The central bank accepts these attestations without reviewing, examining or auditing the process.
In other words, the health of the NZ economy is highly dependent on the ability of the 30 ANZ, ASB, BNZ and Westpac directors to understand, monitor and confirm their companies are fully compliant.
This is a demanding challenge for directors, particularly in an environment where financial organisations are using more and more complex, exotic, synthetic and derivative products.
New Zealand governments placed little emphasis on direct bank regulation and supervision prior to the late 1980s.
Modern regulation and supervision essentially began in 1986 with the passage of the Reserve Bank of New Zealand Amendment Act. This was strengthened by the Reserve Bank of New Zealand Act 1989, which had an objective to promote "the maintenance of a sound and efficient financial system".
Another aim of the 1989 Act was to avoid "significant damage to the financial system that could result from the failure of a registered bank".
It is important to note that the Reserve Bank is the sole regulator of NZ banks, whereas in most other western countries central banks share this responsibility with another regulator, or this other regulator has sole responsibility.
For example, across the Tasman the Australian Prudential Regulation Authority (APRA) is primarily responsible for the banks along with the Australian Securities and Investment Commission (ASIC). The Reserve Bank of Australia is principally responsible for monetary policy.
The Reserve Bank of New Zealand (RBNZ) has a three-pillar approach to supervision. These are:
• Self-discipline. This refers to a bank's internal risk management and governance systems, which are the responsibility of the board of directors and senior management. The RBNZ has the power to object to the appointment of directors and senior managers who may not meet a "fit and proper" test.
• Market discipline. This is the principle whereby market participants monitor a bank's behaviour, the risks it is taking and its financial performance. In theory, market participants will require a bank to raise deposit interest rates if it is perceived to be taking on too much lending risk.
• Regulatory discipline. This involves certain rules and mandatory obligations in specific areas, including minimum capital and liquidity requirements.
A May 2017 report by the International Monetary Fund (IMF) into NZ's financial stability found fault with this three-pillar approach. The IMF believes that the RBNZ's approach is too reliant on self-discipline and market discipline and doesn't put enough emphasis on regulatory discipline.
The IMF wrote: "The RBNZ approach to supervision relies on three pillars: self, market and regulatory discipline. The authorities have strengthened regulatory discipline since the IMF's last report, but the three-pillar framework should be improved by adopting a more intensive approach to supervision. This would increase the ability of supervisors (the RBNZ) to be proactive to exercise regulatory discipline and obtain reliable information to enforce self-discipline and market-discipline."
The IMF added: "The RBNZ is encouraged to issue enforceable supervisory standards on key risks, review the enforcement regime to promote preventive action, and initiate on-site programs targeted on areas of high risk".
In other words, a strong emphasis on self-discipline and market discipline can be totally ineffective — as it was with the sharemarket in the 1980s and finance companies in the early 2000s — unless there are some additional rules that are closely monitored. The IMF is suggesting that the RBNZ should have more rules, particularly around risk.
Kerry McDonald, former chairman of the BNZ between 1996 and 2008 and National Australia Bank director, also has major concerns. In an insightful letter written to Finance Minister Grant Robertson late last year, he argued it was "inappropriate and anomalous that the RBNZ is both the central bank and the regulator of the NZ banking system".
McDonald believes the FMA should be the bank regulator.
He was critical of the RBNZ's emphasis on self-discipline and market discipline, particularly considering the inappropriate behaviour of major banks across the Tasman.
McDonald noted that the Australian House of Representatives' Coleman Report, a review of the Australian banks, stated "the major banks have a poor compliance culture and have repeatedly failed to protect the interests of consumers".
McDonald wrote that he was never formally interviewed by the RBNZ on regulatory issues during his 12-year reign as the BNZ chair.
He noted that the directors of NZ licensed banks are required to make important decisions in relation to and in the best interest of the NZ banks, not the interests of their Australian parent.
He wrote: "I do not think the NZ bank boards currently have the capability to govern their banks independent from their group [Australian parent]; and that they are not 'fit for purpose' bank boards with the requisite professional and expert skills and capabilities that this requires".
Consequently, many questions need to be asked about NZ bank governance, including: does the NZ board or the Australian parent appoint the NZ CEO? Does the NZ CEO report to the NZ chair or the Australian CEO? Does the NZ board determine NZ strategy or is this mainly determined in Australia?
Thus, it is important to look at the composition of the major NZ bank boards and a list of these is included in the accompanying table.
Although two of the four banks give very limited information on their directors, the following observations can be made:
• All four CEOs are board directors; two are male and two female. They are all internal appointments, with two being appointed directly from their Australian parent.
• Of the remaining 26 directors, nine are female and eight of the 26 live offshore.
• Most of the overseas based directors have extensive banking experience while the NZ resident directors have limited sector experience. The NZ based directors are more generalist, with legal, accounting, professional director, executive and political backgrounds.
• Sir John Key has jumped from the country's most important political position to chairman of the ANZ, arguably the country's most important business position.
• Kevin Kenrick is CEO of TVNZ, while Tony Carter and Bruce Hassall are Fletcher Building directors.
• Shayne Elliott of ANZ is the only Australian CEO on a major NZ bank board.
A quick assessment of the NZ resident directors suggests that they don't have sufficient in-depth banking expertise to monitor their company's compliance, particularly in a strong "self-discipline" and "market discipline" environment. This situation is exacerbated by the RBNZ's poor execution, as demonstrated by the CBL Insurance debacle.
This column is not suggesting that any NZ bank is in trouble. However, it is advocating that our banks are less likely to have problems if they are well regulated and have NZ based directors with in-depth financial sector expertise.
There is considerable speculation about the impact that incoming Reserve Bank governor Adrian Orr will have on monetary policy and interest rates.
However, one of Orr's biggest challenges will be to improve the RBNZ's oversight and supervision of the country's banks, as well as our insurance sector.
- Brian Gaynor is an executive director of Milford Asset Management, which holds shares in the four major Australian banks on behalf of clients.
