Reserve Bank of New Zealand Amendment Bill (No 3)

I will take just a brief call on Part 1. National is supporting this bill as one of a suite of bills designed to shore up some problems that have emerged in recent years. It has been a fairly technical bill. The reality is that as soon as we regulate one sector of the financial system, we create, by definition, an incentive for others to operate outside the rules. This is known as the process of financial disintermediation. I note just in passing, for those readers of the Dominion Post who saw the consequences of this reported on the front page just this morning, that the collapse of some of the second-tier financial institutions we are referring to now has created a space for some fairly dubious new institutions to gain business. That is the reality of this process. It is a cat and mouse game between the regulator and the private sector. In the course of recent years we have discovered that the non-regulated second-tier sector we are addressing here has created some major problems for those involved.

Part 1 attempts to put some precision around the definitions of the institutions concerned, the governance structures, and the actual requirements that the regulator—which will be, of course, the Reserve Bank of New Zealand—will expect of these second-tier non-bank financial institutions. In looking at the definitions in Part 1, my colleague Craig Foss has given an excellent overview of this issue, and he has answered some other parliamentarians’ questions about the slightly strange term “non-bank”. As my colleague put it, it has a very specific meaning in the law precisely because of the requirements that anyone who wishes to use the term “bank” must follow.

I was not privileged to be a member of the Finance and Expenditure Committee during this process, but it has put a lot of work into this bill. If members look through the tracked changes in Part 1 they can see—and I take this as just one example of many—the care with which the select committee has sought to define a building society, unless the building society is a registered bank. Then if members look at new section 157, to be inserted by clause 11, they will find that there are consequential amendments in terms of the expected governance regime for that particular type of non-bank deposit taker that take account of the specific characteristics of building societies.

I want to draw attention to a couple of other points in Part 1. New section 157F deals with the issue of risk. Parliament is making a bold statement here, which is that eliminating all risk is not part of the deal. That is not an exact quotation, which is in new section 157F(2)(b)(i) and states: “it is not the purpose of this Part to eliminate all risk in relation to the performance of deposit takers or to limit diversity among deposit takers;”. But we will never overcome the principle that we cannot legislate for common sense. I am sorry, but that is the reality. We are trying to reduce some risk around this issue.

I have always felt that the phrase “caveat emptor” was as cold as charity when it comes to this type of issue, given the degree of financial expertise required on the part of any person who wishes to put his or her deposits and savings into an institution of this type. To expect them to be able to undertake on their own behalf the type of assessment of the risk is, I think, a bridge too far. So although I understand the reason for that old phrase “caveat emptor”, I think that the reality is that we live in a slightly greyer world than this, and we have had to respond in the manner set out in this bill.

I will also focus on the question of the credit ratings, which is also dealt with in Part 1. Clause 11 inserts new Part 5D, and in that part new section 157I sets out definitions of appropriate rating agencies. That provision is perhaps a little more controversial. A bit of a judgment call was required here. There is no question that there is a role for this second-tier financial structure in our community, in spite of the very sad collapse of certain non-bank deposit takers or finance companies in New Zealand over the last 6 months or so. I hope this bill will go some way towards illuminating the situation.

I rise on behalf of the National Party to support the Reserve Bank of New Zealand Amendment Bill (No 3). The bill implements the main elements of the new regulatory framework for non-bank deposit takers. It deals mainly with prudential regulations for non-bank deposit takers. There is a suite of bills currently before Parliament and the Finance and Expenditure Committee, including the Financial Advisers Bill and the Financial Service Providers (Registration and Dispute Resolution) Bill, which will add to the portfolio of products aimed at hardening up the regulation of non-bank deposit takers.

I acknowledge the members of the Finance and Expenditure Committee, which dealt with the bill, and particularly my colleague from the Hawke’s Bay, Craig Foss, whose experience in matters of banking is excellent and certainly helped us to understand the issues in the bill. I think Craig will be heavily involved in the Financial Advisers Bill as it goes forward, and his contribution needs to be acknowledged.

We are focusing on Part 1. I want to look at a number of clauses within it, starting with clause 8, which deals with policy advice. The clause was amended by the select committee to clarify that the advice that can be requested by the Minister under the regime must be connected with the functions of the Reserve Bank. The advisory function of the bank must not limit the bank in the performance of its primary role. The primary role of the bank is dealing with monetary policy, the official cash rate, and the policy targets agreement. We wanted to clarify that the bank’s additional responsibility to provide advice to the Minister in relation to non-bank deposit takers was secondary to its responsibility for monetary policy. We wanted to make it clear that the bank’s predominant role is, and will always remain, dealing with monetary policy.

The select committee inserted new clause 8A, to make sure that any information collected from non-bank deposit takers would remain confidential to the Reserve Bank, in the same way that information it collects from the main banks is kept confidential. There were further amendments by way of insertion of new clauses 8B, 8C, and 8D, and they were interesting amendments. Mr Woolerton may recall that, currently, the Governor of the Reserve Bank and the deputy governor cannot have an interest in any banks that operate within New Zealand. We felt it was really important that the governor and the deputy governor not have an involvement, a financial interest, in any non-bank deposit takers, as well, to avoid conflicts of interest that could cause issues down the track—particularly given that the bank is seeking quite detailed information from non-bank deposit takers.

The key part of Part 1 is new Part 5D, inserted by clause 11. New Part 5D is a new part of the Reserve Bank of New Zealand Act 1989. It relates specifically to the regulation of deposit takers. It adjusts the Act to allow the Reserve Bank to deal with non-bank deposit takers. New Part 5D is the substantive part of the bill—a very important part. I want to talk about a number of important provisions in it.

I will talk firstly about the provisions that deal with the definition of deposit takers. That definition is very important. It is vital to defining what type of organisation this bill applies to. Members of the committee heard from a number of submitters who were concerned that they would now have compliance costs accorded to them unnecessarily, because, in fact, they were not in the business of taking deposits from members of the public. We made it clear, through new section 157C, which organisation would and would not fall under this regime.

There is an interesting point in subsection (4). It allows groups to be excluded from, or included in, the regime by Order in Council. That is a point I wanted to highlight. I also want to highlight what came to be known as the “hire business clause”. The “hire business clause” comes in via subsection (5). It allows the governor the power to exempt—or to include, for that matter—a business, according to the nature of its business activities. The concern from the likes of hire businesses, which take deposits from customers for hire equipment, was that they would be considered deposit takers, when, in fact, the principal reason for their business was to hire out products to consumers on a day-to-day basis. Although they take deposits to prevent the products from being stolen or damaged, their principal business is not being deposit takers. We inserted that provision to make that very clear, and that is good.

I want to touch on new section 157I, which insists that deposit takers must have a current credit rating. You see, up until this point in time, non-bank deposit takers have not been required to have a current credit rating, although some do have one. Hanover Finance, I believe, had a BB+ rating—which did not prevent that company from falling over. The fact of the matter is that now, under this legislation, non-bank deposit takers that are defined as such must have a credit rating. New section 157I insists that that be the case.

The committee had a look at that, and we put in a new provision to define the principles to be followed by the bank in deciding whether to approve a certain credit agency, so that New Zealanders can have some surety that the credit agencies that are being used to provide these credit ratings have some substance to them. Members will see a range of measures in new section 157J that define the principles to be followed.

That is all I want to say on Part 1. I will leave it at that point. Part 1 is the substantive part of the bill. It defines how we are to adopt credit ratings for non-bank deposit takers. It brings non-bank deposit takers under the auspices of the Reserve Bank of New Zealand Act, and I think that is a good thing. That is why the National Party will support Part 1 going forward.

Further to what my two colleagues have said, yes, we are speaking on Part 1 of the Reserve Bank of New Zealand Amendment Bill (No 3). I will cover some specifics, and I have some questions I would like to ask of the Minister in the chair, Chris Carter, about these matters. I look forward to his clarifying some of the issues.

The principal Act is the Reserve Bank of New Zealand Act, and I would particularly like to talk to clause 6, which substitutes a new section 16, “Dealing in foreign exchange by Bank”. Clause 7 then talks about foreign reserves. Another bill recently clarified that for the Reserve Bank; I cannot quite remember its correct title. This bill is a clarification, actually, of what the Reserve Bank does, of what it is allowed to do, and of which agents it can use or can use it.

But I would be interested to ask the Minister, if the Ministry of Education was ever dealing in foreign exchange, for example, whether it would deal in it via the Reserve Bank or the Debt Management Office, or whether it would deal in it direct, because that perhaps would give us a clue as to some of the efficiencies in the Public Service. There would not be any point in the Ministry of Education buying foreign exchange through a particular trading bank, for example, or the Ministry of Health selling foreign exchange through the same trading bank, because the bank would be the winner there at the end of the day. So I would like the Minister in the chair to clarify that. I imagine he knows about the Ministry of Education; I would like to think so.

Clauses 8B, 8C, and 8D just provide detail. They talk about the removal of the governor or the deputy governor, and the disqualification of them—that is, they cannot have a vested interest or shares or an equity holding in, or be exposed to, non-bank financial institutions. That obviously makes sense, as suddenly the Reserve Bank will be the regulatory arm for those institutions. That is, I think, identical language to that used to describe what those individuals are able or not able to be or to have in relation to existing banks, which is to be shareholders or to have substantial stakes in those banks—or at least they must declare any stakes that they may have in them. It is quite difficult, in the very thin stock exchange and equity market that we have, for those individuals to not have some investments in those banks, but I am sure the investments are in blind trusts or something like that.

I would ask the Minister in the chair whether he could expand a bit on new section 68B, “Bank to have regard to directions about government policy objectives”, inserted by clause 10. My colleague Chris Tremain spoke about this a little. The bill has gone through a few drafts, to be fair, but when it first came to the Finance and Expenditure Committee one interpretation of it—and, again, I alluded to this in my second reading speech—was that there was possible politicisation of monetary policy here. The extreme example of such politicisation was Robert Muldoon and the old reserve asset ratios. If he wanted to pump the economy up in an election year, funnily enough he would change those ratios.

In fact, what we originally saw here was the ability of the Minister to virtually influence the Reserve Bank, in a bit of a roundabout way, to change the cost of capital to certain institutions. Now, that is totally unacceptable, and I covered the reasons why it is not acceptable in my earlier speech. But if it was an election year—as, for example, it is right now—and the Minister of Finance, in an extreme example, wanted to pump things up, he could have got on the phone to ask for some policy advice from the Reserve Bank governor, and said: “Hey, this is a request for policy advice. We think the housing market needs to go up again. What do you think?”. The Reserve Bank governor was obliged to respond to that question, and the Minister of Finance could have given him directions.

Things are a lot tighter in this final version of this bill, to be fair. However, I would like the Minister in the chair to answer some of the questions about exactly how that process would work. If possible, I ask him to give us an example of the policy questions that the Minister of Finance may ask the Reserve Bank governor, and to describe the way that that process would work, including the checks and balances in it, with reference also to the banking side of the economy, which is of course the larger one.

Many people who are exposed to debt and who have borrowed from the many non-bank institutions are, as a previous speaker alluded to, actually very, very vulnerable. We saw in the Dominion Post today that a little finance company—I think it was in Porirua or Taitā—is advertising interest rates of 8 percent per week. When compounded, that 8 percent actually translates to something like 400 percent per annum—I think, in that example, the paper just used a blind and multiplied 8 by 52, and got a figure of 400-odd percent per annum. The finance company declares the rate per week on its board at the front of its office. The problem is that although the company has actually been up front about its hugely exorbitant interest rates, many people do not see the distinction between the weekly rate and the rate when compounded per annum. That company, because of its exorbitant pricing, and because it is taking advantage of the vulnerable, is up against the Commerce Commission. I also understand that there are some quite extreme collateral obligations around those companies, which, now they have been publicised, will be investigated, I am sure.

💬 Tim Groser: Hopefully.

Yes, hopefully.

I will now talk to clause 11, which inserts a new Part 5D. I do not know why all this has happened. I guess it was to get the bill through more quickly, with fewer parts to talk about. But there are many new parts of the principal Act in there that I would like to talk to—particularly the credit rating provisions set out in new sections 157I, 157J, and 157K. I would like the Minister to answer a few questions and give us his thoughts on who should be an approved credit rating agency, how they should be reviewed, and what criteria the Reserve Bank would look at when approving them. I would also like the Minister to step up and say whether that means that some existing credit rating institutions in New Zealand should be put out, or at least blacklisted, as some others should come in. As Chris Tremain mentioned earlier, many of the failed institutions did actually have credit ratings, but they were not worth the paper they were written on or the TV ads they were portrayed on.

Again, to be fair, once the select committee went through various drafts of this bill that area was tightened up a lot. It was good practice all round, and I would like to acknowledge the officials here, too. I thank them for all of the work that they have done around this bill and many others.

I would also like to speak to new section 157L, which is about governance requirements. Many submitters had concerns regarding the cost of compliance to them, and, as I alluded to earlier, there is a danger here that this is seen as an implied guarantee of deposits by the Reserve Bank—a deposit insurance. Another downside is that it is skewed against the smaller financial institutions, which may be quite robust, very conservative, and below the radar, but which now have to front up to all the costs of getting a credit rating, managing the governance requirements, and changing their deed to allow for the capital adequacy ratios, etc. The larger institutions, of course, have a larger back office and plenty of lawyers to do that stuff for them, and they have more depositors to spread the load over. There is a problem here with regard to the smaller ones, and we have to be very careful that we are not skewing the playing field against some quite robust institutions.

As we go through Part 1, I would also like to speak about risk management. As long as institutions declare what they are investing in and that is public and open—that is, it is clear what the risk is—that should be fine for many of these institutions. The problem we have recently seen is that the risks were not put up front. So, yes, this bill provides a framework, and the Reserve Bank will monitor the companies, allowing them to invest in whatever they may like. The legislation is not very prescriptive on that, as long as the risks are declared. That is the balance between full, prescriptive parliamentary regulation and the belief in caveat emptor, which we spoke about earlier, and I think it is a pretty good fit down there. The good point—it is somewhere else in the bill; it might be in another part—is that it will be reviewed in 5 years. That is very good.

I know many people do not understand the minimum capital requirement. It is quite technical, but here is a simple example. If a bank or one of these institutions wants to lend to a business, it has to have 8 percent of that capital sum allocated and put aside in case there is a default somehow. But if it is lending against a residential home, it has to have only 4 percent of the same amount of capital put aside. When one looks at that, one can understand why many people borrow against their own home in order to fund their business. New Zealand is a nation of small and medium sized enterprises, and many business owners actually put their own home at risk in order to fund their business. One can see why they do that, because the cost of borrowing against their own home is cheaper than if they were to borrow against the cash flows of the business. The monetary inquiry is looking at some of those issues at the moment. Many people approach this the wrong way. The point is that people are taking a risk with their own assets—be it their own home, a second home, or a third home—in order to invest in a business. So those people are taking much more of a risk than their bank, whichever one it may be.

Before I follow on from where Mr Foss left off I would like to say in recognition of Mr Foss that he is an ex-banker with a level of financial literacy far above the norm. I will not speak for any other levels of literacy that the man has, but certainly his financial literacy is far above the norm. The Reserve Bank of New Zealand Amendment Bill (No 3) is designed to attend to problems encountered by people with a normal standard of financial literacy, and it is for people who just want to be assured that their money will be looked after. So part of this bill is to enhance the transparency of what goes on, and to ensure, as Mr Foss has been talking about, that some money is put aside if everything goes wrong.

We talk of deposit takers having a risk management programme, and they should tell people in broad terms what they intend to invest in. Mr Foss has covered that. Other parts of the bill deal with governance, and it tries to attend to the sort of thing we have seen recently where finance companies have ostensibly been out there to take deposits from the public and to on-lend them to business people, developers, and the like.

We are finding now—and I am sure many people are startled to find this—that in many cases the people who own and run these companies are the very same people who are borrowing, and, in fact, they are developers who have set up a finance company to get money off the public to finance themselves in some of their very risky ventures. In many cases there are not the capital ratios that Mr Foss speaks of, and the people who miss out are the innocent members of the public who think when they put their money in that they are investing for their retirement, that they are helping business in New Zealand, and that they have some backing from financial institutions and some regulations that will ensure the return of their capital plus a return of interest for the risk they have taken. Very few of them look seriously at the risk and, in particular, at the categories of risk that are so familiar to people like Mr Foss and to the people who live in his world—or the one he used to inhabit.

I am not saying that with any sense of nastiness. I have a high regard for Mr Foss in his previous occupation. But people are searching for a guide when they are investing. This bill goes some way towards that. We would all like to see it go further, but, as Mr Tremain was talking about—or maybe it was Mr Foss, in his earlier speech—it is a question of balancing the entrepreneurial activity that we require in a free and open economy, and ensuring that there is enough regulation to encourage people to put money into a financial institution in order to encourage the growth and the entrepreneurial activity to take place. Unless both sides of that equation are satisfied we will be starved for capital. In fact, that is what is happening worldwide at the present time—the depositors have taken flight.

I shall pick up from the earlier speaker, Doug Woolerton, who was starting to talk about scarcity of capital. That is a big problem. The word “capital” goes right through here—if one looks at the new section 157R about capital ratio requirement, and even before that it talks about “capital”, etc. As I said earlier, it is a very, very scarce commodity. When times are good, there seems to be plenty of it, but as we have recently found out, all around the world, particularly down here in New Zealand where we are at the end of the capital queue, if you like, it is particularly scarce. That is reflected in New Zealand in what we have to pay for our capital, as well as the general state of our economy.

But it is not just capital that the framework in this bill will start to address. It is the definition and the qualification of what a particular asset is. Then one has to apply so much capital to it. It works the other way, actually. So if one has a house, for example, it is bricks and mortar, and a certain amount of capital is required for that, which is 4 percent. If one has a business with a house above it, then all sorts of different ratios start to apply. Because capital is so scarce, many institutions will go to all sorts of lengths to make sure, or to try to make sure at least, that the regulatory body such as the central bank, or Reserve Bank in this instance, agrees with them about the class of that asset—whatever it is—and therefore that is how much capital is required to be stashed away for it.

If one takes the house example, one could have a mortgage in Australian dollars—one could have borrowed Australian dollars to fund that house mortgage. So not only is there risk on that house of bricks and mortar, and one’s income to be able to fund the mortgage—one’s income might be in Australian dollars, so one has foreign exchange risk. Or one might have a house in New Zealand, from which one is earning money in Australia, for example, so the bank is exposed not only to the bricks and mortar, and one’s income to fund the mortgage, but also to the exchange rate between Australia and New Zealand, and also to the interest rates of New Zealand and Australia, where someone could borrow there to fund oneself here. Take that to the huge extreme, of course, with Uridashi bonds, with the good old Japanese housewife lending about $120 billion, I think it is, to New Zealand.

This raises a very important point, because we must always remember that New Zealand is a debtor nation, and, sadly, that is one of the reasons we have to pay such high interest rates, which have, incidentally, approximately doubled over the last 9 years. We have to address that and not just assume that we are a creditor nation. It makes one approach many things in another way when one confronts the fact that one owes an awful lot more than one owns or earns.

I refer to parts of Part 1, including new section 157S, “Deposit takers and trustees must ensure capital ratio included in trust deed”, and new section 157T, “Deposit taker must maintain capital ratio required to be included in trust deed”; that is all very good, but it does require quite a bit of work for those various institutions. That is countered by the fact that at the Finance and Expenditure Committee we extended time for them to have all that in place to 18 months, which is, obviously, 1½ financial years for most of them. The credit-rating agencies will start to look at their assets to find out how much capital they need, and therefore tell them how much the ratios and what their exposures are, in regard to their trustees and what their allocations are, and the Reserve Bank reassures us that at the end of this quarter it will have at least a starting list of credit-rating agencies. Again, Mr Chair, I alert you to the questions I asked of the Minister in the chair before, around those agencies, and I would like him to consider answering those, and I am sure those listening in would like him to at least consider some reply to them.

In my second reading speech I talked about this thing called Basel II. Basel is a place in Switzerland that used to be the centre of the financial universe. Section 157V starts to talk about that as far as non-bank financial institutions are concerned. All banks reference Basel II—there was a I, now there is a II, and there is, in fact, even a further move from II—and its application to non-bank financial institutions is obviously the commonality between financial institutions and the finance sector.

Interestingly, Basel II has moved to a point where the Reserve Bank can now accept a bank’s own credit rating and measurement models. So as long as a “Foss Bank”, if you like, rocks along to the Reserve Bank and says: “Here’s my model for measuring my exposures; is this OK?”, and the Reserve Banks says yes, then that means I can have different capital ratios outside of Basel II. I would be interested if the Minister could answer whether they would be extending that same freedom—that throttling or flexibility—to non-bank financial institutions. I cannot recall the answer from select committee hearings and submissions, so I would be interested in the Minister’s opinion on that.

Touching on new section 157Y, relating to liquidity requirements, I note it states: “Regulations may impose requirement that liquidity requirements be included in trust deed”, and members can also look at new section 157Z. I presume they are talking about debt ratios, exposure, the 60 percent, 80 percent, or 10 percent leverage—whatever it might be. But again, when the legislation states: “Regulations may impose requirement” we need to know from the Minister in the chair that whatever is required of the institutions, pari passu—meaning all things being equal—for the banking institutions the requirements will be the same, and the cost of capital is not being increased to non-bank deposit-takers. That is my largest fear, because many people rely on such institutions to fund themselves through this increasingly expensive cost of living and increased mortgage rates just to get by. I would be interested in the Minister’s comments around that.

Finally, as we wander through the legislation I will talk about confidentiality of information. Again, the committee made good strides, and I thank the officials for helping us with that, because, again, in the early drafts it was open slather. Confidentiality outside of an institution and the regulatory body—the Reserve Bank, in this instance—is absolutely paramount. Of course, every other bank and institution wants to know the exposures of the competitors, but that information is none of their business; they can fight that out amongst themselves in the market place. It is good that it is confidential, and there are some quite good parameters around that, and checks and balances to stop any dubious leaking of information outside what would be necessary in a prudential bill like this.

I will also talk just a bit further to the offences and penalties. I would like the Minister in the chair to describe some of those in a bit more detail if he could. Earlier I asked about the process around policy advice from the Governor of the Reserve Bank or the Reserve Bank. What happens if one of those parties chooses not to follow that advice? I realise that this particular clause is about the institutions themselves, but what if an institution that is heavily exposed and has a huge amount of deposits chooses not to follow what the Reserve Bank says, because there is a moral hazard there? If a bank or an institution calls the Reserve Bank’s bluff, what happens—if the bank or institution said: “We have done all we can, we have funded all we can, we just have to taihoa, we have good assets here, we just need to ride this storm out.”?

The previous speaker talked about frozen assets. So I ask the Minister in the chair what would happen in that instance. If the Reserve Bank, in that instance, froze a large institution—$100 million in deposits, or whatever it might be—we start to question that, and there could be some systemic problems going down from that, right throughout the financial system. The simple outcome of that is that interest rates will be higher in New Zealand for longer, as they have been, in truth, with this Government here for the last 9 years.

Incidentally, if this bill had come in in 2000 or 1999, the underlying interest rate that these institutions would have had to deal with would have been 4.5 percent. That was the official cash rate when Dr Cullen became Prime Minister—at least, Minister of Finance; I am getting a bit ahead of myself there—and we have recently seen 8.25 percent. Thank you, Mr Chair.

The question was put that the amendments set out on Supplementary Order Paper 225 in the name of the Hon Dr Michael Cullen to Part 1 be agreed to.

Amendments agreed to.

Part 1 as amended agreed to.

Part 2 Amendments to Part 6 of principal Act