Reforming the RB: next steps

The government yesterday released a series of decisions as part of the next stage of the multi-year review of the Reserve Bank Act.   The decisions were in two classes: the first set around the governance of the institution are firm decisions now to embodied in draft legislation to be introduced (but not enacted) before the election, and the second set are in-principle decisions around prudential regulation and deposit insurance on which there is to be a further round of consultation next year.

On the latter set of proposals, I’m only going to comment briefly today.  There is one important decision I support –  a common framework for the prudential regulation of all deposit-takers (rather than separate ones for banks and for non-banks).   Much of the rest I’m fairly sceptical of:

  •  the decision to cap deposit insurance at $50000 is as flawed, and would prove as untenable in a crisis, as I warned in a post when the consultative document was released.  The proposed limit is well out of step with those in other advanced countries, notably Australia, and as I noted earlier “failing to get this right, ex ante simply increases the risk that when the crisis comes we’ll end up bailing out wholesale creditors (including foreign ones) too”,
  • the government is still toying with introducing statutory preference for depositors over other creditors.  This would be a mistake, and nowhere is it noted that it would tend to reinforce the advantage large banks tend to have locally in competing for retail deposits (since the small retail banks have little other funding to subordinate),
  • the in-principle decisions shift more policymaking powers out of the hands of elected people (the Minister of Finance) to unelected ones.

Remarkably, in the entire Cabinet paper there was no reference to the recent decision by the Governor to set minimum capital requirements for locally-incorporated banks well above international norms, even as the paper talked about a need for more, more-intensive, supervision in future.    As the Bank’s own favoured expert pointed out, there is usually something of a trade-off between the two, whether in how bridges are engineered or bank risk managed.

But my main focus was on the governance decisions, outlined in detail in the associated Cabinet paper.    Flicking through my hard copy, there are lots of specific and detailed points where I support the decisions being made (although specific legislative drafting may matter even there) and there are some general aspects that represent significant steps forward.  But if they proceed on governance as Cabinet has decided, we will end up with an unwieldy beast, mostly as a consequence of the government’s determination not to adopt the model used in a majority of advanced democracies (including small ones, and also notably Australia), in which monetary policy and financial system prudential regulation are conducted by two separate institutions.   And the existing democratic deficits will be worsened.

(I’m not sure if The Treasury has yet published the submissions that were made on the consultative document covering these issues. But in case anyone is looking, I did not make one.  That was solely because the morning I sat down to start writing one, in the week submissions closed, my mother died and so other things took priority.)

It is unambiguously good that the proposed new legislation will complete the work of reversing the key weakness of the 1989 Reserve Bank Act, in putting all the Bank’s powers in the hands of a single (unelected) official, complemented with provisions the rested on the naive assumption that it would be easy to tell if the Governor was not doing his/her job (mostly then about monetary policy) and that the Board would act in the public interest in thus holding the Governor to account.

We now already have an (anaemic) statutory Monetary Policy Committee –  feeble in construction and operation, and not very open or accountable, but it is better than nothing and in future it might evolve towards something good.  Under the proposed new legislation, all the remaining functions and powers of the Bank would become matters for the Board (a new one, the existing one would be dis-established), which could in turn delegate some of those powers to the Governor and other management as they chose.    And the Governor will not even be a member of the new Board – the intention is that it should be wholly non-executive, more akin to the model used in many Crown entities, including the FMA.

But there are a number of significant problems with what Cabinet has decided.

First, as the documents acknowledge, the Bank has extensive policymaking powers (that go far beyond those of most –  all? –  Crown entities) but decisions on those policies will be made wholly be non-elected (and thus not effectively accountable to the public) people.   There will be the figleaf in which the Governor and the Board are formally appointed by the Minister, but (a) the Minister will only have veto power and will (as now) only be able to appoint someone the Board has proposed, and (b) Board members could only be appointed from among those names proposed by a (statutory) nominating committee, including consultation with other political parties.

These models are quite out of step with how most other advanced countries appoint people to these key positions, where it is recognised that the elected government should be able to appoint people largely as they see fit (again, the model in Australia).  There has long been a substantial democratic deficit, but it is being further entrenched.  (The Cabinet paper notes that the nominating committee model is used for the New Zealand Superannuation Fund, but it is clearly and explicitly not a policymaking body.)     These models might be satisfactory if the powers of the Bank were operational and implementational only –  where one wants to ensure that ministers can’t influence decisions regarding application of rules to specific individuals or institutions –  but not when it involves major, highly contentious, policy decisions (such as the recent bank capital decisions, or the use of LVR or DTI restructions).  My own preference –  and I note that the National Party has spoken in these terms as well –  would be for the major regulatory policymaking powers to be reserved to the (elected) Minister and Parliament, leaving the practical implementation of policy in operationally independent hands.  There is no sign in the Cabinet paper (or in the earlier consultative document) that such an option was even seriously looked at.

So further entrenchment of the lack of effective democratic control of major areas of policy –  where, pace Paul Tucker, there is no general agreement on policy models, how to assess success, and where there are significant distributional effects –  is a significant (apparently deliberate) weakness.

But the other is an apparently irresolvable tension between the sorts of skills and people required from Board members.  The new Board’s day job will be the goverance and overall responsibility for the Bank in all areas other than those that are the responsibility of the Monetary Policy Committee.   That includes regulation of deposit-takers and insurers, operation of securities settlement systems, foreign reserves management, and all the standard corporate functions.  Given that documents talk of requiring people to have appropriate skills, you will presumably be expecting to see a standard mix of lawyers and accountants with some sort of banking and regulatory flavour.  Given their policy making powers, you sort of hope there are some serious policy people.

But these people are also to be primarily responsible for the appointment of the Governor, for the appointment of the other Monetary Policy Committee members, for things like the MPC Code of Conduct, for issues around resource allocation for monetary policy, and (I think) still for holding the MPC to account.  The sort of people who would be likely to be well-equipped to make those sort of choices, decisions, and recommendations are unlikely to overlap very much with the sort of people you might expect on a Board primarily focused on the regulation of deposit-takers and insurers.    It is simply flawed model, only compounded by the risks around lack of clarity over who has control over precisely what, particularly in a crisis or a new era of unconventional monetary policy instruments.

A better model would simply have made the Minister (and Cabinet) directly responsible for all statutory appointments (Governor, MPC members, Board members), but the much more sensible model would have been to have spun out the regulatory functions into a New Zealand Prudential Regulatory Agency (with policymaking powers reverting to the Minister), and allowing both a monetary policy focused central bank and the NZPRA to develop their own cultures of excellence and specialisation, with much greater clarity as to who is responsible for what.

The other unfortunate choice I wanted to highlight today was around funding the Reserve Bank. I have no particular problem with allowng for levies to partially fund the prudential functions.  But I do have a problem with the main Bank funding continuing to be secured through the Funding Agreement model.   I wrote about that in a couple of posts –  one at the time the last Funding Agreement was approved and the other in 2018 as the current review process was kicking off.  The Funding Agreement model is (a) voluntary, (b) hardly transparent at all, and (c) perpetuates the myth that “the Reserve Bank is different”.   Sure, we want operational choices at arms-length from politicians, but we nonetheless fund Police (for example) by means of annual parliamentary appropriation, one of the cornerstones of parliamentary control in our system of government.

It is bad enough that the Funding Agreement model is being retained (with some modifications, the details of which I might come back to when we have a bill) but what shocked me was the announcement that the government intends to legislate to remove the current requirement that any Funding Agreement must secure parliamentary ratification.     The only grounds they seem to offer for this is that “parliamentary ratification impedes flexibility” but (a) they could readily have moved to shorter terms for funding agreements, and (b) most agencies operate, rightly, with annual appropriations, approved each and every year by Parliament.  Generally, governments can’t spend what Parliament has not appropriated.  There is simple no good reason why the Reserve Bank –  a powerful policymaking agency (not just a referee –  like the courts –  or a detailed implementation body) –  should be any different.

I may well have further comments on these and other issues next year, including when the bill is presented and is open for select committee scrutiny.  But my summary position is that whatever good aspects there are in what Cabinet has decided, it is –  a bit like the new MPC system –  a lost opportunity to have created a so much better system, including one more open, more accountable, and without such gaping democratic deficits.  In both cases, although on paper the Governor will be materially weaker than he was under the 1989 Act, in practice it is likely that a wily Governor will be almost as powerful as ever.  That leaves us too vulnerable to poor or mediocre Governors (real stars will shine whatever the governance structure).

One aspect of the Bank still up in the air is the appointment of the chair and deputy chair of the current Board (and realistically the current legislation is likely to be on the books until at least mid-2021 even if the current government is returned).  The Board terms of both the chair (Neil Quigley) and the deputy chair (Kerrin Vautier) expires on 31 January and 8 February respectively.  Both will have already served the customary maximum of two full five year terms on the Board.  And under the legislative amendments last year not only does the Minister get to appoint Board members but (appropriately) he now gets to appoint the chair and deputy chair.    It will be interesting to see what choices he makes.  He could simply reappoint Quigley and Vautier to see out the current functions of the Board, but the Board is widely regarded as having done a poor job, and it isn’t obvious that after 10 years plus on the old Board you’d expect them to be the people to lead the new Board after the new legislation.   A better call would be to appoint as chair someone whom the Minister would regard as a credible candidate to the chair the new-look regulatory-focused corporate-like Board as well, and thus to oversee the transition (although that option is complicated by the timing: if the current government lost office any reforms might proceed rather differently).

 

 

6 thoughts on “Reforming the RB: next steps

  1. Now try this for cheap-skating

    Middlemore Hospital seeking donations to help the White Island burn victims – this is the same hospital which is carrying $31 million in unpaid debts racked up by pacific people who fly in and immediately admit themselves for diabetes and dialysis – the same government which donated $1 million to Samoa for measles treatment
    https://www.newshub.co.nz/home/new-zealand/2019/12/white-island-eruption-middlemore-hospital-seeking-donations-for-national-burn-centre.html

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  2. I would have thought that the combination of OBR and deposit insurance for the most politically compelling baliout cases (small depositors who might not be expected to have exercised diligence) would have been more than sufficient.

    Why would you expect substantial bailout risk to be present for the relatively small number of depositors who will have more than $50k in the bank and would face a haircut on the portion of their deposits over $50k under OBR?

    On the other stuff, agree that the Bank will need a strong board on the prudential side. The combination of responsibilities over prudential and general oversight would suggest a mix of board expertise, with some members with a strong background in the technical detail, and others with more general governance expertise. I’m not sure that that is that different from the Board responsibilities in other cases for concerns where technical understanding of what the company is up to will matter as well as general governance competence.

    It is depressing to see confirmed that they’ve not been thinking about the interaction of the capital requirements and insurance though.

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    • Thanks Eric

      On the Board, no disagreement there. My point was that the new Board is likely to be chosen as a bunch of general director-types and people with banking/insurnace (and perhaps even regulatory policy) experience. But that won’t equip them to do the job around oversight and appointment of the key mon pol roles, let alone in some sense holding them to account, or judging what resources need to be used in the macro functions. The current Board has done badly enough – recall them ruling out from MPC anyone with a present or future monetary policy research interest.

      On dep insurance and bailout risk, I guess my glib answer is “look at 2008” when coverage was massively extended on a ad hoc unfunded basis, combined with the fact of the Aus dep insurance limit being so high (but not that out of line internationally). At best, if the scheme was ever used in conjunction with OBR it would be likely to be with the dep insurance threshold raised arbitrarily ex post, with none of the additional coverage cost having been borne by depositors.

      I’d rather have a threshold that would be easier to defend in a crisis and charge a risk-based levy upfront.

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      • Did some reading over the break and discovered that the deposit insurance proposed by the government is not just for registered banks. It is for deposit takers.

        Can’t find a definition of what that is but it seems to cover the finance company sector. That’s one step away from offering deposit insurance for share portfolios. People know there are at the rougher end of town when they buy debentures from finance companies. If they don’t, they deserve to lose their money.

        did reading around on the key writers and discovered how truly appalling deposit insurance is.

        I can’t find much in the reserve bank and Treasury material talking about the risks and the rather sordid history.

        Everyone uses the bank panic model to which justifies deposit insurance and makes it a free lunch. Trouble is there is little history of any real banking panics. most bank failures and bank runs because the bank is indeed insolvent. And it is insolvent because of risk-taking often encouraged by deposit insurance.

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  3. I am looking into writing a submission hopefully on behalf the taxpayers union.

    Have been looking into deposit insurance over the past few years.

    Oddly enough, FDR opposed deposit insurance because of its abysmal record of the state level in the 1920s. Congress fostered it upon him rather than it being part of his first hundred days

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