Banking conduct and culture – the Governor again

It can be hard to keep up with the twists and turns of the new Governor of the Reserve Bank (a living argument for the need to entrench committee-based decisionmaking –  and, at that, committees that are not under the thumb of the Governor).  Take conduct issues and the Australian Royal Commission as a prime example.

Not many weeks ago –  he has only been in the job for two months –  Orr was apparently content that there were no significant conduct problems here.   That was a bit of a surprise, given the common ownership of many of the financial institutions operating here and the fact –  not to put too fine a point on it –  that only a decade ago we’d been sending people to prison for the way they’d run finance companies.  But, according to the Governor, things were different  –  the culture here was “infinitely better”.    We certainly didn’t need a Royal Commission.

It wasn’t clear what these conduct issues had to do with the Governor anyway –  the Reserve Bank is a prudential regulator (soundness and stability) not a conduct one.  And the Governor did move on to acknowledge that any decision on Royal Commissions or the like wasn’t a matter for him –  the establishment of the Australian one was a highly political call.

But then, before we knew where we were, the Governor had done a volte faceperhaps uneasy that the Financial Markets Authority –  which is a conduct regulator –  was going to get the limelight, and any kudos that came from putting pressure on the banks.  And so we had a joint demarche from the Governor and the chief executive of the FMA, summoning banks to a meeting and demanding –  like some populist political figures, rather than officials in a country governed by the rule of law –  that banks prove their innocence.

There wasn’t much doubt as to the sort of stuff the Governor (and the FMA head) were talking about  –  their letter explicitly referenced the Australian Royal Commission, and the FMA’s own conduct guide.

Last week, the Governor and his FMA counterpart moved on to life insurance companies, sending them a very similarly worded set of demands.

And then a document appeared on the Reserve Bank’s website late last week, under the heading

Banking conduct and culture – The Reserve Bank’s role and efforts ahead

Release date
24 May 2018
An article by Reserve Bank Governor Adrian Orr.

One could only assume it was going to be more of the same.  But as I read it, it became clear that the Governor had changed horses again.   This time we got a very defensive three page essay on banking and banking regulation, apparently in the leadup to the release of the Financial Stability Report tomorrow morning –  the new Governor’s first.

It opens with lots of bluster about various public concerns about banks since the 2008/09 crisis

Globally, and especially following the mid-2009 financial crisis, there has been significant, vocal, public concern about the drivers and cultures of bank behaviour. Are banks too profitable, too short-term, incentivised to over-lend, insufficiently sound, too large to be managed, too global to be regulated, and too open to operational and security risks?

without ever once stopping to note that New Zealand and Australian banks came through that episode in fine shape, and that most of the questions the Governor is referring to relate to places where there were systemic banking failures, and government bailouts of major institutions.

Then we get some references to the Australian environment

The plethora of recent Australian-led banking inquiries is unprecedented, the most significant being the ongoing Australian Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry.  The concerns that gave rise to these inquiries should be heeded, not just by Australian-owned banks, but by all financial service providers in New Zealand, including our own domestically-owned banks and insurers.

never once noting the febrile Australian political environment, and casting aspersions by association (using taxpayer resources to do so) without offering a shred of evidence.  It is what populists do.

And then we get this odd claim

The general public hear plenty of noise from these institutions and local commentators as to whether we are doing too much, or too little, too often. The noise is confusing to the non-expert.  We get that.  The topic is technical, we deal with institutions in confidence at times, and many New Zealanders have not experienced first-hand a financial crisis. 

Actually, we hear very little from the banks.  By all accounts, they are scared of crossing the Reserve Bank in public (recall the previous Governor’s attempt to shut down Stephen Toplis).  And the Reserve Bank itself is highly secretive –  note its refusal to offer any open accounting for its conduct around the Westpac capital models or Kiwibank capital instrument cases.  If the Governor is foreshadowing a new openness from the Reserve Bank on such regulatory issues that would be welcome, but the past has been his Bank’s failure not that of the banks, local commentators, or the public (to whom he seems to be trying to talk down).  Acknowledging that the Reserve Bank can, and has, made mistakes would be a helpful start, a signal of being in earnest.

The Governor moves on to set out three sets of expectations for banks.

First, operating in New Zealand.

This means they must abide by the laws of the land, and these are often different to where they came from. For example, we need the locally incorporated banks to have local directors, who are bound by domestic law and must attest to the bank being sound. These directors should be closest to the bank decision making, and are liable for these decisions.

and so on.  So far, so banal.  The Governor outlines no specific concerns, and appears to be trying to operate by slur – the “evil Australian banks who think they can come here and act as if this is Australia”.    That is no way for a central bank Governor to operate.

The second is a lengthy statement of the point that foreign banks operating here have both home and host regulators.  That’s true, but it isn’t clear that the Governor has a point, and certainly not one related to that “Banking conduct and culture” heading.

Weirdly, he repeats a line he ran in an interview a few weeks ago

No foreign government can commit their current or future taxpayers to bailing out foreign country depositors or shareholders. It is untenable politically.

As I noted then, this is simply irrelevant

For a start, the question of how we manage the failure of a bank in New Zealand has nothing whatever to do with the idea of foreign taxpayers bailing out New Zealand depositors.  I’m not aware that anyone supposed that was very likely.  Indeed, all our planning –  including the requirement for most deposit-taking banks to incorporate locally –  has been based on the idea that New Zealand is on its own (although for the Australian banking groups, whatever happens in the event of failure is likely to be negotiated by politicians from the two countries).   Instead the general issue here is

  • should a large bank simply be allowed to close if it fails, and handled through normal liquidation procedures (few would say yes to that).
  • if not, how best can the bank be kept open,
  • it could be bailed out by the government (benefiting all creditors, including foreign wholesale ones),
  • or the OBR tool could be used, in which all creditors’ claims would be immediately “haircut”, so that the losses fall on shareholders and creditors not on taxpayers but  the bank’s doors remain open.

But the Governor concludes this particular section by asserting that OBR is the failure management resolution tool, when as he knows that isn’t his call –  it is a decision for the Minister of Finance at the time, probably after extended haggling with the Australian government.

The Governor’s third point is

Third, and finally, when we regulate any licensed entity we need to do so in a manner that is both sound (safe) and efficient (dynamic and competitive).

Which is more or less fine (actually, the requirement is around the system as a whole not the individual institution), but a propos of nothing that is apparent in the Governor’s statement.

All of this seems to have rather little (ie nothing) to do with “conduct and culture” but with banks’ gripes about the Reserve Bank’s handling of its responsibilities.

Recent bankers’ complaints about our activities tend to focus on three issues: NZ-specific capital, the role of attestation requirements, and the need to prove their ability to resolve a bank failure inside the legal and fiscal bounds of New Zealand.

to which the Governor’s response is a single sentence dismissal

These are all part of doing business here in New Zealand. It is profitable business, and our goal is for consumers to be well served, taxpayers’ money preserved, and our financial systems sound and efficient.

That isn’t serious policymaking or serious accountability, it is just a set of rhetorical assertions, trying to take cover under the Governor’s joint efforts with the FMA to suggest there is something amiss in the way banks are running themselves in dealing with individual customers.

The Governor goes on

Our aspiration is to have the best ‘regulator-regulated’ relationship in the world built on mutual respect.  This doesn’t mean we will always agree with regulated entities. What it does mean is we will be clear and consistent on our position, engage with regulated entities in open and responsive manner, and balance soundness and efficiency considerations.   This is our service promise to regulated entities. 

I’m not sure it is in the public interest for the “regulator-regulated relationship” to be “best in the world” –  regulatory capture is a really significant risk, and perhaps especially when the regulator has recently done as poorly, and had such atrocious feedback, as the Reserve Bank’s regulatory function.   Not many weeks ago the Governor was pledging to take that feedback seriously and bring about change –  I praised him for it –  but that sentiment all appears lost now.

And so the Governor attempts to bring all this back under the heading of “conduct and culture”.  He claims

All said and done, the effectiveness of all of our efforts rests very much on the conduct and culture of the banks that operate in New Zealand. Culture determines ‘how they do things’.

Actually, that is nonsense.  The Reserve Bank is a prudential regulator, not a conduct one, and the perceived failure of the Reserve Bank in this area over recent years (all that feedback captured in the New Zealand Initiative report) is much more about the conduct and culture of the Reserve Bank of New Zealand than about anything to do with the banks operating here.   A defensive mentality, that doesn’t welcome criticism or scrutiny,  policy measures put out in a rush without decent supporting analysis, and so on.  Those are Reserve Bank failures.  They weren’t the fault of the current Governor, but it is his responsibility to fix that culture.

But then the Governor closes his statement with an attempt to articulate what he means by culture.

  • Do banks acknowledge they are operating in New Zealand – and the responsibilities this implies?
  • Do banks acknowledge the home-host regulator relationship, giving each appropriate respect?  And,
  • Are banks willing to compete in both a sound and efficient manner for the long-term – beyond the tenure of a current CEO or Board? This means investing in the people, systems and capabilities needed for a sustainable New Zealand bank business.

For a start, none of this bears any relationship to the culture and conduct stuff he and the FMA had been demanding of banks, stemming from the Royal Commission.  It is a sign of a Governor on the defensive, trying rhetoric rather than analysis.

How, for example, are banks supposed to prove to the Governor’s satisfaction that they ‘acknowledge they are operating in New Zealand –  and the responsibilities this implies”?  Does that mean just accepting whatever the Governor says or does without challenge?  If the Governor has specific concerns –  thinks the banks have broken the law –  he should take those matters up with them individually.  Otherwise, he should get off his bully pulpit and simply do his job, including fixing up his own institution.

As for his second point, what is “appropriate respect”.  I want banks that obey the law, and challenge it and the Bank when they seem to be doing a poor job.  Respect, Governor, is earned by a track record of consistent competent performance, not demanded as some sort of right.

And as for the final point, it is really very little to do with the Reserve Bank.  If an individual bank were, say, to take a view that prospects in New Zealand were poor, and it was looking to wind down its business here over time, that is matter for the shareholders, not for the New Zealand prudential regulator.   Banks themselves might reasonably ask whether the Reserve Bank is regulating beyond the term of the existing Governor.   But again, if the Governor has specific concerns –  within his statutory mandate –  he should raise them with the banks concerned, and outline them in the FSR.

It was a strange statement, and attracted little media attention (perhaps the Governor is already talking so often that his words have become cheap talk).  It should probably have attracted more, given the rather desperate attempt to cloak a pushback against the banks, around prudential regulatory policy, with his populist “culture and conduct” cause.  It was all a bit empty.

By the time the FSR comes out tomorrow it will have been six days since this recent statement was issued. Who knows what tack the Governor will be taking by then.  It really isn’t good enough –  we should be able to expect a stable and predictable regulatory voice, engaging in substantive issues (if there are such) in substantive ways.  I hope some journalists or MPs take the opportunity tomorrow to call him out on the way in which he has been operating.

 

6 thoughts on “Banking conduct and culture – the Governor again

  1. Disagree with your statement:
    “Bank is a prudential regulator (soundness and stability) not a conduct one. ”
    because:
    bad / dishonest conduct leads to instability and loss of trust.

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    • It can do, but banks most often fail because they make bad, but honest, judgements and events turn out a lot worse than they expected (and, of course, in booms expectations get hyped up).

      Like

      • Not many NZ examples. But the BNZ did lose billions in Australia, where they employed people with dodgy credentials. DFC was maybe not as bad. But BNZ was bailed out, DFC wasn’t, despite the RBNZ advice.

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      • But I’d argue that in all those cases it was hubris and over-optimistic expectations (all the talk of NZ having a comparative advantage in takeovers, or Switzerland of the SOuth Pacific) in a newly deregulated climate where no one really knew what they were doing was the bulk of the story in all those cases. At the margin there were individual examples of bad behaviour – altho perhaps more by the big borrowers – but it wasn’t those narrow conduct things that brought institutions down and threatened the system here and in Aus.

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  2. Yes, watching the Australian royal commission it does appear that “conduct” issues such as approving loans with insufficient oversight can become soundness/stability issues if enough of them are made. I think that was at the heart of the US banks’ problems in the GFC…too many loans made to borrowers who couldn’t afford them… and when they were collateralised nobody knew how sound they were so everything looked suspect.

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    • So far we’ve seen no sign of soundness problems emerging in the Australian banks (or have I missed something?).

      On the US situation, yes I think there was an element of misconduct, especially among some of the originators. But bad conduct wasn’t what brought down the agencies or Merrill Lynch or Citibank or AIG or Lehmans or Bear Stearns or RBS or even (largely) the NZ finance companies. In many ways I wish it were otherwise: misconduct (sin) will receive its reward, but on my reading mostly bank failures happen thru hubris (a fault in itself, but of a different nature) often among quite decent and honourable people, rather than thru the sort of stuff the Aus Royal Commission is looking at. The serious cases there warrant a great deal of societal disapproval, but they aren’t obviously related to things that will threaten the soundness of the bank. Sometimes the most hard-hearted bankers actually come thru crises least badly.

      Liked by 1 person

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