Fit and proper?

Michael Reddell Banking, China, Regulation

Should Jenny Shipley be on the board (actually chairing it) of the local arm of China Construction Bank?   A question primarily, you might have thought, for the owners (CCB in China), perhaps taking account of the views and behaviour of the bank’s customers and investors.  I’d be pretty hesitant about putting my money in a bank (or any other company) that had as the Board chair someone against whom there was the sort of civil judgement that was delivered yesterday by the High Court in the Mainzeal case.  But I’m not, so I don’t really have a strong view on the matter.   And I might be as worried about having a former primary school teacher with no particular expertise in banking, and no reputation for being willing to ask awkward questions and follow through, as chair of the Board of any bank I had money in.

The Reserve Bank doesn’t have the luxury.

And here I’m going to rerun much of an old post on the matter of “fit and proper” rules.

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.

“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 [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.  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.

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.

2019 here again:

I can’t see that the Reserve Bank will have any choice but to indicate to CCB that they would object to the contined presence of Jenny Shipley on the Board.    The Mainzeal case involved the failure of a substantial institution while Shipley was chair of that Board, and not because of some unforeseeable shocks out of the blue, but because of actions and choices that the Board had control over.  The record suggests, apparently, that Shipley had expressed some unease on the Board.  That’s good, but of little or no value to anyone if it changed nothing, and she then did nothing further.

Of course, there is almost no chance the local CCB is going to collapse –  any problems are much more likely to be group ones, over which the local board will have no control.  But rules are rules, and how could the Bank’s fit and proper regime have any residual credibility if Shipley remains chair of the New Zealand registered, Reserve Bank supervised, bank’s board?  And this isn’t a time for pleasantries.  Whether or not she stands aside voluntarily, or the owners remove her, the Reserve Bank should make clear that her continued presence on the Board (let alone chairing it) would not be acceptable to the Reserve Bank.

One could, of course, argue that no CCB New Zealand problems have become apparent on Shipley’s watch.  I presume that is true, but it is also irrelevant.  Since (see above) the regime has no way of knowing who will turn out to be a dud as a director, it can really only exercise condign discipline after the event.  And I don’t think there is really a case for waiting for any appeals either.  The judgement has been delivered.  Perhaps a higher court will interpret the law differently, but there seems to be less dispute about the facts than about the legal implications, and frankly whether or not the directors are finally held financially liable, if a fit and proper regime is to mean anything it has to mean holding people to a higher standard, as bank directors, than is evident in the record at Mainzeal.

As I say, it shouldn’t be a matter for the Reserve Bank.  There is so much high profile coverage of this case that no one can seriously claim to be unaware, and if Shipley’s presence bothered them, they can bank elsewhere.  If enough people are bothered enough, the self-interest of the owners will resolve the situation.  It shouldn’t be the Reserve Bank’s business,  but it is.    They need to be seen to act pretty quickly.

As for Shipley’s membership of the executive board of the China Council……surely that tawdry taxpayer-funded body that sticks up for Beijing at every turn, has Jian Yang on its advisory board, defends Huawei, and won’t stick up for Anne-Marie Brady is just the place for her?  Then again, if the government doesn’t want the last vestiges of any credibility its propaganda body still has to be in shreds, they should probably remove her too.  But that was probably so anyway after all those pro-Beijing words she gave to the People’s Daily in December.   Effective propaganda can’t be too overt.

28 thoughts on “Fit and proper?”

  1. The Reserve Bank should indeed act, in accordance with its rules. But what about the FMA? Why hasn’t there been an investigation and possible prosecution under the Companies Act? A lot of people were very badly hurt in the Mainzeal collapse and most will only receive a fraction of their losses back. How is “reckless trading” to be understood? Is it implied by trading while insolvent?

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  3. “Banks get their money from two sources – either from the bank’s owners – its shareholders – or by borrowing it, from people like us, often in the form of deposits. The money banks get from their owners is the bank’s capital. The rest is borrowed – it is ‘other people’s money’. The average New Zealand bank gets around 92% of its money by borrowing it. Compare this with the average business in New Zealand, for which this figure is about 55%. If you are surprised by this fact, I encourage you to confirm this for yourself by taking a look at your own bank’s balance sheet on our Financial Strength Dashboard which is available via our website.”

    Why do I feel from this Geoff Bascand comment that it has only rather suddenly dawned on the RBNZ that our banks operate as financial intermediaries and not some weird “bank creates money” entity. Our banks clearly take savers deposits and on-lend it to make a margin. I guess Peter Morgan(PJM) needs to reassess his entire concept of “banks create money” concept here in NZ.

    https://www.interest.co.nz/banking/98316/rbnz-deputy-governor-geoff-bascand-says-banks-get-about-92-their-money-borrowing-it

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  4. No, I”m not going to let another repetitive battle ignite between the two of you.

    I’m 100% sure that the Bank would say there is no contradiction between the “banks create money” and Geoff’s description of the structure of bank balance sheets. And even if they wouldn’t, I would.

    The fact the creating loans also creates something on the other side of the (system) balance sheet is neither surprising nor particularly determinative of anything (at least unless you put much more weight on monetary aggregate measures than any central banker or finance ministry official does today).

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    • I guess what is not on the Balance Sheet is the derivatives markets where the banks swap currencies, swap interest rates and use what are essentially promissory notes to lend or borrow against another banks guarantee. That is what causes a chain reaction in international bank defaults when one bank trades off the guarantee of another bank and a collapsed bank fails to honour that agreement.

      I wonder what the risk assessment test is in that sort of a failure that the RBNZ has completed?

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  6. As an unsophisticated depositor in NZ banks I expect my savings to be safe. That means that the directors and senior officers must not use my money for illegal, or self serving, purposes. I expect the Reserve Bank to ensure that people appointed to these positions of guardianship of my savings are ‘fit and proper’ persons however defined.

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    • Yes your savings are safe as long as the RBNZ does not go nutcase with its historical penchant for trigger happy interest rate increases that crush businesses with the consequent loss of jobs which means people can’t pay their mortgages in the process of dampening inflation to its 3% target.

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      • And I would point out that however crazy you think RB monetary policy may have been at times, no bank depositors has lost money as a result in all the years the Bank has had discretionary control of monetary policy (1 February 1990).

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      • The RBNZ had a lucky break that there was 61 Finance companies that collapsed with the loss of $6 billion less some eventual recoveries. That loss bore the brunt of interest rates that went far too high acting as a buffer.

        But at the time there was a clear collapse of lending standards with the banks desperate to lend out the deposits flowing in with 110% zero equity finance and Low documentation loans where the banks would accept your word that you earned $500k income. It was really nothing to do with boom time exuberance but desperation from eroding profitability.

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      • Actual writeoffs were more like $3bn I think. Not all (perhaps not that much) of the highly questionable lending would have been otherwise done by banks. but even if it had been, and even if all the losses had fallen on banks, such losses would not have threatened depositors with the main banks. Bank capital at the end of 2007 was $21bn.

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      • “Auckland’s housing shortfall is at least 46,000 dwellings as a result of exceptional population growth and few new dwellings being built in the wake of the Global Financial Crisis.

        Only in late 2018 did annual new dwelling consents begin to balance with population growth, and it has yet to eat into the shortfall.”

        https://www.interest.co.nz/opinion/98392/auckland-council-chief-economist-david-norman-says-developing-greenfield-land-eye

        David Norman, Auckland Council Chief economist was wrong in identifying the GFC as the cause. Our recession occurred before the GFC arrived in NZ. The collapse in the building sector was engineered by the RBNZ with a wrecking ball through escalating interest rates. The GFC saved the NZ economy from further damage. We were lucky that Allan Bollard emerged from some G20 Central Bank meeting and decided to drop interest rates. Before that he was still busy trying to crank up interest rates when NZ was already roasting in eye watering commercial interest rates hovering around 12% to 15%.

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      • The last time we raised the OCR was mid 2007. The first OCR cut was before the global crisis really intensified.

        (Having said that, David Norman is generally wrong on housing.)

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      • INCREASING numbers of ordinary Kiwi homeowners are losing their houses as mortgagee sales hit a record high. Mortgagee sales have been on the rise as falling property values and the recession which has driven unemployment to 138,000 people continue to put stress on homeowners.

        289 mortgagee sales in June the highest monthly total since records began 15 years ago and a big increase on the same month last year when there were 98 such sales. The previous highest monthly total was 251 in April.

        http://www.stuff.co.nz/sunday-star-times/2814907/Mortgagee-sales-hit-fresh-high

        Michael, by 2009, mortgage sales started to hit 250 a month. Say an average mortgage of $500k as those with the highest mortgages fall first, that is equal to a asset impairment on banks books of $1 billion a month which is $12 billion a year.

        ANZ bank in 2010/11 recorded impairment assets of almost $2 billion.

        You can’t look at bank capital as it is already committed. It is not available. You have to look at liquid assets available to meet savers demand if a bank starts to make losses. ANZ bank had liquid assets of only $2.7 billion. Profit was $1 billion. It really did not take much to tip the bank into reporting a loss and the resultant loss of depositor confidence. With $70 billion savers deposits, it does not take very much for a bank collapse.

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      • Two things:
        1. Impaired assets not write-offs. Actual residential mortgage losses, given a default, are often 20% or less of the value of the loan.

        2. Capital is the buffer (for creditors) against unexpected losses. Liquidity is vital of course, but liquidity is relatively easy for the Reserve Bank to supply – at a price – as we saw during that period.

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      • I realise we are going in circles but it is important that economists understand that Capital is not a buffer. It is a historical record of the cash originally injected into the business and in some cases 100 years ago. Capital is therefore morphed and represented by Assets less Liabilities. Therefore you never talk about sufficient capital to meet creditors obligations. It is always whether you have enough liquid cash assets to meet current creditors obligations.

        Capital + Retained Earnings = Assets – Liabilities

        Forget about the left side of the equation which economists seem rather wrongly focused on. Accountants including liquidators only look at the right side of the equation to see if a company can meet its creditor and therefore solvency obligations.

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      • I don’t think we really are going in circles. I entirely agree that there is no pool of capital just sitting there waiting to be tapped; capital along with deposits fund a bank’s loan (and other asset) book. However, the point I – and other economists typically – are making is that when banks lose money (loans default etc) what is written down first is capital (start of period capital less this year’s losses). That means capital provides a buffer for depositors.. the more of the balance sheet is funded by equity and retained earnings, the larger that buffer (the more delayed is the point when depositors themselves lose money).

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      • The RBNZ is not responsible for mortgage rates

        We have seen that in recent times an instance where the RBNZ cut the OCR and the banks increased their mortgage rates due to their wholesale borrowing rates going up

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      • two otherguys, if you look at the history of the 90 day bank bill rate, it is a almost a mirror image of the OCR. The bank will then assess how much margin it wants to make and set mortgage and deposit rates around the 90 day bank will rate. Previously the RBNZ was more Monetary Policy purists. Currently there has been a divergence due to the use of macroprudential tools, equity restriction rules and behind the scenes tightening of lending criteria using the banks licensing covenants to squeeze credit availabliity.

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  7. So the question remains: why didn’t the FMA investigate? There appear to be grounds for a prosecution under the Companies Act. Was the FMA “leaned on”? Where are the investigative journalists when they’re needed?

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  8. It was obviously years ago when Shipley landed a directorship on the CCB that it was not due to her vast experience in corporate banking, of course she had none. The fact that dear Jenny seems only to get the nod on companies with significant Chinese shareholding is interesting. And explained as the Chinese tend to want locals to be the “front shop person”, and who come from the political sphere. In other words it’s all about influence with politicians, that will further the aims of those Chinese owners and probably their political masters the CCP.
    I’m glad you brought up the NZ China council, what a waste of taxpayer money. NZ funded by $1.7 million a year, stacked with China yesmen & women, and the NZ taxpayer is paying. The Chinese Govt is funding 100% the CI’s on NZ university campus, I’m sure they would willingly fully fund the NZCC if taxpaper funding was axed. Better still, shut it down, along with the NZ Argentina council, the NZ Somalia council and the NZ Poland council.

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