance to us in Australia’s place in that list.

Some others have also made the case for structural separation, including my former colleague Geof Mortlock.  Geof has a new substantive column out today forcefully making the case for change.   Geof and I have been disagreeing about things for 35 years since we started at the Bank in adjoining offices a couple of weeks apart.  He spent most of his Reserve Bank career in the regulatory side of the Bank and for the last decade or so has been a consultant on banking risk/regulatory issues, including a stint at the Australian Prudential Regulatory Authority.      Judging by the occasional emails we exchange and occasional comments here, I suspect we still don’t agree about very much –  quite probably including the substance and extent of financial system regulation and supervision.

But I agree with almost everything in his column today. I encourage you to read it, and I hope that Treasury officials working on Reserve Bank reforms and the Minister of Finance (and his associates) not only read it, but heed it.  It is an overdue change, and if the chance for reform isn’t grasped now the issue is likely to drift for another decade or two, with weak governance, weak accountability, and a regulatory body that is unlikely to command the respect it should earn whether from regulated entities, overseas supervisors or (most importantly) the New Zealand public.

Here is Geof’s list of the main reasons for change

• It would reduce the concentration of excessive power in one government agency. Currently, the Reserve Bank has a very wide range of powers compared to most central banks in the OECD. It has responsibility for monetary policy, foreign exchange reserves management, currency intervention, operating significant parts of the payment system and securities settlement system, prudential regulation of banks, insurers and NBDTs, regulation of money laundering, regulation of the payment system, financial stability oversight, macro-prudential regulation and currency management. I will stop there. The sentence is already too long!  So is the range of functions under one agency. This concentrates excessive power in the Reserve Bank. It also creates potential and actual conflicts of interest, as I argue later in this article. A narrower span of functions would reduce this concentration of power and avoid conflicts of interest.
• Removing regulatory functions from the Reserve Bank would enable the supervisory agency to focus on the job at hand without being distracted by the other central bank tasks, particularly monetary policy. ………the Reserve Bank has tended over the years to accord much greater emphasis, attention, management oversight, resourcing and public reporting to the monetary policy function than to its regulatory responsibilities. The Reserve Bank Board, likewise, has generally paid much greater attention to the monetary policy function than to financial sector regulation. (That said, the Board has performed very poorly in all of its monitoring roles. Sadly, it has been little more than a compliant rubber stamp and cheer leader for senior management).
• Separation of the regulatory functions would also enable the Reserve Bank to focus on its core role of monetary policy and related functions, undistracted by the many regulatory issues which it currently oversees. This would likely be conducive to a more focused and effective central bank. It would help the central bank to lift its game in monetary policy – i.e. to keep inflation broadly around the mid-point of the inflation target range; something that it has consistently failed to achieve in recent years.
• Separation of the regulatory functions would enable a senior management team to be appointed with the skills, knowledge and experience to perform the role effectively – i.e. people with deep knowledge of, and practical experience in, banking, insurance and financial regulatory issues. The current senior management team – and its predecessors – generally lack the skills, knowledge and experience required for the role.  …..
• It would enable the regulatory agency to build the depth of knowledge and skills in its staff to perform the functions required of them. Currently, although the Reserve Bank has able people in the supervisory area, it lacks the depth and breadth of knowledge and industry experience to do the job as effectively as it should. ……

He adds a couple of other considerations that resonated with me

• Separation of the supervisory function from the Reserve Bank would also remove potential conflicts of interest between the Bank’s functions. For example, there is a conflict of interest between the Reserve Bank’s role as owner and operator of core parts of the payment and settlement systems [notably the NZClear securities settlement system], and its supervisory responsibilities in these areas. It is rather like the referee of a rugby game also being an active player on the field. Even worse, this referee gets to write the rules of the game!
• It would ensure that macro-prudential supervision policy is directed at the promotion of financial system stability rather than being used as a de facto monetary policy instrument or for other nefarious purposes that do not necessarily anchor to financial stability. Reflecting this, I very much doubt that, had the responsibility for macro-prudential policy been allocated to a separate prudential regulator, and not the Reserve Bank, the macro-prudential policy tools would have been used as aggressively and relatively clumsily as has been the case under the Bank.

I’m hopeful more than convinced of the argument in that final sentence.

Of course, structural separation is no panacea.  A new agency would need to be built from scratch, even if it took over the existing Reserve Bank staff.  It isn’t as if the field of suitable candidates to lead such an agency is thick on the ground, and building the sort of expertise and culture that the job requires will be the work of several years.  But, on the one hand, we face that challenge anyway: the Governor can’t simply ignore, or pay only lip-service to, the shocking feedback in the NZ Initiative survey.  And, on the other hand, if we don’t make a start –  and put in place structural preconditions that increase the chances of better institutions in the longer-term – things are unlikely to ever reach the standard they should.

It remains disconcerting that the second stage of the Reserve Bank Act review is being led jointly by the Reserve Bank and the Treasury, in a climate in which the Minister of Finance has shown little interest in these sorts of issues.  The situation is crying out for leadership from the government, and not allowing the existing Reserve Bank management to persuade the Minister to settle for something as little different as possible from the inadequate status quo.

(Geof’s comment on the severe weaknesses of the Reserve Bank Board echo my own over the years.  Neither their Annual Reports nor the minutes of their meetings record any dissatisfaction with management ever – even though their primary role is holding the Bank to account, and the Bank is made up of fallible human beings.    I wrote a few weeks ago about the “Charter” (really a code of conduct) the Board has devised for itself.  The “charter” talks of the Board’s right to advise the Governor, and asserts a right to be heard

The Board may advise the Governor on any matter relating to the performance of the Bank’s functions and the exercise of its powers. The Governor is not required to act on the Board’s advice, but is required to have regard to it.

Where advice relates to matters of significance, the Board may give that advice to the Governor in writing, having first discussed the matter with the Governor in a Board meeting.

The Board will maintain a record of any formal Board advice given to the Governor.

There was no record in the minutes over the last couple of years of any material oral advice (despite (a) legal requirements to maintain records of public affairs, and (b) some difficult issues, including –  for example –  the Toplis affair).  So I lodged an OIA request seeking copies of any written advice.

There was none of course. In fact, the Board chair went so far as to claim that this was a mark of the effectiveness of the Board.   I think he must have left off an “in”.    Geof’s term –  and I think I’ve used it before too –  was cheerleaders.  But hopeless at almost anything else, and useless to the citizenry. )