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Speech by Mr Graeme Wheeler, Governor of the Reserve Bank of New Zealand, to Craigs Investment Partners' Investor Day, Auckland, 2 March 2017.
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Graeme Wheeler: Some thoughts on the balance of risks around the Reserve Bank’s monetary policy setting Speech by Mr Graeme Wheeler, Governor of the Reserve Bank of New Zealand, to Craigs Investment Partners’ Investor Day, Auckland, 2 March 2017. * * * Introduction Thank you for inviting me to join you today. It’s a pleasure to exchange views on the challenges facing the Reserve Bank (Bank) and investors in interpreting policy signals and political and market developments. In particular, I will focus on what we consider to be the main risks around the interest rate projections in the February 2017 Monetary Policy Statement (MPS). New Zealand is one of the few countries where the central bank publishes interest rate projections in its MPS. These projections represent the Bank’s central view of the policy path needed to return inflation to the 2 percent mid-point of the target range specified in the Policy Targets Agreement (PTA). Such projections are highly conditional and based on a range of assumptions – many of which lie beyond the Bank’s control. Such factors include: the outlook for global growth, inflation and commodity prices; movements in exchange rates and long term interest rates; the scale of migration flows; and the government’s spending and tax policies. These key assumptions, and other factors that affect the economy’s output gap (or the extent to which there are capacity constraints, and therefore inflation pressures in the economy) are extensively debated in-house prior to finalising the MPS. The OCR track contained in the February 2017 MPS The Official Cash Rate (OCR) projections in the November 2016 MPS contained a slight easing bias, building in a 20 percent probability of a further 25 basis-point interest rate cut. This easing bias was replaced with a neutral bias in the February 2017 MPS, which shows an unchanged OCR until mid-2019. This suggests that if the economy were to develop along the lines of the Bank’s economic projections, the current OCR would be sufficient to return annual consumer price inflation to around 2 percent. (The track incorporated a 25 basis point increase in the OCR in late 2019. As the economy would then be entering its 11th year of expansion, the usual maturation processes in a business cycle suggest it would be reasonable to expect an eventual rise in the policy rate as capacity pressures become more broad based.) 1 / 11 BIS central bankers' speeches The risks around future OCR movements are considered to be equally weighted. In effect, there is an equal probability that the next OCR adjustment could be up or down. We consider the balance of risks for the global outlook to be downside. For the domestic economy, there is some potential upside for output growth if migration and commodity prices turn out to be stronger than forecast, but the risks around inflation look balanced. Of course, small open economies such as New Zealand are hit by multiple shocks that may be political, economic or financial policy-related, or linked to natural or other disasters. The Bank reviews the implications of these events for the PTA and the OCR and summarises its conclusions every six weeks in OCR statements and the quarterly MPS. Policymakers confront large shocks that are difficult to predict. For example, we saw how financial markets and policy makers did not anticipate the 1997 Asian Financial Crisis, the 2008 Global Financial Crisis, the outcome of the United Kingdom European Union membership referendum, or the recent US Presidential election. Nevertheless, policy makers need to think carefully about risk and uncertainty and the ‘what if’ consequences of possible developments. Like many central banks, the Bank uses scenario analysis to model the possible economic impacts of specific shocks of a given magnitude. Several scenarios have been included in MPSs over the past few years – the February 2017 MPS included scenarios showing a sharp rise in commodity prices and softer growth in private consumption. Considering the implications of possible shocks becomes even more important when levels of uncertainty are particularly high, which is currently the case1 (even though measures of equity market volatility remain low2). 2 / 11 BIS central bankers' speeches Risks surrounding New Zealand’s economic expansion New Zealand’s current economic expansion is entering its eighth year of what the OECD describe as a strong broad-based expansion. In the absence of major shocks, prospects look reasonable for continued strong growth over the next two years driven by accommodative monetary policy, construction spending, and net inward migration. If these prospects are realised, the current expansion would be New Zealand’s longest in over 50 years. 3 / 11 BIS central bankers' speeches Table 1 compares the latest summary macro-economic indicators with the 30 year average. Table 1: Summary macro-economic indicators Year to December 2016 30 Year Average GDP growth (%) 3.5** 2.5 CPI Inflation (%) 1.3 2.1* Employment growth (%)*** 3.2 1.7 Unemployment rate (%) 5.2 6.2 Current account balance (% GDP) -2.7** -3.7 *CPI Inflation is a post-1991 average, reflecting the inflation targeting period. ** RBNZ estimate *** Based on filled jobs in the Quarterly Employment Survey Source: Statistics New Zealand, RBNZ Expansions in small open advanced economies generally come to an end due to one or more factors: Global economic growth weakens or slows in major trading partners and affects the terms of trade and export growth. This might be triggered by a sharp rise in oil prices or a financial crisis. A major domestic policy correction is needed to address a deteriorating fiscal or current account deficit. Long-term interest rates rise significantly in response to offshore movements triggered by higher inflation expectations, and/or increased risk premia in major economies. Alternatively, domestic short-term rates may need to rise sharply to moderate inflation pressures associated with growing supply and demand imbalances. At this stage the Bank’s policy analysis does not suggest the need to adjust monetary policy in response to fiscal imbalances, external indebtedness or domestic inflationary pressures. In addition, New Zealand’s financial system remains sound and continues to operate effectively. i) domestic risks The strength of the expansion will be affected by changes in households’ desire to save, the scale of net immigration, and shifts in expectations about future inflation. Our forecasts do not incorporate any significant change in the household saving rate, but assume a reduced flow of net immigration that remains high by historical standards. Measures of long-term inflation expectations continue to be well-anchored at 2 percent. 4 / 11 BIS central bankers' speeches The possibility of worsening imbalances in the housing market remains a major risk with continued low interest rates and strong migration, and rising construction cost inflation reflecting increasing resource pressures. There are upside risks in respect of our migration projections. Although departures remain low, arrivals have continued to increase with arrivals by migrants on work visas being particularly strong in recent months. New Zealand house price indicators (such as the growth in real house prices, house price-toincome ratios and house price-to-rent ratios) are very high internationally and historically. At a time of heightened uncertainty, households are particularly vulnerable to a correction in house prices given the large rise in household debt since 1990. Household debt is now equivalent to around 165 percent of household disposable income, up from 100 percent in 2000 and 60 percent in 1990. Households are also exposed to a normalisation in mortgage rates given the short interest rate duration of the mortgage market (with 89 percent of mortgage loans re-pricing within two years). In addition, the share of lending at debt-to-income ratios of over 5 and 6 has increased steadily for all borrower groups since September 2014. Fortunately, house price inflation has moderated substantially in recent months in response to increased housing supply, rising mortgage rates, the tighter lending criteria adopted by banks, and the impact of loan-to-value restrictions. Nationwide house prices have been broadly unchanged over the past six months, compared to a 12 percent increase in the six months prior. It’s too early to say whether this moderation will continue, but future developments in respect of housing market imbalances and debt servicing costs are likely to be important influences on household spending and the level of aggregate demand in the economy. 5 / 11 BIS central bankers' speeches Another risk is that the exchange rate remains higher than projected in the MPS, suppressing tradables inflation and net exports. As we indicated in the MPS, whether monetary easing would be required to offset this would depend on the factors driving the exchange rate (e.g. weaker global growth, higher commodity prices) and how domestic capacity pressures were changing. ii) external risks Developments in the global economy often have major impacts on small open economies through channels such as trade flows, commodity prices, exchange rates, capital movements and funding costs. There have been four troughs in global economic activity over the past 50 years – 1975, 1982, 1991, and 2009 – where we saw declines in world real GDP per capita.3 Three of these troughs were linked to oil price increases and the policy responses to them (1975, 1982, and 1991). The other was caused by the Global Financial Crisis (2009). Several sources of uncertainty currently exist in the global economy including: The outlook for growth in Europe and the extent to which consumer and business confidence might be affected by issues such as Brexit negotiations, migration, upcoming elections in large European countries, the Greek debt negotiations and concerns regarding the vulnerability of some European banks. The extent to which the US Administration follows through with its ‘America first” policy platform and adopts trade protectionist measures. Uncertainty also exists around the degree of fiscal stimulus likely to be adopted and its composition (e.g. through reductions in corporate tax rates, including border tax adjustments, and increases in infrastructure spending). The outlook for medium-term growth in China given the very rapid build-up in corporate (mainly SOE) debt since 2008, and the rising level of bad debts in the shadow banking 6 / 11 BIS central bankers' speeches sector. Uncertainty also exists around the pace at which the comprehensive economic reforms identified in the 3rd Plenum will be implemented. Sources of uncertainty elsewhere include the Middle East, Russia, North Korea, and Brazil, but unless developments in these countries trigger commodity or security-related risks, such events are less likely to have major global economic and financial impacts. To what extent could developments in the US, Europe and China affect New Zealand’s economy? Many of the risks in these regions are well known, and already reflected in relative prices such as interest rates, exchange rates and commodity prices. It is new information, either through additional data or greater clarity about policy intent, that leads to reassessments of judgements around economic impacts and transmission effects. a) Brexit The financial market turbulence immediately following the Brexit vote appears to have largely settled down, and the UK economy has performed better than expected since this vote. Clearly, however, much uncertainty lies ahead as the actual Brexit negotiations get underway and as we wait to observe the overall tone, shape and outcomes of these discussions. Although the EU and UK are important trading partners of each other, and have much to gain through trade, there is always a risk that political considerations predominate and lead to more restrictive longer-term trading arrangements. The combined EU and UK economies absorb around 14 percent of our goods exports and 23 percent of our service exports. If negotiations appear to head to an impasse or unfavourable outcomes, financial market pressures could spread into global markets and affect our external funding costs, equity markets and exchange rate. Greater uncertainty, along with higher funding costs, could reduce investment intentions with longer-run implications for domestic output and productivity. b) Slowdown in China A significant slowdown in economic growth in China would directly impact New Zealand (through trade volumes, investment, commodity prices, tourism etc.) and indirectly through reduced growth prospects in our regional trading partners – China, Australia and the rest of Asia account for around three quarters of our trade. China accounts for around 15 percent of world output (at current market exchange rates) and is New Zealand’s largest trading partner for exports and imports of goods. IMF estimates suggest that an investment-driven, one percentage point drop in China’s output growth would reduce G20 growth by ¼ percentage point.4 However, while there are important issues around the build-up of debt, house price inflation, capital outflows, and the slow speed of reform in the SOE sector, the consensus international forecasts are that the Chinese economy will avoid any material slowdown and grow by around 6¼ percent pa over the next two years. New Zealand would be partly protected from any mild slowdown in China as some of our main exports (e.g. dairy products, meat, and tourism) are supported by China’s move towards more consumption-led growth. But demand for these and other exports would weaken in the case of a more severe slowdown, especially if combined with financial disruption. c) Risks emanating from the United States Currently, the greatest source of uncertainty that could have important impacts on our economy relate to fiscal expansion (on the upside) and an increase in trade protectionism (on the downside) in the United States. 7 / 11 BIS central bankers' speeches i) Increase in trade protection In the run up to the US election, Donald Trump labelled China a ‘currency manipulator’ (a view not shared by the IMF) and suggested that tariffs of 45 percent should be imposed on China, and tariffs also be levied on imports from Mexico. House Republicans continue to push hard on their corporate tax plan that involves border tax adjustments that would redefine the taxable base for corporate income. It would disallow deduction of import costs and exempt export revenues. The White House has indicated it will publish its tax proposals in early March. Such calls for protectionism are contrary to the global trend in trade liberalisation over recent decades. They also come at a time when the growth in merchandise trade volumes over the past five years is the weakest since the early 1980s and new trade-restrictive measures by G20 countries are at their highest level since the GFC.5 There is much uncertainty around the objectives of trade policy under the new US Administration, and the specific policy instruments that will be used in pursuit of these goals. However some lines seem clear. The US Administration withdrew from the Trans Pacific Partnership, the negotiations around the Transatlantic Trade and Investment Partnership between the EU and US are in jeopardy, and the Administration has signaled it wants to renegotiate the North America Free Trade Agreement. Higher tariffs would raise prices for US consumers, could require a more accelerated tightening in monetary policy by the Federal Reserve, and could be expected to put upward pressure on the US dollar exchange rate. Furthermore, US tariffs would invite retaliatory actions by other countries. This would raise prices to consumers, and distort global supply chains as producers 8 / 11 BIS central bankers' speeches in the US and elsewhere change sources of supply and product destination. Increased protectionist measures would represent a negative global supply shock. Recent simulations conducted by the OECD estimate the potential impact of a general 10 percentage point increase in trade costs imposed by the major trading economies – the US, Europe, and China.6 Such an increase could have a major impact, especially on the countries introducing these restrictions: their GDP could fall by 2 to 3 percent; imports by 5 to 10 percent; and exports by 10 to 15 percent, with the US the worst affected. And the rest of the world would suffer too from falling GDP, imports, and exports. New Zealand would not fare well in such circumstances. Even if our exports of goods and services to the US—currently over $8 billion – were not directly subject to higher tariffs, we would be hard hit by a downturn in the global economy, including among our main trading partners, in response to the direct and indirect impact of protectionist measures. We would experience lower global demand and weaker commodity prices. Our exporters would also experience efficiency losses and increased costs if they faced disruptions to established supply chains. We would also experience spillovers as foreign producers’ diverted trade in response to tariffs and more general trading conditions. World financial conditions would also change as heightened uncertainty and a rise in global risk aversion would likely lead to higher external funding costs even as global growth slows. In such a situation portfolio flows may shift to larger more liquid financial markets and our exchange rate could fall, placing upward pressure on domestic prices and eroding real incomes. ii) Fiscal expansion in the US 9 / 11 BIS central bankers' speeches As with the protectionist sentiment, it is too soon to be specific about the nature and size of fiscal stimulus in the US. However, the possibility of a significant US fiscal stimulus represents an upside risk for New Zealand. A significant stimulus would boost economic demand in the US and spillover to other countries. New Zealand would benefit through higher commodity prices and increased exports to the US and to our other trading partners experiencing higher growth as a result of the US stimulus. Modelling within the Bank suggests that a fiscal expansion that boosts US GDP by 1 percent would increase New Zealand’s GDP by around 0.3 percent after 18 months. This increase in GDP results from higher commodity prices and expanded trade with the US and other regions benefiting from the US stimulus. In the absence of offsetting changes, the Federal Reserve would likely need to tighten monetary policy more quickly than currently expected and the expectation and implementation of increases in the Fed Funds rate would put upward pressure on the US exchange rate. US long term interest rates would be expected to rise given the increased Government debt issuance. In New Zealand, our long-term interest rates would be expected to increase and flow into higher mortgage rates, but the tightening in monetary conditions might be offset by some weakening in the NZ dollar exchange rate. Conclusion The Reserve Bank’s economic projections in the February 2017 Monetary Policy Statement, which are based on several assumptions, suggest that the economy could grow by around 3½ percent pa over the next two years. Headline consumer price inflation is expected to return to the mid-point of the target band gradually, reflecting the strength of the economy, and despite persistent negative tradables inflation. The official cash rate projections contained a neutral bias with an unchanged OCR until mid2019. This means that if the economy were to develop in line with the Bank’s economic projections, the OCR would remain at its current level over the next two years. However, small open economies such as New Zealand are hit by multiple shocks and the Bank assesses whether these, or a combination of them, warrants a change in monetary policy. While the outlook for global growth has improved over the past 6 months due to rising commodity prices and stronger business and consumer sentiment, several major sources of uncertainty exist in Europe, China and the United States. The balance of risk in the global economy is on the 10 / 11 BIS central bankers' speeches downside. Many of the risks in these regions are well known, and already reflected in relative prices such as interest rates, exchange rates and commodity prices. The greatest source of uncertainty relates to the US Administration policies in respect to its ‘America first’ policy platform. Although a substantial US fiscal stimulus could be positive for growth in the global economy, the prospect of a marked increase in protectionism – coming at a time when global trade is growing slowly and trade disputes are increasing – would have sizeable impacts on the global economy. Domestically, there are several uncertainties around the economy including the future path for commodity prices, the exchange rate, migration, the housing market, and household saving. The greatest source of uncertainty currently lies around the housing market and the possibility that imbalances in the housing market might deteriorate. Fortunately, house price inflation has moderated substantially in recent months, but it’s too early to say whether this moderation will continue. We remain comfortable with our economic projections. Given the external and domestic risks in respect of output and inflation, we consider the risks evenly balanced in respect of the OCR. The Global Economic Policy Uncertainty Index is a GDP-weighted average of national EPU indices for 15 countries that account for around three-quarters of global output at current prices. Each country’s EPU index is constructed from an algorithm that searches newspapers for words related to uncertainty in an economic or policy context. The VIX is an index of S and P 500 options. 2 One possible reason why the VIX is muted despite rising uncertainty is that stocks are moving in different directions following recent US policy signals, supressing realised correlation and index volatility. However the Chicago Board of Options Exchange Skew Index, which measures the price of buying protection against dramatic moves in the S and P 500, indicates that investors appear to be concerned about tail risks. 3 IMF, April 2009, World Economic Outlook, Box 1.1 Global Business Cycles 4 IMF, April 2016, World Economic Outlook and 2016 China Article IV consultation report 5 WTO Report on G20 Trade Measures (mid-October 2015 to mid-May 2016) 6 OECD, November 2016 Economic Outlook 11 / 11 BIS central bankers' speeches
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Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to the New Zealand Bankers' Association, Auckland, 7 March 2017.
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Grant Spencer: Review of bank capital requirements Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to the New Zealand Bankers’ Association, Auckland, 7 March 2017. * * * Introduction Since the traumatic experience of the Global Financial Crisis (GFC) in 2007–2009, banks and regulators have been revising their assessment of appropriate levels of capital. Bank capital is an important cushion for the financial system. It is the form of funding that stands first in line to absorb any losses that banks may incur. Having sufficient capital promotes financial stability by reducing the likelihood of bank insolvency and moderating the effect of credit cycles. The main international regulatory response to the GFC went under the broad banner of ‘Basel III’. This has involved a higher minimum quantity of capital and also a better quality of capital, for example, in terms of loss absorbency. While the new Basel III requirements are still being phased in, many national regulators, including the Australian Prudential Regulation Authority (APRA) in Australia and ourselves in New Zealand, have moved ahead of the Basel timetable. Several countries have also chosen to adopt more conservative capital rules than Basel III. The Final Report of the Financial System Inquiry (FSI) in Australia, recommended bolstering Australian banks’ capital ratios so that they are “unquestionably strong”, with the top quartile of internationally active banks given as a guide.1 APRA is implementing the FSI recommendations and this has resulted in a number of capital raisings by the Australian banks over the past year. APRA have indicated that their final position on “unquestionably strong” is not far away. In New Zealand, our broad approach has been to adopt the Basel standards, where appropriate, and implement them with a conservative bias. For example, the Reserve Bank has imposed restrictions on components of banks’ internal risk models. New Zealand has chosen not to adopt some aspects of Basel III, such as the internal modelling approach for market risk, where we have felt that a policy is overly complex or inappropriate for New Zealand conditions.2 This conservative approach to bank capital has been warranted by New Zealand’s relatively high risk profile and the Reserve Bank’s non-interventionist approach to banking supervision. Both of these factors are likely to be present going forward. In the changing international regulatory environment, it is becoming less clear whether New Zealand’s historical position on bank capital is being maintained relative to Australia and other peers. We believe it is time to review New Zealand’s position and review more broadly our capital framework in light of international and domestic developments and our experience with the current regime. Today I want to set the scene for the review of bank capital that the Reserve Bank will undertake over the coming year. I will explain the high level objective of the review, elaborate on the international and domestic context and set out principles that will guide the review. Objective of the review The aim of the Capital Review is to identify the most appropriate regulatory framework for setting capital requirements for New Zealand banks. Consistent with the Reserve Bank’s legislative purposes, minimum capital requirements should promote the maintenance of a sound and efficient financial system. In broad terms, higher levels of capital will improve the soundness of the financial system as the likelihood of bank failures is reduced and the potential impact of credit cycles is moderated. 1/9 BIS central bankers' speeches However, the capital regime may reduce the efficiency of financial intermediation if ratios are pushed too high or standards are made overly complex. Capital is a more expensive form of funding for the banks and so higher capital ratios can potentially increase the overall cost of funding the system as well as improving its soundness. Our aim is to agree a capital regime that ensures a very high level of confidence in the solvency of the banking system, while avoiding unnecessary economic inefficiency. In pursuing this objective, the Capital Review will look at the three key components of the regulatory capital regime: The definition of eligible capital instruments The measurement of risk, in particular the risk weights attached to credit exposures The minimum capital ratios and buffers These three factors are interdependent and the links between them must be carefully considered. The calibration of the capital ratios needs to be set in the context of the risk weights applying to exposures as well as the capacity of eligible capital instruments to absorb losses. Also, the role of capital buffers versus hard minimum requirements needs to be considered. The Capital Review will examine how well the Reserve Bank’s current framework operates and consider potential improvements. The Reserve Bank will consult the banks and the public on its findings and on any proposed changes to the capital framework. Outcomes of the Review will be heavily influenced by the international regulatory context, the risk characteristics of the New Zealand system and the Reserve Bank’s regulatory approach. I will start with the international context. How do our banks compare to international peers? This is not a straightforward question to answer, but we need to understand how the idiosyncrasies and relative conservatism of New Zealand’s approach to the Basel framework affects the headline capital ratios of New Zealand banks compared to peer country banks. The Basel Committee regularly publishes reports that compare banks’ capital levels on an unadjusted basis. The most recent report3 has the large internationally active banks reporting a median Common Equity Tier 1(CET1) ratio of 12.1%, with 25th and 75th percentiles of 10.9% and 13.8%. At the same date, our four largest banks reported a weighted average CET1 ratio of 10.5%, putting them, on an unadjusted basis, in the bottom quartile. For the entire New Zealand banking system, Tier 1 capital ratios have also been at the lower end of international comparisons. However, such comparisons can be misleading as countries have implemented the Basel Framework in different ways. The Reserve Bank has made a number of amendments to better reflect New Zealand risks, for instance our farm lending adjustments raise the average risk weight on banks’ exposures by around 20–30 percentage points compared to a usual implementation of the IRB framework.4 Risk weights on residential mortgages are also higher than for a range of peer countries, as seen in Table 1. The relatively cautious approach adopted in New Zealand with regard to risk measurement means that, on a like-for like basis, New Zealand’s relative capital position should be higher than the headline ratios suggest. The question is by how much. Table 1. Housing risk weights for selected countries (large banks) 2/9 BIS central bankers' speeches Country Weighted average risk weight Australia 23.5%5 Canada 7.2% Denmark 13.9% New Zealand 28.3% Sweden 6.8% United Kingdom 11.7% Source: Pillar 3 reports6 APRA has also applied the Basel Framework on a relatively conservative basis. 7 Taking into account differences in the calculation of capital and risk-weighted exposures, APRA estimated that the Australian major banks’ CET1 capital ratios, as at December 2015, would be 3.5 percentage points higher if calculated on a more internationally comparable basis. Running a similar analysis on the New Zealand framework, we estimate that CET1 ratios are roughly equivalent to at least an additional 1 to 2 percentage points of CET1 capital under an internationally normalised regime. This adjustment would place our four largest banks in the second or third quartile of the banks included in the Basel III monitoring studies. Alternative approaches to comparing capital adequacy also suggest that New Zealand banks may effectively be around the median of international comparators. Looking at simple leverage ratios, as of June 2016, the median leverage ratio of large internationally active banks was 5.6%. By comparison, we estimate that our four largest banks would have reported a weighted average leverage ratio of around 6.3%, placing them in the third quartile. Another basis for comparison is Standard & Poor’s “Risk-adjusted capital” (RAC) framework. S&P’s methodology uses risk weights based on their view of each country’s economic and banking industry risks. Relative to the world’s top 100 banks by Tier 1 capital, S&P’s methodology suggests that the weighted average of the four largest New Zealand banks’ RAC ratios is around the 56th percentile, although their position would fall to the 32nd percentile once adjusted for concentration risk.8 These scores are influenced by S&P’s view that New Zealand’s underlying economic imbalances are “very high” compared to peers.9 These initial comparisons point to New Zealand banks being “in the pack” in terms of capital ratios relative to international peers. Further work will be done as part of the Review to further clarify New Zealand’s current relative position. Basel Committee developments Over the past few years the Basel Committee has finalised aspects of the Basel III Capital Framework. The most recent reforms addressed aspects of the measurement of risk-weighted 3/9 BIS central bankers' speeches exposures. Most of the changes to market risk measurement have been finalised but proposed changes to the credit risk and operational risk frameworks are still being discussed. The proposed credit risk reforms include restricting the scope of the IRB approach to a smaller range of portfolios, imposing constraints on parameters used by internal models and developing a more risk-sensitive standardised approach. The Basel Committee has proposed a floor linking the revised IRB approach to the revised Standardised approach. European regulators want a relatively low floor, while US regulators have been arguing for a higher floor. The proposal for operational risk would see internally modelled approaches removed from the framework, to be replaced with a single standardised approach. The different state of banking systems between countries and the potentially significant impact of the reforms has seen on-going differences between members and a delay in concluding a framework. We hope that the Basel Committee will be able to finalise and publish these standards in the coming months, particularly those related to the use of internal modelling approaches. However, if this becomes a drawn out process we may need to conclude some aspects of the Review without the benefit of a fully agreed Basel framework. Australian FSI and increased capital requirements The Australian Financial System Inquiry (FSI) made three key recommendations on capital standards for Authorised Deposit-taking Institutions (ADIs): Set capital standards so that ADIs’ capital ratios are ‘unquestionably strong’. Raise internally modelled risk weights on residential mortgages to narrow the difference in risk weights between IRB and Standardised ADIs. Implement a framework for minimum loss-absorbing capacity in line with international practice, to facilitate orderly resolution and minimise taxpayer support. In accepting the recommendations, APRA has taken as a guide for ‘unquestionably strong’ capital, the top quartile of capital levels of internationally-active banks. To help fulfil the recommendations, APRA has over the past year increased residential mortgage risk weights for IRB banks to an average level of 25%.10 In response, the major banks raised around $23 billion in common equity over late 2015 and early 2016, as well as significant quantities of Additional Tier 1 and Tier 2 capital.11 These capital raisings have bolstered the resilience of the Australian parents of New Zealand’s four largest banks. While this contributes to the ultimate soundness of the New Zealand subsidiaries, it does not directly strengthen their balance sheets. The increase in risk weights on Australian exposures means that most of the new capital is being absorbed by the need to maintain existing capital ratios in the Australian businesses. APRA has indicated that their final position on ‘unquestionably strong’ is not far off, although detailed capital standards may not be finalised until later in the year. APRA had been waiting for finalisation of the Basel Committee revisions but does not wish to be held up by the current Basel impasse. Recent comments by the APRA chair 12 indicate that the banks should be able to meet any new requirements in an orderly manner. New Zealand domestic context The Capital Review will assess how our future capital framework might be shaped by domestic considerations. These relate to New Zealand’s risk profile, the shape of our financial system and also our regulatory approach. 4/9 BIS central bankers' speeches New Zealand’s exports are concentrated in a small number of commodity-based sectors which can be subject to considerable price volatility. Bank exposures to commodity export industries are a key risk in the domestic system. Residential mortgage exposures are also a major source of risk given the system’s heavy exposure to housing and the capacity for house prices to become very stretched – as at present. New Zealand is a net debtor country, having run current account deficits continuously over the past 40 years. About half of the country’s gross external debt is issued by the New Zealand banking system which then on-lends to businesses and households. This reliance on external funding is an important vulnerability of the New Zealand system, as starkly demonstrated during the GFC. While liquidity buffers must be the first line of defence against funding market disruptions, a strongly capitalised system also helps to mitigate the risk of reduced market access. New Zealand’s financial system is less diversified relative to peer countries. Financial intermediation is concentrated in a few large institutions and capital markets play a relatively minor role. Rating agency risk assessments of the large New Zealand banks is heavily influenced by expectations of support from the Australian parent banks. Under the S&P regime, this factor lifts the ratings of the large New Zealand banks by an average of 4 notches from BBB+ on a standalone basis, to AA- , the rating applied to the Australian parents. While the implicit support of the parent banks is valuable for the New Zealand system, it is also a vulnerability. For example, in recent times the Australian parent banks have been on negative outlook and, separately, APRA has placed restrictions on the ability of the parent banks to give credit support to their international subsidiaries. Should implicit parental support be eroded, it is important that our banks be seen as strong on a standalone basis in order to maintain their international standing. The Capital Review will draw on the emerging international literature on optimal capital and include an assessment of optimal capital that takes account of New Zealand-specific characteristics. The final calibration of capital requirements will also take account of the results and insights from bank stress-testing and other analytical work we are undertaking in support of the Capital Review. Capital review principles Consistent with the objective of the Review, the Reserve Bank will adopt principles that reflect the international and domestic context as well as the Reserve Bank’s approach to prudential supervision.13 The Bank will have regard to six high-level principles: 1. Capital must readily absorb bank losses ahead of creditors and depositors ‘Capital’ is the portion of a bank’s funding that can absorb losses ahead of creditors, allowing the bank to continue operating as a going concern or reduce losses to creditors and depositors in the event of failure. A key word in this principle is readily. To be useful in supporting a distressed bank, capital instruments must be able to absorb losses as and when they arise. Capital instruments can be ranked based on their subordination, permanence and loss absorbency, with Common Equity Tier 1 (CET1) capital being the highest quality capital instrument. The Reserve Bank will consider the roles of the different tiers of capital and whether more emphasis should be placed on simpler and higher quality forms of capital. We are particularly interested in reviewing the role of convertible capital instruments and will give this some priority in the Review. 5/9 BIS central bankers' speeches The principle of loss absorbency is also relevant for our assessment of buffers that are required in addition to minimum capital ratios. The current regime includes a conservation buffer of 2.5% and the potential for a counter-cyclical capital buffer under our macro-prudential framework. Such buffers enhance the ability of banks to readily absorb losses while remaining compliant with minimum ratios. An appropriate structure for capital buffers will be an important issue for the Review. 2. Capital requirements should be set in relation to the risk of bank exposures Regulatory capital requirements must reflect the underlying risk of exposures in order to avoid distorting banks’ risk-return decisions. Critics of the Basel framework maintain that ever-increasing risk granularity has led to a spurious sense of sophistication and that the pendulum should swing back to simpler, more objective measures of risk.14 In particular, the use of internal models to determine capital requirements has been shown in practice to lead to excessively wide estimates of risk for what is the same underlying exposure.15 The Basel Committee has agreed that a simplification of the framework and a reduction in model-based variation in capital requirements is desirable. However, as noted, we are yet to see the final shape of these reforms. We believe that model-based variations in risk measurement are less pronounced in New Zealand, due in part to our restrictions on internal model parameters and our relatively simple approach to market risk measurement. However, we agree that excessive complexity is undesirable and that risk differentiation should only occur when it is based on objective and credible measurement. In the Review, we will examine whether some simplification of the framework might produce more transparent and relevant outcomes. 3. Where there are multiple methods for determining capital requirements, outcomes should not vary substantially between methods Related to the previous principle, the Reserve Bank considers that if internal models are used to determine capital requirements alongside Standardised approaches, the calibration of the two should not result in unduly different outcomes. Standardised approaches can be seen as a default treatment for risk measurement. If Internal Model banks are able to use relevant data and risk management systems to better understand and measure the risks in their business, capital requirements might vary from the Standardised approach. However, the degree of difference should depend on the value added by Internal models over and above that achieved under the Standardised approach. For example, it may be difficult to justify large differences between Modelled and Standardised approaches where banks’ private information adds little to what is publicly available, say in the case of exposures to sovereign and local governments, or to publicly listed companies. 4. Reflecting the risks inherent in the New Zealand financial system and the Reserve Bank’s regulatory approach, New Zealand bank capital requirements should be conservative relative to international peers As discussed, New Zealand’s economy and financial system have risk characteristics that set us apart, including: our exposure to export markets; our dependence on international capital markets; our high degree of banking industry concentration; and the low diversification in banks’ lending portfolios. Further, New Zealand’s regulatory approach puts less weight on active supervision and relatively more on high level safety buffers such as regulatory capital. When calibrating capital requirements we need to be mindful that the Basel standards are based on the experiences and needs of large and diversified G10 and G20 financial systems. This may not be an appropriate starting point for New Zealand.16 Certainly in our current framework we 6/9 BIS central bankers' speeches have modified the Basel standards to take account of New Zealand-specific risks, including in relation to residential mortgage and farm lending that were not adequately captured in the Basel standards.17 Based on New Zealand’s risk profile and our approach to banking supervision, we would expect the Review to deliver an outcome where capital standards are seen as conservative relative to the Basel standards and to the standards of peer countries. 5. The capital framework should be practical to administer, minimise unnecessary complexity and compliance costs, and take into consideration relationships with home country regulators By international standards our banks are small with relatively straightforward business models. Similarly, the Reserve Bank is a relatively small prudential regulator. The full Basel framework is complex and voluminous as it aims to identify and measure the risks faced by the world’s largest and most complicated banks. We have chosen not to adopt some of the more complex features of the Basel framework, particularly in the area of market risk. In other areas where we have allowed the use of internal models, such as for operational risk, we have imposed overlays to provide a degree of comfort that capital will not fall below prescribed levels. Prudential regulators always face trade-offs between the level of simplicity and complexity in their requirements, the resourcing and monitoring of the framework, and the demands of the regulated entities. For example, adopting a full-service approach to implementing the Basel framework would impose higher resource and compliance costs on the regulator and the banks than a simpler framework. There would need to be clear and proven net benefits from the full-service model over the simpler but conservative approach that we currently prefer. However, we are mindful that our largest banks operate as subsidiaries of foreign banks and that some degree of alignment with international standards can help to reduce banks’ compliance costs. As we undertake the Capital Review, we will be consulting on the Reserve Bank’s preference to move towards a simpler capital regime, not a more complex one. 6. The capital framework should be transparent to enable effective market discipline Market discipline has been at the heart of the Reserve Bank’s approach to prudential supervision for over two decades.18 Effective market discipline requires banks to disclose prudential information that can be readily understood by creditors and is comparable across banks. This principle reinforces principles 3 and 5: avoiding large differences in outcomes between capital methodologies; and avoiding unnecessary complexity. Timetable for the Capital Review We will release a high level Issues Paper in April, outlining the areas of the capital framework that the Reserve Bank intends to examine, followed by more detailed consultation papers. As I noted at the outset, we will be seeking stakeholders’ views in three broad areas: what sorts of capital instruments should qualify (the numerator); how risk exposures should be measured (the denominator); and the minimum capital ratios and buffers. The Issues Paper will request stakeholders’ initial views on the areas we intend to cover and issues that might warrant particular attention. Further consultation documents with options for changes to the framework and recommended policy positions will be targeted for the third quarter. We plan to conclude the Review by the first quarter of 2018. Conclusion Today I have discussed the context for the upcoming Capital Review and outlined a number of 7/9 BIS central bankers' speeches key issues that the Reserve Bank will be considering over the coming year. Capital policy has multiple dimensions and trade-offs and we will welcome your views as we consult on the various aspects. We will assess the current framework and recommend policy changes in the context of international developments, New Zealand’s risk profile and the Reserve Bank’s regulatory approach. In doing so, we will be guided by principles that broadly promote conservatism and simplicity. We will ensure that the quantity and quality of banks’ capital remain consistent with promoting a sound and efficient financial system. Thank you for the opportunity to share these ideas with you today. 1 ‘Financial System Inquiry – Final Report’ (2014). 2 For further discussion of the Reserve Bank’s adoption of the Basel III standards, and the rationale for minimum capital requirements more generally, see the Bulletin article ‘The Reserve Bank’s application of the Basel III capital requirements for banks’ (2015). 3 Basel III Monitoring Report (February 2017)’. 4 These figures are for the 100 “Group 1” banks under the Basel Quantitative Impact Study definition, i.e. banks with Tier 1 capital in excess of €3bn, who are well diversified and are internationally active. “Group 2” banks, which are the 110 other banks that participate in the QIS, reported a median CET1 ratio of 13.9%, with a 25th and 75th percentile of 11.4% and 18.3%. 5 See, for instance, the Bulletin article ‘Bank farm capital: does it cost the earth?’ (2011). 6 The Australian housing risk weight is in the process of being increased to an average of 25%. 7 Data as at most recent Pillar 3 regulatory disclosure. Sample includes ANZ, CBA, NAB, WBC (Australia), BMO, CIBC, RBC, Scotiabank, TD (Canada), Danske, Nordea DK, Jyske, Nykredit, Sydbank (Denmark), ANZ, ASB, BNZ, WNZL (New Zealand), Handelsbanken, Nordea Group, SEB, Swedbank (Sweden), Barclays, Co-operative, HSBC, LBG, NBS, RBS, Standard Chartered (UK). 8 S e e APRA Information Paper: International capital comparison study (2015), and International capital comparison update (2016).. 9 See Standard & Poor’s ‘Top 100 Banks: Risk-Adjusted Capital Ratios Have Improved For Most Banks In 2015’, August 2016, and the December 2016 Standard & Poor’s Global Ratings reports for ANZ New Zealand, ASB Bank, Bank of New Zealand, and Westpac New Zealand. Concentration and diversification adjustments take into account Standard & Poor’s views of banks’ single-name, industry sector, geographic, and business line concentration or diversification. 10 See, for instance, Standard & Poor’s Banking Industry Country Risk Assessment, January 2017. 11 See ‘APRA reaffirms revised mortgage risk weight target’ (2016). 12 See the Reserve Bank of Australia Financial Stability Review, October 2015 and March 2016, for more details on ADIs’ recent capital raisings. 13 See 10 February comments by Wayne Byres. 14 See ‘New Zealand’s evolving approach to prudential supervision’ (2016) for a recent discussion of the Reserve Bank’s supervisory philosophy. 15 See for instance, ‘The dog and the frisbee’ (2012) by Andrew Haldane. 16 See the Basel Committee’s ‘Analysis of risk-weighted assets for credit risk in the banking book’ (2013, 2016) for their reports into the causes of variation in risk-weighted assets under the Internal-Ratings Based approach. A hypothetical portfolio exercise showed that, for the sample, practice-based variation in risk estimation for sovereign, bank and large corporate exposures could lead to a ±22% difference in reported capital ratios, for the same underlying risk. 8/9 BIS central bankers' speeches 17 To give an example of why this might be the case, the asset correlations used in the internal-ratings based supervisory formulae are based on either G10 supervisory data or were ‘reverse-engineered’ from the outputs of internal capital models developed by internationally active banks in the 1990s and early 2000s. These calibrations may not be appropriate in New Zealand. See ‘An explanatory note on the Basel II IRB risk weight functions’ (2005). 18 These include higher minimum loss-given-default parameters and higher asset correlations. 9/9 BIS central bankers' speeches
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Speech by Dr John McDermott, Assistant Governor and Chief Economist of the Reserve Bank of New Zealand, to the New Zealand Manufacturers and Exporters Association (NZMEA), Christchurch, 15 May 2017.
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The Value of Forecasting in an Uncertain World A speech delivered to the New Zealand Manufacturers and Exporters Association (NZMEA) in Christchurch On 15 May 2017 By Dr John McDermott, Assistant Governor and Head of Economics 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz "We are all forecasters." Tetlock and Gardner, Superforecasting. 1 It has often been said that there is no escaping forecasting. Every decision we make in life involves forming a view about what the future might hold. Likewise, there is no escape for the Bank. We have a Policy Targets Agreement that requires us to keep future inflation between 1 and 3 percent and therefore we need to form a view of where we currently are, how future developments might influence the path of output and inflation, and thus how we should respond. 2 We use our forecasting to establish a clear and well-founded plan for what monetary policy settings are necessary to achieve our inflation target, to communicate this plan to the public and to support the effectiveness and transmission of monetary policy. We present our forecasts in the quarterly Monetary Policy Statement. A great deal of effort goes into producing these forecasts. More often than not, the world does not turn out as we forecast. However, forecasting is still a valuable and necessary part of the monetary policy process. Producing forecasts and allowing them to be publically subject to challenge enables us to build a solid foundation for policy decisions, learn from developments, and improve our policy outcomes. Forecasting is not supposed to be prophecy; rather, it is about being precise about our thinking. Uncertainty and the challenges for forecasters A major challenge for forecasters is ‘radical uncertainty’, that is, we fundamentally don’t know what the future holds. Examples of this uncertainty are ‘black swan’ events that fall outside any existing experience. The term is derived from the northern hemisphere belief that all swans were white, based on the empirical 1 Philip Tetlock and Dab Gardner (2015), Superforecasting: the art and science of prediction, Cornerstone Digital. Our specific mandate is established by the RBNZ Act (1989) and the Policy Targets Agreement (PTA) which state that the Bank should use monetary policy to maintain price stability in the New Zealand economy. We have considerable flexibility around how we do this, reflecting the tradeoffs necessary to protect the overall economy (for example the impact on the volatility of the exchange rate or output), and acknowledging the range of relevant factors outside the Bank’s control. It also recognises that judgements are a necessary part of the task, for example, providing the Bank with discretion around how quickly it seeks to return inflation to target in the future. evidence that every swan ever observed was white. 3 For the first European migrants to Australia, discovering black swans was a completely unexpected event, lying outside of all evidence and experience up until that point. For forecasters, such unpredictable events are a particular challenge. We have a wide range of information about the past and current state of the economy, and are setting policy to influence the future direction of the economy. But the economy is populated with thousands of households and businesses responding to their own particular circumstances and opportunities, so it is never certain how the economy will evolve over time. Even without black swan events, the chain reactions of economic activity are so complex and so changeable that the range of possible – let alone probable – outcomes is vast. Tetlock and Gardner argue that the best forecasters understand that the world is uncertain and therefore react to it flexibly. 4 Good forecasters are careful, curious, and comfortable with numbers, and, crucially, when the facts change they change their minds. And that is how we strive to be. Conversely, the worst forecasters remain dogmatically attached to their forecasts, unchanging in the face of the evidence. Forecasting in uncertainty: dynamic programming and conditional forecasts So how do we make policy for an uncertain future? The approach that the Bank takes is to develop forecasts that are highly conditional on the information currently available. That is, our forecasts are subject to revision when additional information comes to light. These forecasts are then used in what Alan Blinder would describe as a ‘dynamic programming’ plan. 5 This means thinking about what you want to 3 Nassem Taleb (2007), The Black Swan: The Impact of the Highly Improbable, Random House. Taleb defines these black swan events as outside of previous experience, with an extremely significant impact, and that we have a tendency to try to explain it after the fact. Examples relevant to monetary policy in New Zealand include the 9/11 attacks or the Canterbury earthquakes. 4 Tetlock and Gardner, op.cit. The authors demonstrate that the best forecasters blend technical expertise and mastery of the data with judgement and humility. In addition, teams of forecasters can produce better results when the team is open to sharing and constructive debate. Alan Blinder (1998), Central Banking in Theory and Practice, MIT. achieve in the future and working backwards to form a plan today that will deliver that goal. In our case the goal is inflation near 2 percent in two or three years’ time, and the plan is given by the forecast of the Official Cash Rate (OCR). If events broadly unfold as envisaged then we carry out that plan, if not, then we adjust the plan. A feature of our inflation forecasts are that they always end up at the mid-point of the target band. When planning our actions we necessarily plan to succeed in achieving this target. If we thought we would not achieve this we would modify our OCR forecasts. As such, the forecasts show our judgement of the highest probability path to achieve the goal, but this path is not fixed. As new information becomes available, we assess it and where appropriate incorporate it into our understanding and our plans. Consequently, our policy settings are, and should be, responsive to any developments that might occur, and should move rapidly when required. For example, the sharp fall in inflation expectations in March 2016 (amongst other developments) led to us substantially revise our 90-day interest rate projection 6 and move away from a neutral stance to an easing bias (figure 1). 7 Figure 1: Inflation expectations and selected 90 day interest rate projections Source: RBNZ estimates. 6 Since November 2016 this has been replaced by the OCR projection. For further detail see Rebecca Williams, ‘Business cycle review: 2008 to present day’ RBNZ Bulletin 80(2) March 2017. The value of producing quantitative forecasts: internal discipline and the learning process So why do we produce specific forecasts given that our forecasts are conditional and subject to radical uncertainty? Being numerically precise about our view of the future allows us to test ideas, which in turn accelerates our ability to learn and understand what is going on. Over time, this helps to ensure that our forecasts are as robust as possible and form a solid basis for monetary policy decisions, minimising potentially costly forecast errors and supporting good policy outcomes. Testing is an integral part of robust analysis. As Nate Silver puts it, "The more eagerly we commit to scrutinising and testing our theories, the more readily we accept that our knowledge of the world is uncertain, the more willingly we acknowledge that perfect prediction is impossible, the less we will live in fear of our failures, and the more freedom we will have to let our minds flow freely." 8 When an outturn is different from that forecast, the Bank seeks to discover why, what it means for the outlook for monetary policy, and what we could do to make a better forecast next time. 9 We use our depth of experience to examine the data, distinguish the signal from the noise, and identify where to adapt our approach or where to maintain our existing views. For example, residential investment at the end of 2016 was considerably weaker than the Bank had forecast. In seeking to understand this forecast error, the Bank considered the composition of residential investment. We found that a sharp fall in transfer costs (based on decreasing house sales) was the cause of weak residential investment, rather than weakness in actual construction activity. Accounting for this information should support better forecasts for this part of the economy in the future (figure 2). 8 Nate Silver (2012), The Signal and the Noise: Why So Many Predictions Fail—but Some Don’t, Penguin Books. 9 For example see: Kirdan Lees, ‘Assessing Forecast Performance’, RBNZ Bulletin 79 (10) June 2016; C J McDermott, ‘Understanding low inflation in New Zealand’, a speech delivered to the Bay of Plenty Employers and Manufacturers Association (EMA) in Rotorua, 11 October 2016; and Geordie Reid, ‘Evaluating the Reserve Bank’s forecasting performance’, RBNZ Bulletin 79(13) August 2016. Figure 2: Residential building activity and house sales $m 000s House sales Residential building work put in place Source: RBNZ estimates. Producing forecasts: avoiding biases and supporting robust outcomes Forecasting can also help reduce human biases that are often present in decision making. Our brains are designed to react to surprises by making sense of them. In seeking to do so, we often rewrite our perceptions from prior to these events. 10 Even black swans may feel retrospectively predictable. This is known as ‘hindsight bias’ or the ‘knew it all along effect’. 11 As forecasters, we need to be particularly aware of this bias. To learn from our errors, we need to recognise that they are errors. By recording our quantitative forecasts and accompanying reasoning, we prevent ourselves from rewriting our original position and ensure we take on the full insights from any forecast errors we make. Over time the Bank has built an extensive institutional knowledge base of New Zealand economic data and experience of monetary policy formulation. Each time we forecast, we examine the latest data, identify where new information should lead us to change views, and incorporate lessons learned to ensure that our 10 Daniel Kahneman (2011), Thinking, Fast and Slow, Farrar, Straus and Giroux. 11 Baruch Fischhof and Ruth Beyth, ‘I knew it would happen: Remembered probabilities of once-future things’, Organizational Behavior and Human Performance 13(1), August 1975. forecasts keep evolving and are as accurate as possible. 12 To use Kahneman’s terminology, our forecasts force us to think more slowly. Forecasting is not the only essential part of monetary policy formulation. The Bank has a well-defined process for monetary policy decisions, based on a Monetary Policy Committee (MPC) that provides advice to the Governing Committee. 13 The MPC includes two external members to add to the Committee’s diversity of backgrounds and views. These external members provide a ‘reality check’ on the Bank’s thinking, and subject us to valuable independent scrutiny. 14 The MPC structure is supported by a set of working practices that ensure that colleagues closest to the data and forecasting processes present their work to the MPC, and that subsequent discussions are broad-ranging and unconstrained in order to avoid groupthink or other biases. 15 This means that the analytics of our Economics and Financial Markets Departments are blended with the experience of senior staff and Committee members, achieving better results through incorporating judgement in the forecasting process. How do we create forecasts at the Reserve Bank? The Bank monitors a wide range of data to gauge the current state of the economy, distilling the underlying trends and signals from the noise and assessing what the emerging picture means for the stance of monetary policy. In addition to formal model-based analysis, monetary policy formulation is supported by the feedback we 12 In essence, this is a Bayesian approach combining priors with new information using judgement. For a readable introduction see James V. Stone (2015), Bayes’ Rule with Matlab: A Tutorial to Bayesian Analysis, Sebtel Press. 13 The Governor retains statutory responsibility for OCR decisions, but the Bank has in practice delegated the decision on the appropriate policy settings to the Governing Committee. 14 The MPC has included external members since 2001. External members are limited to serving a 1 to 3 year term to ensure that they remain truly external. The two current and previous members are: Tony Caughey; Conor English; Richard Townshend; Luke Moriarty; Pip Dunphy; Earl Rattray; Liz Coutts; Bronwyn Monopoli; Terry McFadgen; Malcolm Bailey; Kerrin M Vautier; and Brent Layton. 15 For more detail see C J McDermott, ‘How the Bank formulates and assesses its monetary policy decisions’, a speech delivered to the Manawatu Chamber of Commerce in Palmerston North, 13 July 2016; and Adam Richardson, ‘Behind the scenes of an OCR decision in New Zealand’, RBNZ Bulletin 79(11) July 2016. For example, by convention the Governor speaks last in MPC meetings so as not to unduly influence the direction of the debate before a diverse range of views are heard from staff. receive from regular meetings with private businesses, industry associations and government agencies. We also undertake longer-term research projects to improve our understanding of specific features of the economy. 16 At the heart of our forecasting is our structural model, the New Zealand Structural Inflation Model (NZSIM). This is a theoretically rich framework that describes key behavioural relationships in the New Zealand economy and how they influence inflation. NZSIM generates the core forecasts for informing monetary policy decisions, and helps us identify the fundamental economic drivers and empirical relationships to explain the observed economic data. 17 The information collated over the forecast round is fed into NZSIM, and the theoretical structure of the model ensures that our forecasts are consistent. For example, the national income accounting discipline is preserved, we can distinguish between domestic and imported inflation which sum up to CPI inflation, and we are able to trace the forces driving economic growth. During the monetary policy decision-making process, the NZSIM forecasts are crosschecked with other modelling, and where appropriate modified to take into account additional information not directly represented in the model. That is, our forecasts are ‘model-assisted’ rather than ‘model-produced’. 18 NZSIM also can consider alternative scenarios, meaning that we can test competing ideas and assess how monetary policy should respond if circumstances develop differently. NZSIM necessarily abstracts from reality, and (as with any modelling) requires some difficult tradeoffs to be made, balancing the amount of detail that can be incorporated without sacrificing the ease of interpretation and resulting policy recommendations. 16 For examples of recent papers see the RBNZ’s Analytical Note series, available at http://www.rbnz.govt.nz/research-and-publications/analytical-notes. For more detail on the NZSIM model, see Neroli Austin and Geordie Reid, NZSIM: A model of the New Zealand economy for forecasting and policy analysis, RBNZ Bulletin 80(1) January 2017. An example of how we modified our forecasting framework to capture insights from analysis was when we moved to an adaptive (backward looking) inflation expectations measure from a survey measure of inflation expectations. This adjustment was to reflect the findings of Karagedikli and McDermott (2016), who found that more backward looking measures of inflation expectations were able to explain the low level of inflation since 2011 better than surveyed measures. See Özer Karagedikli and C J McDermott, ‘Inflation expectations and low inflation in New Zealand’ RBNZ Discussion Paper 2016/09. The combination of tractable model outputs and the expert judgement of Bank colleagues and Committee members forms the basis for building nuanced and detailed policy recommendations. Over the last few decades, increases in computing power have enabled the Bank to vastly expand its modelling and research capability, including making NZSIM possible. However, one significant limiting factor to forecast improvement is data: macroeconomic statistics have not fundamentally changed over the 30 years we have been using inflation targeting. 19 For instance, New Zealand is one of only two advanced countries that use a quarterly consumer price index rather than monthly. This is likely to be a fruitful avenue for future improvement that would greatly improve the Bank’s forecasting ability. The benefits of publishing our forecasts: improving the effectiveness of monetary policy The RBNZ Act 20 requires the Bank to publically set out its monetary policy stance and underlying reasoning, including a review of previous decisions. This information is published in our quarterly Monetary Policy Statement, along with our economic forecasts and accompanying explanation. The Bank was the first central bank to publish its planned interest rate path, starting in 1997, and we continue to rank as one of the most transparent central banks. 21 Publishing these macroeconomic forecasts and our planned OCR path provides a clear ‘line in the sand’ as to the Bank’s thinking. It also helps synthesise our views in a more approachable format, enabling commentators, market participants, and others to understand the Bank’s monetary policy stance. 19 New Zealand still lacks a complete set of national accounts, for example we do not have quarterly income GDP or flow of funds data. 20 Section 15 of the RBNZ Act 1989. 21 Nergiz Dincer and Barry Eichengreen Transparency Index 2014, available at http://eml.berkeley.edu/~eichengr/Dincer-Eichengreen_figures&tables_2014_9-4-15.pdf. Communication is a key part of the monetary policy transmission mechanism as it helps people to understand the Bank’s thinking and expected policy direction. 22 By building people’s understanding of how the Bank is likely to react to news, the predictability of monetary policy decisions is enhanced and policy uncertainty is reduced. We are a long way from the days when central bankers cultivated their ability to “mumble with great incoherence”. 23 To inform the market about the uncertainty inherent in projections, some central banks publish fan charts showing the range of possible outcomes around the highest probability scenario. While this approach shows the extent of uncertainty, it does not help people understand how the central bank’s forecasts may evolve if some of the contingencies change. Consequently, in recent Monetary Policy Statements we have published a range of potential scenarios to help people understand how the forecasts would change should the economy develop differently. We believe that this approach is potentially more helpful. Figure 3 illustrates how market participants understand the way the Bank is likely to incorporate economic and financial information into its projections. The market revisions (red line) are generally good at anticipating changes to our 1-year ahead 90-day interest rate projection (blue line), which suggests that they understand the conditional nature of the forecasts and the Bank’s likely response (or ‘reaction function’) to new information. 22 C J McDermott, ‘Policy uncertainty from a central bank perspective’, Australian Economic Review, March 2017 discusses how policy uncertainty, or ‘instrinsic uncertainty’, is reduced by having a clear policy framework and structure for decision-making. 23 Alan Greenspan in his often-quoted testimony to Congress in 1987. Another fun quote of Greenspan is: “I know you think you understand what you thought I said but I'm not sure you realize that what you heard is not what I meant”. Figure 3: MPS and market revisions Source: RBNZ estimates. Case Study: the increase in the OCR in 2014 The increase in the OCR in the first half of 2014 provides a good case study of our conditional approach to forecasting in a ‘radically uncertain’ world. At the start of 2014 the global economy appeared to be recovering from the 2008/9 global financial crises, with the IMF asking whether the “tide was rising”. 24 The New Zealand economy was growing strongly: the terms of trade had reached their highest level in 40 years; construction activity was robust; immigration was boosting housing and consumer demand; and monetary policy was providing substantial stimulus to the economy. Under these circumstances, we judged that there was a high probability that inflationary pressures were rising, contingent on the global and domestic economy developing as forecast and our knowledge of the structure of economic relationships. This view about rising inflation pressures was shared by the private sector forecasters and the IMF. Consequently, the OCR, which was set at an accommodative level of 2.5 percent, was raised by a total of 1.0 percentage points at successive OCR reviews in the first half of 2014. However, by September 2014 it had become apparent that the forecast contingencies were not developing as expected. Firstly, uncertainty around the central scenario had risen: the global economy was not strengthening as anticipated 24 IMF, World Economic Outlook update, ‘Is the tide rising?’, January 2014. and New Zealand terms of trade had fallen by about 7 percent since the start of 2014. Secondly, uncertainty about the structure of the domestic economic relationships was becoming apparent as CPI inflation remained moderate despite the inflationary pressures. Under these circumstances the Bank judged it appropriate to put a hold on interest rates, await the flow of new economic data, and investigate the evolution of domestic economic relationships. In the event, this decision proved correct. Global economic growth continued to be sluggish through 2015 and 2016. The Bank’s analysis of the domestic economic relationships concluded that resource pressures were not as strong as previously estimated, in part due to the record level of migration that the New Zealand economy was experiencing. 25 Low inflation had also changed the price-setting behaviour of New Zealand businesses, who were placing a greater weight on recent low inflation (rather than expectations of future inflation) in their wage-setting and pricing decisions. 26 Incorporating these lessons into our forecasting framework meant that by mid-2015 the most probable scenario had changed to a continuation of low inflation (figure 4). The Bank commenced a new cycle of reducing the OCR, to an eventual low of 1.75 percent in November 2016. Today, in May 2017, the most likely scenario is for the OCR to remain stable for some time, although uncertainty remains high. Figure 4: selected 90-day forward rates Source: RBNZ estimates. 25 See December 2017 Monetary Policy Statement, Box C. Özer Karagedikli and C J McDermott, “Inflation expectations and low inflation in New Zealand”, RBNZ Discussion paper 2016/09. Conclusion Forecasting is a valuable part of the monetary policy process, helping the Bank to plan for the future, make well-founded policy decisions, communicate its understanding and intentions, and accommodate new information as it appears. It requires the Bank to be rigorous, unbiased, and open to new ideas in formulating and implementing monetary policy. Because we operate in a world of radical uncertainty, we do not know what might happen in the future; we are not fortune tellers. However, because we want our forecasts to be relevant and useful, we present them numerically, an approach that comes with risks. As Tetlock and Gardner put it, “use the number and you risk being unfairly blamed. Stick with phrases as fuzzy as a puff of smoke and you are safe”. 27 We do not want to be safe in this context as we welcome scrutiny, both internally and externally, as it builds understanding and fosters accountability. Finally, good forecasting happens when the numbers are supported by evidence and reasoning, and subject to public scrutiny. When things – inevitably – do not turn out as projected we seek to learn from those episodes and continually work to improve our forecasts and policy-making. 27 Tetlock and Garnder, op.sit.
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of New Zealand, to MOTU, at the Royal Society of New Zealand, Wellington, 17 July 2017.
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New Zealand’s net foreign liabilities: What lies beneath, and ahead? A speech delivered to MOTU, at the Royal Society of New Zealand, Wellington On 17 July 2017 By Geoff Bascand, Deputy Governor1 1 I am very grateful to Rebecca Williams for her considerable help in the preparation of this speech, along with assistance from Sarah Drought and other Bank colleagues. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz New Zealand’s net foreign liabilities (NFL) – what we owe the rest of the world, broadly speaking – reached nearly 85 percent of GDP at the start of 2009. Eight years later, they sit at 58.5 percent of GDP, their lowest level since the late-1980s (figure 1). Today I’m going to put this improvement into some international and domestic context. I’ll discuss some of the reasons for the improvement, and offer some thoughts on how sustainable the improvement might be. Figure 1: New Zealand’s NFL since 1972 (share of annual GDP, recessions indicated by grey bars) Source: Statistics New Zealand, RBNZ estimates, Lane and Milesi-Ferretti (2007) for data prior to 1989. Recessions based on estimates by Hall and McDermott (2016). What are ‘net foreign liabilities’, and why should New Zealanders care about them? Essentially, one can think of NFL as being New Zealand’s net external debt. NFL are the difference between what we owe the rest of the world (our liabilities) and what the rest of the world owes us (our assets).2 These assets and liabilities include equity (direct investment in companies, for example) and debt (e.g. loans), but in New Zealand’s case in net terms they are largely made up of debt (55 percent of GDP). NFL change through our transactions with the rest of the world and through revaluations of the stock of assets or liabilities (figure 2 provides an overview of these dynamics). Most of our international transactions are through the current account, which essentially reflects the difference between what people in New Zealand save (current income less current expenditure) and invest. Nationally, we’ve invested more than we’ve saved, with the difference being met by the savings of nonresidents. This has accumulated into a large NFL position over several decades. 2 Statistics New Zealand terms net foreign liabilities as the net international investment position (NIIP). Since New Zealand’s NIIP is negative, we describe it as net foreign liabilities. Ref #7076865 v2.1 Figure 2: The external accounts Source: Adapted from Statistics New Zealand. Borrowing from the rest of the world isn’t automatically ‘bad’. It can be a good thing if it leads to productive investment that enhances New Zealand’s economic performance and leads to high per-capita incomes over time, but debt-fuelled consumption is less sustainable.3 However, relying on non-residents to fund our level of investment makes us vulnerable to changes in the availability or cost of that funding.4 That vulnerability may be exposed in times of acute financial stress – triggered by global or domestic events – if non-residents become much less willing to provide funding. For example, we saw during the Global Financial Crisis (GFC) how quickly previously liquid sources of funding dried up, with access to funding cut off or available only at much higher interest rates. Because financial intermediaries – particularly banks – facilitate most of the financial flows between New Zealand and the rest of the world, high levels of offshore debt increase the risk that the 3 Measurement of net foreign liabilities should not be confused with measures of net worth. New Zealand’s notional balance sheet is a much more comprehensive concept that would include tangible, intangible, and contingent assets and liabilities, such as physical assets/liabilities (e.g, roading, housing, plant and machinery, disaster risks), natural assets (e.g land, water and atmospheric emissions), human capital and social capital (e.g legal and communal). New Zealand’s NFL reflects cross-border investments in, and income and debt servicing flows associated with, these assets and liabilities. For the household sector alone, net worth as at December 2016 is estimated at $1,365 billion. This comprises financial assets of $801 billion (which includes net equity in rental properties held by unincorporated businesses) and non-financial assets (owner-occupied housing and land) of $758 billion, offset by financial liabilities of $195 billion. 4 See Steenkamp (2010) and Smith (2011) for further discussion of the vulnerability arising from high net foreign liabilities, and the importance of the composition of the gross positions underlying it. Ref #7076865 v2.1 banking sector and financial system more broadly come under pressure in times of financial stress. In that type of situation, the Reserve Bank would act in the usual way, providing liquidity to the banking sector, and lowering the Official Cash Rate to mitigate the impact on interest rates faced by households and businesses in order to meet our inflation target. Nonetheless, households and businesses might still have difficulty in accessing finance. Of course, just how vulnerable we are is also influenced by the type of offshore funding – with equity generally seen as less risky than debt – and by the maturity and currency denomination of that funding.5 Our floating exchange rate would also act as a buffer in the event of deterioration in market sentiment. How significant is the improvement in New Zealand’s NFL? In dollar terms the value of NFL has not fallen substantially – it stood at NZ$159 billion in March 2009, and at NZ$155 billion in March 2017. But relative to GDP, over the same period, NFL fell by 25 percentage points, from nearly 85 percent to just below 60 percent. How does this improvement compare to other countries? Figure 3 illustrates that New Zealand’s improvement is unexceptional amongst the advanced economies shown.6 That several other countries have seen an improvement could reflect common/global factors such as low rates of investment since the GFC,7 and lower global interest rates. An improvement across many economies also implies deterioration in the position of others (as conceptually the NFL positions of all countries should sum to zero). Hargreaves and Watson (2011) discuss some of these mitigating factors, such as New Zealand’s liabilities largely either being denominated in domestic currency or hedged so that they effectively are. 6 Other advanced economy central banks have also recently investigated changes in their external positions since the GFC. See Bruneau, Leboeuf and Nolin (2017) and Debelle (2017) for Canada and Australia respectively. 7 Bascand (2016), “Changing dynamics in household behaviour: what do they mean for inflationary pressure?” Ref #7076865 v2.1 Figure 3: Change in NFL between December 2009 and December 2016 (percentage points of GDP) Source: IMF, Statistics New Zealand, Ireland Central Statistics Office, Statistics Norway, RBNZ estimates. Note: A decline in NFL is equivalent to an increase in the net international investment position (NIIP) and vice versa. The China value is the change in NFL between December 2010 and December 2016, due to comparable IMF data being unavailable prior to 2010. New Zealand’s NFL relative to GDP remains large compared to that of many advanced economies, albeit similar to that of Australia and the United States (figure 4). Figure 4: NFL as at the December 2016 quarter (share of annual GDP) Source: IMF, Statistics New Zealand, RBNZ estimates. Note: A negative NFL position (shown in blue) is equivalent to a positive NIIP. While the improvement in our NFL is moderate by international standards, it is unusual when compared to New Zealand’s experience in past expansions. Changes of a similar magnitude have been seen in the past, but have been partially reversed by this point in the economic Ref #7076865 v2.1 cycle. In the current expansion the current account deficit has remained fairly stable relative to GDP, whereas it had usually begun to widen at this point in previous expansions (figure 5). Indeed, reflecting these episodes, the Bank and others had been forecasting the current account deficit to widen throughout most of the post-GFC period (figure 6). Figure 5: Current account over GDP expansions (annual total, share of GDP) Source: Statistics New Zealand, RBNZ estimates. Note: Expansions based on estimates from Hall and McDermott (2016), with data shown as quarters from the trough. Comparisons with earlier expansions are complicated by significant structural changes – for example, restrictions on New Zealand’s then capital account (now known as the financial account) were removed at the end of 1984, and the exchange rate was floated in early 1985. Figure 6: RBNZ current account forecasts (annual total, share of GDP) Source: Statistics New Zealand, RBNZ estimates. Note: This figure includes any statistical revisions to the current account. Ref #7076865 v2.1 What accounts for the improvement in our NFL position? Understanding what has driven the improvement can help us assess how sustainable the improvement might be. I will explore this through two lenses: a balance of payments perspective and a saving and investment perspective. (i) Balance of payments perspective A balance of payments perspective reveals that much of the improvement in our NFL can be accounted for by lower interest payments on our debt, the recent strength in tourism and education exports, and favourable net revaluations. Figure 7 decomposes the current account balance into the goods, services and investment income balances (primary and secondary – see figure 2 or the note below figure 7). Figure 7: Current account decomposition (annual total, share of GDP) Source: Statistics New Zealand, RBNZ estimates. Note: The primary income balance includes transactions such as interest payments, dividends from owning shares and profits from directly owning a company; the secondary income balance includes current transfers such as taxes and donations. The narrowing of the primary income deficit (which reflects what we are repaying/paying non-resident lenders and investors) as a share of GDP since the GFC is a key reason why the current account deficit has not widened as in the past. Since 2009, the primary income deficit has averaged just over 4 percent of GDP (and has been closer to 3 percent more recently) – a marked improvement from the average deficit of nearly 6 percent over the previous decade. This improvement mainly reflects reduced interest payments offshore, as global interest rates have fallen and have remained low and the stock of our external debt Ref #7076865 v2.1 has fallen as a share of GDP. In contrast, the income New Zealand has earned from investment abroad (an inflow) has been stable relative to GDP. In the years following the GFC, the improvement in the goods balance also contributed to the narrowing of the current account deficit, supported by the recovery in the terms of trade (the price of our exports relative to our imports). Although the annual goods balance has been in deficit over the past two years – but not to the same extent as prior to the GFC – it has been more than offset by an improvement in the services balance (figure 7). This improvement is due to the strong performance of the tourism and education export sectors. While most of our international transactions occur through the current account, there are other channels. For example, offshore insurance claims arising from the Canterbury earthquakes resulted in a large increase in the capital account in 2010/11 (figure 8).8 Between 2013 and 2015, net errors and omissions also played a large role. This can be due to coverage issues (it may take some time for new firms to be captured in surveys) or measurement errors (misreporting by survey respondents, or errors during compilation). A risk is that these net errors and omissions reflect an inflow of non-resident funding not captured in the financial account, which would imply a larger NFL position than current data suggest. Figure 8: Decomposition of the financial account (annual total, share of GDP) Source: Statistics New Zealand, RBNZ estimates. 8 While this resulted in a material improvement in NFL immediately following the earthquakes, it was subsequently unwound through the current account as reconstruction took place. Statistics New Zealand (2011) explains how the insurance claims arising from the Canterbury earthquakes have been treated in the international accounts. Ref #7076865 v2.1 Our NFL position can also be significantly affected by revaluations of the stock of domestic and foreign assets and liabilities. Figure 9 shows the cumulative value of transactions (through the financial account) together with revaluations between March 2009 and March 2017. This figure highlights that revaluations caused by market price changes have played a large role in how our NFL position has evolved since 2009. In particular, the market values of our foreign assets were revised higher to a much greater extent than our foreign liabilities, resulting in a positive net valuation effect. That likely reflects the relatively sharp increase in global equity markets over this period (including relative to New Zealand), and the fact that equity accounts for a higher share of New Zealand’s foreign assets than foreign liabilities. Were it not for these favourable revaluations, our NFL as a share of GDP would have been about 8 percentage points larger. Figure 9: Cumulative contributions of financial account flows and revaluations to New Zealand’s NIIP, March 2009 to March 2017 Source: Statistics New Zealand, RBNZ estimates. Note: Additional valuation changes include exchange rate changes, financial derivative valuation changes and other valuation changes. (ii) Saving and investment perspective Figure 10 illustrates the contributions of the government, household and business sectors to the current account.9 Underlying these contributions is what I’ll refer to as net saving – the 9 Recent statistical developments, including the release of institutional sector accounts, have supported better understanding of sectoral contributions. ‘Business’ includes producer enterprises (corporate and non-corporate), private non-profit institutions serving households and financial intermediaries. Producer enterprises make up most of the gross saving and investment in ‘business’. Ref #7076865 v2.1 difference between gross saving and investment in each sector.10 Overall, improved contributions from the business and government sectors have offset the widening gap between household saving and investment in recent years. Figure 10: Sectoral contributions to the current account (March year, share of GDP) Source: Statistics New Zealand (Income and Expenditure account), RBNZ estimates. Note: (1) Income and Expenditure data by sector is available only to March 2016. Within this, business sector data is only available to March 2015, so the March 2016 contribution is estimated as a residual; (2) consistent gross saving and investment data for non-government sectors are only available from 1999, so their contribution is captured in the ‘private sector’ data prior to this. During the mid-2000s, the imbalance in the saving and investment positions of the household and business sectors weighed heavily on the current account, whereas the net saving of the general government sector provided some offset. While investment by the household and business sectors increased only modestly as a share of GDP over this period, the saving of each sector declined by over 5 percentage points of GDP. The result was a large saving-investment gap that needed to be met by external funding. Since 2009, the business sector has provided a small boost to the current account. This has largely been due to increased saving as a share of GDP, although investment as a share of GDP remains lower than in the mid-2000s. The government sector net saving position began 10 Technically the difference between gross saving and investment is referred to as net lending, and it captures current and capital transactions. Capital transactions have been removed from this chart to illustrate the contributions of each sector to the current account only. The capital account is almost entirely dominated by insurance flows resulting from the Canterbury earthquakes. Note that I use the term ‘net saving’ differently to Statistics New Zealand that defines net saving as gross saving less consumption of fixed capital. Ref #7076865 v2.1 to reverse in the aftermath of the GFC, due to the fiscal stimulus provided during the recession and following the Canterbury earthquakes in 2010/11. Since 2012, government investment has remained steady as a share of GDP, and along with the gradual fiscal consolidation has meant that the government’s contribution to the current account has improved from being negative to neutral currently. Increased saving and lower investment by the household sector after the GFC meant that the sector’s contribution to the current account was fairly neutral until 2012. Since 2013, the household sector’s net saving position has reversed (due to both a decline in saving and an increase in investment) and the sector’s imbalance is again weighing on the current account. In part, this may reflect the positive supply shock from high levels of migration, which raises the demand for capital and thereby would be expected to boost investment (by both households and businesses) relative to saving in the short term. What might the improvement in New Zealand’s NFL position mean for the Bank? From a financial stability standpoint, the reduction in NFL-GDP has helped lower risks to the financial system. That’s because financial intermediaries – particularly banks – facilitate most of the financial flows between New Zealand and the rest of the world, accounting for most of the offshore borrowing. Banks decide how much credit to provide to households and businesses, how to fund the provision of credit, and how much to charge relative to their cost of funding. As the predominant financial intermediaries, banks have accounted for much of the reduction in NFL-GDP since 2009, as credit growth was funded to a greater extent by domestic deposits than was the case prior to the GFC (figure 11).11 11 The acceleration in deposit growth post-GFC was boosted by insurance inflows from the Canterbury earthquakes. Ref #7076865 v2.1 Figure 11: Annual increase in credit and deposit funding Source: Statistics New Zealand, RBNZ SSR, RBNZ liquidity survey. Note: Deposits counted as core funding includes haircuts made as part of the liquidity policy, which increase according to the size of the deposit. It remains unclear how much of the reduction in NFL as a share of GDP reflected changes in bank behaviour and how much reflected lower demand for credit. Banks actively reduced reliance on offshore funding – particularly at short maturities12 – in order to reduce risk and respond to regulatory changes (such as the liquidity policy introduced by the Bank in 2010). However, lower demand for credit and relatively strong growth in retail deposits also meant that less offshore funding was required in the wake of the GFC. Taken together, the reduced reliance on offshore funding and the lengthening maturity of banks’ offshore borrowing have helped reduce the risks to the financial system from a funding shock. Since a large NFL position generally makes the economy more vulnerable to domestic and global shocks, the improvement in our NFL-GDP after 2009 suggests that New Zealand might have become a slightly less risky proposition for overseas lenders and investors. However, the perceived riskiness of the New Zealand economy and its institutions should be reflected in its credit ratings, which have not yet improved.13,14 In part, this reflects that the reduction in New Zealand’s NFL-GDP is average compared to other countries, and the absolute level remains high. In theory, lower perceived risk would put downward pressure on the risk premium component of interest rates that New Zealand faces on its external 12 The share of New Zealand’s non-equity liabilities with residual maturity of one year or less declined from over 50 percent just prior to the GFC to 31 percent in the March 2017 quarter. 13 See Widdowson and Wood (2008) for discussion on credit ratings. 14 New Zealand’s sovereign credit rating has been stable since a downgrade by two rating agencies in 2011. The credit ratings of New Zealand’s four largest banks were also downgraded by two rating agencies in 2011, with a further downgrade by one agency in June 2017 as a result of the downgrade to their Australian parent banks. Ref #7076865 v2.1 funding.15 However, the effect is likely to be small compared to all of the other factors that influence New Zealand’s interest rates, and in practice it is very difficult to identify such effects – especially in a world of quantitative easing and other unconventional policies. To the extent that the lower NFL position reflects an enduring improvement in New Zealand’s savings-investment balance, there are wider impacts. If sustained, higher domestic savings relative to investment demands would help to lower New Zealand’s neutral real interest rate. Estimates of neutral rates have been declining internationally (including in New Zealand) in response to changes in saving and investment trends since the GFC. A striking feature of the improvement in New Zealand’s NFL relative to GDP since 2009 is that it has occurred despite the real exchange rate being high over much of this period compared to previous expansions.16 We typically expect a higher real exchange rate to contribute to a widening of the current account deficit, as exports become less competitive and lower import prices encourage substitution away from domestically produced goods and services. However, the strength of the real exchange rate since 2010 is partly related to the increase in the terms of trade over this period (figure 12), which provided some offset to the dynamics noted above. Figure 12: Real TWI and the merchandise terms of trade (OTI) Source: RBNZ (real analytical TWI 17 post-1984, real analytical TWI 5 pre-1984), Statistics New Zealand. The improvement in NFL-GDP suggests that the exchange rate may be more sustainable than previously assumed. However, the improvement has been from a very high starting 15 See Orr, Edey and Kennedy (1995) and OECD (2013). 16 See figure 5 in Williams (2017). Ref #7076865 v2.1 point. NFL-GDP near 60 percent remains high by international standards, and continues to be a concern of rating agencies, especially given our exposure to commodity exports that can be subject to large price swings. There are a number of ways to look at whether a real exchange rate is in equilibrium, including the assessment from various models, and whether growth and debt servicing paths are sustainable. One model (of several) the Bank uses is the macro-balance model, which assesses the degree to which the exchange rate is currently too high or low in order to stabilise NFL-GDP at its current level.17 This model indicates that the current level of the real exchange rate is consistent with NFL remaining at about 60 percent of GDP, given the Bank’s medium-term outlook for key economic variables (including a continuing upward trend in the terms of trade and a slight improvement in the household saving rate). However, it yields no further reduction from the current NFL-GDP level. A lower New Zealand dollar would be needed to lower NFL-GDP and our external vulnerabilities further. Indeed, from a growth point of view, a lower exchange rate would help rebalance growth towards the tradables sector, especially as not all traded industries are benefitting from the current high terms of trade. How sustainable do we believe the improvement in New Zealand’s NFL position might be? Turning from the past to the future, where might New Zealand’s external position head from here? Our current medium-term forecast (from the May 2017 Monetary Policy Statement) has NFLGDP remaining at about its current level of just below 60 percent over the forecast horizon (to 2020). Many assumptions about the domestic and global economy underlie this forecast; some of the most relevant are that: the terms of trade continues its gradual upward trend; exports of services continue to increase at the same rate as GDP; the implied interest rate on our foreign debt increases only gradually, and remains below its pre-GFC peak; annual household consumption growth moderates gradually over the medium term, and is outpaced by income growth (implying a slight improvement in the household saving rate); and, nominal business investment remains low as a share of GDP. 17 Graham and Steenkamp (2012) provide an updated description of the RBNZ’s macro-balance model of the exchange rate, which was previously presented in Brook and Hargreaves (2000). Ref #7076865 v2.1 The Bank has used scenario analysis to test the sensitivity of the NFL-GDP outlook to changes in these (and other) assumptions, through the lens of its main forecasting model, NZSIM.18 Running a series of scenarios, each with various adjustments (either higher or lower) to the main forecast assumptions listed above,19 doesn’t imply a dramatic change to our NFL-GDP forecast. It would require a combination of these factors, moving NFL in the same direction, to see a material change in the medium-term outlook. That said, NZSIM is a business cycle model designed to aid the Bank in its monetary policy formation and communications, and is not naturally well-suited to assessing longer-term or structural issues such as NFL sustainability. Another way to consider the sustainability of the improvement is by looking at some of the broader risks around it. Over history, the underlying factor behind large changes in NFL appears to be big swings in the saving and investment behaviour of the various sectors. For example, the sharp deterioration in New Zealand’s NFL position in the first half of the 1990s occurred at a time of declining government saving (that resulted in large fiscal deficits) and a surge in private-sector investment.20 The mid-2000s also saw NFL rise notably as a share of GDP and, as noted earlier, this was a period of declining saving from both the household and business sectors. Revaluations also play a role in changes in NFL over time, with their importance increasing as the stock grows larger.21 In the absence of a large economic shock, we can be fairly confident that government will provide a positive contribution to New Zealand’s current account going forward. The main political parties are committed to prudent fiscal management. The Government plans to reduce its net debt from about 24 percent of GDP currently to between 10 and 15 percent of GDP over the long term,22 and the Labour Party’s stated objective is to reduce net debt to 20 percent of GDP within five years if elected.23 18 See Austin and Reid (2017) for a description of NZSIM. 19 For example, the terms of trade being 5 percent higher or lower than assumed in the May Statement, or the implied interest rate on NFL rising back to its 2003-08 average. 20 The earlier liberalisation of capital flows and easing of restrictions on foreign investment played an important role in facilitating the rise in investment in the 1990s. Given New Zealand’s historically low savings rate, it seems unlikely that the surge in investment could have been funded from domestic sources. See Brook, Collins and Smith (1998). 21 Fidora, Schmitz and Tcheng (2017) examined 138 episodes of sizeable NFL reductions across advanced and emerging economies to identify the factors underlying those reductions that were sustained over the medium term. The authors conclude that sustained reduction in NFL is more likely for advanced economies when a current account surplus and strong real GDP growth are experienced. 22 Fiscal Strategy Report, published 25 May 2017. The Government intends to be within the 10-15 percent of GDP band by 2025. 23 Labour and Greens Party Budget Responsibility Rules in government after the 2017 election, accessed at http://www.labour.org.nz/budgetresponsibility. Ref #7076865 v2.1 The business sector has been providing a small boost to the current account in recent years mostly through an increase in saving as a share of GDP. Business investment relative to GDP has remained broadly stable. While this dynamic has contributed to the narrowing of New Zealand’s current account deficit, it may not necessarily be a desirable feature over the longer term. Lower business investment as a share of the economy would likely lead to a deterioration in the capital stock and lower growth in productivity. Over the long term, such a development would lower potential GDP growth and could result in a higher NFL-GDP ratio as actual GDP growth slowed. A key source of risk surrounding the outlook for New Zealand’s NFL – and the economy and financial system more widely – is the saving and investment behaviour of households. Real household consumption has been less responsive to housing wealth since the mid-2000s, and household consumption was weaker than the Bank anticipated in recent years, particularly on a per capita basis.24 However, household spending has been much stronger in the past few quarters, and recent downwards revisions to household saving estimates25 have led to a widening of the household sector’s saving-investment gap (as seen in figure 10). Much of the investment undertaken by the household sector is in the form of new house builds and renovations to existing homes.26 If the housing demands associated with population pressure and existing shortages cannot be met by increased household sector or domestic saving more broadly, it will be reflected in a deterioration in our NFL position. 24 Bascand (2016) and Wong (2017). 25 These downward revisions were included in the annual Income and Expenditure accounts for the year to March 2016. Household saving was revised significantly lower for the years 2013 to 2015, in part due to a correction in how income was allocated across sectors (the income was reallocated from the household to the business sector). 26 Purchase of existing homes is not regarded as investment by the household sector as a whole, as buying and selling of existing homes is a transfer between households. Ref #7076865 v2.1 This brings me to my final observation, which is the role the financial system plays in these dynamics. Domestic deposit growth has slowed over the past year and continues to be outpaced by credit growth, meaning the banking system’s exposure to offshore funding markets has increased recently, albeit at longer maturities. If the gap between credit and deposit growth is sustained, banks will likely become more dependent on offshore markets to sustain credit growth and replace expiring funding. However, banks have recently begun to compete more aggressively for deposits and tighten lending standards, which should help alleviate offshore funding pressures and prevent a significant increase in NFL. The Bank will be following closely the extent to which banks: source required funding domestically (which could be driven by ‘sector-led’ behaviour and/or the incentives provided by higher deposit rates); tighten lending standards to constrain credit growth; or return to a situation similar to that of the previous expansion, when banks met demand for credit through increasing reliance on offshore funding. Conclusion In summary, the large improvement in New Zealand’s NFL-GDP since 2009, and the stability of the current account deficit through a prolonged expansion, provide tentative evidence of reduced vulnerability of the New Zealand economy and the sustainability of the current growth phase. New Zealand’s reliance on offshore funding has fallen over the past decade, and the maturity of bank borrowing has lengthened, reducing the risks from a funding shock. The macroeconomic factors that have driven the improvement in our NFL position are varied, some potentially more transient or fortuitous than others. At least in part, however, it reflects a lower saving-investment imbalance, relative to the mid-2000s. Looking ahead, it appears that it would take a combination of factors, working together, to see NFL-GDP diverge materially from its current level of about 60 percent. That said, we have seen big changes in NFL-GDP in the past, and these appear to have been driven by large swings in the saving and investment behaviour of the various sectors. Significant uncertainty remains regarding household behaviour and the contribution of the sector to New Zealand’s saving-investment gap, and the extent that banks as intermediaries might increase their reliance on offshore funding. As always, the Bank will be monitoring these developments closely. We welcome the improvement in New Zealand’s NFL position since the GFC, but do not see it is a reason to become complacent. Ref #7076865 v2.1 References Bascand, Geoff (2016), “Changing dynamics in household behaviour: What do they mean for inflationary pressures?”, a speech delivered to the Australia National University, 22 November 2016. Brook, Anne-Marie, Sean Collins and Christie Smith (1998), “The 1991-97 business cycle in review”, Reserve Bank of New Zealand Bulletin, 61(4), pp. 269-290. Brook, Anne-Marie and David Hargreaves (2000), “A macroeconomic balance measure of New Zealand’s equilibrium exchange rate”, Reserve Bank of New Zealand Discussion Paper, DP2000/09. Bruneu, Gabriel, Maxime Leboeuf and Guillaume Nolin (2017), “Canada’s International Investment Position: Benefits and Potential Vulnerabilities”, Bank of Canada Financial System Review June 2017, pp. 43-57. Debelle, Guy, “Recent Trends in Australian Capital Flows”, speech delivered to the Australia Financial Review Banking and Wealth Summit, Sydney, 6 April 2017. Fidora, Michael, Martin Schmitz and Celine Tcheng (2017), “Reducing large net foreign liabilities”, European Central Bank Working Paper No. 2074 Graham, James and Daan Steenkamp (2012), “Extending the Reserve Bank’s macroeconomic balance model of the exchange rate”, Reserve Bank of New Zealand Analytical Note, AN2012/08. Hargreaves, David and Elizabeth Watson (2011), “Sudden stops, external debt and the exchange rate”, Reserve Bank of New Zealand Bulletin, 74(4), pp. 17-27. Holston, Kathryn, Thomas Laubach and John C. Williams (2016), “Measuring the Natural Rate of Interest: International Trends and Determinants”, Federal Reserve Bank of San Francisco Working Paper 2016-11. Lane, Philip R. and Gian Maria Milesi-Ferretti (2007), “The external wealth of nations mark II: Revised and extended estimates of foreign assets and liabilities, 1970-2004”, Journal of International Economics 73, November, pp. 223-250. Ref #7076865 v2.1 OECD (2013), “Chapter 1: Policies to support sustainable long-term growth in New Zealand – Correcting large macroeconomic imbalances that may harm long-term growth”, OECD Economic Surveys: New Zealand, June 2013, pp.83 87. Orr, Adrian, Malcolm Edey and Michael Kennedy (1995), “Real long-term interest rates: the evidence from pooled-time-series”, OCED Economic Studies, No. 25, II, pp. 75-107. Smith, Christie (2011), “Conference summary – New Zealand’s macroeconomic imbalances – causes and remedies”, Reserve Bank of New Zealand Bulletin, 73(4), pp. 11-21. Statistics New Zealand (2011), “Revised treatment of the Canterbury earthquakes’ insurance claims in New Zealand’s international and national accounts”, Statistics New Zealand, June 2011. Steenkamp, Daan (2010), “New Zealand’s imbalances in a cross-country context”, Reserve Bank of New Zealand Bulletin, 73(4), pp. 37-49. Widdowson, Doug and Andy Wood (2008), “A user’s guide to credit ratings”, Reserve Bank of New Zealand Bulletin, 71(3), pp.56-62. Williams, Rebecca (2017), “Characterising the current economic expansion: 2009 to present day”, Reserve Bank of New Zealand Bulletin, 80(3). Wong, Martin (2017), “Revisiting the wealth effect on consumption in New Zealand”, Reserve Bank of New Zealand Analytical Note, AN2017/03. Ref #7076865 v2.1
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Speech by Dr John McDermott, Assistant Governor and Head of Economics of the Reserve Bank of New Zealand, to HiFX, Auckland, 26 July 2017.
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John McDermott: Looking at the stars Speech by Dr John McDermott, Assistant Governor and Head of Economics of the Reserve Bank of New Zealand, to HiFX, Auckland, 26 July 2017. * * * I would like to thank Jamie Culling for his help in the preparing this speech, along with assistance from Sarah Drought and other Bank colleagues. Introduction Thank you for inviting me to speak with you today; it is a pleasure to be here. Today I’m going to talk to you about the ‘stars’ I look at in the New Zealand economy. When looking at the stars, it is not a desperate attempt to adopt astrology to aid my understanding of the economy. Rather, I am looking at the trends in our economy. I will expand on this in a moment. The Reserve Bank of New Zealand has operated a flexible inflation-targeting framework for nearly 30 years.1 Over time, the practice of inflation targeting has become more systematic and transparent. Transparency improves the understanding of our goals and policy intentions, which makes policy more effective and allows for more rational evaluations of the Bank’s decisions. Today’s speech adds to this transparency by outlining how we think about the trends of the New Zealand economy, and how knowing these trends helps us implement the flexible inflation targeting framework. Our inflation targeting framework focuses on keeping future annual CPI inflation outcomes between 1 percent and 3 percent on average, over the medium term, with a focus on keeping future average inflation near the 2 percent target midpoint. Key to this is the notion that there is an equilibrium level at which the economy could operate that would be consistent with inflation remaining stable at 2 percent. In practice, the economy faces a range of shocks (such as a rise in the price of our exports, or an increase in net immigration) that push output away from its equilibrium. This would not be such an issue if there were no frictions in the economy and prices could adjust seamlessly – prices and wages would rise and fall across sectors, as required to re-allocate resources efficiently and move output back to its equilibrium level. But the world is not so simple. Many frictions exist in the economy, which prevent or slow the adjustment in prices and output.2 For example, wages and prices are typically only reset periodically, and labour is often not quickly transferable across sectors and locations. These frictions create a role for monetary policy in stabilising the rate of inflation over the business cycle, while also seeking to moderate the swings in output away from its equilibrium level.3 To do this, the Bank influences interest rates across the economy, to stimulate or dampen output, and move inflation back towards its target level. The Bank lowers the Official Cash Rate (OCR) when inflation is weak, which encourages households and businesses to bring forward spending, thereby stimulating output leading to higher inflation. Conversely, when inflation is too strong, higher interest rates encourage savings and a delay in spending plans, which dampens output growth leading to lower inflation. In addition, changes in interest rates may alter the exchange rate and hence the relative price of domestic and foreign goods. When we model the economy, the concept of a frictionless economy is represented, somewhat imperfectly, by a collection of interrelated and unobservable trends of key macroeconomic variables.4 These trends are the anchors around which we aim to stabilise the economy, and thereby inflation over the medium-term. While the Bank cannot influence many of these trends, estimating and understanding them is crucial for monetary policy to be set appropriately. As such, we devote a significant amount of time and effort to it. 1 / 11 BIS central bankers' speeches In our economic models, these unobserved trends are conventionally denoted with the superscript ‘star’ (*). Three particularly important trends are: r* - the neutral interest rate; Y*potential output; and e*- the equilibrium real exchange rate. Another important unobservable variable is core inflation, or π*. Core inflation, along with future expectations of it, is a key variable we can influence. Although we target headline inflation, there are components of inflation we cannot control, such as commodity prices (e.g. oil), and changes in central and local government charges (e.g. changes in GST). Core inflation is useful because by filtering out temporary or unusual features, it provides a better guide to future medium-term inflation. The framework we use, assessing output relative to trend and the OCR relative to the neutral interest rate, is an approach adopted by many of the flexible inflation-targeting central banks.5 As such, numerous central bank publications refer either directly to one of the trends mentioned above, or imply the concept of trends in their framework.6 In a number of speeches and publications over the past few years we have explained our thinking behind the important trends, or ‘stars’ if you like. This speech draws on recent work to provide an update on how we think about the trends in the New Zealand economy. r* - The Neutral Interest Rate First, we look at the neutral interest rate, r*.7 While there are a range of interest rates of different maturities and different levels of risk, each with their own trend, the benchmark neutral rate we estimate is the nominal neutral Official Cash Rate (OCR).8 The neutral interest rate is the rate of interest where desired savings equal desired investment, and can be thought of as the level of the OCR that is neither contractionary nor expansionary for the economy. 9, 10 To put this another way, an OCR above neutral provides a headwind for output and inflation, while an OCR below neutral provides a boost to output and inflation. Because the neutral OCR rate is unobservable, the Bank uses a range of models, surveys, and financial market prices to help form our estimate of neutral. We also care about real interest rates, and use a suite of models for inflation expectations (which also have a wide range of measures) alongside our neutral interest rate.11 2 / 11 BIS central bankers' speeches Over time, the neutral interest rate has been slowly falling; a trend that has been seen in many countries around the world. Economic theory tells us that changes in neutral real interest rates reflect changes in real economic factors such as population growth, productivity growth, preferences for savings, and world conditions.12 A combination of these factors appears to have been contributing to the fall in neutral, both in New Zealand and abroad.13 Currently, we estimate that the neutral interest rate has moved below 4 percent, with the median of the indicator suite currently sitting around 3 ½ percent (figure 1). Given the neutral rate is an unobservable long-run variable; it is very difficult to estimate precisely. The estimates in the models from our indicator suite currently range between 2.6 and 4.6 percent, highlighting the significant uncertainty around our estimate. Overall, a neutral rate of around 3 ½ percent implies that monetary policy is stimulatory at present, given an OCR of 1.75 percent. Upcoming projections will incorporate an assumption of a 3.5 percent neutral rate into our modelling frameworks. We have been factoring in this on-going decline in the neutral interest rate for some time, so the overall impact on the outlook for interest rates over our projection horizon from this particular update will be modest. Y* – Potential output The neutral interest rate and the economy’s potential output are interrelated, with both factors sharing common drivers. Potential output, or Y*, is the level of output that is sustainable, and is a useful conceptual tool in gauging aggregate output consistent with stable inflation.14 In our 3 / 11 BIS central bankers' speeches framework, the difference between the actual level of output and the level of potential output – the output gap (figure 2) – is a key influence on inflation. In the short-run, frictions such as stickiness of nominal wages and other prices can prevent the economy from achieving its potential output when it is hit by a shock. When an economy is running ahead of its potential, a positive ‘output gap’ is said to exist, where pricing pressure increases in order to ration demand on scarce resources (such as capital and labour), boosting general inflation. The longer output is away from its potential, the greater the adjustments costs incurred as output converges back to potential. Sustaining growth and minimising these adjustment costs is highly desirable, given how much recessions hurt social and economic outcomes.15 Neither potential output nor the output gap can be directly observed. Ultimately, estimating potential requires determining whether movements in observed output are temporary cyclical movements, or permanent changes to the economy’s structure. To estimate potential output, we use a production function approach that combines the inputs of production — labour and capital — along with total factor productivity.16 We have a range of uncertainty with respect to the output gap; around ± 2 percent of potential output. Given the challenges in estimating potential output in real time,17 we cross-check the results from this approach against a number of other potential output estimates, including estimates from time-series models, and fully-estimated structural models.18 Moreover, the estimate for the output gap is checked against a range of measures, including indicators from 4 / 11 BIS central bankers' speeches the labour market and business surveys.19 Given the important role that the potential output estimate (and thereby the output gap) plays in influencing inflation pressure, these estimates garner considerable discussion and scrutiny as part of the policy process, and are judgementally-adjusted as necessary. Potential output growth in New Zealand is currently estimated to be 2.9 percent per annum (figure 3). The current strength of potential output growth has been driven by growth in the labour supply (especially strong net immigration flows) and the capital stock. There has been almost no contribution from productivity growth in recent years.20 This is not unique to New Zealand, and is a heavily-debated topic internationally. There are multiple ideas behind waning productivity growth. Firstly, there could simply be less innovation now than in the past. 21 Or, it may be the case that we just have not utilised recent innovations yet.22 Alternatively, measurement errors may be at play; for example, it is hard to measure efficiency gains from use of the internet or ICT services.23 e* – Equilibrium real exchange rate24 Of all the prices within our economy, the real exchange rate is one that is not subject to short-run rigidities. Indeed, the real exchange rate can and does move rapidly over time, as economic developments such as a rise in the terms of trade (figure 4) – the ratio of our export prices to import prices – are quickly reflected in its relative price. The fast-moving nature of the real exchange rate means it plays an important role in absorbing shocks to our economy. 25 But while part of the movement in the real exchange rate over time reflects persistent fundamental developments (such as structural improvements in the terms of trade or changes in relative productivity), much of the movement in the real exchange rate reflects deviations away from its 5 / 11 BIS central bankers' speeches medium-term equilibrium level, e*. This feature of the exchange rate to ‘overshoot’ or ‘undershoot’ its equilibrium stems from the fact that currencies can react to incoming news instantly, while other prices (besides interest rates) are slower to adjust. These deviations may result in mis-allocation of resources between tradable and non-tradable goods. There are various definitions of the equilibrium real exchange rate, which tend to focus on the drivers of the exchange rate over a given time horizon.26 The medium-term notion of equilibrium tends to be based on the value of the real exchange rate that would be consistent with internal balance (output at potential) and external balance (the current account sustainably financed). One of the several models that the Bank uses is the macro-balance model, which assesses the degree to which the exchange rate is currently too high or too low in order to stabilise the net foreign liabilities (NFL) to GDP ratio at its current level.27 This model indicates that the current level of the real exchange rate is consistent with NFL remaining at about 60 percent of GDP, given the Bank’s medium-term outlook for key economic variables (such as the terms of trade). However, it yields no further reduction in NFL-GDP from its current level. A lower New Zealand dollar would be needed to lower NFL-GDP and our external vulnerabilities further. Indeed, from a growth point of view, a lower real exchange rate would help rebalance growth towards the tradables sector, especially as not all traded industries are benefiting from the current high terms of trade.28 π* – Core inflation As noted earlier, monetary policy typically has little influence on many underlying trends in the economy. But it does influence inflation, and expectations about future inflation, even if we cannot influence every price. A useful concept for a flexible inflation-targeting central bank is core inflation, which abstracts from one-off or highly volatile price movements, like large changes in the price of an individual product (e.g. oil). This is important because while idiosyncratic price 6 / 11 BIS central bankers' speeches movements can materially affect headline CPI inflation, they may not reflect fundamental or persistent sources of inflation pressure. Consequently, central banks often use core inflation as an important measure of inflation over which it has some control.29 Specifically, core inflation abstracts from noise and provides a clearer picture of how far inflation is from our objective under the Policy Targets Agreement. Because inflation is affected by factors outside of the Bank’s control, and people’s expectations need not coincide perfectly with the Bank’s mediumterm objective, we monitor a range of core inflation measures to gauge current inflation pressure. The measures of core inflation we examine include, among others, model-based measures and exclusion-based measures.30 The model- and exclusion-based measures reflect the current central tendency of price movements, while other measures focus more directly on future (beliefs about) inflation outcomes. Our sectoral factor model reflects, in part, both concepts of core inflation.31 The sectoral factor model is our preferred measure of core inflation because it best predicts where headline inflation will converge to in the future once the transient noise dissipates, and is smoother than our other (relatively) more volatile core inflation measures.32 Based on this measure, core inflation is currently estimated to be 1.4 percent (figure 5), and has broadly tracked sideways over the past year. So while inflation pressures have lifted from the lows seen in early 2015, they still appear to be relatively moderate. Revisions to this measure occur from time to time, but the sectoral factor model is only one measure in our suite of inflation indicators, so changes to a single measure are unlikely to materially alter the overall assessment of inflation pressures at any particular period. Conclusion 7 / 11 BIS central bankers' speeches To set monetary policy we need to know where the key macroeconomic factors (such as interest rates, output, and the exchange rate) are tracking relative to their equilibrium levels, denoted by our ‘stars’. These stars are unobservable and complex to estimate, so we use a range of techniques to help form our view of their values over time Like the night sky, our stars keep moving. To respond to an evolving macroeconomic environment and set monetary policy appropriately, we keep track of the changes in the underlying state of the economy. Regularly explaining our view of the stars helps financial market participants and others better understand our analytical framework and policy decisions. References Adler, G., Duval, M. R. A., Furceri, D., Sinem, K., Koloskova, K., & Poplawski-Ribeiro, M. (2017). Gone with the Headwinds: Global Productivity. International Monetary Fund. Archibald, J., & Hunter, L. (2001). What is the neutral real interest rate, and how can we use it? Reserve Bank of New Zealand Bulletin, 64(3), 15-28. Armstrong, J. (2015). The Reserve Bank of New Zealand’s output gap indicator suite and its realtime properties. Reserve Bank of New Zealand Analytical Note AN2015/08. Reserve Bank of New Zealand. Armstrong, J., & Karagedikli, O. (2017). The role of non-participants in labour market dynamics. Reserve Bank of New Zealand Analytical Note. AN2017/01. Reserve Bank of New Zealand. Armstrong, J., Kamber, G., & Karagedikli, O. (2016). Developing a labour utilisation composite index for New Zealand. Reserve Bank of New Zealand Analytical Note. AN2016/04. Reserve Bank of New Zealand. Barro, R., & Sala-i-Martin, X. (2003). Economic Growth, Second Edition. MIT Press. ISBN: 9780262025539. Bascand, G. (2017). New Zealand’s net foreign liabilities: What lies beneath, and ahead?. A speech delivered to MOTU, at the Royal Society of New Zealand, Wellington on 17 July 2017. Reserve Bank of New Zealand. Berkmen, S. P., Gelos, G., Rennhack, R., & Walsh, J. P. (2012). The global financial crisis: Explaining cross-country differences in the output impact. Journal of International Money and Finance, 31(1), 42-59. Bernanke, B. S. (2005). The global saving glut and the US current account deficit (No. 77). Sandridge Lecture, Virginia Association of Economists. BoE. (2017) Inflation Report. May 2017. Bank of England Brynjolfsson, E., & McAfee, A. (2014). The second machine age: Work, progress, and prosperity in a time of brilliant technologies. WW Norton & Company. Chetwin, W., & Wood, A. (2013). Neutral interest rates in the post-crisis period. Reserve Bank of New Zealand Analytical Note AN2013/07. Reserve Bank of New Zealand. Conway, P. (2016). Achieving New Zealand’s Productivity Potential. Productivity Commission Research Paper 2016/1. Productivity Commission. FOMC. (2017). Minutes of the Federal Open Market Committee. May 2-3, 2017. 8 / 11 BIS central bankers' speeches Gordon, R. J. (2016). The rise and fall of American growth: The US standard of living since the civil war. Princeton University Press. Graham, J., & Steenkamp, D. (2012). Extending the Reserve Bank’s macroeconomic balance model of the exchange rate Reserve Bank of New Zealand Analytical Note AN2012/08. Reserve Bank of New Zealand. Jarocinski, M., & Lenza, M. (2016). How large is the output gap in the euro area. ECB Research Bulletin, 24(1). Kamber, G., & Wong, B. (2016). Testing an Interpretation of Core Inflation Measures in New Zealand. Reserve bank of New Zealand Analytical Note AN2016/06. Reserve Bank of New Zealand. Karagedikli, O., Ryan, M., Steenkamp, D., & Vehbi, T. (2013) What happens when the Kiwi flies? Sectoral Effects of the Exchange Rate Shocks. Reserve Bank of New Zealand Discussion Paper DP2013/05. Reserve Bank of New Zealand. Kato, T. (2009). Impact of the Global Financial Crisis and Its Implications for the East Asian Economy. In keynote speech, Korea International Financial Association, First International Conference, Seoul, Korea. Kirker, M. (2010). What drives core inflation? A dynamic factor model analysis of tradable and non-tradable prices. Reserve Bank of New Zealand Discussion Paper DP2010/13. Reserve Bank of New Zealand. Lewis, M. (2016). Inflation expectations curve: a tool for monitoring inflation expectations. Reserve Bank Analytical Note, AN2016/01. Reserve Bank of New Zealand. Lienert, A., & Gillmore, D. (2015). The Reserve Bank's method of estimating "potential output". Reserve Bank of New Zealand Analytical Note AN2015/01. Reserve Bank of New Zealand. McDonald, C. (2012). Kiwi drivers: the New Zealand dollar experience. Reserve Bank of New Zealand Analytical Note AN2012/02. Reserve Bank of New Zealand. Okun, A. M. (1963). Potential GNP: its measurement and significance (pp. 98-103). Yale University, Cowles Foundation for Research in Economics. Parker, M. (2016). Price-setting behaviour in New Zealand. New Zealand Economic Papers, 1-20. Pescatori, A., & Turunen, J. (2015). Lower for longer: Neutral Rates in the United States. IMF Working Paper. WP/15/135. Price, G. (2013). Some revisions to the sectoral factor model of core inflation. Reserve Bank of New Zealand Analytical Note AN2013/06. Reserve Bank of New Zealand. Ranchhod, S. (2013). Measures of New Zealand core inflation. Reserve Bank of New Zealand Bulletin, 76(1). Reserve Bank of New Zealand. RBA. (2017). Minutes of the Monetary Policy Meeting of the Reserve Bank Board. 4 July 2017. Reserve Bank of Australia. Richardson, A., & Williams, R. (2015). Estimating New Zealand’s neutral interest rate. Reserve Bank of New Zealand Analytical Note, AN2015/05. Steenkamp, D. (2016). Factor substitution and productivity in New Zealand. Reserve Bank of New Zealand Discussion Paper DP2016/12. Reserve Bank of New Zealand. 9 / 11 BIS central bankers' speeches Summers, L. H. (2014). US economic prospects: Secular stagnation, hysteresis, and the zero lower bound. Business Economics, 49(2), 65-73. Svensson, L (1999) ‘Inflation targeting: Some extensions’. Scandinavian Journal of Economics 101(3), pp 337–361. Williams, J. (2016). Monetary Policy in a Low R-star World. FRBSF Economic Letter. 2016-23. Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press. 1 The Reserve Bank of New Zealand Act 1989 came into force on 1st February, 1990. 2 See Parker (2016) for a discussion of firms’ price setting behaviour in New Zealand. 3 At its core, flexible inflation targeting highlights the objective of monetary policy – stable inflation – whilst also permitting flexibility in the short-run trade-off between inflation control and economic stability. 4 The frictionless economy referred to here is broadly consistent with a New Keynesian perspective outlined in Woodford (2003). 5 See Svensson (1999). 6 See, for example, RBA (2017); BoE (2017); FOMC (2017); Jarocinski & Lenza (2016). 7 In much academia and policy research, r* will denote the real neutral interest rate, which is the nominal neutral interest rate minus expected inflation. Here, I am referring to nominal rates, assuming inflation expectations are stable. 8 Richardson & Williams (2015) provide detail on estimation of the neutral interest rate. 9 For further detail on the definition of the neutral rate, see Chetwin & Wood (2013). 10 Savings in this context could be thought of as domestic or foreign savings, if referring to a closed or open economy, respectively. 11 Lewis (2016) uses various surveyed measures of inflation expectations and yield curve modelling techniques to develop a framework for monitoring inflation expectations. 12 For example, a sustained fall in productivity growth lowers the returns to investment, making it less desirable to invest. If the desire to invest falls and the desire to save remains unchanged, a lower neutral rate will be required to reconcile savings and investment plans. For further discussion of factors that can affect the neutral rate, see Archibald & Hunter (2001), and Williams (2016). 13 For a discussion on the lower neutral rate, see Pescatori & Turunen (2015); return on investment, see Summers (2014); the “global savings glut” hypothesis, see Bernanke (2005); demographics, see Barro & Salai-Martin (2003). 14 This definition of potential output follows Okun (1963). Potential output here refers to the goods market. A related concept in the labour market is the natural rate of unemployment (NAIRU). Like the other trend variables presented here, it is unobservable and subject to uncertainty. 15 For example, Kato (2009) and Beckman et al. (2009) both discuss the effects of the Global Financial Crisis on Asia and developing economies, respectively. 16 For details surrounding our estimations of potential output, see Lienert & Gillmore (2015). 17 Challenges arise on a number of fronts, including that potential output can vary substantially over time and that data revisions to GDP in particular can result in substantial revisions to our estimates of potential output in “realtime” versus ex-post. 18 For details on our estimation of the output gap, see Armstrong (2015). 10 / 11 BIS central bankers' speeches 19 For a discussion of labour market flows and dynamics, see Armstrong & Karagedikli (2017) or Armstrong, Kamber, & Karagedikli (2016). 20 For discussion on New Zealand’s productivity performance, see Steenkamp (2016) or Conway (2016). Steenkamp produces aggregate TFP estimates for New Zealand, while Conway outlines why New Zealand has struggled to lift productivity in recent decades. 21 For example, OECD (2016) shows that government R&D budgets are receding in many countries. 22 There is debate as to whether the slowdown in innovation is permanent, or whether it is temporary as breakthroughs in Artificial Intelligence and robotics loom. See Gordon (2016), or Brynjolfsson, E., & McAfee, A. (2014). 23 Particular internet-based services (e.g. Google searches or Wikipedia) are largely not reflected in GDP measurements, as there is often no price attached to their use. See Box 1 in Adler, et al. (2017) for further information. 24 The real exchange rate is the nominal exchange rate, measured on a trade-weighted basis, adjusted for the relative prices between New Zealand and our trading partners. This captures the fact that New Zealand faces many exchange rates, and a weighted measure of individual bilateral exchange rates is necessary to summarise the country’s exchange rate position. 25 For discussion on the role of the exchange rate as a shock absorber, see: Karagedikli, et al. (2013). 26 The drivers of New Zealand’s exchange rate are examined in McDonald (2012). 27 Graham & Steenkamp (2012) outline the macroeconomic balance model. 28 For discussion on recent developments in New Zealand’s NFL, see Bascand (2017). 29 For discussion surrounding drivers of core inflation in New Zealand, see Kirker (2010). 30 A number of core inflation measures are discussed in Ranchhod (2013). 31 “The sectoral factor model provides a measure of core inflation that distinguishes between price movements in the two major sectors of the economy, and hence helps to identify where inflationary pressures are coming from.” (Price, 2013, pg. 2). 32 For further details on the econometric assessment of the sectoral factor model, among others, see Kamber & Wong (2016). 11 / 11 BIS central bankers' speeches
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Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to KangaNews New Zealand Debt Capital Markets Summit, Auckland, 2 August 2017.
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Grant Spencer: Banking regulation - where to from here? Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to KangaNews New Zealand Debt Capital Markets Summit, Auckland, 2 August 2017. * * * Background I began my present job as Head of Financial Stability at the Reserve Bank in April 2007. That month saw the first straw in the wind of the US sub-prime crisis – the failure of a real estate trust called “New Century Financial”. Over the next three years the Reserve Bank was kept very busy attempting to protect the New Zealand banking system and economy from the ravages of the global financial crisis (GFC). In the aftermath of the GFC from 2010 onwards, we saw a step up in banking regulation globally, epitomised by the G20-sponsored Basel III reforms, Financial Stability Board initiatives, and the Dodd-Frank Act in the USA. The reforms sought to reduce risk-taking by banks, increase capital and liquidity buffers, and improve resolution regimes so that government bail-outs could be more avoidable in the future. While the Australian and New Zealand banks were less directly affected by the GFC than their Northern Hemisphere counterparts, they were severely tested, particularly when shut out of international funding markets for several months following Lehman Brothers’ collapse. It was inevitable and appropriate that the tightening of banking regulation would be felt in this part of the world. The New Zealand banking system is highly integrated with international markets and needs to maintain a strong reputation if it is to continue its lead role in intermediating New Zealand’s financial dealings with the rest of the world. As the post-GFC reforms rolled out internationally, the Reserve Bank endeavoured to tailor the reforms to suit the specific characteristics of the New Zealand financial system and our regulatory philosophy. We did not adopt certain policies such as the leverage ratio and compensation policies, but in broad terms have adopted most of the components of Basel III. That said, some of these policies may be better suited to the major banking systems of the US and Europe, than to New Zealand’s relatively vanilla banking system. This raises the question of how closely we need to follow international standards in order to realise the undoubted benefits of international recognition. We are currently reviewing our regulatory experience over the post-GFC period and thinking how we might shape the New Zealand framework going forward. Two particular catalysts in this regard are the recent IMF Financial Sector Assessment Program (FSAP) report, and our recently initiated review of bank capital adequacy. To guide our planning we need to revisit the objectives of the regime, our regulatory philosophy, the experience to date with the post-GFC reforms, and the trade-offs involved in deviating from international norms. Today I will summarise these guiding principles and discuss how they are likely to influence key regulatory initiatives over the coming years. While I will focus my remarks on banking regulation, the principles and key themes apply more broadly to the other financial sectors that the Reserve bank regulates. I will comment specifically on our upcoming review of the insurance regime. Objectives and regulatory philosophy The Reserve Bank’s mandate is to promote the maintenance of a sound and efficient financial system. While we see soundness as the primary goal of prudential regulation, the secondary 1/8 BIS central bankers' speeches goal of efficiency has an important influence on our approach. When setting prudential requirements we need to be mindful of inefficiencies that can be created if they needlessly or disproportionately add to the cost of financial intermediation, stifle innovation or disadvantage some institutions over others. Broadly speaking, our regulatory interventions aim to improve soundness and safety while as far as possible minimising the efficiency costs of those interventions. We focus our attention on areas where there is strong justification for regulation based on clear market failure and where the benefits to society of regulation are expected to well exceed the costs. The main source of market failure in banking is negative externalities – which occur when banks do not fully take into account the wider effects of their commercial decisions. For example, the combined effect of mortgage credit expansion on house prices and housing risk is not factored into the risk assessments of individual banks. Nor do bank owners and creditors take into account the systemic costs of failure that can be well in excess of private capital losses. As the GFC demonstrated, governments may feel compelled to commit public funds to rescue failing banks in order to limit the systemic damage from such events. The presence of externalities means that, in the absence of prudential regulation, banks may take on greater risk than is appropriate from the point of view of the broader economy and society. The prudential framework reinforces incentives for banks and their creditors to understand and manage the risks they take. In some areas, incentives alone are insufficient and we have imposed direct regulatory requirements. Our approach is built on three pillars: self; market and regulatory discipline.1 The self-discipline pillar aims to support institutions’ internal risk management and governance, and has been at the heart of the Reserve Bank’s approach to banking supervision for close to three decades. The primary responsibility for prudent risk management lies with the directors and senior management of banks. Giving boards and management the right incentives to act prudently is the first priority of our regulatory framework. The market discipline pillar seeks to reinforce incentives for prudent behaviour by requiring the disclosure of financial and risk-related information by banks and also through our own publications (such as our Financial Stability Reports). The aim is to increase market participants’ understanding of risks in the individual institutions and the wider financial system, enabling investors to differentiate between institutions and thereby apply market discipline to those institutions. The third pillar of regulatory discipline, which has grown in prominence since the GFC, involves the application of prudential standards intended to reduce various aspects of risk in bank balance sheets, for example via minimum capital and liquidity requirements. While the Basel Committee has promoted global prudential standards, the approaches of different countries span a wide spectrum. At the intensive end are regulators with long lists of prescriptive prudential requirements and supervisory guidance, with extensive compliance monitoring. At the other end of the spectrum are regulators who choose to be less prescriptive, and instead rely on setting higher, more conservative buffers or limits on a narrower set of key variables. Our preference is the latter. A less activist approach to regulatory discipline is more consistent with our emphasis on self- and market discipline. Those disciplines can be eroded if institutions feel that the responsibility for risk management has been taken over by the regulator. A less prescriptive approach is also less likely to impose excessive compliance and efficiency costs. This more permissive view has guided our approach to loan-to-value ratio (LVR) limits, for example, where we have set broad speed limits on high-LVR mortgage lending rather than outright restrictions. 2/8 BIS central bankers' speeches How close should New Zealand stick to international norms? In shaping our regulatory approach – with its emphasis on self- and market discipline and being at the more permissive end of the spectrum – we must consider the potential costs of deviating too far from international norms. This is especially important to consider as we seek to tailor the sometimes complex international regulatory environment to New Zealand’s relatively vanilla banking system. The integration of our banking system with international financial markets means that the adoption of the key elements of the Basel framework is desirable; a strong degree of commonality between New Zealand’s banking regulations and those of the major countries enhances our financial system’s international credibility. Thus, while there might be efficiency gains from a more streamlined regime that is free of unnecessary complexity, there would also be efficiency losses if the New Zealand regime ceased to be recognised as broadly in line with international standards. This could result in a higher risk premium in bank funding costs and potentially reduced access to international capital markets. As you might expect, much of the “demand” for adopting Basel regulations in New Zealand comes from the four major Australian-owned banks, who generally seek to have a regulatory framework that is closely aligned with the Australian Prudential Regulation Authority’s (APRA) requirements. The FSAP report acknowledged the Reserve Bank’s close cooperation with APRA and recommended that we strengthen this relationship further. We will continue to develop the relationship with APRA but both sides are well aware of the differences in our circumstances and our different regulatory approaches. Over recent years we adopted most of the key Basel initiatives even when some have been less than ideally suited to New Zealand circumstances. At the same time the Reserve Bank has taken on additional compliance oversight roles, some of which require specialised skill sets. Two examples are the oversight of banks’ internal capital models and the non-objection process for bank capital instruments. Such activities do not sit very well with the regulatory philosophy that I have described. Nor are they easily handled with the limited resources of a small Central Bank. Such an approach has however been consistent with maintaining recognition of the New Zealand regulatory regime by international investors and rating agencies. The IMF takes the view that our framework needs to be brought more into line with the international orthodoxy. The recent FSAP report 2 on New Zealand found the Reserve Bank’s prudential framework to be less than fully compliant with the Basel Core Principles in many areas. This assessment relates more to the Reserve Bank’s intensity of supervision than to its adoption of Basel standards per se. The IMF recommends that the Reserve Bank take on significantly more resources in order to: more proactively engage with the banks; issue more comprehensive rules and guidance on key prudential matters; and more frequently verify and enforce compliance. Can we retain our regulatory approach and still achieve the benefits of international recognition? I believe we can. Notwithstanding the views of the IMF, compliance with the international prudential frameworks is not always a black and white choice; the Basel framework sets minimum standards for key prudential requirements but often offers a menu of choices within those standards, for countries to tailor to their specific circumstances. Further, while Basel Committee members such as APRA are more bound to comply with the Basel standards, a small country like New Zealand implicitly has a greater degree of freedom. In summary, our objectives are to retain our regulatory philosophy with relative emphasis on governance and market discipline. We want to streamline and simplify the current regulatory regime in a number of areas but at the same time heed the IMF’s advice about improving the effectiveness of our supervisory model. Underpinning this, we need to maintain the high 3/8 BIS central bankers' speeches international reputation of the New Zealand financial system. I now turn to how these broad objectives might influence the shape of the Bank’s current regulatory initiatives. Supervisory model As I mentioned, the FSAP report recommends that we issue more guidance, and be more prescriptive in many of our banking and insurance requirements. The IMF also says we should seek more assurance of compliance via direct on-site verification and validation. The report recommends a significant increase in resourcing to support such changes. The IMF acknowledge that their recommendations imply a departure from the current balance in the three pillars approach and philosophy. However they also take the view that the Reserve Bank needs to increase resourcing in order to effectively implement its current low-intensity model. The Reserve Bank’s preferred approach is to improve the effectiveness of the supervision model through a combination of simpler regulations, some increase in resourcing, and streamlining approval processes. We will continue to emphasise the quality of banks’ decision making processes, with director accountability for compliance through the attestation regime. In this context, current Reserve Bank “non-objection” regimes run the risk of weakening internal incentives for banks to “get it right first time”. We will look at these processes closely in the context of our current review of the attestation regime and other governance arrangements which underpin the self-discipline pillar. The review will also consider whether the attestation regime needs to be supported with supervisory guidance and/or verification. With regard to the broader question of improving verification, we believe the best approach could be through increased use of thematic reviews. These reviews are conducted by our supervisors, and hone in on industry-wide areas of supervisory interest. Recent reviews in banking have looked at outsourcing arrangements and problem loan identification. In the insurance sector we have recently reviewed disclosure compliance. Such thematic reviews achieve the combined purpose of compliance assessment, an improved understanding of risks by the supervisors, and the sharing of best practice across the industry. We are also looking to make greater use of targeted reviews by external experts in cases where serious non-compliance becomes apparent at particular institutions.3 Capital review In a speech in March I outlined the principles that would guide the current review of the capital adequacy framework for locally incorporated banks.4 The two overarching principles were conservatism and simplicity. Regarding the latter, we do not believe that New Zealand’s relatively vanilla banking system warrants a high degree of complexity in its capital regime. We are leaning towards simplifying both the allowable capital instruments and the methods for measuring risk, though we are in the consultative phase and far from making any decisions. On the allowable capital instruments, many of you will have read our “numerator” consultation paper and we are keen to receive your submissions (the consultation closes on 8 September).5 It proposes that we remove contingent debt instruments from regulatory capital, which were introduced to the framework in 2013 as part of Basel III. Several factors lean us in this direction. There is an inevitable interaction between capital regulations and tax law, and an inherent tension with both sets of regulations when an instrument has both debt and equity characteristics. Debt status brings about tax benefits whereas equity characteristics can see an instrument accepted as loss-absorbing capital from the Reserve Bank’s perspective. Banks often seek to structure financial instruments to maximise the regulatory capital value of the instrument, while reducing 4/8 BIS central bankers' speeches their tax liability. In our experience this often leads to complexity in instrument design, greyness around their true loss-absorbing capacity, and high compliance costs. Further, it is questionable whether contingent debt has added any real economic value in terms of improving the risk-return options available to issuers and investors. Two thirds of the contingent debt issued since 2013 has been by Australian-owned banks to their parents, with the remainder largely issued to retail investors. The former may be driven mainly by the tax treatment, while retail investors receive an interest premium over deposits but may not appreciate the underlying conversion or write-down risk. In this context, we are concerned that contingent debt may be a financial innovation that is born more of regulatory arbitrage than of market need. On the risk measurement side, we will be taking stock of the current framework, particularly around the internal risk models used by the four largest banks since 2008. Our experience, and that of other regulators, is that it can be very difficult to assess whether these models provide objective measures of the underlying risks banks face. In theory, internal models allow banks to more accurately manage their risks, and thereby more efficiently align capital with those risks. On the other hand, internal models add complexity to the regulatory framework that may not be warranted in some risk areas, and the banks’ assigned risk weights are often lower than would be prescribed by standardised models. While deliberations are on-going, the Basel Committee has signalled its intent to make some major changes to the risk measurement framework, in particular a greater use of floors to ensure modelled outcomes do not deviate excessively from standardised measures. We expect to release a consultation paper looking at these risk measurement issues once the “numerator” consultation is complete, around mid-September. We also intend reviewing the capital ratios themselves. The key relevant principle here will be conservatism relative to international peers. New Zealand’s relatively high risk profile supports such an approach, as does the Reserve Bank’s non-prescriptive regulatory philosophy. We are also conscious that the international minimum standards are not calibrated to deal with some of the issues we face in New Zealand, including high industry and portfolio concentration. An interesting issue to address in this part of the review will be the future role and management of conservation buffers, including the counter-cyclical buffer, relative to the minimum capital requirements. We plan to progress these issues later in the year and in early 2018. The dashboard Market discipline is a key part of the Reserve Bank’s regulatory philosophy. We know market discipline works best when it is supported by the timely and transparent disclosure of financial information. In this rapidly advancing digital age, we have an opportunity to improve the effectiveness of disclosure regimes – the “Dashboard” is an important step in this direction. It will be located on the Reserve Bank’s website and will provide market participants and the general public with more timely and comparable quarterly data on New Zealand incorporated banks. The information will cover capital, liquidity and asset quality as well as profitability and balance sheet positions. It will replace existing (off quarter) disclosure statements and make information more easily available and comparable. The information will be available at different levels of granularity to meet the needs of different users.6 We see the current Dashboard project as an important step in an on-going effort to support and enhance more effective and efficient disclosure for banks, insurers and other financial institutions. We are working closely with the banks and want to make sure we get it right. We expect to have the first Dashboard published in the first quarter of 2018. Looking further ahead, we see scope for ongoing advances in effective disclosure and private data management for supervised institutions. Advances in digital services and data management tools are likely to offer a range of new opportunities for assessing and managing the prudential 5/8 BIS central bankers' speeches performance and compliance of banks, non-banks and insurers alike. I expect technology will also offer increasing scope for automation in many of these processes. We anticipate greater use of “Big Data” in our supervisory assessments and in providing warning signs of crises or market concerns. But the day of full “robo-supervision” may still be some way off! Macro-prudential policy Macro-prudential is a relatively new policy area that we have so far implemented through LVR speed limits, applied in 2013, and modified in 2015 and in October last year. The objectives of the macro-prudential policy framework are set out in the 2013 Memorandum of Understanding between the Governor and the Minister of Finance, which also outlines the instruments we can use to respond to emerging systemic risks. Macro-prudential policies have been adopted by many countries in recent years as the underlying issues have been global in nature. The very low level of inflation and interest rates in most countries since the GFC has led to rapid increases in leverage and an escalation of systemic risk in property markets, particularly housing. Macro-prudential policies in New Zealand and elsewhere have been aimed at moderating systemic risk by directly limiting housing-related credit risk on banks’ balance sheets. These instruments are more prescriptive than our baseline micro-prudential tools. They target a specific and significant systemic risk in the form of a leveraged and highly stretched housing market. In a booming housing market, such as we have seen in recent years, we believe the adverse externalities from rapid mortgage credit growth become accentuated, warranting the imposition of temporary macro-prudential measures such as the LVR speed limits. The Bank currently has a consultation paper out on debt-to-income (DTI) limits. We regard a DTI instrument as complementary to the LVR speed limits. Limits on DTIs reduce the likelihood of a mortgage borrower defaulting, in response to interest rate or unemployment shocks, while lower LVRs help to reduce the risk of banks facing losses arising from a default. They are not just two types of hammer hitting the same nail. Of course, banks already investigate borrowers’ repayment capacity when deciding whether to grant a loan as part of prudent banking practice. At times, however, high volumes of high-DTI lending can contribute to a build-up of risk across the financial system which individual banks may not take fully into account. This is why the IMF and the Reserve Bank believe it is appropriate to have this tool in the macro-prudential toolkit, even though we would not wish to use it while the Auckland and national housing markets continue to moderate. Thinking more broadly about the macro-prudential framework, we will seek to achieve more broad-based support by ensuring that the policy framework is understood by stakeholders, including the public. It should be positioned consistently with our macro-financial monitoring and our micro-prudential policy and supervision. Policy adjustments should follow a systematic and well-articulated process in response to emerging systemic risks. It is important to be clear what macro-prudential policy can and cannot achieve. For example, while macro-prudential policies can help reduce housing-related risk in the banking system, they cannot control house price inflation. These broad macro-prudential framework issues will be jointly examined next year by the Reserve Bank and Treasury when the Bank’s Memorandum of Understanding with the Minister of Finance comes up for review. IPSA review My comments today have focussed on the future of banking regulation. However, many of the issues around banking are also relevant for the Reserve Bank’s oversight of insurance companies. Certainly our regulatory philosophy applies to insurers (and non-bank deposit takers) 6/8 BIS central bankers' speeches just as it does to banks. This includes our key principles of simplicity and conservatism. We will be applying these in the upcoming review of the Insurance Prudential Supervision Act (IPSA), which has now been in place for close to seven years.7 We are undertaking the review in recognition of the experience we have gained operating under the legislation, and developments in international standards and guidance. The review aims to ensure a cost-effective supervisory approach that promotes the soundness and efficiency of, and confidence in, the insurance sector. It is a comprehensive review and the range of issues is wide. It includes the legislative scope (who is required to be licensed), the treatment of overseas insurance business, governance requirements and distress management mechanisms. Earlier this year we published an issues paper, which sought submissions on the scope of the review and areas which the review should prioritise. We are currently reviewing the submissions, and thank those who provided feedback. The FSAP report on insurance will be an important input to our thinking. While recognising the relative youth of our supervisory regime, and the Reserve Bank’s three pillar supervisory philosophy, the IMF assessors made a wide ranging set of recommendations. As in the banking area, we are particularly interested in the FSAP findings that could enhance the oversight framework within the existing three pillars approach. These include the development of clearer and more enforceable prudential requirements, enhancements to verification and improvements to disclosure and market conduct requirements. Conclusion Today I have provided some of our thinking on the Reserve Bank’s objectives for financial regulation and how these are expected to shape our framework over the coming years. Of primary importance is to maintain the high international reputation of the New Zealand financial system. However we seek also to reinforce our regulatory approach based on the less-intensive supervisory model and simple-yet-conservative prudential requirements. We believe this approach continues to suit New Zealand’s small and relatively vanilla financial system. We will continue to place emphasis on getting the right incentives in place for prudent institutional governance, supported by effective market discipline that increasingly makes use of technology advances. The greater use of thematic and external reviews will enhance our approach to supervision, while maintaining an appropriate balance between the three pillars of the prudential framework. We will also explore how the macro-prudential framework can be made more robust through a well-signalled and understood policy process. 1 For a more detailed discussion of the three pillars approach, and how it applies across the different sectors we regulate, see Fiennes (2016), New Zealand’s evolving approach to prudential supervision. 2 See the Financial System Stability Assessment report. The Reserve Bank has published a Bulletin article summarising the IMF’s recommendations, see Hunt (2017), Outcomes of the 2016 New Zealand Financial Sector Assessment Programme. 3 Under Section 95 of the Reserve Bank of New Zealand Act, the Reserve Bank can require a registered bank to provide the Reserve Bank with a report prepared by a party approved by the Reserve Bank on the corporate, financial, prudential or other matters of the registered bank. 4 Spencer (2017), Review of bank capital requirements. A consultation paper outlining the intended scope of the review is available on the Review of the capital adequacy framework for registered banks page. 5 See the news release for the Review of the capital adequacy framework for registered banks consultation. 6 6 Further information on the Dashboard is available on the Dashboard approach to quarterly disclosure consultation page. 7/8 BIS central bankers' speeches 7 See the news release for the review of the Insurance Prudential Supervision Act and links therein for the Terms of Reference and Issues Paper. 8/8 BIS central bankers' speeches
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Speech by Mr Graeme Wheeler, Governor of the Reserve Bank of New Zealand, to The Northern Club, Auckland, 30 August 2017.
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Reflections on the stewardship of the Reserve Bank A speech delivered to The Northern Club in Auckland On 30 August 2017 By Graeme Wheeler, Governor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Thank you for the invitation to join you, it’s a pleasure to speak again at the Northern Club. Today, I will offer thoughts on the stewardship of the Reserve Bank over the past five years in meeting its price stability and financial stability objectives, and discuss some policy challenges the Bank may face in the future. 1 It’s been a remarkable five years, especially with the challenges thrown up by the global economy and an over- heated domestic housing market. 1. A challenging international and domestic environment As a small open economy, developments beyond our shores have a large influence on New Zealand’s economic outcomes. The global expansion, which is about to enter its ninth year, is the weakest in 70 years. Until recently, output growth in the advanced economies has been below trend, and headline and core inflation continue to be low despite unprecedented monetary stimulus. Several factors account for the weak recovery: corporate and household deleveraging following the Global Financial Crisis (GFC) has been more prolonged than expected – especially in the euro area; productivity and business investment in the advanced economies have been weak; and trade has been much less of a catalyst than normal. Increasingly, the gravitational centre for the global economy is shifting away from the US and Europe to the East Asia region. Each five year window brings its own set of risks and challenges. Over the past five years on the international front we’ve seen: • Increasing use of unconventional monetary policies (including negative interest rates and unprecedented amounts of quantitative easing) to deliver the cheapest financing the world has experienced. 2 While aimed at stimulating spending, it also led to rapid increases in asset valuations (bonds, equities, and real estate) and a sharp compression in credit spreads and risk premia. • The largest slowdown in global trade since the early 1980s, which has seen countries seeking to boost domestic growth through lower exchange rates. 3 • Sharp swings in commodity prices with peak to trough movements of 75 percent in oil and other commodities. 4 • A continued build up in global debt that is now at record highs relative to global output. 5 • Unexpected political developments in Europe, the UK and the US that substantially increased uncertainty, although measures of financial market volatility remain close to 25 year lows. 6 Back home, New Zealand experienced: • The strongest migration surge since the 1860s (equivalent to a 6 percent increase in the working-age population since 2012) and the labour force participation rate reached historically high levels. 7 8 • A long period of negative tradables inflation – probably the longest since the Great Depression. 9 • A 75 percent decline in dairy prices before recovering partially. 10 • A major switching of expenditure and production to the non-tradables sector, in part to free up resources for the Canterbury rebuild. 11 • Annual house price inflation that reached 30 percent in Auckland and spread rapidly throughout the country. In a world of unconventional monetary policy and unprecedented liquidity, investors’ bid up asset prices and, in doing so, compressed risk premia. In these settings, New Zealand, with its stronger output growth, higher interest rates, and impressive international rankings on numerous business and governance–related surveys attracted portfolio flows from the rest of the world. 12,13 These flows put upward pressure on the exchange rate, and lowered long term interest rates. The appreciating exchange rate made it more difficult for our exporters to compete on global markets (if not matched by rising export prices) and skewed growth away from the tradables sector. By lowering tradables inflation, it also increased the risk that headline inflation would remain low and feed through into falling long-term inflation expectations. Lower long term interest rates reduced the funding costs for New Zealand banks and led to historically low mortgage rates. These, in conjunction with constraints on housing supply and strong population growth, stimulated rapid house price inflation-initially in Auckland and later across the country. 2. New Zealand’s Recent Macro-Economic Performance Despite the difficult international backdrop, New Zealand’s economy has generally performed well over the past five years. As shown in table 1, compared to the period 1990 – 2012 (that is the 22 year period since flexible inflation targeting was first introduced) the five years from the beginning of 2013 have seen slightly faster GDP growth and much stronger employment growth. Over the past five years, headline CPI inflation has been weaker, our current account deficit has been smaller as a share of GDP, while the unemployment rate has been around its average for the period since the mid-1990s even with record increases in migration and labour force participation. Labour productivity has been disappointing, a challenge we share with many other advanced economies. 14 Some of these outcomes lie well beyond the influence of the Reserve Bank’s policy levers. For example, monetary policy cannot directly influence the supply of labour, the productivity of labour and capital, the innovation that takes place within the economy, or the country’s external position. Table 1: New Zealand Indicators (annual average percentage change) Global GDP Growth NZ’s Real GDP Growth Employment Growth Headline Inflation Core Inflation 1990 – 2012 3.6 2.6 1.6 2.5 2.2 15 2013 - current 3.3 2.8 2.5 1.0 1.4 Source: Stats NZ, RBNZ estimates, IMF World Economic Outlook Over the past five years, the Bank’s monetary policy has been an important driver behind the rate of output and employment growth, and the path of non-tradable inflation and inflation expectations. During this time monetary policy has been stimulatory, with the Official Cash Rate averaging 2-3 percentage points below the neutral interest rate (the interest rate at which monetary policy is neither stimulatory nor contractionary). Monetary policy isn’t however, the only driver of growth in output and employment – the pent up demand for investment in construction and infrastructure, the rise in the terms of trade and the rapid increase in population are also important factors. Our low annual rate of headline inflation (1 percent over the past five years) has mainly been due to the 4½ years of negative tradables inflation experienced from mid-2012 until late2016. Tradables inflation, much of which lies beyond the Bank’s control, averaged minus 1.2 percent during this period. Annual non-tradables inflation, which the Bank has considerable influence over, averaged 2.3 percent since 2013 and core inflation averaged 1.4 percent and remained within the 1 to 3 percent target band established for headline inflation. 16 Looking at the key relative prices in the economy we would have preferred a lower exchange rate over this period. The TWI remains 4 percent higher than it was prior to the seven cuts in the Official Cash Rate that commenced in June 2015. To a large extent the high exchange rate reflects the favourable performance of the economy, the high terms of trade, and weakness in the US dollar. The appreciation in the exchange rate has been a headwind for the tradables sector and, by reducing already weak tradables inflation, made it more difficult to reach the Bank’s inflation goals. A lower New Zealand dollar is needed to increase tradables inflation and help deliver more balanced growth. 3. The impact of Macro-Prudential Policy With low interest rates unable to constrain credit growth, rapid house price inflation was creating financial stability risks for the banking system and, given the very high levels of household debt, increasing the risk that a rapid fall in house prices could have a severe economic impact. We were conscious that the introduction of LVR restrictions would make life difficult for the Bank, given the sensitivities around housing. Loan-to-value ratio restrictions (LVRs) reduced the systemic risk to the banking system flowing from the rapid increase in house prices. Requiring new borrowers to have a greater equity contribution in their house purchases reduced the overall riskiness of banks’ mortgage portfolios. When LVRs were introduced in October 2013, 21 percent of the stock of mortgage lending across the banking system was at LVRs of 80 percent or higher. With a third of new mortgage lending at that time taking place at LVRs of 80 percent or higher, the overall stock of high LVR mortgages was likely to approach 25 percent. As a result of the LVR restrictions, the stock of highly leveraged loans across the banks’ mortgage portfolios is now around 8 percent. Figure 1: LVR policy continues to strengthen bank balance sheets High-LVR share of bank’s residential mortgage portfolios Introduction of restrictions on high-LVR lending Source: Registered banks’ Disclosure Statements, RBNZ Lending Position Survey Some commentators expected the LVR restrictions to fall heavily on first home borrowers. While some first home buyers wanting high LVR loans have been affected by the restrictions, banks have given priority to first home buyers within their 10 percent speed limit. Figure 3 shows that over the past 2½ years the share of first home buyers in real estate transactions has been around 21 percent-its level in early 2013. Over this period, first home buyers have taken out nearly $21 billion of mortgage loans from the banking system, with 28 percent of that lending at LVRs greater than 80 percent. Figure 2: Share of house sales by buyer- type Source: Core Logic It’s encouraging that nation-wide annual house price inflation has fallen from its peak of 21 percent in August 2015 to 1 percent currently (figure 4). Several factors contributed to the slowdown including the tightening of investor LVRs in October 2016, more restrictive lending conditions by banks, the rise in mortgage rates in early 2017 and increasing concerns about housing affordability. Figure 3: Annual house price inflation % % Auckland Rest of New Zealand -10 -10 -20 -20 Source: REINZ LVR policy has been aimed at reducing financial stability risks as house prices became increasingly stretched. LVRs are not expected to be a permanent measure and the conditions for their removal would be: signs that financial stability risks have eased; and a degree of confidence that these risks won’t worsen again when LVRs are removed. On the former measure, the financial risk picture is improving. Banks are carrying a lower share of high LVR mortgages as a result of the LVR limits having been in place, and the slowdown in house price inflation is positive - although prices remain very elevated relative to incomes and rents. However, the underlying drivers of housing demand (population growth, low interest rates) remain strong with housing demand still outstripping supply. There is a risk of a housing market resurgence (and a sharp lift in high LVR lending) if LVRs were removed at this time. The Bank will continue to review developments, bearing in mind that removal could be made in stages as a safeguard to a resurgent market. 4. The outlook for the New Zealand Economy In the absence of major unanticipated shocks, prospects look promising for continued robust economic growth over the next two years. If this occurs, the current expansion would be the longest in 50 years 17. Our forecasts suggest that GDP growth will exceed the growth rate of potential output and be driven by continued accommodative monetary policy, population growth, high terms of trade and, in the outer period, by the budgetary stimulus announced in the 2017 Budget. A positive output gap is forecast with inflation gradually approaching the mid-point of the target band. 18 i) Domestic risks The main domestic risks we face lie with migration and the housing market. A sharp decline in net immigration Since early 2012 net permanent and long-term working age immigration has totaled 220,000 – equivalent to a 6 percent increase in the working age population. Migrants have mainly been in the 15-29 year age group. This migration has increased the demand for housing and goods and services, while also increasing labour supply (and hence potential output). Migration has had a positive net demand effect, although its impact has been weaker than in previous migration cycles, and is one factor moderating wage outcomes. Our forecasts assume net immigration of 140,000 people over the next three years – a further 3.5 percent boost to the working age population. A much sharper reduction in arrivals or increase in departures, absent an increase in global growth, would slow domestic economic growth by reducing employment and demand growth. A resurgence in house price inflation House price to income ratios are high in New Zealand, and especially in Auckland. Although house price inflation has slowed markedly, a further surge in house prices can’t be ruled out as mortgage rates are low, net migration flows are strong and large supply and demand imbalances remain in the housing market. A strong resurgence in house price inflation would increase the risk of a subsequent future correction. With a debt to income ratio of 167 percent (up from the 2009 peak of 159 percent) households are already heavily exposed to the risk of rising interest rates or falling house prices. In addition, the share of high Debt-to-Income (DTI) lending to first home buyers, other owner occupiers and investors is high, making borrowers more vulnerable to rises in interest rates and/or reductions in income (e.g. associated with unemployment). This increases the risk of forced sales in a downturn leading to falls in house prices and flow-on effects on bank balance sheets and the broader economy. This is why we have been consulting on whether a DTI instrument should be included in the macro-prudential toolkit. We wouldn’t seek to use it while the housing market continues to moderate. Figure 4: Share of New Lending with High DTI Ratios (June 2017 month) Source: RBNZ ii) International risks Other than unanticipated major geo-political developments, the main risk on the international side lies with the build-up of global debt. If one examines why the large advanced economies move into recession it has generally been because of inflationary shocks (and the policy response to them) or problems in their financial sectors. For example, since the early 1970s the US economy has experienced five recessions. Three had their origins in sharp spikes in oil prices, and the last two resulted from asset price corrections that affected financial market stability. 19 The likelihood of central banks having to lean hard against a rapid burst in global inflation looks to be low. Structural factors are playing a dominant role in the low inflation environment. These factors include: ongoing declines in the cost of information technology and capital goods; increasing global competition in the services sector (e.g. in education, health care, construction, retailing and distribution); the emergence of the gig economy; 20 the technological revolution in the oil and gas industry that has dramatically lowered production costs and enabled new sources of supply; and the wage moderation that is taking place across the advanced economies. Wage moderation seems to be linked to several factors, such as the diminished bargaining power of labour, technological change, global outsourcing, demographics, and changes in labour market composition. The greater risk lies in a large correction in asset prices that leaves investors with little or no equity in their investments at a time when the broader economy is under pressure. Two aspects are of concern in this regard: • The global stock of non-financial sector debt is at a historical high of 220 percent of GDP – up from 180 percent in 2007. Table 2: Non-financial sector debt as a share of GDP (%) Total (share of global GDP) Advanced Economy (share of AE GDP) Emerging Market Economies (share of EE GDP) Source: BIS Most of the growth in debt has occurred in the emerging markets especially on the corporate side (which has increased from 55 percent to 95 percent of EE GDP) and household sector (from 20 percent to 35 percent). Most of the growth in advanced economy debt occurred in the general government sector – which rose from 70 percent to 115 percent of AE GDP). • Asset valuations (e.g. fixed income, equities) are high relative to a variety of benchmarks. Whether current prices represent fair value depends a great deal on the outlook for future inflation and interest rates, particularly in the advanced economies. On this front, financial markets remain confident that central banks will continue to maintain highly stimulatory monetary policy settings for the foreseeable future. Measures of financial market volatility remain close to historic lows. However, investors are acutely conscious that the major central banks are large holders of long- dated Government securities, (and some have corporate debt and equities in their portfolios), and are highly attuned to any hint of a possible tightening in policy rates or winding back in the scale of quantitative easing. If growth in the global economy slows because of debt-related or other issues, our economy will be affected. However, there is scope to help buffer against such shocks. We have greater room for monetary policy manoeuvre than central banks in many advanced economies. Our Official Cash Rate is 1.75 percent – above the zero and negative policy rates of several advanced country central banks - and the Bank has not grossed up its balance sheet by buying domestic assets. Similarly, with budget surpluses and low net Government debt relative to GDP, the Government has flexibility on the fiscal policy side. 5. New Zealand’s Monetary Policy Framework i) Flexible inflation targeting remains highly relevant Flexible inflation targeting was introduced by the RBNZ in 1990 and has been adopted by most central banks in the advanced economies and several emerging market economies. 21 With inflation below target in nearly all advanced economies, there have been questions from time to time whether flexible inflation targeting is still an appropriate framework for monetary policy. We believe that it is still the best monetary policy framework for New Zealand. It has helped to deliver low inflation while enabling the Bank to take account of domestic and external developments in framing its monetary policy responses. No country has abandoned flexible inflation targeting, nor has any country adopted nominal income targeting or price level targeting that are sometimes suggested as alternatives. 22 ii) Maintaining flexibility in specifying the inflation goal Central banks make monetary policy decisions by drawing on the data available, research, models, forecasts and judgement. At a technical level it involves estimating potential output, output gaps, and the neutral interest rate, and assessing the transmission mechanisms through which interest rate changes affect output growth and inflation, and the time lags involved. Structural changes in the economy can have important effects on factors that are central to monetary policy decision making. We’ve seen the relationship between the output gap and inflation change with Philips curves flattening across the advanced economies, even in countries with rapid employment growth and low unemployment rates. The fact that the Reserve Bank has much less control over tradables inflation did not matter as much when the annual percentage change in import prices in world terms was 2.6 percent in the five years prior to the GFC, but it does when they have averaged minus 1.4 percent since March 2013. The specification of a target range for CPI inflation should be the main focus of the Policy Targets Agreement (PTA). It’s important that the PTA also recognise that several factors can cause inflation to move outside the target range and require the Bank to provide analysis and explanations in the Monetary Policy Statement when this occurs. Specifying a single inflation rate that the central bank should seek to achieve at all times should be avoided - it suggests a spurious accuracy that central banks are unable to deliver. A reference to the mid-point of the target range however, is appropriate – our research indicates this was a useful factor in reducing inflation expectations. 23 Some offshore commentators have suggested that central banks should raise their inflation targets, perhaps to around 4 percent, in order to move policy rates away from the effective lower bound and give central banks more policy flexibility to respond to any marked slowdown in activity. It is not clear that central banks could readily increase inflation to these levels and attempting to do so would further stimulate asset markets, at least in the short run. Raising an inflation target when productivity growth is weak makes little economic sense. Some have suggested that the inflation goal should be specified in terms of core inflation rather than headline CPI inflation. A CPI benchmark has many benefits – it’s easier to communicate because it more closely resonates with people’s experience of living costs, and headline CPI inflation affects real rates of return and real wage outcomes that in turn influence household labour supply and spending decisions. iii) The importance of continually reassessing policy settings Monetary policy decisions involve balancing various risks facing the economy, while recognising that inflation outcomes and policy choices are often shaped by decisions that lie beyond the influence of the central bank. Inevitably, central bank forecasts and assumptions require modification as new information becomes available. For example, the Bank raised the OCR four times in the first half of 2014. At that time the IMF were forecasting higher global growth and the New Zealand economy was growing rapidly, with the latter due to the terms of trade being at a 40-year high, strong construction activity, rising net immigration and highly accommodative monetary policy. We forecast a positive output gap and rising inflationary pressures. This view was shared by private sector forecasters and the IMF, and market pricing built in increases in the OCR. By late 2014, the global economy was not strengthening as anticipated, oil prices had almost halved since June 2014 and whole milk powder prices were down by 40 percent. Faced with the prospect of a weaker economy and lower inflation pressures, the Bank moved to a neutral bias and then began the first of seven OCR cuts in June 2015. Central banks do not expect to be able to accurately forecast commodity prices. What matters is that central banks make sensible decisions on the basis of the information available, reflect carefully on the views held by financial markets and key institutions, remain open-minded, carefully assess new information as it becomes available, and change their forecasts and policy settings when it considers it appropriate. We are satisfied that the Bank met these tests. iv) Macro-prudential policy is valuable in addressing financial stability risks Experience in several countries indicates that monetary policy is generally not a good vehicle for leaning against inflated asset prices. In these situations interest rates would have to increase very substantially in order to dampen asset prices and the rise in interest rates could do substantial damage to the economy by depressing spending, reducing risk taking, and undermining the competitiveness of the tradables sector. Prudential and macro-prudential policies can play a valuable role in reducing the systemic risks to the banking system associated with inflated asset markets. We are likely to see macro-prudential instruments become even more important and widely deployed by countries in years to come. 6. Prudential regulation On the prudential side, over the last five years we tightened prudential standards, adjusted inefficient or poorly targeted regulation and took steps to lower compliance costs. We completed the licensing of nearly 100 insurers. A year-long review of bank regulation, with a particular focus on policy development and regulatory processes, was undertaken with extensive consultation with the banking sector. We clarified and tightened the policy on outsourcing of banks’ key functions and systems, and obtained Government approval for the regulation of key financial market infrastructures. We are currently reviewing the quality of bank capital instruments and assessing whether banks are adequately capitalised, and reviewing the effectiveness of the Insurance (Prudential Supervision) Act, 2010. The IMF’s Financial Sector Assessment Programme (FSAP) conducted last year identified the types of banking sector risks (high exposure to housing and inflated house prices, heavy reliance on external funding, exposure to commodity price fluctuations) that are regularly discussed in our Financial Stability Reports. It concluded that the banking system is well placed to withstand large but plausible shocks, as judged by a range of stress tests. However, the IMF recommended, among other things, strengthening the macro-prudential regime to include a debt-to-income instrument, and addressing weaknesses in the approach to financial market infrastructures regulation and bank crisis resolution. There were no particular surprises in the IMF’s recommendations, although they did comment that the Bank is not adequately resourced to support its existing low-intensity approach to banking regulation and supervision. We are reviewing the IMF’s recommendations. 7. Operational business In addition to meeting its responsibilities in respect of price stability and financial stability, the Bank manages a $27 billion balance sheet and runs several businesses that include treasury operations, payments systems, and currency and custody management. These businesses are undergoing major technology renewals and/or changes to their business models. A highlight of the last five years was the delivery of a new series of bank notes with enhanced security features that were well-received by the public and international bank note producers. A disappointing element was the failure of negotiations to sell New Zealand Clear. Considerable emphasis has been placed on increasing the management strength across the Bank, benchmarking performance, testing back-up systems with the Auckland office and managing enterprise risk. This emphasis is essential as the Bank has broad responsibilities, conducted with only 260 staff, and needs to manage multiple business and policy-related risks. Concluding Comments Every five year window brings its own set of challenges. On the international front we’ve seen increasing use of unconventional monetary policies, sluggish international trade, sharp swings in commodity prices, a continued rapid build-up in global debt, and unexpected political developments in Europe, the UK and the US. Back home we’ve experienced the strongest migration surge since the 1800s, probably the longest period of negative tradables inflation since the Great Depression, a 75 percent decline in dairy prices before recovering, a major shift in resources to the non-tradables sector to support the Canterbury rebuild, and annual national house price inflation reached 21 percent. Despite these challenges, the New Zealand economy has generally performed well during this time. Since 2012, GDP growth has averaged 2.8 percent and employment growth 2.5 percent. Both exceed the trend rate of growth. Headline CPI inflation averaged 1 percent due to 4½ years of negative tradables inflation, while core inflation averaged 1.4 percent. Over the past five years, the Bank’s monetary policy has been an important driver behind the rate of output and employment growth, and the path of non-tradable inflation and inflation expectations. Long term inflation expectations remain well anchored at the target mid-point of 2 percent. We have also had a stable financial system. Nationwide annual house price inflation has declined to 1 percent due to LVR restrictions, the tightening in bank lending, the rise in mortgage rates and increasing concerns about housing affordability. LVR restrictions have been effective in reducing financial stability risks as house prices became increasingly stretched. LVRs are not expected to be a permanent measure, but their removal would require a degree of confidence that financial stability risks won’t deteriorate again. However, debt to income ratios have risen in recent years, and with the underlying drivers of housing demand (population growth, low interest rates) remaining strong and demand outstripping supply, there’s a risk of a housing market resurgence (and a sharp lift in high LVR lending) if LVRs were removed at this time. In the absence of major unanticipated shocks, prospects look promising for continued robust economic growth in New Zealand over the next two years. The greatest risk we face at this stage relates to the inflated global asset prices and the continuing build up in global debt. If growth in the global economy slows, we have some scope to buffer our economy. We’ve greater room for monetary policy manoeuvre than central banks in many advanced economies. Our official cash rate is 1.75 percent – above the zero and negative interest rates of several advanced country central banks – and the Bank has not grossed up its balance sheet by buying domestic assets. With a budget surplus and low net debt relative to GDP, there’s also flexibility on the fiscal policy side. I wish to thank the Board of the Bank for their intensive scrutiny, support and advice over the past five years. The Board plays a critical role in monitoring the performance of the Bank and the Governor. I have been fortunate to work closely with three excellent and insightful chairs in Dr Grimes, Dr Carr and Dr Quigley. Above all, I wish to thank my colleagues in the Bank. It has been a great pleasure to work with my fellow governors on the Governing Committee and with the Senior Management Group. The fact that the Bank continues to maintain a strong international reputation is due to the high calibre, dedication and commitment of colleagues throughout the institution. The Reserve Bank is mandated by the Reserve Bank of New Zealand Act to contribute to New Zealand’s economic growth by maintaining stable prices, promoting financial systems soundness and efficiency, and meeting the currency demands of the public Major central banks in advanced economies have conducted around USD12 trillion of quantitative easing since 2008. Countries whose central banks currently have their main policy rate below ½ percent, account for around 1/3rd of world output. Merchandise trade growth over the 5 years to 2017 was the slowest period of 5 year growth since the early 1980s. Protectionist measures and trade disputes in 2016 were at their highest level since the GFC. The price of Brent Crude averaged USD 115/barrel from early 2011 to mid-2014 and fell to USD 28/barrel in January 2016. Over the past 12 months it has averaged around USD 50/barrel. Global non-financial sector debt was 220 percent of global GDP in 2016, up from 180 percent in 2007. Financial market volatility remains close to historic lows in equity, bond and fx markets (as shown by the MOVE index of US Treasury options, the VIX index of S and P options and the CVIX index of FX options). Net permanent long-term migration of working age entrants has totalled 220,000 since 2012. This is equivalent to a 6 percent increase in the working-age population. The labour force participation rate currently stands at 70 percent. The participation rate over the past 25 years has averaged 67 percent. Tradables inflation was negative over the period 2012 Q2 to 2016 Q4, and averaged minus 1.2 percent per annum during that time. Whole milk powder prices fall from USD 5208 per metric tonne in October 2013 and fell to USD 1590 per metric tonne in August 2015. They have averaged around USD 3100 per metric tonne in 2017. The cost of Canterbury reconstruction following the four earthquakes is expected to be around NZD 40 billion in 2015 dollars. The insurance payout, expected to be around NZD 36 to 40 billion, is the 5th largest global insurance payout. Average daily foreign exchange turnover in the NZ dollar averaged USD105 billion in April 2016, of which USD 40 billion were spot transactions. New Zealand is ranked number 1 on the following international surveys: World Bank Group ‘Doing Business Report, Transparency International’s, ‘Corruption Perceptions Index’; and is number 2 on the Institute for Economics and Peace’s ‘Global Peace Index’. Labour productivity growth (real GDP/total hours worked) has been flat for the period since the beginning of 2013. From 1993 Q3 to 2012 Q4 the Reserve Bank’s sectoral factor model suggests annual core inflation was 2.2 percent. As measured by the Reserve Bank’s sectoral factor model. The target band is specified in terms of annual CPI inflation, not ‘core’ inflation. Williams, R (2017) ‘Business Cycle Review: 2008 to present day’ RBNZ Bulletin Vol 80, No. 2, March 2017 Potential output refers to the sustainable long term growth path of the economy when resources are fully employed and price stability is achieved. The output gap reflects the difference between the level of output in the economy and potential output and, as such, indicates the degree of excess capacity or capacity constraints in the economy and the implications for inflationary pressures. We regard the neutral interest rate as the policy rate consistent with the economy growing at its potential in the medium term and having inflation expectations matching the price stability objective. In the US the 1973-5, 1981-2, and 1990-91 recessions were triggered to a significant extent by sharp rises in oil prices in 1973 (OPECI), 1979 (OPEC2) and 1990 (Iraqi invasion of Kuwait). The 2001 recession was related to the collapse of the high-tech bubble, and the 2008-9 recession was due to the range of financial market and regulator factors that led to the GFC. i.e. an increase in the use of temporary labour and contractors for short-term engagements. Flexible inflation targeting involves assigning the central bank the explicit goal of maintaining inflation in a range of consistent with overall price stability, giving the central bank the independence to pursue that goal and holding it accountable for reaching the price stability objective. Around 30 countries have adopted flexible inflation targeting. See for example https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Discussion%20papers/2016/dp16-07.pdf
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Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to the Institute of Directors, Auckland, 5 December 2017.
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Grant Spencer: Low inflation and its implications for monetary policy Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to the Institute of Directors, Auckland, 5 December 2017. * * * Thank you to the Institute of Directors for inviting me to speak here in Auckland. Today I will discuss the low inflation environment we are experiencing here in New Zealand and in many other countries. To start, I would like you to think about the mobile phone in your pocket, because it represents some of the global trends I will refer to. It is a symbol of how manufacturing has become global, how costs of production have been lowered, particularly for technology-based goods and services, and how we are now connected to global markets through digital devices and the internet. These are themes I will return to. Since the Global Financial Crisis in 2008 we have seen persistently low inflation both internationally and at home. Inflation has surprised on the downside relative to forecasts from economic models (figure 1). And it has persisted in recent years despite falling unemployment rates here and in most of the advanced economies. This global pattern is depicted in figure 2. 1 / 12 BIS central bankers' speeches Source: OECD, RBNZ calculations. Scatter plot shows 2017 data1 In response to very weak activity and low inflation following the GFC, many central banks allowed their policy interest rates to fall to zero and below, and injected significant stimulus through quantitative easing. Despite the persistent application of very easy monetary policy and a recovery of demand in the major economies, inflation has been slow to move up towards central bank targets (typically 2 percent p.a.) In New Zealand we avoided zero policy interest rates and quantitative easing, but have also maintained a very easy monetary policy stance since the GFC. If this low inflation is a global phenomenon, we need to consider global factors to understand the potential causes. In the initial post-GFC period, the clear common driver was weak demand as households and firms restricted spending and consolidated their positions in the wake of severe financial stress. However, with the persistence of low inflation as activity recovered, we also need to consider broader supply-side factors, such as the changing pattern of production across the world and the impact of digital technology. We need to consider how these global factors and also domestic developments might be affecting the shape of the New Zealand economy and the pricing behaviour of individuals and firms. I will first talk about some of the key global supply-side trends that have contributed to low inflation internationally. I will then discuss how the domestic inflation process may be changing and how the Phillips curve may be flattening (more on that later). Finally I will discuss the policy implications of these developments and some of the associated risks. Global factors and low inflation The increasing globalisation of the world economy – the breaking down of barriers between product and factor markets – has been a major contributor to low inflation in advanced economies.2 Globalisation over the past ten years has had many aspects. Significant among these have been the expansion of global supply chains, the rapid growth of China, and the growth of the digital economy. The expansion of global supply chains has led to the outsourcing of labour-intensive stages of production to cheaper locations in emerging economies. To follow my earlier phone example, 2 / 12 BIS central bankers' speeches Apple has close to 123,000 employees in the US, but over 700,000 world-wide. The iPhone is designed in the United States; it uses components sourced from several countries including South Korea, Taiwan, and Japan; and is assembled in China. Outsourcing and supply chain integration of this sort has lowered the price of a wide range of manufactures sold across the world (figure 3). It has also placed downward pressure on the wages of lower skilled jobs in advanced economies. Both have translated to less inflationary pressure in the advanced economies. A number of emerging economies have participated in the expansion of global supply chains. However, the huge scale and growth of China’s economy has had a profound effect. Since joining the World Trade Organisation (WTO) in 2001, China has quickly become the largest exporting nation in the world, with around 13 percent of merchandise exports and 18 per cent of manufacturing exports (figure 4). Apart from exports, China’s other main growth engine has been its high levels of investment which has contributed to excess capacity in some key sectors such as steel (figure 5). This capacity expansion has had a restraining effect on prices of industrial materials and, in turn, a wide range of manufactured goods. 3 / 12 BIS central bankers' speeches A third factor contributing to low global inflation is the rise of the digital economy. Prices of ICT goods and services (Information, Communications and Technology) have fallen world-wide, as unit costs have fallen and supply has expanded. The falling price of ICT globally has been reflected in New Zealand CPI components (figure 6), where prices of computing and telecommunication equipment and services have largely been falling since 2000. Advancements in technology also mean that consumers get more for less. Since the first commercialised 8-bit 4 / 12 BIS central bankers' speeches microprocessor was introduced in 1974 there has been 20 doublings of technology for the same price, according to Moore’s Law, generating a growth factor of 1,048,576. This brings me back to the iPhone, which has 240,000 times as much power as the computer used to power the Voyager deep space probe launched in 1977. In short, these tremendous advances in computing power are bringing down the price of technology and related services. Perhaps more significantly, the new digital distribution channels and falling price of computers and phones have lowered barriers to entry across a whole range of markets. Companies utilising digital channels are growing rapidly as they challenge incumbent firms. Online sales are growing market share in general retailing, financial services, travel services, education and health services. The result is increased competition to meet the needs of consumers and producers and downward pressure on both input and output prices. The new digital channels are significantly altering the competitive landscape in some sectors, particularly in traditional sheltered markets where producers are being newly exposed to competition from online providers. These three significant global factors have contributed to a negative inflation trend for the prices of imports and other tradable goods in New Zealand over the past decade. Commodity prices have added a cyclical component to the trend (figure 7). These global factors have also contributed to reduced inflation in “non-traded” sectors which have become increasingly exposed to competitive pressures. 5 / 12 BIS central bankers' speeches The Phillips Curve and domestic pricing behaviour The Phillips Curve underpins how central banks think about inflation.3 Devised by New Zealander Bill Phillips while teaching at the London School of Economics, the Phillips Curve relates inflation to measures of economic slack such as unemployment. The greater the degree of economic slack, the lower the inflationary pressure. Currently, many advanced economies are experiencing unemployment rates below perceived “neutral” levels but are not seeing the expected inflation response (figure 2).4 This has led central banks to re-evaluate their models. Has there been a breakdown in how we measure economic activity and capacity? Is there a breakdown in the relationship between inflation and economic slack? Or have low inflation expectations been a more dominant driver? All of these issues appear to be relevant. In New Zealand, the link between measures of domestic slack and inflation has proved elusive in recent years. Simply plotting the unemployment and inflation data (figure 8), it can be observed that there is now less inflation for a given level of unemployment and less apparent responsiveness of inflation to changes in unemployment. However, it is also clear that the overall relationship between unemployment and inflation has been quite weak and that other causal factors, both international and domestic, have been playing an important role.5 6 / 12 BIS central bankers' speeches Source: Stats NZ, RBNZ. Chart excludes volatile CPI observations affected by the New Zealand GST increase in 2010. The measurement of economic slack is becoming more difficult. Total potential output – or capacity – is not directly observable and it may be that the increasing flexibility and mobility of labour is causing us to understate our measures of capacity. We will increasingly need to refer to a range of labour market indicators in addition to unemployment when assessing the extent of slack in the labour market. There is not much doubt that an increase in international labour mobility has also affected wage inflation in New Zealand. In some of the traditional non-traded sectors like construction there is now greater scope for employers to meet skill shortages through international hires, even though recent stretch in the construction industry has seen wage costs increasing for certain occupations and skills. On a national scale, we have experienced ongoing high levels of inward migration. Over the past 3 years, the population has grown by around 6 percent, of which less than a third is from natural growth. An increasing share of the inward migration has been on work visas (figure 9), thus contributing to higher productive capacity. In this way, emerging excess demand for labour has been moderated on the supply side as a result of increased international labour mobility. 7 / 12 BIS central bankers' speeches With the New Zealand economy becoming generally more integrated with the global economy, we are likely to see less variability in measures of economic slack and also less variability in labour costs, consistent with a flattening of the Philips Curve. New Zealand has always been a price taker for goods traded in the international markets. It now appears that, with labour mobility and globalisation effects, we are increasingly a price taker in “non-traded” goods and services (figure 10). For example, suppliers of education and tourism services are now operating in increasingly competitive international markets. They are facing international competition for their services and also for their labour inputs. Both sectors have been growing as a share of GDP. 8 / 12 BIS central bankers' speeches A crucial factor in the Phillips Curve relationship is inflation expectations. If firms and workers expect higher inflation to result from current capacity pressures then they will more quickly bid up prices and wages. Given the absence of such behaviour, we have looked closely at the role of expectations in price-setting behaviour. 6 This research shows that, in an environment where inflation has been low for some time, businesses have been placing greater weight on past inflation in setting prices. That is, in a low inflation world, businesses tend to use last year’s inflation outcome as a reasonable estimate of next year’s inflation. This adds further momentum to low inflation and reinforces the role of inflation expectations in the flattening of the Phillips curve. In summary, the global trends discussed earlier, together with an increasingly open New Zealand economy and low inflation expectations, appear to be changing the nature of the price formation process in New Zealand. Traded goods prices have been affected directly by the global trends, particularly for manufactures. Non-traded prices have also been affected as a result of a more globally integrated economy and by the momentum of low inflation expectations. The result has been lower average inflation and a flatter Phillips curve. While the scale and permanence of these changes remain very uncertain, they do have implications for how we approach monetary policy. Policy implications of low inflation How might these developments impact monetary policy? Do we need to tweak our approach, or rethink our framework? The first thing to say is that these changes to the inflation process are uncertain and it is unclear how long lasting they will be. Also, with long-term inflation expectations anchored at 2%, there remains broad confidence in the effectiveness of the current framework. We should therefore be cautious about making any recommendations for change. I have talked today about the main developments affecting the low inflation record: a favourable 9 / 12 BIS central bankers' speeches and long-lasting global supply shock arising from supply-chains, the rise of China and the digital economy; and a domestic economy that is now more integrated with the global economy. Both are important but have somewhat different implications for monetary policy. Lower world inflation The positive global supply shock has increased global production while dampening world inflation. From New Zealand’s perspective the shock has lowered import price inflation, particularly for manufacturers, and increased national income as import prices have fallen relative to export prices. However, while the higher terms of trade have supported aggregate demand, the dominant effect on CPI inflation has been the lower import price inflation. Our policy approach to this weakness in imported inflation has been to less than fully offset. The weakness was not expected to be so persistent and it has been overlaid with uncertain and cyclical commodity price movements. Also, the existing easy monetary policy stance and positive terms of trade effects were expected to add to domestic inflation pressures. The persistence of the shock has resulted in CPI inflation running below the 2% target mid-point for a considerable period. Such a policy response to external supply shocks is consistent with our flexible inflation targeting framework. More recently we have been assuming greater persistence in low global inflation and this is contributing to our current flat track for future OCR levels. In our recent November Monetary policy statement, we assume that weak global inflation will persist in line with the forecasts of the international institutions. This now puts some risk on the upside for inflation and interest rates. If the assumption proves incorrect and global inflation picks up in response to increased global growth, then we would likely see higher international interest rates, a lower NZ dollar exchange rate and higher traded goods inflation. This would put upward pressure on domestic interest rates, as portrayed in “Scenario 1” of our November policy statement. Flatter Phillips curve The policy response to the second development – a more globally integrated domestic economy and a potentially flatter Phillips curve – is less clear. We have insufficient evidence to say that the flattening of the Phillips curve is permanent rather than temporary. And we have not yet observed how wages and prices respond to a very tight capacity situation. However, if this change is long lasting and New Zealand firms are increasingly integrated with global markets, then domestic ‘non-traded’ inflation may become less responsive to monetary policy changes. In the extreme case, New Zealand would be a fully open economy with all prices and wages set in international markets. The exchange rate would become the main conduit for monetary policy to achieve its price stability objective. The other potential cause of the “flattening effect” is the strength and persistence of low inflation expectations, making it more difficult for monetary policy to affect actual inflation through changes in aggregate demand and economic slack. While the extreme case of a flat Phillips curve is more expositional than real, it may be the case that deviations from the 2% CPI inflation target will be harder to close, in the sense of requiring larger policy changes and larger movements in economic slack, as measured by unemployment and the output gap. Given that the PTA says we must avoid unnecessary instability in output, interest rates and the exchange rate, and also have regard to the efficiency and soundness of the financial system, this suggests that we should be patient in bringing CPI inflation back to the 2 percent target. This indeed is the approach we have been taking in recent years. In the context of the November Monetary Policy Statement, non-traded inflation is forecast to pick up from late 2018 in response to increasing capacity pressures. If this response does not 10 / 12 BIS central bankers' speeches eventuate then we would have to consider a further easing of policy to generate additional domestic demand pressure, particularly if global inflation remains low in line with our forecasts. However, we would need to be careful not to generate unwarranted instability in output, the exchange rate or indeed household debt. It is fair to say that our flexible inflation targeting approach is becoming more flexible. In pursuing our long term price stability objective, relatively more weight is being attached to the stabilisation of output and employment in the short to medium term. In this respect the Reserve Bank’s direction is consistent with the Government’s initiative to introduce a dual mandate for monetary policy. However, we should recognise that such an approach can only be sustained if inflation expectations remain low and stable. Monetary policy will only have greater scope to stabilise the real economy if its long term commitment to price stability is maintained. Conclusion Inflation has been persistently low since the GFC, both in New Zealand and globally. Initially this was related to a long period of weak demand as firms and households repaired their balance sheets. However the low inflation has persisted as activity has recovered and unemployment has fallen. A consistent pattern across many countries suggests that global supply-side factors have been at work. I spoke of three such factors: global supply chains, the rise of China and the digital economy. These developments have contributed positively to the global economy and have been evident locally in low traded goods inflation and a rising terms of trade. The domestic economy and inflation process have also been affected by the trend towards a more globally integrated economy, increased labour mobility and the momentum of low inflation expectations – which have likely flattened the New Zealand Phillips curve. While the degree and perseverance of this effect are very uncertain, they appear to have reduced the responsiveness of inflation to changes in economic slack. The Reserve Bank’s flexible inflation targeting approach to monetary policy has tended to look through the positive global supply shock, although persistent low global inflation is now incorporated in the Bank’s future policy track. Monetary policy has also been patient in light of the apparent Phillips curve flattening. The combined effect of these developments has seen inflation running below the 2% target mid-point for some time. To the extent that the leverage of monetary policy over domestic inflation may have reduced, this suggests a cautious approach when responding to inflation deviations from target and careful attention to our assessment of economic slack. It may be appropriate for monetary policy to put relatively more weight on output, employment and financial stability relative to inflation. However, this can only be sustained if monetary policy’s long term price stability credentials are maintained. References Auer, R., Borio, C., & Filardo, A. (2017). The globalisation of inflation: the growing importance of global value chains. Globalisation and Monetary Policy Institute Working Paper no. 300. Federal Reserve Bank of Dallas. Armstrong, J., & Karagedikli, O. (2017). The role of non-participants in labour market dynamics. Reserve Bank of New Zealand Analytical Note, AN2017/01. RBNZ. Armstrong, J. & McDonald, C. (2016). Why the drivers of migration matter for the labour market. Reserve Bank of New Zealand Analytical Note, AN2016/02. RBNZ Culling, J. (forthcoming). Low global wage growth. Reserve Bank of New Zealand Analytical Note. 11 / 12 BIS central bankers' speeches Duhigg, C., & Bradsher, K. (2012). How the U.S. Lost Out on iPhone Work. The New York Times. Jacob, P. (forthcoming). The flattening of the New Zealand Phillips curve: Rounding up the suspects. Reserve Bank of New Zealand Analytical Note. Karagedikli, O. & McDermott, J. (2016). Inflation expectations and low inflation in New Zealand. Reserve Bank of New Zealand Discussion Paper, DP2016/09. RBNZ. McDonald, C. (2017). Does past inflation predict the future?. Reserve Bank of New Zealand Analytical Note, AN2017/04. RBNZ. Phillips, A. (1958). The relation between unemployment and the rate of change of money wage rates in the United Kingdom, 1861–1957. Economica, 25(100), 283–299. Vehbi, T. (2016). The macroeconomic impact of the age and composition of migration. Reserve Bank of New Zealand Analytical Note, AN2016/03. RBNZ. Williams, R. (2017a). Business cycle review: 2008 to present day. Reserve Bank of New Zealand Bulletin, 80, 3. RBNZ. Williams, R. (2017b). Characterising the current economic expansion: 2009 to present day. Reserve Bank of New Zealand Bulletin, 80, 3. RBNZ. 1 Unemployment gaps are calculated as the difference between unemployment and the OECD’s NAIRU estimate. Core inflation gaps are calculated as the difference between core inflation and target inflation. Core measures used are consumer price inflation excluding food and energy, while the US measure is the personal consumer expenditure (PCE) measure excluding food and energy. 2 Auer et al. (2017) discuss the globalisation of inflation in more depth. 3 Phillips (1958). 4 Culling (forthcoming) & Box C in the November 2017 MPS discuss factors associated with the apparent disconnect between inflation and unemployment. 5 See Armstrong et al., (2017). A number of explanations exist. It could be that the level of unemployment consistent with stable inflation has fallen. Alternatively, that central bankers have been successful in anchoring inflation expectations. Jacob (forthcoming) finds that increases in the volatility of supply shocks may have contributed to an apparent flattening of the Phillips curve. 6 See Karagedikli & McDermott (2016) for research on Phillips curve specifications and the time-varying nature of price setting. McDonald (2017) shows real-time forecasts of non-tradables inflation using various Phillips curve specifications. Also, Box B in the August 2017 MPS discusses the implications of inflation expectations for monetary policy. 12 / 12 BIS central bankers' speeches
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of New Zealand, to members of the NZ Bankers' Association, Auckland, 28 February 2018.
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Geoff Bascand: The effect of daylight - disclosure and market discipline Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of New Zealand, to members of the NZ Bankers' Association, Auckland, 28 February 2018. * * * Introduction1 Thank you for coming today and giving me the opportunity to share the Reserve Bank’s views on disclosure. I’m going to cover how we use a disclosure regime to support a sound and efficient financial system and the beneficial impact of more informed stakeholders. The Reserve Bank’s prudential framework emphasises the importance of disclosure of information from the entities we have responsibility for regulating and supervising – registered banks, licensed insurers and licensed non-bank deposit takers (NBDTs). It’s a key part of market discipline, one of the three pillars of our prudential framework. It reflects the influence investors and other stakeholders can have on an institution’s behaviour and risk profile.2 By potentially influencing the business’ behaviour, stakeholders can contribute to its long term viability, and the health of our financial system more generally. One of the Reserve Bank’s key statutory purposes is a sound and efficient financial system. So our interests are well aligned with stakeholders who want information on a financial institution’s performance, strength, and risk profile. Indeed the demand for meaningful market information is broad, ranging from depositors, policyholders, shareholders, creditors, through to rating agencies, credit and market analysts, and the financial media. The Reserve Bank as the prudential regulator is also a ‘user’ of such information – it informs our policy settings (e.g. capital ratios) and information may inform a range of specific supervisory actions to address any concerns about an entity we might have (e.g. to assess solvency and associated risks). I should note, however, the information set we have includes the same information that is provided to the public, as well as other ‘private’ information that institutions report to us, sometimes under compulsion of statutory powers. This latter set might be more granular, detailed or proprietary. Information may also be kept confidential to the Reserve Bank to avoid market disruption or because it may have a detrimental impact on an individual financial institution’s competitive position. In addition, there are constraints on public disclosure contained in our governing legislation3 which prevent public disclosure of that information except in prescribed circumstances. Those provisions allow regulated entities and the Bank to discuss sensitive commercial information in candour, which is a necessary element for prudential supervision. There are some limits to what is sensible to disclose and when; such judgements can be quite contentious. Moreover, we recognise that disclosure is not without cost. While mindful of these considerations, the Reserve Bank is disposed towards openness and enhancing disclosures. I’m going to touch on attributes that make information relevant and useful for external stakeholders including that it is reliable, accessible and comparable. I’ll also highlight some key initiatives to improve our disclosure regime including the Bank Financial Strength Dashboard, follow-ups to the bank director attestation review, and related initiatives in the insurance sector. Why is disclosure important? 1 / 11 BIS central bankers' speeches In general terms the disclosure of information is a response to the inherent issues when two economic agents enter into a transaction. Typically one party has greater information than the other – a situation termed ‘asymmetric information’. Disclosure helps resolve a number of potential conflicts. These can be internal – for example between an institution’s senior management and directors who are monitoring performance on behalf of owners. And external – between the institution and a range of other stakeholders. In short, managers have better firm-specific information than directors, shareholders and other stakeholders, and don’t necessarily have an incentive to fully report information that may be detrimental to their self-interests, or the interests of the institution as a whole. Therefore both board directors and external stakeholders demand information from a firm’s managers so they can carry out their respective monitoring roles. There is a well-established literature on corporate governance that focusses on the various mechanisms designed to address the internal informational advantage between management and the Board. Hence, disclosure also supports an entity’s internal monitoring or ‘self-discipline’ – a second pillar of our prudential framework. I’ll return to the topic of corporate governance when I cover the Reserve Bank’s bank director attestation review. Public disclosure can be challenging. There may be weak incentives for a financial institution to produce and share information. While market participants may demand information, what’s produced may not meet their needs, be ad hoc and/or not based on generally accepted and comparable accounting standards, for example. And there may be few ways of being sure the information being provided is reliable and gives a fair picture of the institution’s financial position – something that otherwise may only emerge once an institution comes under stress or evidence of fraud is made public. There is a clear role for professional bodies and regulatory authorities to set minimum requirements attached to publicly disclosed information in order to help ensure its integrity, and to make it ultimately useful for stakeholders. These include auditors, accounting standards boards, stock market exchanges, financial market conduct authorities and prudential authorities. There are a number of local and international examples that illustrate the importance of public disclosure – or more to the point, the failings of poor disclosure: In the United States a number of financial and accounting scandals in the early 2000s associated with Enron and WorldCom, prompted a major overhaul of regulation which included a focus on increased financial disclosure. These scandals also highlighted another aspect of public disclosure tied to the necessary independence of auditors and their role in attesting to the veracity of financial reporting. Serious conflict of interest issues can arise in the relationship between a financial institution and the auditors/accounting firms it hires. Here in New Zealand, the finance company sector experienced a wave of failures prior to the Reserve Bank assuming responsibility for the regulation of ‘non-bank deposit takers’ in 2008. The failures featured inadequate risk management, including over-exposure to certain sectors and related-party lending. The poor quality of information disclosed to ‘mum and dad’ investors was another key failing.TV advertisements with well-known New Zealand personalities painted a misleading picture of the risk-reward profile for their potential investments. Compounding the problem was the advice potential investors were receiving from financial advisers during this period. Internationally the demand for public disclosure and transparency has increased since the global financial crisis (GFC). The crisis highlighted the difficulty of evaluating complex financial products and deficiencies in public disclosure across a number of jurisdictions. The complexities served to heighten uncertainties about the financial strength of some individual banks, and undermined confidence in the banking system as a whole. 2 / 11 BIS central bankers' speeches Good public disclosure It is clear that there are real benefits from public disclosure of information – provided that information is trustworthy. It helps to: Build stakeholder confidence that the institution is presenting an accurate and reliable picture of its financial position, and complying with all relevant laws, regulations and rules. It helps avoid both the perception and/or realisation of financial malfeasance on the part of the institution. The old adage that ‘sunlight is the best disinfectant’ is relevant here. Enable diverse private sector stakeholders to monitor the institution and make appropriate and well-informed decisions on whether to invest in the institution as a potential shareholder, bondholder or depositor, or to enter into an insurance contract in the case of insurers. Create a well-informed market, which is a precondition for improving the efficiency of the financial system by helping to better allocate society’s scarce resources. Welfare is enhanced when funds flow freely between more and less risky investment opportunities, provided those risks can be discerned and priced adequately. This applies to investments in financial institutions as much as it does to the businesses and financial products that they lend to or invest in. For example, riskier financial institutions should face commensurately higher funding costs. There is some evidence, mostly from the United States and Europe, that market information affects the pricing, risk and behaviour of financial institutions. The Reserve Bank has recently undertaken some analytical work that finds similar, albeit tentative, results for New Zealand. 4 This analysis also suggests that the more visibility disclosures get, the more impact they have. This work is informing our evolving approach to disclosures, set out below. The disclosure of information, by itself, will not achieve the benefits described above. Too much information, and the wrong sort, can obfuscate, confuse and detract from market participants’ ability to monitor and exert discipline over financial institutions. Too much information may also, paradoxically, be used to hide evidence of poor practice or wrong-doing. Most importantly, the information itself needs to be trustworthy and meet a number of attributes to be effective. International standards identify a number of characteristics of public information that can enhance the benefits of disclosure and market discipline:5 Decision-useful and accessible: That means presented in a way that is appropriate for the information and distributed in ways market participants can easily access. Timely: Information should be of sufficient frequency and timeliness to be useful. Comprehensive and meaningful: Information should be sufficiently comprehensive so market participants can form a well-rounded view, including the risks faced. It should be sufficiently aggregated to provide a proper overall picture, and sufficiently disaggregated so distinct material items can be clearly identified. Reliable: Information should accurately reflect what it purports to describe. Note, there is some potential trade-off between reliability (getting the numbers 100 percent right) and timeliness. Comparable: The methods and assumptions used in the preparation of information (particularly for financial reporting based on accounting standards which allow a degree of flexibility) should be transparent.. More explicit standardisation of reporting requirements (both financial and other information) would enhance comparability and the identification of how banks differ by financial performance, business activities, various prudential metrics, risk profile and risk management processes/practices. Consistent over time: Disclosure should enable trends to be identified in the institution’s balance sheet position, performance and risk profile over time. 3 / 11 BIS central bankers' speeches Taken together, these criteria provide a useful framework for benchmarking disclosure requirements and outcomes across different financial sectors. Global efforts to enhance and improve financial institution disclosure Following the GFC there has been a global and ongoing effort to improve public disclosure and consequently market discipline. For example, the international standards for supervision of banks produced by the Basel Committee were revised in 2012. They now include two new core principles on Financial reporting and external audit (BCP 27) and Disclosure and transparency (BCP 28) which replaced a single core principle on Accounting and disclosure from the earlier 2006 standards. The Basel standards are used by the IMF in their Financial Sector Assessment Programme (FSAP) which evaluates a member country’s approach to banking supervision. The IMF recently conducted an FSAP for New Zealand and I’ll touch on the results of their assessment shortly.6 While the Reserve Bank’s mandate is prudential (i.e. financial soundness), disclosure is also very important from a market conduct and consumer and investor protection perspective. These latter objectives generally sit with other entities, but equally demand high quality disclosure of information. Regulation has also evolved significantly in the conduct dimension, in New Zealand through the Financial Markets Conduct Act (2013) and the establishment of the Financial Markets Authority in 2011. For the insurance sector, the International Association of Insurance Supervisors (IAIS) is the global standard setter, with core principles first issued in 2011. The IAIS’ principles are also used by the IMF for FSAP purposes. ICP 20 is on Public disclosure and requires the supervisor to set requirements for insurers to disclose relevant, comprehensive and adequate information. It needs to be timely and give policyholders and market participants a clear view of their business activities, performance and financial position. The Reserve Bank’s approach to registered bank disclosure Public disclosure has been a cornerstone of the Reserve Bank’s approach to prudential regulation and supervision, particularly since 1996 when the disclosure regime for registered banks was introduced. The Reserve Bank has periodically reviewed the disclosure regime and made changes that underscore the Reserve Bank’s commitment to effective disclosure. It’s an ongoing process and there are further improvements we are making. A brief overview of the bank disclosure regime Currently all registered banks are required to produce disclosure statements on a quarterly basis. The required content varies depending on whether it is a full year, half year or ‘off-quarter’ disclosure statement, and whether the bank is locally incorporated or a branch of an overseas incorporated bank.7 The disclosure statements include financial reporting and other supplementary information, such as a bank’s capital adequacy position and asset quality. The Reserve Bank’s disclosure requirements for banks are overlaid on top of financial reporting obligations in the Financial Markets Conduct (FMC) Act 2013 and Financial Reporting Act 2013, which are enforced by the Financial Markets Authority (FMA). Under those Acts banks must prepare annual financial statements in accordance with generally accepted accounting practices. The Act also requires that the annual financial statements are audited by a qualified auditor.8 Banks are exempt from many of the product disclosure requirements of the FMC Act by virtue of the separate disclosure regime imposed under the RBNZ Act. RBNZ disclosure statements must be signed by bank directors, attesting to the veracity of the information provided (for branches, the NZ CEO also signs). Banks must publish their quarterly disclosure statements on their websites and make hard copies available on request. The 4 / 11 BIS central bankers' speeches attestation links a bank’s internal governance processes and practices (thereby aligning the interests of senior management and the Board) to the supply of public information. Reserve Bank additional requirements include the preparation of off-quarter and half year disclosure statements based on interim financial reporting standards, a requirement for the full year disclosure statement to include the auditor’s report, including an opinion on the supplementary information that is provided, and penalties for false or misleading director attestation. Reserve Bank supervisors also meet annually with the audit firms of registered banks. IMF FSAP evaluation of the Reserve Bank’s approach to bank disclosure The IMF assessed the Reserve Bank’s disclosure framework for registered banks against the core principles developed by the Basel Committee. For BCP 27 Financial reporting and external audit the New Zealand regime was assessed as ‘largely compliant’ – effectively a pass mark. The New Zealand legal framework provides for financial statements to be prepared in accordance with New Zealand equivalents to internationally recognised accounting standards, and to be audited by a qualified external auditor in accordance with equivalent standards to international auditing standards. One specific area where New Zealand was marked down was because the Reserve Bank does not determine or verify that banks use valuation practices consistent with New Zealand accounting standards, relying instead on the existing auditing process and director attestation. The IMF recommended that the Reserve Bank engage in a more focussed way with external auditors to discuss valuation practices of banks in their financial reporting. We will add this to the list of issues that we explore in our engagement with auditors. For BCP 28 Disclosure and transparency, the Reserve Bank received the highest grade, being assessed as ‘compliant’. The IMF noted that the Reserve Bank is committed to achieving highquality disclosure by banks in line with international standards. There were no specific recommendations; however we were encouraged to extend disclosure to include information on bank staff remuneration. We don’t currently require that and see remuneration frameworks as the responsibility of directors. The Bank Financial Strength Dashboard – improving the accessibility and comparability of bank information The Reserve Bank regularly reviews the specific requirements it imposes on banks to ensure the disclosure regime remains fit for purpose. A major review over 2009–11 streamlined requirements, resulting in cost savings for banks without weakening market information. More recently the Reserve Bank undertook a Regulatory Stocktake over 2014–15. The objective was to enhance the efficiency, clarity and consistency of the prudential requirements for banks and nonbank deposit takers. Reviewing bank disclosure requirements was a key part of the Stocktake and in particular whether off-quarter disclosure requirements continued to deliver clear benefits, relative to the costs imposed on banks to prepare. The Stocktake concluded that there was little merit in continuing to impose off-quarter disclosure requirements on branches, but some form of continued disclosure for locally incorporated banks was warranted. The Stocktake also highlighted issues with accessing and comparing disclosure statements. Differences in how information is presented reduce the ability of non-expert users to review and understand disclosure information. It also imposes costs on more experienced users in their efforts to compare across registered banks. Currently the Reserve Bank provides a summary table on its website of individual bank data. This 5 / 11 BIS central bankers' speeches is based on the non-templated bank disclosure statement data (i.e. non-standardised) and therefore suffers from the same issues noted above. In addition, the summary table does not hold a prominent place on the website, nor is the data particularly timely. As a consequence the Reserve Bank has developed and consulted on a Bank Financial Strength Dashboard concept that will be a big step forward in reporting of bank information. The Dashboard will be a user-friendly interactive online tool that will provide a central repository of key information about the prudential and financial condition of New Zealand incorporated banks. The underlying data will be updated quarterly and hosted on the Reserve Bank’s website. The information will be drawn from data that banks provide to the Reserve Bank and presented in an accessible and user-friendly format. Importantly, the new Dashboard will allow users to make side-by-side comparisons of banks in an `apples-with-apples’ scenario on key subject areas. They are likely to include: credit ratings, capital adequacy, asset quality, profitability, the balance sheet, and liquidity. The main benefits of the Dashboard are the material enhancement to market discipline by improving the accessibilityand comparability of information available to market participants. This will significantly reduce the costs for existing users of disclosure statements to digest and analyse bank-specific information and conduct comparative analysis. In addition, the Reserve Bank expects that the Dashboard will widen the range of stakeholders who will use publicly disclosed bank information, extending the points of influence and avenues of market discipline. Ordinary depositors are one group who arguably only exert a fairly weak level of influence over banks at the moment. While retaining the Reserve Bank’s prudential focus, the Dashboard will also contribute to the wider public policy objectives for informed investor/consumer decisionmaking. The Dashboard information will be aim to be comprehensive with a high-level summary of key metrics, and the ability to drill down to more detailed information. Simple text will accompany the data to help explain it to users. Additional content is expected to be added over time as experience with the Dashboard builds and we receive feedback from users. The quarterly standardised and comparable data will enable users to readily identify trends in data, and hence be consistent over time. It is expected that the publication lag will also be somewhat shorter as data would be updated on the Reserve Bank’s website within two months compared to four months at present –therefore improving the timeliness of the data. While the Dashboard information will not be subject to the same formal director attestation requirements, the reliability of the information provided by banks will be ensured by the due diligence that the Reserve Bank expects banks to add to their internal processes tied to private reporting. Banks will have the opportunity to review their own Dashboard data prior to publication, as well as providing commentary. The Reserve Bank will process all corrections to private reporting before publication of the Dashboard. In addition, banks will be able to correct their Dashboard data after publication has occurred. These revisions will be made transparent in order to support market discipline. We are finalising web page development for the Dashboard and release is currently planned for late May using banks’ data for Q1 2018. There will be an awareness campaign to promote the Dashboard as a user-friendly, authoritative and reliable source of information. All banks, including branches will still be subject to half and full year disclosure requirements and the associated director attestation process. The Reserve Bank will be making technical amendments to the half and full year disclosure requirements so they align with the quarterly information provided in the Dashboard. Improving bank reporting of regulatory capital 6 / 11 BIS central bankers' speeches Current disclosure requirements include information on regulatory capital. Banks must provide information on their capital ratio which includes a risk-adjusted measure of banks’ assets (riskweighted assets). New Zealand banks use either a standardised approach to risk-weights (prescribed by the Reserve Bank), or an approach based on internal modelling and various regulatory formula (currently used by the big-4 banks). The calculations are crucial to understanding banks’ exposures and financial strength but can be difficult to evaluate. The standardised approach for the calculation of risk-weights is inherently more transparent to the public than the customisation of internal models. Even for the Reserve Bank, which has access to banks’ modelling documentation and regularly meets with the big-4 banks’ modelling teams, it is sometimes unclear how risk-weights have been arrived at. The Reserve Bank is currently reviewing capital requirements for locally incorporated banks, including the disclosure of risk-weighted asset data. It is our view that improvements to their transparency can be made, and we are consulting on this and any associated costs that may arise. In the December 2017 consultation document (PDF 1MB), and broadly consistent with recent Basel guidance, the Reserve Bank is proposing an option that would require the big-4 banks to disclose capital ratios under both the internal models and standardised approaches – so-called ‘dual reporting’. The Reserve Bank hopes that as a result of dual reporting internal models banks will provide more public explanation of the reason for any marked variation between their internal models measure and the standardised calculation, as well as their modelling assumptions and methods in general. Bank director attestation review As I discussed earlier, the bank disclosure regime is supported by a requirement for bank directors to attest to (i.e. sign-off on) the accuracy of information contained in the disclosure statements. This is a crucial aspect of New Zealand’s regulatory regime. Directors are responsible and accountable for the integrity of bank reporting. Due diligence helps support the internal governance processes of the bank, driving responsibilities, systems and processes to generate and scrutinise management information. The question arises as to how confident users can be in the robustness of attestation statements. Directors and users of disclosure statements are aided by the reporting of external auditors, but to what extent should the Reserve Bank review the information directors have relied on, or independently test and challenge their assurances? Currently, the Reserve Bank evaluates the reliability of directors’ attestations and compliance with RBNZ guidelines through reviews of documentation such as risk appetite statements, financial information, reports submitted to bank management, and meetings with bank management and directors. The IMF (in its 2017 FSAP report), while not contesting the attestation regime, urged the Reserve Bank to more rigorously test attestations through specific reviews, especially for locally-owned banks. For example, they expressed a concern that the Reserve Bank did not undertake much independent verification of banks’ internal risk management practices or Board effectiveness. Last year, and partly in response to the IMF’s FSAP, the Reserve Bank undertook a thematic review of the attestation process across 15 locally-incorporated banks. The review was carried out by Deloitte on behalf of the Reserve Bank. Deloitte determined the attestation regime as ‘largely effective’ based on a weighted average of scores using their methodology, with some variation across individual banks. Deloitte noted a number of a general issues that potentially limit the effectiveness of the regime: 7 / 11 BIS central bankers' speeches A reliance on high-quality directors to make the regime work. The number of directorships held by directors, length of tenure, lack of banking experience, risk of capture by management and lack of diverse skills on the Board all potentially affect the effectiveness of the regime. There is a correlation between the effectiveness of the attestation regime and an open and honest culture within the bank. Sign-off from directors is only appropriate if they believe that staff at all levels will communicate ‘bad news’ upwards. In the absence of Reserve Bank guidance, banks could be applying different processes to verify attestations; applying different materiality thresholds, and; applying some policies differently. There may be a role for the Reserve Bank to provide more specific guidance on specific policies, and to independently verify an individual bank’s attestation process. The Reserve Bank has begun considering both the findings from the IMF FSAP (which were released in April last year), and those from the more recent attestation review. In relation to FSAP, the Reserve Bank is closely examining the recommendations that, taken together, may further enhance the three pillar approach to regulation and supervision. Particularly key are the recommendations about independent verification by the Reserve Bank of banks’ internal policies and processes, and the provision of more explicit guidance to help provide a better benchmark to support bank director attestation. Our view is that rather than a fundamental shift to a more intrusive supervisory regime such as checking an individual institution’s reporting via on-site inspections, our verification is likely to be undertaken through greater use of thematic reviews (i.e. reviewing policies and practices across the banking sector). We continue to see directors and auditors owning the primary verification role. The Reserve Bank will be considering the findings of the attestation review in the context of how it might better support banks’ internal governance processes (i.e. self-discipline). No final policy decisions have been made, but some elements of this enhanced approach may include: More frequent engagement with bank Board of directors. This will provide a greater opportunity for the Reserve Bank to communicate any concerns with directors, and help to address the information asymmetry between senior management and directors described earlier. The Reserve Bank will also gain a potentially better insight into the effectiveness of the Board and how it is discharging its oversight duties. The Reserve Bank will also consider how to support directors in understanding their duties, via induction sessions for new independent directors. The development of guidance on the Reserve Bank’s expectations around risk management. This will help provide a clearer and more consistent benchmark for bank directors to attest whether they believe their institution is adequately managing risks. Formally embedding a ‘positive assurance’ process for attestation sign-off. The review highlighted that most banks adopt a limited or ‘negative’ assurance process whereby management states to directors that they are not aware of any compliance or risk appetite breaches. The Reserve Bank would prefer to see senior management actively demonstrating or providing evidence of compliance to directors. Reviewing requirements in the Reserve Bank’s corporate governance policy (BS14) related to, for example, tenure limits for independent directors, limits on directorships and requirements on banking experience. Reviewing BS10 to require banks to undertake on-going suitability assessments of their directors and senior managers. The Reserve Bank will also be providing greater clarity on the definition of ‘senior manager’ for the purposes of the current non-objection process. Insurer disclosure 8 / 11 BIS central bankers' speeches Overview of disclosure regime Public disclosure of information also forms an important part of the market discipline pillar for the insurance sector – a sector the Reserve Bank assumed responsibility for in 2010 under the Insurance (Prudential) Supervision Act (IPSA). Section 4(e) of IPSA defines disclosure in the public interest: “the desirability of providing to the public adequate information to enable the public to make [their own] decisions”. The insurer public disclosure regime is based on accounting and audit standards (enforced by the FMA as is the case for registered banks). For example, the Financial Reporting Act requires all insurers to produce audited financial statements within four months of the financial year-end. These financial statements are available from the Companies Office website, while some insurers also publish them on their own website. Licensed insurers are also subject to additional disclosure requirements imposed by IPSA and Reserve Bank standards and guidelines. Under IPSA most licensed insurers must have, and disclose on its website, a financial strength rating prepared by an approved rating agency to policyholders before issuing and renewing insurance policies. The Reserve Bank also publishes these financial strength ratings on its website. Overseas insurers must disclose the existence of any overseas policyholder preference if one exists. Licensed Insurers must also disclose their financial strength ratings to policyholders before entering into or renewing a contract of insurance. As part of Reserve Bank solvency standards, insurers are required to disclose solvency positions and regulatory capital information in their financial statements and on their website. IPSA requires that actuarial information contained in financial statements is reviewed by the licensed insurer’s appointed actuary and subject to a separate report which is included in the financial statements. Guidance material on governance creates an additional expectation on insurers tied to the disclosure of governance arrangements to shareholders, policyholders and other stakeholders. IMF FSAP evaluation of insurer disclosure regime As I noted earlier, the IMF evaluates the effectiveness of insurance supervision by benchmarking a jurisdiction against the 26 core principles developed by the IAIS. With respect to ICP 20 on Public disclosure, the New Zealand regime was assessed as ‘partly observed’ –reflecting that some gaps exist. The IMF argued that comparison across insurers is made difficult by accounting standards that allow some management discretion on details to be disclosed, and because branches are allowed to present solvency information using home-jurisdiction methodologies. They also noted that disclosure requirements were lacking in areas such as asset-liability management, descriptions of risk concentration and the interaction between capital adequacy and risk exposures – in other words were not comprehensive. The IMF recommended improving insurer disclosure in a number of areas, including ways to improve solvency information to make it easier to compare across insurers and between subsidiaries and branches. This is particularly key as branches account for a much larger share of the insurance market compared to the role branches play in the banking sector. The Reserve Bank is currently undertaking a review of IPSA. recommendations will be considered during the legislative review. 9 / 11 A number of the IMF’s BIS central bankers' speeches Reserve Bank thematic review of disclosure requirements The Reserve Bank has conducted its own review of insurers’ compliance with existing disclosure requirements in a thematic review completed in June last year. The Reserve Bank sampled 36 insurers and was generally disappointed with the overall level of compliance with the requirements. The most common issues were: Insurers not meeting requirements to disclose financial strength ratings in writing prior to policyholders entering into and/or renewing a contract of insurance. For some overseas insurers this included failure to correctly disclose the existence of an overseas policyholder preference. Solvency disclosure in financial statements being incomplete or incorrect. Website disclosures being incomplete, incorrect or not updated. The Reserve Bank has shared the general findings with all insurers and other interested parties in order to improve compliance across the industry as a whole. In addition, the Reserve Bank has followed up with individual insurers whose compliance levels were assessed as low or poor – 19 of the 36 insurers sampled. These insurers were provided with specific feedback and required to provide a written response on the findings, actions taken and timeframes. Insurers generally responded positively to this feedback and have taken steps to improve compliance with the requirements, giving greater comfort on the internal assurance processes tied to the disclosure requirements. It is our intention to undertake a further review of compliance in 2018; however, the exact timing and detail has yet to be finalised. Statistical reporting is a key component of a disclosure regime. To date, statistical reporting on the insurance sector has been impeded by the newness of the regulatory regime, lack of historical information and inconsistent or poor quality of information. A new regular statistical publication on the insurance sector, which we believe will help incentivise the industry to provide better quality information over time, was released for the first time yesterday. The Reserve Bank is considering measures to enhance the integrity of insurers’ statistical returns, including the option of audited statements. Public reporting of non-compliance and sanctions A further aspect of disclosure that warrants discussion is the Reserve Bank’s approach to reporting on bank and insurer non-compliance with regulatory requirements. As noted earlier, most institution-specific matters are required to be kept confidential by the Reserve Bank. For registered banks, regulations setting disclosure requirements require that compliance breaches will be reported in their disclosure statements. However, public notice or censure of a regulated institution by the Reserve Bank is also an available option, recognising that public understanding and attention is likely to sharpen the incentives for good behaviour in future. Recent preliminary work by the Bank provides some evidence of market discipline when public notices have been issued.9 The Reserve Bank assesses the merits of public warnings or censures on a case-by-case basis, balancing the public interest in transparency and the deterrence effect against the natural justice of protection of information if prosecution is being considered and the seriousness of the offence. Alongside the Dashboard we also expect to begin reporting breaches on a separate page on our website. This is likely to provide greater transparency around non-compliance breaches than current reporting practices, due to information about breaches being published on a more frequent and accessible basis. In this context, we will also be considering whether requiring 10 / 11 BIS central bankers' speeches information to be published on very minor or inconsequential breaches may be disproportionate. We are aware that directors are concerned that undue focus is being given to immaterial matters. Conclusion Financial markets rely on information for their operation. While there are many participants in the information market contributing to its production, distribution and assurance, there are also some problems and biases that can lead to less than full or meaningful disclosure by financial institutions. The role of regulators in supporting fair and accurate reporting is an important one. The Reserve Bank places considerable store on public disclosure as a means for investors, customers and other stakeholders to hold banks and insurers to account. The Reserve Bank is introducing a number of initiatives to strengthen the disclosure system in both banking and insurance. The Bank Financial Strength Dashboard will significantly improve the accessibility, comparability and timeliness of information about banks’ financial positions. The integrity of bank reporting appropriately is vouched for by bank directors through their attestation statements. The Reserve Bank is actively considering steps to enhance the effectiveness of the attestation regime through expecting evidence of positive assurance, more thematic reviews, more explicit guidance on good banking practices, more frequent engagement with bank directors, and a review of the materiality of disclosures. The insurance sector also has scope to improve its disclosure performance. Regulatory initiatives will be considered during the review of IPSA, but in the meantime, disclosure practice will be scrutinised closely through our engagement with insurers, and supported by new and expanded statistical reporting that commenced yesterday. 1 I am very grateful to Chris Hunt for considerable help in the preparation of this speech, along with valuable comments from other Reserve Bank colleagues. 2 See Fiennes, T (2016)’Regulation and the Importance of Market Discipline’, speech delivered to NZBA and Bank of New Zealand, 4 February. 3 Section 105 Reserve Bank of NZ Act 1989; section 135 IPSA; section 54 NBDT Act. 4 Haworth, C (2018) ‘Measuring market discipline in New Zealand’ RBNZ Analytical Note . 5 There is a strong parallel with the desirable properties of official statistics. In 1994, the United Nations adopted ‘fundamental principles of official statistics’ recognising that reliable and objective information through official statistics is crucial for decision making. Statistics New Zealand developed ‘principles and protocols for producers of Tier 1 statistics’ in a similar vein, encompassing principles of relevance, integrity, quality, coherence, accessibility, confidentiality, etc. 6 See the Reserve Bank’s Financial Sector Assessment Programme page for information on the FSAP, including the IMF’s main report and accompanying technical notes. 7 Off-quarter disclosure statements refer to the first and third quarters of a bank’s annual financial reporting cycle. 8 The FMAis also required to perform regular reviews of auditing firms on their compliance with the New Zealand standards issued by the New Zealand External Reporting Board (XRB). The XRB is a body that implements all accounting and auditing standards issued by the International Accounting Standards Board (IASB) and the International Auditing and Assurance Standard Board (IAASB) respectively, by issuing New Zealand equivalents. 9 Haworth (2018), op cit. 11 / 11 BIS central bankers' speeches
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Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to INFINZ, Auckland, 13 March 2018.
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Grant Spencer: Getting the best out of macro-prudential policy Speech by Mr Grant Spencer, Deputy Governor of the Reserve Bank of New Zealand, to INFINZ, Auckland, 13 March 2018. * * * Introduction It is five years since we first introduced macro-prudential policy in the form of loan-to-value ratio (LVR) restrictions in October 2013. It is time now to take a step back and review the experience with this new policy framework. Indeed we are committed to undertake such a review under the Memorandum of Understanding (MoU) on Macro-prudential Policy that was signed with the Minister of Finance in 2013. The review will be undertaken jointly with Treasury as part of the Government’s broader review of the Reserve Bank of New Zealand Act. You will hear a wide range of views on the LVRs from a number of perspectives – some favourable and some less so. From the Reserve Bank’s perspective, the LVRs have assisted us in achieving our economic and financial stability objectives. The LVRs have reduced housingrelated risk in the banking system and also helped to ease housing market pressures. The policy has been particularly useful in the current environment of globally low interest rates, where domestic monetary policy has been unable to counter the strong housing cycle of recent years. But do we have the most appropriate macro-prudential framework for our circumstances in New Zealand? What role could the other instruments in our toolkit play to enhance and/or complement the LVRs? Should we be considering other macro-prudential instruments? Is the governance structure sensible? There are diverse views on these questions. With the review of the macro-prudential framework ahead of us, my intention today is to consider the key issues that might be addressed and to offer some thoughts, based on our experience, for options to improve the policy framework. I have been closely involved in the Reserve Bank’s development and implementation of macro-prudential policy and I am keen to see macroprudential policy continue to develop as a credible and sustainable policy over the longer term. I will first discuss the New Zealand and international experience with macro-prudential policy, and some of the lessons we have learned. I will then make some observations and suggestions aimed at putting macro-prudential policy on a more systematic and sustainable footing. These are my own views and are not a formal Reserve Bank position. The New Zealand Experience As set out in the MoU, the objective of our macro-prudential policy is to increase the resilience of the financial system to credit, asset price and liquidity shocks, with a secondary outcome of moderating the credit cycle. The four macro-prudential instruments – the countercyclical capital buffer (CCB), sectoral capital overlays, the core funding ratio, and limits on high LVR mortgage lending – are designed to provide additional buffers to the financial system on top of the baseline prudential settings in periods of cyclical pressure. Given the potential impact and public profile of the framework, the MoU requires the Reserve Bank to consult with the Government prior to the use of the macro-prudential instruments. Accountability has been supported by our regular reporting on macro-prudential developments in our biannual Financial Stability Reports. The first set of LVR limits in October 2013 was motivated by our concern about increasing risks in the housing market and the associated trends in high-LVR lending by banks. Our view was that increasing household indebtedness and a build-up of housing credit risk on banks’ balance 1/7 BIS central bankers' speeches sheets, combined with an increasing degree of stretch in house prices, was making the financial system increasingly vulnerable to a sharp correction in the housing market. The initial response of the market to this first round of limits, in terms of housing credit growth and house price inflation, was encouraging. But further pressures and growing risks, particularly in Auckland, led the Bank to refine the LVR policy in 2015 and again in late 2016. More recently, the moderation in the housing market and associated financial stability risks have allowed us to begin a staged easing of the policy, although we remain cautious in the face of ongoing housing shortages. Based on this experience, our assessment is that the LVRs have had transitory effects on the rate of house price inflation but have had sustained beneficial effects on the resilience of banks’ and households’ balance sheets. The share of outstanding mortgages with an LVR greater than 80 percent has steadily trended down as a result of the LVR policy, from 21 percent in September 2013 to 7 percent in December 2017. Recent Reserve Bank estimates suggest that banks’ credit losses from a severe housing downturn could be reduced by around 20 percent. 1 Also, with larger equity buffers, fewer households would be under pressure to sell their house or cut back on consumption in such a downturn. Overall, I believe the LVR policy is regarded as a qualified success. While it has its critics, it has also won considerable support amongst policy makers, the public and the banks. The banks have recognised the benefit of an external industry constraint that prevents an escalation of mortgage risk as banks compete for market share through greater risk taking. I take five broad lessons from the experience with macro-prudential policy to date. First, it is a policy that can reliably improve banking system resilience, on a sustained basis, but that has limited capacity to influence asset prices. The latter should not surprise us given the wide range of factors that influence asset prices more generally. Second, and arising from the first, macro-prudential policy should always have a prudential purpose, and be modest in its ambition. It should not seek to control housing or financial cycles. It should seek to build resilience to these cycles while at the same time lean against the extremities of those cycles. Third, to improve transparency and understanding, macro-prudential policy should have a wellunderstood and systematic framework for policy adjustments that is fully consistent with the underlying prudential framework. Fourth, there is a need to build and sustain support for the macro-prudential framework – amongst politicians, the public and the banks themselves. To succeed long term, macroprudential policy must gain broad acceptance, along the lines of monetary policy. Part of the challenge here is that many observers assume the main objective of macro-prudential policy is to stabilise asset price and credit growth rather than build financial system resilience. Fifth, a good infrastructure is required to support macro-prudential policy. The Reserve Bank has invested heavily in better measurement and analysis of housing and rural credit risk. This has had positive spin-offs for prudential policy more broadly. International Experience The countries we look to for lessons about our own policy are those with similar banking systems and with a propensity for housing cycles – such as Australia, Canada, Ireland, and the UK. The latter three have been active in macro-prudential policy for several years while Australia has been a more recent starter. The experience of these countries tends to reinforce the lessons I have mentioned. In Ireland, the Central Bank sees borrower-based macro-prudential policies as an integral part of mitigating systemic risk from housing. Over time the Irish policy has been tailored to address 2/7 BIS central bankers' speeches both the collateral (LVR) and serviceability (loan to income ratio (LTI)) dimensions of borrower risk, with separate limits on each dimension for different categories of borrowers. The flexibility of the policy means the Central Bank can proactively respond to risks it sees in different segments of the mortgage market. The CBI commits to annually publish a review of the effectiveness and calibration of its macro-prudential policy.2 In the Bank of England’s case, they place a limit on high LTI lending. This is seen as an ‘insurance’ policy, with the calibration currently set at a non-binding level. The aim of the measure is to prevent a deterioration in lending standards, not necessarily to actively lean against mortgage lending at present.3 In a similar vein, the UK Financial Policy Committee’s approach to setting the CCB is to maintain it at a positive, neutral level, and to stand ready to either raise or lower it in line with the Committee’s assessment of aggregate risks to the system.4 Further the CCB is seen as an important signalling device – underlining the FPCs view on the evolving shape of systemic risk in the UK system. We should also consider the evidence and analysis of the IMF and other international bodies which have reviewed macro-prudential experiences across a number of countries.5 While few macro-prudential regimes have been tested through a full financial cycle, evidence suggests that macro-prudential policies have limited success in leaning against asset price and credit growth cycles, particularly during strong upswings. The key benefit of capital and borrower-based macro-prudential tools is from the buffers they create which help to build system resilience against potential shocks. Regarding the shape of operating and governance frameworks for macro-prudential, there is no clear convergence on operating models and the sharing of responsibilities between different parts of government. However, there is a growing consensus on the desirability of: a clear assignment of the macro-prudential mandate and powers; well-defined policy objectives that are modest as to what macro-prudential policy can and should achieve; the need for high quality analysis and monitoring of systemic risks to support decisionmaking; and transparency and accountability mechanisms that support policy legitimacy. Taken together, these elements of a macro-prudential framework will tend to support both an ability and a willingness to act on the part of the macro-prudential authority. It is also important to clearly articulate the processes underlying the policy framework, including the links between the tools, the intermediate targets of a policy intervention, and the ultimate stability goal. In doing so, macro-prudential authorities can improve public understanding and build an enduring constituency for financial stability.6 The IMF’s recent Financial Sector Assessment Programme (FSAP) benchmarked the New Zealand macro-prudential framework against their view of emerging best practice.7 The report noted approvingly the Bank’s clear mandate for financial stability, independence of the Bank’s decision-making process, and a demonstrated willingness to act. Key recommendations of the report were to further clarify the respective roles of the Bank and the Minister when considering variations to the framework, such as inclusion of a debt to income (DTI) instrument in the toolkit, and to continue to enhance accountability mechanisms. What does all this mean for the New Zealand framework going forward? I will first discuss the policy instruments and then turn to the governance framework. The Policy Instruments 3/7 BIS central bankers' speeches I doubt there is a single set of instruments that will always be relevant to meet evolving macrofinancial risks. However, based on our own and international experience, I expect that both LVRs and some form of debt servicing instrument will become part of the macro-prudential “furniture” over time. They represent the two key risk factors in mortgage lending, and I expect housing cycles will continue to be an ongoing (but variable) source of systemic risk in the NZ financial system. The Counter Cyclical Capital Buffer (CCB) is likely to remain as part of the Basel 3 framework and is commonly used internationally, including as a signalling device. While it has not yet been activated in NZ, it could be given closer consideration when the Reserve Bank comes to look at minimum capital ratios as part of its broader review of bank capital requirements. The Core Funding Ratio (CFR) is an existing (micro) prudential policy instrument. It currently requires banks to have at least 75% of their funding in “Core” instruments such as retail deposits. While not yet used as a macro-prudential tool, it could easily and usefully be activated in response to an increase in system-wide liquidity risk. The Sectoral Capital Ratio (SCR) has not been used to date but would seem a potentially useful additional buffer against increasing risk in a particular sector such as housing or dairy. Whatever instruments are relevant for the toolkit through time, I believe the upcoming Review should consider a structure for macro-prudential instruments which allows them to be “off’ or “on” through time, but where they remain established within banks’ reporting and compliance systems. These instruments relate to risk metrics that we expect banks to keep track of, whether or not they are subject to ceilings or floors. Macro-prudential policy would adjust back to ‘neutral’ or non-binding settings when no heightened risk is present and no policy constraint is intended. This sort of structure already exists for the CFR and the CCB, since changes to these instruments would overlay existing core funding and capital requirements. Neutral settings for the LVRs and other instruments would be a matter for future analysis and consultation. With ‘neutral’ settings, banks would not need to remove/add the operational frameworks as policies are turned on and off. Rather they would just need to adjust the settings of existing policies. The public would become increasingly familiar with the policies and the potential for changes to settings. Policy changes would become easier to implement and to communicate. In principle, macro-prudential policy would follow a more transparent and systematic process that looks more like our monetary policy process. Such an approach would be more amenable to the analysis and assessment necessary for effective policy accountability. While we stated at the outset in 2013 that LVRs would be temporary, I believe there is a case to consider maintaining a policy infrastructure of this sort, with policies being adjusted through time between binding and non-binding settings. This is similar to the ‘insurance’ approach adopted by the Bank of England where a loan to income ceiling has been set at a non-binding level. One aspect that would need to be considered carefully before moving in this direction would be any increased risk of avoidance activity. Regarding the contents of the policy tool-kit, the mix of instruments should slowly evolve through time. In the present economic and financial environment I support retention of the four instruments listed in the MOU (LVRs, CCB, CFR, SCR) and the addition of a carefully designed debt to income (DTI) or debt servicing instrument. You will recall that the Bank consulted on including a DTI instrument in the toolkit last year. That process was overtaken by the general election and a decision on inclusion or otherwise was deferred to the upcoming Macro-Prudential Review. The DTI is a natural complement to the LVR, focused on reducing the risk of borrower default. Many macro-prudential authorities overseas view some form of debt servicing ratio as a key anchor and safeguard for macro-financial stability. The Review should give serious consideration to adding such an instrument to the toolkit. Governance 4/7 BIS central bankers' speeches The current macro-prudential MoU gives decision making powers to the Governor, but commits the Reserve Bank to prior consultation with the Minister and Treasury. The development of any new instruments is undertaken in consultation with the Treasury and also includes public consultation. In the case of policy adjustments, consultation with the banks is required ahead of implementation. So the present governance model for macro-prudential policy has the Reserve Bank in the driving seat, but requiring extensive consultation with Government and the public, in particular when considering new instruments. In the upcoming review of macro-prudential policy, and of the Reserve Bank Act, it will make sense to integrate the intent of the current MoU into the Reserve Bank Act. At present, macroprudential policy operates under the same high-level financial stability objective, and relies on the same prudential powers, as conventional prudential policy. This has worked effectively to date and I believe it is important to retain this common ground between the two policies, in particular the same high level prudential purpose. However, the Review will be taking a fresh look at the detail of the governance architecture, including operational objectives, policy guidance, prudential powers, decision making and accountability mechanisms. In working through these areas it will be important to allow for the differences between micro and macro-prudential policy. What are these differences, and how might they be reflected in a revised governance structure? I see two key differentiating characteristics of macro-prudential policy: first, macro-prudential only addresses significant systemic shocks, not idiosyncratic day-to-day shocks; and second, macro-prudential has a stabilisation role (albeit a secondary one) as it seeks to moderate cyclical extremes in credit growth and asset prices. Thinking about where the micro/macro-prudential differences might be reflected in a revised Act, the first is in objectives. Current objectives for the Reserve Bank’s broad financial stability role (sections 1A and 68 of the Act) are focussed on “promoting the maintenance of a sound and efficient financial system”. The Bank is also required to have regard to any statement of Government policy on the Bank’s functions issued by the Minister (section 68B). The objectives and policy guidance for macro-prudential are consistent with this but more specific. The current MoU objective is: “to increase the resilience of the domestic financial system and counter instability in the domestic financial system arising from credit, asset price or liquidity shocks.” Guiding principles for macro-prudential in the MOU include the principle of supporting monetary policy where possible and being fully consistent with micro prudential policy. The objective and guidance from the MoU should be lifted into the Act and potentially enhanced, for example with the principle that macro-prudential policies should be applied uniformly across all banks. Further elements of the governance regime might include: a list of areas that macro-prudential policies could be applied to8, e.g. capital, loan to value ratios, debt servicing capacity; and potentially a PTA-like document that would express operational objectives agreed from time to time with the Government of the day. I expect the technical details of the macro-prudential instruments would continue to be set out in the Banking Supervision handbook. The specific characteristics of macro-prudential that I have mentioned ̶ the common ground with micro-prudential policy and its stabilisation role ̶ point to the macro-prudential mandate remaining with the Reserve Bank. There are significant synergies across the micro and macroprudential functions, and the stabilisation aspect requires a macro-analysis capability and degree of coordination with monetary policy. The IMF in its 2017 FSAP report underlines this point and supports the Reserve Bank having responsibility for macro-prudential – but with full accountability. They point out that shared responsibility models, where macro-prudential decisions are made jointly by councils (e.g. made up of the ministry of finance, central bank and regulatory agencies), often suffer from inaction bias. 5/7 BIS central bankers' speeches An important further aspect of governance is decision-making. Given the planned introduction of a new decision making committee (MPC) for monetary policy, the Review should consider establishing a financial policy committee (FPC) for decisions relating to both micro and macro prudential policy. The Reserve Bank has supported a two-committee (MPC/FPC) model in place of the current single Governing Committee, for example in the Bank’s 2017 “Briefing for Incoming Minister”.9 I would expect an FPC to have overlapping membership with the MPC, at least including the Governor. However, it would likely include internal financial policy experts who do not sit on the MPC. Externals could be included on the FPC, although the complexity of the subject matter, the high volume of prudential decisions, and the need to avoid conflicts of interest would severely limit the number of viable candidates. Unlike in the UK where there are separate micro and macro-prudential committees, it would be sensible in the New Zealand context to have a single FPC that covers all prudential/regulatory policy issues. This would help to ensure consistency between the micro and macro-prudential policy frameworks. The FPC would be responsible for all decisions involving changes to the prudential/regulatory framework and also give guidance to the Governor on the shape of the Reserve Bank’s supervisory framework. Potentially the FPC could be a sounding board for important supervisory actions with respect to individual financial institutions. However, such operational decisions can be highly complex and, in stress situations, very time-critical. They should therefore continue to be the final responsibility of the Governor. The FPC would need to be held accountable for its micro and macro-prudential decisions. This would continue to be achieved through scrutiny by the Reserve Bank board on behalf of the Minister; by the Parliament through FEC; and by the public and financial markets through policy consultations and transparent reporting. The six-monthly Financial Stability Report would continue to be an important accountability document, supported by speeches and, potentially, published FPC minutes. As I mentioned, the information infrastructure will play a crucial role. There have been significant improvements in the information collections since the advent of macro-prudential policy in 2013. The increasing richness of data and analysis will continue to play a crucial role in underpinning macro-prudential decision making and the associated accountability structure. Conclusion In conclusion, there is a broadly held view that macro-prudential policy has been a useful addition to the financial policy toolkit since its introduction in 2013. While having limited scope to sustainably influence credit and asset price cycles, macro-prudential rules have significantly improved the resilience of banks’ balance sheets to potential housing market shocks. With the upcoming Review of the Reserve Bank’s financial policy framework, it is timely to consider ways in which macro-prudential policy may be improved and more broadly accepted. We need to get the best out of macro-prudential policy and position it as a lasting policy framework. We have close to five years of experience to draw on. Key lessons, reinforced by the international experience, are that macro-prudential policy must be modest in its ambitions and always have a prudential rationale. Macro-prudential policy cannot be used simply to try and manage the housing cycle. It must be applied consistently and backed by sound analysis, with transparent reporting and accountability. In anticipation of the Review I have presented some thoughts on how the macro-prudential framework may be improved, through a more systematic approach to policy adjustments, and a clearer articulation of the governance structure within the Reserve Bank Act. Such changes, including potentially a new Financial Policy Committee (FPC), should assist in gaining public understanding and help to put macro-prudential policy on a sound footing for the future. 6/7 BIS central bankers' speeches Macro-prudential is a very new policy framework that has filled an important policy gap. It needs to be given the best chance of future success. 1 See Box A in the November 2017 Financial Stability Report. Since banks’ risk weights are designed to be proportionate to the riskiness of their lending, the decline in the high-LVR share has reduced the regulatory capital buffers held against these loans. To counter this, the Reserve Bank has separately increased capital requirements for high-LVR and investor mortgages since 2013. 2 See Central Bank of Ireland (2017), Review of residential mortgage lending requirements. 3 See, for example, Bank of England (2017), Financial Stability Report, November 2017. 4 See Bank of England (2016), The Financial Policy Committee’s approach to setting the countercyclical capital buffer. 5 See IMF-FSB-BIS (2016) Elements of Effective Macroprudential Policies: Lessons from International Experience. 6 See, for example, CGFS (2016), Objective-setting and communication of macroprudential policies, and Gai (2017), The Design, Implementation and Governance of Macroprudential Policy. 7 IMF (2017), New Zealand Financial Sector Assessment Program: Technical note – Macroprudential institutional framework and policies. 8 Along the lines of section 78 in the current Act. 9 2017 Briefing to the Incoming Minister 7/7 BIS central bankers' speeches
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Speech by Dr John McDermott, Assistant Governor and Head of Economics of the Reserve Bank of New Zealand, at the Reserve Bank of Australia conference on central bank frameworks, Sydney, 12 April 2018.
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Inflation targeting in New Zealand: an experience in evolution A speech delivered to the Reserve Bank of Australia conference on central bank frameworks, in Sydney On 12 April 2018 By Dr John McDermott, Assistant Governor and Rebecca Williams, Economics Advisor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction It is a pleasure to discuss an issue that is especially pertinent for the Reserve Bank of New Zealand at present – the evolution of central bank frameworks. As many of you will be aware, the New Zealand Government is in the process of changing our monetary policy framework, to add employment to our existing mandate of price stability and formalise a decision-making structure based on a committee. This would bring us closer to a framework like the one here in Australia, and in the United States of America. This paper is in a section titled Twenty Years of Inflation Targeting, but in New Zealand it has actually been much closer to thirty. The RBNZ Act came into effect February 1990, making New Zealand the first country to formally adopt inflation targeting as we now know it. New Zealand’s experience has been one of evolution. As the Bank established its credibility – by which I mean it became clear that we could and would meet our price stability objective – we were able to develop a more flexible approach to inflation targeting, consistent with the literature and with developments in other inflation-targeting countries. We are about to enter the next stage of that evolution. I believe this next step is indeed an evolution, which builds on the flexible approach we have been taking for some time, rather than a revolution. That said, it is still too early to determine precisely what effect the new framework will have on the implementation of monetary policy. The New Zealand framework has changed significantly over thirty years, reflecting lessons learned and the changing economic and political environment. And it is likely to continue to evolve as we are faced with new developments. You may be very familiar with our pioneer’s tale, and want me to cut to the chase – our move towards a dual mandate and formalised committee. But before I touch on where we are going, I want to provide you with some context – where we started, and where we have been. The origins of inflation targeting: a need for credibility As I have noted, inflation targeting as we now know it was pioneered in New Zealand. 1,2 Other countries had been pursuing disinflationary monetary policy since the late 1970s, and by the early 1980s most OECD countries were announcing some form of money or credit target in an attempt to convince public and markets that they were taking the challenge of controlling inflation seriously (Reddell, 1999). But the focus internationally was on these ‘intermediate’ targets – the quantity of money or credit – rather than targeting inflation itself. Intermediate targets were thought to be informative for monetary policy as they were 1 Bernanke et al. (1999) provide a widely-cited definition of inflation targeting. 2 Italy, Greece and Portugal all published single year targets for inflation at times during the early 1980s, and Sweden briefly operated a form of price level targeting in the 1930s. However, none of these provided a complete, sustained structure for inflation targeting of the kind now understood by the term. In the 1970s and 1980s, West Germany conducted monetary policy in a framework that closely resembled inflation targeting, although it was officially designated as money targeting (Bernanke and Mihov, 1996). In addition, in 1995 the Bundesbank itself drew a distinction between its approach and inflation-targeting, arguing at the time that inflation-targeting was the inferior approach. Ref #7482042 v2.2 susceptible to a degree of central bank control. However, the extent to which intermediate targets were connected to the objective of price stability was subject to debate. 3 In the 1970s and 1980s, New Zealand had a very poor track record of price stability. Annual inflation had been around 10 to 15 percent since the early 1970s (figure 1), and was considerably higher than inflation in our main trading partners. A key driver of high inflation in New Zealand over this period was government spending, accommodated by generally loose monetary policy (Grimes, 1996). There had been episodes of tight monetary policy over this period. But successive governments had been unwilling to face the short-term costs to output and employment that disinflation brought with it, and had loosened policy again. Figure 1: Annual CPI inflation (target range shaded) Source: Statistics New Zealand. Bringing high inflation under control was a key priority for the Labour Government that came into power in New Zealand in July 1984. 4 In 1986, the then Minister of Finance Roger Douglas invited officials to explore options for reforming the monetary policy framework, aiming to reduce the scope for political influence that had seen past attempts to control inflation fail so badly. The framework that evolved over the next four years was the culmination of various strands of economic thought and the principles that were underpinning the wider reform of New Zealand’s public sector at the time. 5,6 At its core, the framework that emerged provided the Bank with a means to establish credibility that we would bring inflation down and keep it there. 3 See for example Friedman (1984) and Friedman (1990). 4 Then Reserve Bank Governor Spencer Russell (1984) discussed the new Government’s commitment to bring inflation under control: “We have had periods of tight monetary policy in the past. But by backing off at the eleventh hour, money and credit growth rates have been allowed to expand excessively again and the benefits from the temporary period of tightness have been lost. The Government has made it clear this will not be the case again”. 5 Reddell (1999) contains a detailed discussion of the origins and early development of the inflation target; Grimes (1996) also provides a comprehensive summary of monetary policy developments within the wider reform environment. 6 Don Brash, who was the first Governor of the inflation-targeting era, once said of the origins of inflation targeting in New Zealand “I will simply note that history can be surprisingly confusing, even for those who were there” (Brash, 1998). Ref #7482042 v2.2 And why does credibility matter? If policymakers are able to convince firms and workers that they will set policy to achieve the inflation target, this anchoring of inflation expectations makes it more likely that prices and wages will be set in a manner consistent with the target, even in the face of shocks to the economy. This naturally makes the target itself easier to achieve. Picture the New Zealand inflation-targeting framework as a newly-planted tree. In the 1970s and 1980s, several seedlings of low inflation had been planted, but none took hold. The ground conditions – a highly regulated financial market and economy – were not conducive to growth, and the winds of politics kept blowing the seeds of low-inflation away before they had a chance to flourish. By the mid-1980s, ground conditions were much improved. New Zealand had gone through a dramatic period of financial market reform in the nine months between July 1984 and March 1985. The float of the New Zealand dollar and the commitment of the government to fund the fiscal deficit via issuance of public debt to the private sector freed up the Bank to pursue domestic monetary policy (Kamber et al., 2015). To ensure that inflation-targeting could establish credibility and take hold, four highly-related aspects of the framework were provided as stakes in the ground to support the new sapling. 7 These stakes were: operational independence; transparency; the single objective of price stability; and the Governor as sole decision maker, which I will now discuss in turn. (i) Operational independence (RBNZ Act Section 13) Firstly, operational independence. The Reserve Bank Act (1989) provided the Bank with its operational independence and its monetary policy objective. 8 It was heavily influenced by the literature on the time inconsistency of monetary policy and the experience during the 1970s and 1980s, in which successive governments had been unwilling to endure the shortterm effects of disinflation for the longer-term gains of price stability. 9 The specific monetary policy target of the 1989 Act was to be publicly agreed in a Policy Targets Agreement (PTA) between the Minister of Finance and the Governor of the Reserve Bank. Prior to the late1980s, Reserve Bank independence had been non-existent: the 1973 Amendment to the RBNZ Act had stated that the Bank was to “give effect to the monetary policy of the 7 It is worth noting that the Act does not specify that there must be targets for inflation itself. The Act specifies only “policy targets for the carrying out by the Bank of its [price stability objective]”, which leaves open the possibility of specifying targets such as nominal GDP consistent with medium-term price stability. 8 Except as otherwise provided for in the Act: Section 12 allows for the Bank to be directed by the Governor-General to implement policy for a different economic objective than the one in Section 8, by Order in Council on the advice of the Minister. This Section was included primarily for use in times of emergency (such as wartime) and has never been used. Any temporary redirection of policy would be well publicised since Orders in Council must be published in the New Zealand Gazette. The Reserve Bank Act (1989) can be accessed at http://www.legislation.govt.nz/act/public/1989/0157/latest/DLM199364.html. 9 The time inconsistency problem is that authorities have an incentive to promise low inflation in the future, but then renege in order to boost activity (in order to obtain more votes, for example). As firms and households begin to anticipate this behaviour, their expectations of inflation increase and so they set prices and demand wages accordingly. The economy then ends up in a worse position with higher inflation and (potentially) higher unemployment (see, for example, Barro and Gordon, 1983). Ref #7482042 v2.2 Government”. 10 The RBNZ Act (1989) provided the Bank with credibility in meeting its objective by no longer being subject to concerns or incentives regarding the electoral cycle. (ii) Transparency (RBNZ Act Section 15) Monetary policy operates with significant lags and in an inherently uncertain environment, and therefore naturally requires a great deal of judgement and discretion. To ensure that operational independence was used appropriately, the Act also specified a high degree of transparency in how the Bank formulated policy. The Act requires the Bank to publish regular statements on its monetary policy decisions and for these to be laid before Parliament. The Governor’s deliberations were also to be monitored and assessed by a Board consisting of members appointed by the Minister of Finance. (iii) Single objective (RBNZ Act Section 8) Providing the Bank with one objective, rather than a list of objectives – production, trade, full employment and price stability – as had been the case previously, made it more credible that the Bank could actually achieve its mandate. The Act states “The primary function of the Bank is to formulate and implement monetary policy directed to the economic objective of achieving and maintaining stability in the general level of prices.” It acknowledged that price stability was the greatest contribution monetary policy could make to New Zealand’s economic wellbeing. It recognised the limitations of monetary policy over the medium term, and provided the Bank, financial markets and wider public with a clear objective for policy. Moreover, the initial PTA clearly defined price stability with a numerical target band of 0 to 2 percent. This clear numerical target provided a nominal anchor against which the Governor’s performance could be assessed and around which inflation expectations could converge. (iv) Single decision maker (RBNZ Act Section 9) The final stake in the ground was the assignment of authority and responsibility to an individual – the Governor. This ‘single decision-maker’ model was highly influenced by the principles underpinning the reform of the wider public sector at the time, which gave individual public sector managers the authority to manage but made them directly accountable for outputs (Reddell, 1999 and Sherwin, 1999). The employment contract between the Minister of Finance and the Governor evolved into the PTA. The legislation made it clear that the Governor could lose his or her job for “inadequate performance” in meeting these objectives. 11 In summary, the inflation-targeting framework established in the late 1980s was planted under conditions that increased its likelihood of success. The four stakes of operational independence, transparency, the single objective of price stability, and the single decisionmaker model provided essential support to a new framework, and encouraged it to take root and establish its credibility. And why have I taken you on this history lesson? To provide you with some context on the New Zealand framework, and to introduce some aspects of the framework that remain as critical today as they were in 1989, and some that are about to change. But I will come back to that shortly. 10 Graham and Smith (2012) provide a history of Reserve Bank of New Zealand independence. 11 Donald Brash (2002) recalls the response of the Minister responsible for the Reserve Bank legislation to his initial surprise that the PTA would be between the Government and Governor, rather than the Government and the Bank “We can’t fire the whole Bank. Realistically, we can’t even fire the whole Board. But we sure as hell can fire you!” Ref #7482042 v2.2 The evolution of inflation targeting: increasingly flexible Since being planted in the late-1980s, New Zealand’s framework has evolved significantly. As pioneers, it was always unlikely that we could introduce a framework that got everything ‘right’ from the start, especially given that the environment in which policy operates has itself developed a lot over the years (Sherwin, 2000). The evolution of the inflation-targeting framework in New Zealand can be characterised as one of increasing flexibility, consistent with the academic literature and with developments in other advanced economies. As our tree grew taller and its roots grew deeper – as we gained credibility by actually meeting our target, and anchored inflation expectations – we could be more confident that our tree could bend in the wind, without being uprooted. What exactly do I mean by flexibility? Over the past three decades, monetary policymakers and academics have learned that there is a trade-off, not between inflation and output, but between the volatility of inflation and output. Monetary policy that is set to offset short-term movements in inflation away from target – referred to as ‘strict’ inflation targeting – will result in more volatility in output and other economic variables such as employment and the exchange rate. 12 As the Bank established its credibility in achieving its inflation target, we could allow some volatility in realised inflation in order to offset some volatility elsewhere in the economy. In practice, this means that interest rates have generally been adjusted more slowly. And in this sense, the Bank has increasingly paid regard to the wider economy despite having a consistent overall objective of price stability specified in the Act. This increasingly flexible approach has, however, been reflected in the evolving content of successive PTAs over the past thirty years. The PTA – which you will remember provides the Bank with its specific target in meeting its overall objective – must be renegotiated with the Minister of Finance each time a Governor is appointed or reappointed, and has also tended to be updated on the formation of a new government. This process naturally lends itself to incremental adjustments, influenced by the economic and political environment at the time. Since 1990, there have been 13 PTAs, with some alterations more significant than others. The Reserve Bank of New Zealand has seen more changes to its target than most other inflation-targeting central banks, and the process of renegotiation also provides more opportunity for government direction than is the case in some other countries (Wadsworth, 2017). In some ways, the number of changes has been less than ideal, as it has the potential to undermine the public’s faith in the policy target. But since these changes have formalised things that we have learned in the process of operating policy, and reflected the underlying goals of the public via the political process, they have been entirely appropriate. There are several highly-related dimensions of flexibility, and I will now take you through some key developments in New Zealand’s inflation-targeting framework along these dimensions, which are summarised in table 1 below. 12 See for example Svensson (1997). Ref #7482042 v2.2 Table 1: Evolution of flexible inflation targeting in New Zealand 1990-2017 Time to target Early to mid-1990s Late 1990s & 2000s Initially, target to be achieved by a set date Time to target implicitly lengthened; Bank to respond to general inflationary pressure Dec 1990: Annual inflation to remain inside the target band, and the Bank to calculate and explain deviations due to shocks outside the Bank’s control (explicit ‘caveats’) Target definition Explicit medium-term focus has remained List of shocks that could result in deviation from target became illustrative, rather than exhaustive 2002: medium-term focus made explicit 1999: Bank shall seek to avoid unnecessary instability in output, interest rates and the exchange rate Secondary considerations 2010s 2012: Bank to have regard to the efficiency and soundness of the financial system; Bank to monitor asset prices Other secondary considerations (stability of output, interest rates and the exchange rate) have remained Initially, 0-2 percent 1996: 0-3 percent 2002: 1-3 percent 2012: 1-3 percent, with a focus on the 2 percent target midpoint Early to mid-1990s The initial inflation target of 0-2 percent originated primarily as a communications device – a way for Minister Roger Douglas to refocus expectations and convince the public that the anti-inflation drive would continue (Reddell, 1999). 13 Inflation was within the target by 1991, and stayed there until June 1995 when adverse weather pushed up the prices of fruit and vegetables and saw inflation increase to 2.2 percent. 13 During a televised interview broadcast on 1 April 1988, Roger Douglas said that policy was to be directed to reducing inflation to “around zero to one percent” over the following couple of years. By the June 1988 RBNZ Bulletin the Bank felt confident enough to describe the ultimate goal as being “price stability by the 1990s” and that “in terms of the CPI, this objective is likely to be consistent with a small positive measured inflation rate, in the order of 0-2 percent, as a result of several problems in the construction of the index.” (Reddell, 1988). Ref #7482042 v2.2 Over the next few years, inflation remained at the top of or marginally above the target range. With hindsight, the Bank was slow to recognise the pace of acceleration of the economy in 1992/93, and relied on the transmission of policy via the exchange rate to a greater extent than was ideal given the structural changes we later learned were underway (RBNZ, 2000a). The Bank learned that keeping inflation within such a narrow range could likely only be achieved at the cost of undesirably high volatility in the real economy, and began talking about the target as something that we would constantly aim for rather than something we could – or should – deliver every quarter (Brash, 2002). Since December 1990, PTAs had contained some allowance for actual inflation to deviate from target. These were in the form of explicit ‘caveats’ or ‘principal shocks’ recognised as being outside the Bank’s control. We were required to calculate and publish the direct effect these had on inflation outcomes. In practice, we found it increasingly difficult to determine which items to include or exclude, and were exposed to (although never received much) criticism that we could manipulate the calculation in order to meet our objective. In 1996, the target was widened to 0-3 percent, reflecting the new National/New Zealand First Coalition Government’s preferences (RBNZ, 2000b). The Bank was comfortable with this widening as we felt it was unlikely to materially affect monetary policy credibility or adversely affect inflation expectations. 14 By allowing slightly more inflation variability it enabled policy to offset volatility in the real economy to a greater extent. The 1996 PTA also modified the explanation of the Bank’s overall objective to be more explicit that price stability was the best contribution that monetary policy could make to economic growth and employment, rather than simply being an end in and of itself (RBNZ, 2000b). Late 1990s and 2000s As the Bank learned more about the transmission of monetary policy in the New Zealand economy during the 1990s, we put increasing weight on real economy channels and less on direct exchange rate effects (Brash, 1998). Specifically, we found that the pass-through of nominal exchange rate changes into local prices had become more muted over the 1990s. This meant that the slower part of the monetary policy transmission mechanism – via the real economy – was given even greater prominence in meeting our objective (RBNZ, 2000a). This change in emphasis effectively lengthened the horizon over which policy was formulated, which in itself encouraged less variability in interest rates, the exchange rate and output. In 1999, the incoming Labour/Alliance Coalition Government initiated the modification of the PTA to state that “In pursuing its price stability objective, the Bank… shall seek to avoid unnecessary instability in output, interest rates and the exchange rate”. The Bank viewed these changes as largely confirming the flexible approach we had been taking for most of the inflation-targeting period (RBNZ, 2000b). It reflected that several policy paths could be chosen in order to meet our inflation target, and the effect of these paths on the real 14 Recent research by the Bank has found that the widening of the target did result in an increase in long- term inflation expectations, but that this increase was not statistically significant (Lewis and McDermott, 2016). Ref #7482042 v2.2 economy and other variables was influential in determining which path was ultimately selected (RBNZ, 2000c). The changes were also a reflection of economic developments. The Bank initially underestimated the combined effect of the Asian financial crisis and the droughts that affected rural New Zealand in the summers of 1997/98 and 1998/99, which led to recession in New Zealand. We operate in an uncertain world, and monetary policy would never have been able to completely offset the effect of these shocks. Yet the way we implemented monetary policy over this period – via the Monetary Conditions Index (MCI), 15 which was introduced in mid-1997 – shaped the response in a way that probably contributed to the fall in output and added unnecessary interest rate volatility (RBNZ, 2000a). The Bank recognised this, and we replaced the MCI with the Official Cash Rate (OCR) as the instrument of monetary policy in March 1999. The MCI was a branch that we lopped off fairly quickly. In May 2000, the Minister of Finance invited Professor Lars Svensson to review the operation of monetary policy in New Zealand. He found the framework to be “entirely consistent with the best international practice of flexible inflation targeting, with a mediumterm inflation target that avoids unnecessary variability in output, interest rates and the exchange rate” (Svensson, 2000). He did recommend a move from the single-decision maker to committee model, but the Government chose not to support this recommendation at this time (see Government’s response to Monetary Policy Review, 2001). But during the early 2000s, concern continued to grow among politicians, industry representatives, commentators and the wider public that the economy’s trend growth rate had been unnecessarily constrained by the performance of monetary policy (RBNZ, 2002). Those expressing concern suggested that this constraint resulted from a target that was too low and policy that was too aggressive. It was argued that these factors had resulted in interest rates that were too high on average, and in interest rates and the exchange rate being too volatile. The Bank noted the long-held and internationally-accepted view that monetary policy was unlikely to have a large influence on the long-run performance of the economy, and that there was no evidence that policy in New Zealand was more aggressive than elsewhere. But we also had not found any clear evidence that trend inflation of 2 percent would produce better or worse outcomes for trend growth than trend inflation of 1.5 percent. In the end, the target (and therefore midpoint) was changed to 1-3 percent in the 2002 PTA. Recent Bank research has found that this change was accompanied by an immediate increase in long-run inflation expectations (Lewis and McDermott, 2016). The 2002 PTA also made the medium-term focus of monetary policy explicit, and firmly embedded the flexible approach (see, for example, Hunt, 2004). It changed the target from “12-monthly increases” to “future CPI inflation outcomes… on average over the medium term”. This medium-term focus has been an enduring feature of PTAs to this day. The Bank 15 The MCI was a weighted summation of the exchange rate and short-term interest rate, with weights reflecting each variable’s medium-term effect on aggregate demand and thus inflation. The MCI was used to identify the overall stance of monetary policy and to communicate the likely direction and extent of change in stance going forward. Ref #7482042 v2.2 has interpreted this target to mean that it should set policy in order for inflation to remain or settle comfortably within the target band in the latter half of a three-year horizon (Bollard and Ng, 2008). During the mid-2000s, economic developments reignited concern about the monetary policy framework. Although New Zealand had been one of the faster-growing OECD economies since the early 1990s, this growth had been accompanied by the emergence of macroeconomic imbalances: a relatively large current account deficit, high house price inflation and household indebtedness, and a real exchange rate that had risen to levels sometimes regarded as unjustified by medium-term fundamentals (RBNZ, 2007b). In early 2007, the Government requested another inquiry into the monetary policy framework. The Bank reiterated that there was no compelling evidence to suggest that these features had arisen from the design of the monetary policy framework. We recognised that with the benefit of hindsight, we had been slow to fully recognise the strength of demand and housing market pressure on inflation over the cycle. However, this was a feature of having to operate policy under uncertainty (RBNZ, 2007a and Chetwin and Reddell, 2012). We noted that solutions to New Zealand’s imbalances were likely to lie in other policy domains, and suggested several ‘supplementary stabilisation instruments’. 16 Following the review, the Government decided not to make any changes to the RBNZ Act or the PTA, 17 nor introduce any of the suggested instruments (see FEC, 2008 for the full report). Monetary policy during the global financial crisis (GFC) of 2008/09 demonstrated the flexibility of the inflation targeting framework. Despite CPI inflation being driven well above the target band by higher oil prices over 2008, the Bank reduced the Official Cash Rate (OCR) by 575 basis points between June 2008 and June 2009. Our tree remained firmly planted, anchored by its roots of credibility, despite the largest global storm since the Great Depression. Longer-term inflation expectations remained within the target range, and the reduction in the OCR helped support the New Zealand economy at a time of global distress (see, for example, Chetwin, 2012). 2010s The GFC led many central banks to focus more heavily on how financial system developments should be treated by monetary policy. The Bank had always monitored asset prices and taken them into account in both monetary and prudential policy (see Bollard, 2004), and the Reserve Bank Act had long contained a requirement for the Bank to have regard for financial stability when setting monetary policy. However, the 2012 PTA made this explicit by adding asset prices to the list of prices the Bank was directed to monitor, and including the requirement that the Bank “have regard to the efficiency and soundness of the financial system” (see Kendall and Ng, 2013). 16 These included cyclical variations in migrant approvals, increasing the responsiveness of housing supply, measures to limit procyclicality in fiscal policy, and consideration of various aspects of the tax regime (RBNZ, 2007a and RBNZ, 2007b). 17 The FEC (2008, p.16) report stated that “Continuity is an important part of this framework, providing the public with confidence in the framework’s commitment to low and stable inflation. In view of the broad success of the framework, we do not recommend any change to the framework.” Ref #7482042 v2.2 The Reserve Bank of New Zealand is unusual internationally, although not unique, in having both monetary policy and prudential responsibilities. In October 2013, the Bank introduced restrictions on high-LVR mortgage lending. 18 While these macroprudential tools were introduced for financial stability purposes, they clearly interact with monetary policy’s goal of price stability – particularly given the strong relationship between house prices and domestic demand we have observed in previous economic cycles in New Zealand. Although they have different objectives, our macroprudential policies were complementary to monetary policy when first introduced; the LVR restrictions were acting to reduce growth in house prices at a time when the Bank expected inflationary pressures to build (see Williams, 2017a). But as the outlook for inflation weakened, the policies began to have opposing implications for the business cycle. The PTA is clear that monetary policy must have regard to financial stability but it does not – and probably cannot – specify exactly what trade-offs should be entertained. The optimal balance between price and financial stability remains an area of ongoing research in New Zealand and abroad. 19 An explicit reference to the target midpoint was also incorporated into the 2012 PTA, so that it now read “keep future CPI inflation outcomes between 1 per cent and 3 per cent on average over the medium term, with a focus on keeping future average inflation near the 2 per cent target midpoint”. This was motivated by the desire to anchor inflation expectations more firmly to 2 per cent, as they had been close to the upper end of the target band for most of the inflation targeting period (Kendall and Ng, 2013). In recent years, inflation in New Zealand has been persistently low, as in many countries around the world. We have undertaken a great deal of research to better understand why this has been the case, and what characteristics of this expansion have differed from expansions before it (see Williams, 2017b, for a summary of this work). Some features have simply been revealed with the passage of time, and some reflect our evolving understanding of how the economy operates. But we have not found any features that imply that the framework itself should be revolutionised – that the Bank has been confronted with new developments is an unavoidable fact of life, not just monetary policy. 20 Where to from here? The next stage in our evolution Our increasingly flexible approach to inflation targeting outlined above has been made possible by the achievement and maintenance of credibility regarding our framework. There are two key aspects of the framework – two of our stakes in the ground – that remain as important today as they were in 1989. These are operational independence and transparency. 21 Changes to the PTA have tended to reflect actual Bank practice at the time, but have also often been initiated by the government of the day. The Bank has seen several government reviews of its framework, often in response to macroeconomic developments. And this is 18 See for example Rogers (2013) and Dunstan (2014). 19 Kamber et al. (2015) note that while the importance of coordination depends on the magnitude of the externalities that each policy has on the other, how large these effects are is currently not well understood. Since the Bank is jointly responsible for both policies, these trade-offs should necessarily influence the settings of both monetary and macroprudential policies. 20 See a speech I gave in 2017, on “The value of forecasting in an uncertain world” (McDermott, 2017). 21 See Blinder (1998) for an excellent discussion of central bank independence and transparency. Ref #7482042 v2.2 how it should be – while operational independence within the framework is critical for credibility (and therefore effectiveness), the framework itself should be designed by the government to maximise the wellbeing of New Zealanders. Over the course of thirty years we believe the framework has served New Zealanders well – most of the graduates we have hired in recent years have never known anything other than low and stable inflation. Transparency also remains a critical aspect of the framework. Being transparent about our assessment of the economy and our plan to meet our objective has an influence on expectations, and helps us achieve our objective. The Reserve Bank was the first central bank to publish its interest rate forecast, starting in 1997. 22 And crucially, transparency aids in the assessment of our actions, and allows us to be held to account. 23 But what of the other supports, the single decision-maker and single objective? As I noted at the very start, these are the two aspects of the framework that the New Zealand Government is in the process of changing, to formalise a committee structure and add employment to our mandate. We agree that the single-decision maker model has become less relevant over time. In reality, Reserve Bank Governors have a long history of utilising advisory committees (Bollard et al., 2006). And in 2013, we established the Governing Committee that at the time consisted of the Governor (as Chair), two Deputy Governors and myself (as Assistant Governor). While the Governor retains the right of veto on decisions, and continues to have statutory responsibility for policy, the Committee members work together to test ideas and build consensus around the monetary policy decision (Wheeler, 2013 and Richardson, 2016). The flexibility of our approach to inflation targeting requires a great deal of judgement, and the use of a committee maximises the knowledge and experience of members individually and as a collective. The Government will formalise a monetary policy committee (MPC) in the Act, and add members from outside the Bank, ‘externals’, onto the committee. The Act will allow the MPC to have between five and seven members, but there will be seven initially, and there will always be more internal than external members. All members will be nominated by the Reserve Bank Board, and appointed by the Minister of Finance. There will also be a nonvoting observer from the New Zealand Treasury. Figure 2 illustrates the structure of the committee to be established in the Act. 22 Dincer and Eichengreen (2014) found that New Zealand was one of the most transparent central banks in the world (third behind Sweden and the Czech Republic in 2014), although by their estimates we rank much lower on central bank independence. The authors base the transparency indices on public reports and communications by each central bank, and the independence indices on central bank law in each country. 23 See Ford, Kendall and Richardson (2015) for more on the evaluation of monetary policy. Ref #7482042 v2.2 Figure 2: Monetary Policy Committee to be established in the Reserve Bank of New Zealand Act Source:https://beehive.govt.nz/release/new-pta-requires-reserve-bank-consider-employmentalongside-price-stability-mandate The MPC and Minister of Finance will agree a Charter setting out the approach to issues defined in the Act, including the approach to communications. Details of the first Charter are yet to be determined, but the Minister intends for the MPC to aim to reach decisions by consensus, and for non-attributed votes to be published where there is not consensus. The Minister also intends for non-attributed records of meetings to be published that reflect any differences of view among the MPC. We will no doubt explain these and other changes – and their potential implications for the setting and communicating of policy – as they are finalised. Of course, the creation of a formal (or indeed informal) committee does not guarantee superior outcomes. How the MPC will operate in practice is also extremely important. Committees are more successful when they have processes in place that aim to minimise various human biases, such as the pressure to conform, confirmation bias, and a tendency to rely on the most recent events to a greater extent than is sometimes warranted. 24 The Bank will continue to ensure our internal processes aim to maximise the benefits that committees can provide. And what of the move to a ‘dual mandate’? The Bank has always had regard to developments in the labour market, and this has been encouraged by our increasingly flexible approach. We have a long history of meeting with businesses and organisations 24 The movie 12 Angry Men (1957, MGM) provides an excellent demonstration of how ‘committees’ (a jury in this case) should not behave, for example publicly revealing individual priors at the start of the meeting. Ref #7482042 v2.2 across the country, and we regularly assess the available labour market data and are committed to discussing labour market developments. So my current sense is that, to a large extent, the changes are a way of ensuring that the flexibility in our approach endures. The exact wording of the full employment objective in the Act is yet to be determined. However, the PTA that Adrian Orr signed a few weeks ago on March 26th reflected the upcoming changes to the Act, and does not provide the Bank with a numerical target for full employment as it has with price stability. This is helpful, as ‘maximum sustainable employment’ cannot be fully captured by a single indicator. Focusing too narrowly on one indicator, such as the unemployment rate, can be misleading. For example, a fall in the unemployment rate could be the result of an increased demand for labour – typically reflecting a strong economy – or the result of people dropping out of the labour force altogether because they are unable to find a job and have become discouraged. These different causes have very different implications for how the labour market is evolving and would therefore have very different implications for monetary policy. Specifying a numerical target for inflation but leaving the employment target as a qualitative objective is consistent with the practice here in Australia, and in the United States too. The Bank will continue to consider a wide range of labour market indicators when formulating policy, although we will communicate our assessment of and outlook for the labour market in more detail than we have in the past. And just as with inflation, our understanding of the labour market can always be improved as we are faced with new data, new developments, and as new research methods become available. That said, there are widely-recognised limits to what monetary policy can do over the long run. We have some influence over the degree to which the unemployment rate, as just one example, deviates from its underlying trend. But ultimately that underlying trend is determined by factors outside of our ability to influence, that rely instead upon the age and skills of the population, the efficiency with which jobs are matched to available workers, and the nature of employment regulation. Conclusion I would like to conclude by reiterating that New Zealand’s experience with inflation targeting has been one of evolution. The Reserve Bank Act (1989) provided the supports that enabled us to establish credibility in our intent to meet our objective of price stability. As we lowered inflation, and anchored expectations within the target range, we could implement an increasingly flexible approach to monetary policy that has been reflected in successive PTAs. This flexible approach means that we have long had regard to the real economy, including employment. That the Bank has operational independence and is transparent in meeting our objective is as important for credibility today as it was in 1989. But the framework and the specific targets that we operate within and towards are for the public, via the political process, to determine. The Government is currently in the process of changing the framework, to assign monetary policy responsibility to a committee with external members and add employment to the Bank’s current mandate of price stability. Ref #7482042 v2.2 I see the inclusion of (maximum sustainable) employment into our mandate as reinforcing the flexibility of inflation targeting. That said, it is still too early to determine what effect these changes will have on the conduct and communication of monetary policy. I expect that in five or ten years’ time someone from the Reserve Bank of New Zealand will be back at a similar conference, to explain how it all went. Ref #7482042 v2.2 References Barro, Robert and David Gordon (1983), “Rules, Discretion and Reputation in a Model of Monetary Policy”, Journal of Monetary Economics, 12(1), pp.101-121. Bernanke, Ben and Ilian Mihov (1997), “What does the Bundesbank target?”, European Economic Review, 41(1997), pp. 1025-1053. Bernanke, Ben, Thomas Laubach, Frederic Mishkin and Adam Posen (1999), Inflation Targeting: Lessons from the International Experience, Princeton University Press, Princeton, New Jersey. Blinder, Alan (1998), Central Banking in Theory and Practice, The MIT Press, Cambridge, Massachusetts. Bollard, Alan (2004), “Asset prices and monetary policy”, Reserve Bank of New Zealand Bulletin, 67(1), pp. 27-34. Bollard, Alan and Özer Karagedliki (2006), “Inflation targeting: The New Zealand experience and some lessons”, paper prepared for the Inflation Targeting Performance and Challenges Conference by the Central Bank of Republic of Turkey, held in Istanbul 19-20 January 2005, accessed at https://www.rbnz.govt.nz/research-andpublications/speeches/2006/speech2006-01-18. Bollard, Alan and Tim Ng (2008), “Flexibility and the limits to inflation targeting”, Reserve Bank of New Zealand Bulletin, 71(3), pp. 5-13. Brash, Donald (1998), “Inflation targeting in New Zealand: experience and practice”, Reserve Bank of New Zealand Bulletin, 61(3), pp. 221-227. Brash, Donald (2002), “Inflation Targeting 14 years on”, a speech delivered at the American Economics Association conference in Atlanta 5 January 2002, accessed at https://www.rbnz.govt.nz/research-and-publications/speeches/2002/speech2002-01-05. Chetwin, Willy (2012), “Business cycle review, 1998-2011”, Reserve Bank of New Zealand Bulletin, 75(1), pp. 14-27. Chetwin, Willy and Michael Reddell (2012), “Monetary policy in the last business cycle: some perspectives”, Reserve Bank of New Zealand Bulletin, 75(2), pp. 3-14. Dincer, N. Nergiz and Barry Eichengreen (2014), “Central Bank Transparency and Independence: Updates and New Measures”, International Journal of Central Banking, 10(1), pp. 189-259. Updated estimates can be found at https://eml.berkeley.edu/~eichengr/data.shtml. Dunstan, Ashley (2014), “Interactions between monetary and macro-prudential policies”, Reserve Bank of New Zealand Bulletin, 77(2), pp. 15-25. Ref #7482042 v2.2 FEC (2008), “Inquiry into the future monetary policy framework”, Report of the Finance and Expenditure Committee, September 2008, accessed at https://www.parliament.nz/en/pb/sc/reports/document/48DBSCH_SCR4210_1/inquiry-intothe-future-monetary-policy-framework-i3n. Ford, Dean, Elizabeth Kendall and Adam Richardson (2015), “Evaluating monetary policy”, Reserve Bank of New Zealand Bulletin, 78(7), pp. 1-21. Friedman, Benjamin (1984), “The value of intermediate targets in implementing monetary policy”, NBER Working Paper, No. 1487, November 1984. Friedman, Benjamin (1990), “Targets and instruments of monetary policy”, in Friedman, Benjamin and Frank Hahn, Handbook of Monetary Economics, Volume II, Elsevier Science B.V., Amsterdam. Government’s Response to Monetary Policy Review (2001), released 30 May 2001, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/independentreview-of-the-operation-of-monetary-policy-2. Graham, James and Christie Smith (2012), “A brief history of monetary policy objectives and independence in New Zealand”, Reserve Bank of New Zealand Bulletin, 75(1), pp. 28-37. Grimes, Arthur (1996), “Chapter 8: Monetary Policy”, in Silverstone, Brian, Alan Bollard and Ralph Lattimore, A Study of Economic Reform: The Case of New Zealand, Elsevier Science B.V., Amsterdam. Hunt, Chris (2004), “Interpreting clause 4(b) of the Policy Targets Agreement: avoiding unnecessary instability in output, interest rates and the exchange rate”. Reserve Bank of New Zealand Bulletin, 67(2), pp.5-20. Kamber, Güneş, Özer Karagedliki and Christie Smith, “Applying an Inflation Targeting Lens to Macroprudential Policy ‘Institutions’”, International Journal of Central Banking, 11(S1), pp. 395-429. Kendall, Ross and Tim Ng (2013), “The 2012 Policy Targets Agreement: an evolution in flexible inflation targeting in New Zealand”, Reserve Bank of New Zealand Bulletin, 76(4), pp. 3-12. Lewis, Michelle and C. John McDermott (2016), “New Zealand’s experience with changing its inflation target and the impact on inflation expectations”, New Zealand Economic Papers, 50(3), pp. 343-361. McDermott, John (2017), ‘The value of forecasting in an uncertain world”, a speech delivered to the New Zealand Manufacturers and Exporters Association (NZMEA) in Christchurch 15 May 2017, accessed at https://www.rbnz.govt.nz/research-andpublications/speeches/2017/speech-2017-05-15. Ref #7482042 v2.2 RBNZ (2000a), “Submission by the Reserve Bank of New Zealand”, response to the Independent Review of the Operation of Monetary Policy, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/independent-review-of-theoperation-of-monetary-policy-2. RBNZ (2000b), “The evolution of Policy Targets Agreements”, supporting paper to the Independent Review of the Operation of Monetary Policy, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/independent-review-of-theoperation-of-monetary-policy-2. RBNZ (2000c), “Inflation targeting in principle and in practice”, supporting paper to the Independent Review of the Operation of Monetary Policy, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/independent-review-of-theoperation-of-monetary-policy-2/inflation-targeting-in-principle-and-in-practice. RBNZ (2002), “The Policy Targets Agreement: a briefing note”, accessed at https://www.rbnz.govt.nz/monetary-policy/policy-targets-agreements/pta2002/briefing-noteand-related-papers-2002. RBNZ (2007a), “Main submission to the Finance and Expenditure Select Committee Inquiry into the Future Monetary Policy Framework”, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/finance-and-expenditureselect-committee-inquiry-into-the-future-monetary-policy-framework. RBNZ (2007b), “Supporting Paper A6: Supplementary Stabilisation Instruments Project and the Macroeconomic Policy Forum”, supporting paper to the Finance and Expenditure Select Committee Inquiry into the Future Monetary Policy Framework, accessed at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/finance-and-expenditureselect-committee-inquiry-into-the-future-monetary-policy-framework. Reddell, Michael (1988), “Inflation and the monetary policy strategy”, Reserve Bank of New Zealand Bulletin, 51(2), pp. 81-84. Reddell, Michael (1999), “Origins and early development of the inflation target”, Reserve Bank of New Zealand Bulletin, 62(3), pp. 63-71. Richardson, Adam (2016), “Behind the scenes of an OCR decision in New Zealand”, Reserve Bank of New Zealand Bulletin, 79(11), pp. 1-15. Rogers, Lamorna (2013), “A new approach to macro-prudential policy for New Zealand”, Reserve Bank of New Zealand Bulletin, 76(3), pp. 12-22. Russell, Spencer (1984), “Monetary policy since the change in government”, Reserve Bank of New Zealand Bulletin, 47(9), pp. 467-468. Sherwin, Murray (1999), “Inflation targeting: 10 years on”, Reserve Bank of New Zealand Bulletin, 62(3), pp. 72-80. Ref #7482042 v2.2 Svensson, Lars (1997), “Inflation targeting in an open economy: Strict or flexible inflation targeting?”, Reserve Bank of New Zealand Discussion Paper, G97/8. Svensson, Lars (2000), “Independent Review of the Operation of Monetary Policy in New Zealand: Report to the Minister of Finance”, accessed at https://www.rbnz.govt.nz/monetarypolicy/about-monetary-policy/independent-review-of-the-operation-of-monetary-policy-2. Wadsworth, Amber (2017), “An international comparison of inflation-targeting frameworks”, Reserve Bank of New Zealand Bulletin, 80(8), pp. 1-34. Wheeler, Graeme (2013), “Decision making in the Reserve Bank of New Zealand”, a speech delivered to the University of Auckland Business School in Auckland 7 March 2013, accessed at https://www.rbnz.govt.nz/research-andpublications/speeches/2013/speech2013-03-07. Williams, Rebecca (2017a), “Business cycle review: 2008 to present day”, Reserve Bank of New Zealand Bulletin, 80(2), pp.1-22. Williams, Rebecca (2017b), “Characterising the current economic expansion: 2009 to present day”, Reserve Bank of New Zealand Bulletin, 80(3), pp.1-22. Ref #7482042 v2.2
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of New Zealand, at The Point Conference, hosted by Payments New Zealand, Auckland, 26 June 2018.
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In search of gold: Exploring central bank issued digital currency A speech delivered to The Point Conference in Auckland On 26 June 2018 By Geoff Bascand, Deputy Governor Introduction Kia ora and thank you to Payments New Zealand for the invitation to speak. Payments systems are highly interconnected by nature, so it is fitting that we are all here connecting with each other—learning, listening and discussing the hot topics in payments. 1 The payments system is an integral part of our financial system. It is also one that is evolving at considerable pace. We have already heard this morning about changing consumer demands and advances in financial technologies. Retail payments have become faster, and much easier to access. We can now initiate payments in a variety of ways – we can simply tap our credit cards, hold up our mobile phones, or pay for things remotely using a mobile banking app. Sellers at farmers’ markets can now receive card payments by plugging a small device into their mobile phones, and charities can now collect donations on the street using Q-code technology. All of these developments have made transactions more convenient, faster, and accessible for consumers and merchants. But they have mostly been concentrated at the front-end of the payments process. Crypto-currencies, and the blockchain technology they rely on, are bringing about more farreaching changes in the payments system and the way we view money. Blockchain technology is unique because there is no central agent managing the system, and there is no separation between sending the payment instruction and the final settlement of funds. It’s a different type of payment system and could bring new opportunities to payments and currency. This period of change can be compared to an earlier time when exploration was fast-paced and the stakes were high—the 1860s, when the gold rush hit New Zealand. During this period, miners came from all over the world to find gold in our valleys and rivers. Gold, a form of money (in respect, then, of its payment and store of value properties), could be found by anyone with a bit of luck, determination and hard work. The early 1860s gold rush is not unlike the search for wealth that has fuelled the speculation in privately issued crypto-currencies. But beyond the speculation surrounding Bitcoin prices, and the debate regarding whether it is a currency, an asset or a bubble, there lies a fundamental question—should central banks enter this terrain, and issue digital currencies of their own to the public? The Reserve Bank has a strong record of innovation and welcomes technological progress. 2 However, when considering digital currencies, it should be remembered that riches did not come easily during the gold rush, and they will not come easily now. A central bank digital currency would be attractive to us if it could improve our currency distribution, payments efficiency and monetary or financial stability. But these benefits are by no means guaranteed, and could come at some cost. We must explore both the pros and the cons before deciding to issue digital currency of our own to the public. Many other central banks are doing the same. So that is what I will do today. Like prospectors during the gold rush, I want to take you on a journey to uncover the risks, the gold, and possibly the fool’s gold, in issuing a central bank 1 I am thankful for the assistance of Amber Wadsworth in preparing this speech. 2 I spoke about our banknote innovation in 2014 “Brighter Money – enhancing innovation and embracing heritage”. digital currency. I’ll start by describing exactly what I mean by a central bank digital currency. I will then explore how issuing a central bank digital currency could impact some of the core central bank functions. I address three key questions: • • • What could issuing a central bank digital currency mean for currency distribution? Can a central bank digital currency improve the current inefficiencies in payments? Would issuing a central bank digital currency destabilise the financial system? To answer these questions I will draw from the material recently published in our central bank digital currency bulletin series. 3 Finally, I will touch on regulatory aspects of privately issued digital currencies. What is digital currency? When I mention digital currency, or digital money, some of you might immediately think of crypto-currencies, like Bitcoin. Some of you might think of your digital account balances. And others might think of credit or debit cards. In fact, I am referring to all of these things. Digital currency includes all electronic forms of money that represent a store of value, medium of exchange (or payment) and unit of account. Unlike banknotes and coins (cash), digital currencies can be issued by anyone, which also means a wide variety of currencies have been issued. We can use the Money Tree (figure 1) to broadly class digital currencies into two groups—conventional digital currencies, which rely on existing infrastructure, and crypto-currencies, which rely on cryptography and distributed ledger technology (DLT). 4 The most common example of privately issued conventional digital currencies are bank deposits. These electronic deposits carry a promise to be converted to fiat money—cash—at par value, which makes them very stable. The most common example of privately issued crypto-currencies is Bitcoin. These currencies are independent from fiat money, and not backed by other assets, which contributes to their notorious price volatility. 3 The central bank digital currency series comprises of three Reserve Bank Bulletins. The first article ‘What is digital currency?’ explains the various forms of digital currencies. The second article ‘Decrypting the role of distributed ledger technology for payments processes’ explains the ways the distributed ledgers differ from conventional payment systems, or not. The third article ‘The pros and cons of central bank issued digital currencies’ explores the implications of issuing a digital currency for currency distribution, payments, monetary policy and financial stability. I omit consideration of monetary policy implications in this speech. 4 Cryptography refers to the conversion of data into a code that cannot be deciphered by unintended recipients, e.g. for transmission over a public network. DLT refers to a record of transactions or account balances (of cryptocurrencies) that is shared across a group of entities. Blockchain is a form of DLT that is open source, and fully able to be downloaded, viewed and used by anyone. Figure 1: The Money Tree A central bank digital currency could take many different forms. So in order to explore the pros and cons of a digital currency issued by a central bank, I will set out six assumptions regarding the type of digital currency we are discussing today. Figure 2: Key assumptions for a central bank digital currency Our first assumption is that a central bank digital currency would be available to everyone. The Reserve Bank of New Zealand already issues a digital currency to commercial banks, through their accounts with us. 5 But we could also offer digital currency to the public via accounts, prepaid cards, or some other mechanism. Secondly, this digital currency could be a crypto-currency and use distributed ledger technology. Or it could be a conventional digital currency and based on existing payment technology. For example, a conventional currency could involve members of the public holding bank accounts at the Reserve Bank (i.e account-based). Or it could involve members of the public holding currency on cards or other tokens, similar to prepaid cards e.g. Visa Prezzy cards (i.e. token-based). 5 The Reserve bank is currently reviewing its access policies to the wholesale accounts it provides to financial institutions. Third, this digital currency would co-circulate with banknotes and coins (and other privately issued currencies). In New Zealand, we are not considering removing cash—demand for cash continues to grow as a share of the economy, and currently sits at 2.7 percent of GDP. Fourth, a digital currency would be convertible to cash at a fixed rate rather than having a variable exchange rate. This would help develop trust in the value of the digital currency and would avoid introducing a dual currency system. Fifth, we assume that the public could not borrow from the Reserve Bank. This means that the digital currency issued by the central bank would operate like cash. Lastly, the central bank would not pay interest on balances of its digital currency. Again, this assumption means that the digital currency issued by the central bank would operate more like cash, which does not earn interest. The pros and cons of issuing a central bank digital currency Now that we have established what we mean by central bank digital currency, we can begin our exploration of its pros and cons. I liken this exploration to a search for gold because they both evoke images of venturing into new terrain in the hope of discovering something of great value. But such explorations were not without peril, and while they could lead to great rewards, they could also prove fruitless. What could issuing a digital currency mean for currency distribution? The Reserve Bank is the sole provider of banknotes and coins in New Zealand. These banknotes and coins must be easy to use, difficult to imitate, and safely and securely transported between the Reserve Bank and commercial banks. This is not a simple task. New Zealand’s geography means that cash typically moves from Auckland, to the South Island. The Reserve Bank must then repatriate cash back to Wellington for quality inspection and re-issuance. A digital currency has clear distributional benefits compared to banknotes as it does not need to be transported. This makes it safer and cheaper. Issuing a central bank digital currency would also ensure public access to legal tender money regardless of the presence of cash. 6 New Zealand is in the rare situation among advanced economies where we use electronic forms of payments for the majority of transactions, 7 but are simultaneously seeing cash demand grow at a faster rate than GDP. 6 Cash (otherwise known as fiat currency) is the only form of legal tender money available to the public. Legal tender money refers to money that is legally recognised as a valid form of payment and represents a claim on the central bank or government. (McBride, 2015). 7 Credit and debit card payments are very popular in New Zealand, with only 10 percent of the population using cash more than seven times a week. Figure 3: Cash in circulation for advanced economies (percent nominal GDP) Index Index Aust Canada EU Iceland Japan NZ Norway Sweden Switzerland UK US Source: Haver Analytics However, we do not know what could happen in the future. If cash demand falls significantly then retailers and banks might lose the incentive to provide ATMs and cash tills, which are costly to maintain. 8 If cash demand fell to the point where retailers and banks no longer accepted, nor issued, it then legal tender money might disappear. This is the scenario faced by Sweden. A digital currency would provide an alternative, electronic form of legal tender. Issuing a digital currency would also pose some currency distribution challenges: 1. Significant investment in new infrastructure would be required to create, issue and maintain a digital currency network (issuing accounts or tokens to the public). 2. Consumers could lose large sums of money, which might not easily be recovered, if people accidently lost (by accident or theft) the device on which their token, or cryptocurrency is stored. Consumers can also lose cash, but because cash is relatively bulky, we do not tend to hold or carry large sums. 3. It would be vulnerable to outages in electricity and internet connections. This would make it less reliable (than cash) in a state of emergency. Can a central bank digital currency improve on the current inefficiencies in payments? We are also interested in the payments efficiency aspects of a central bank digital currency. The payment implications differ depending on whether the central bank issued a conventional digital currency or a crypto-currency. 9 A central bank issued, conventional digital currency could improve settlement speed and transaction fees compared to existing payments. 10 This is because the currency would be centralised and transactions would be settled by a central bank updating account balances. 8 For example, retailers who accept cash must then perform end-of-day balancing to ensure all cash is accounted for, they must then bundle cash into safes and pay for it to be securely transported to banks. Likewise, bank branches must invest in secure infrastructure to transport cash among their branches and ATM networks, and store cash in branches. 9 Detailed analysis on how DLT can change payments systems is provided in Wadsworth (2018b). 10 Transaction fees could decrease compared to current electronic fees as the number of service providers for electronic payments would be reduced and authorisation, clearing and settlement could be conducted by the central bank. These improvements would be most beneficial for cross-border transactions, which are currently subject to lengthy delays and large fees (and lack of transparency). A crypto-currency issued by a central bank presents a more mixed argument for payments efficiency. DLT combines clearing and settlement into a single step called validation. However, how this impacts the payments process depends on the design of the technology. If a central bank issued crypto-currency was based on Blockchain then it would circumvent the existing conventional payment system and benefit from several pros: 11 • • • • Faster settlement, which reduces default risk. Cheaper cross border transactions. Transparent payments, which incentivises faster payments processing. No single point of failure, which increases resilience to cyber-attacks and operational failures. However, it would also be subject to several cons: • • • • • Slower release of goods and services due to slow confirmation of the payment. High energy use for validation, and relatively high fees for domestic payments. Not scalable to large volumes of transactions due to the longer time taken to validate each block of transactions. Probabilistic finality—there is a very small chance that the transaction could be nullified if a malicious agent managed to change the blockchain. Reliance on crypto-currency exchanges for cross-border transactions which could be subject to cyber-attacks. A central bank could mitigate these cons by introducing limited access, central validation, and control to the ledger. 12 This would improve the speed, cost and scalability of payments, and enable deterministic payment finality (similar to existing payments) and privacy for sensitive information. However, it would reintroduce a single point of failure. Experiments by the Bank of Canada and Monetary Authority of Singapore revealed that these centralised DLTs are very similar to existing payments systems, without additional benefits. 13 Lastly, either token-based conventional digital currencies or crypto-currencies issued by the central bank could offer more anonymity than conventional electronic payments. For example, a central bank could issue a card or token that is not linked to an individual’s identity. This means payments with these tokens offer partial anonymity. I.e. we might find recent purchases no longer show up in our social media adverts. However, any form of digital currency would leave an electronic record of transactions and so be less anonymous than cash. These records could be helpful in deterring tax evasion and illegal transactions. 11 Blockchain is a form of DLT that is public, permissionless, non-hierarchical and open-source. In other words, anyone can read, download and validate transactions on the ledger. To validate transactions a miner must provide ‘proof of work’, supported by a network of users. This means finding a ‘hash’, which represents all the details in the block of transactions, by solving a cryptographic problem using brute computing power. The cryptographic problem is designed to take about 10 minutes to solve. 12 By issuing a permissioned, private, hierarchical and closed-source crypto-currency. 13 Payments Canada, Bank of Canada, and R3 (2017), Deloitte and Monetary Authority of Singapore (2017), Monetary Authority of Singapore and the Association of Banks in Singapore (2017). How would issuing a central bank digital currency impact the financial system? One of the most important contributions of a central bank to prosperity is its responsibility for financial stability. A breakdown in the financial system can cause enormous economic and social harm. We could not issue a digital currency if it might undermine financial stability. Depositors might be attracted to a central bank digital currency as it is low risk. This safe asset would compete with deposits in commercial bank accounts, which could be lost if there was a bank failure. This competition could result in three substantial risks to financial stability. Firstly, if a large number of deposits were held in the digital currency rather than commercial bank accounts, then New Zealand banks might become more reliant on overseas wholesale funding. This would, accentuate our banking system’s susceptibility to downturns in overseas markets. For example, if there was an international shock in the European or US markets, this could have more severe flow through to New Zealand via increased bank funding costs (risk spreads) or reduced availability of funding. Secondly, and relatedly, a central bank digital currency could reduce commercial bank resiliency to economic downturns. This is because commercial banks might have to compete for deposits by offering higher interest rates, which could lower their profitability. Further, commercial banks’ payment fee revenues could be diminished if a central bank digital currency offered cheaper domestic and cross-border transaction fees. Lower bank profitability due to competition might imply that bank activities are being conducted more efficiently (assuming the central bank services were priced appropriately). But there could be adverse consequences for financial stability if less profitable banks become less resilient to shocks, or if they look to replace lost profitability by searching for higher yielding (more risky) assets. We need to be careful not to exaggerate these concerns, however, as commercial banks are already facing increased competition in the deposit and payments aspects of their business from non-banks such as PayPal and TransferWise. This increased competition has not adversely affected bank resiliency to date. Further, US and Canadian history, where commercial bank banknotes co-circulated with government-issued banknotes, suggests commercial bank money can, to some extent, compete with central bank money. 14 Thirdly, and more troubling, the presence of a low-risk digital currency could increase the probability and severity of bank runs during periods of system-wide instability—depositors could easily, and remotely, transfer large deposit holdings to a central bank digital currency during any wide-spread period of perceived financial instability. Other miners in the gold rush The Reserve Bank is not the only participant in the exploration of digital currencies. There are many providers of conventional digital currencies and crypto-currencies. These private currency and DLT providers put competitive pressure on incumbent financial institutions. Competition is good for innovation and efficiencies and could be the most enduring benefit of 14 This co-circulation persisted until legislation granted central banks’ the sole right to issue notes was introduced Fung, Hendry, Weber (2017), Weber the global exploration of new financial technologies. We encourage innovations that improve banking and payments services, provided they do not generate systemic risks. Beyond the payments systems, the Reserve Bank is also responsible for the prudential regulation of banks, non-bank deposit takers and insurers. Private crypto-currencies currently have limited implications for prudentially supervised entities. Entities subject to Reserve Bank prudential regulation face a variety of requirements and incentives to ensure that they manage all their material risks adequately. The Reserve Bank would expect these entities to have prudent risk management in place for any of their activities involving cryptocurrencies. It is not yet clear what prudential scrutiny of a crypto-currency might entail. A crypto-currency itself is not a legal entity, and distributed crypto-currencies like Bitcoin do not have a central agent or issuer to manage the currency. Therefore, crypto-currency regulation could be complex. Currently, the most likely way to regulate crypto-currencies is via crypto-currency exchange platforms (between crypto-currencies and other currencies). Regardless, the use of crypto-currencies by non-regulated institutions is small compared to the size of our financial system so is unlikely to pose a material risk. And the volatility of crypto-currencies (that do not trade at par value with fiat currency) make it highly improbable that any regulated entity would start predominantly using crypto-currency. In addition, anti-money laundering and countering financing of terrorism (AML/CFT) legislation might create significant hurdles for financial entities to associate with cryptocurrencies. AML/CFT legislation requires financial institutions to know their customers, which is at odds with distributed pseudo-anonymous crypto-currencies. Crypto-currency issuers and crypto-currency exchange platforms would need to remove anonymity from cryptocurrencies to implement AML/CFT. The Reserve Bank does not currently plan to issue any new regulation regarding privately issued crypto-currencies as they do not currently pose a systemic risk to financial stability. 15 Moreover, existing prudential regulation and AML/CFT legislation already set out that supervised entities should manage their business prudently and know their customers. Conclusion The gold rush began in New Zealand in 1861. The search for riches continues in today’s technological world. For the Reserve Bank, that is searching for ways to harness new technologies and do things better. We have explored whether issuing a digital currency is one way we can use new technologies to better meet the needs of the public. At this stage it is yet to be seen that a central bank digital currency will bring conclusive benefits. From a system-wide perspective the pros and cons of a central bank digital currency are mixed. Distributing a central bank digital currency could lead to both new costs and cost savings. It would provide an electronic form of legal tender, but would be less reliable in power outages. The payments pros and cons depend on how the digital currency is 15 The FMA is responsible for regulating crypto-currency issuers from the perspective of protecting retail investors and promoting orderly markets (as opposed to prudential regulation). designed. Digital currencies with central control can improve efficiency but potentially at the expense of reduced resilience. There could also be considerable negative impacts on financial stability. Judgement is required to weigh these findings, but it unlikely that a central bank digital currency would be issued if it posed large and significant risks to New Zealand’s financial system. The payments industry is dynamic, which is good. But the Reserve Bank must be a considered prospector in the exploration for digital currency benefits—we have New Zealand’s currency and financial system at stake. Currently, it is too early to determine whether a digital currency should be issued. Central banks and researchers are still probing these technologies and currencies. But we will continue to explore digital currencies; for our benefit and for the benefit of New Zealand’s financial system. References Deloitte and Monetary Authority of Singapore (2017) ‘The future is here. Project Ubin: SGC on distributed ledger’. Fung, B, Hendry, S and W Weber (2017) ‘Canadian Bank Notes and Dominion Notes: lessons for digital currencies’, Bank of Canada Staff Working Paper 2017-5. McBride, N (2015) ‘Payments and the concept of legal tender’, Reserve Bank of New Zealand Bulletin, Vol 78. No. 6. Monetary Authority of Singapore and the Association of Banks in Singapore (2017) ‘Project Ubin phase two. Reimagining interbank real time gross settlement system using distributed ledger technologies’. Payments Canada, Bank of Canada, and R3 (2017) ‘Project Jasper: A Canadian experiment with distributed ledger technology for domestic interbank payments settlement’. Wadsworth, A (2018a) ‘What is digital currency?’ Reserve Bank of New Zealand Bulletin, Vol 81. No. 3. Wadsworth, A (2018b) ‘Decrypting the role of distributed ledger technology in payments processes’ Reserve Bank of New Zealand Bulletin, Vol 81. No. 5. Wadsworth, A (2018c) ‘The pros and cons of issuing a central bank digital currency’ Reserve Bank of New Zealand Bulletin, Vol 81. No. 7. Weber, W (2015) ‘Government and private e-money-like systems: Federal Reserve notes and National Bank notes, Bank of Canada Staff Working Paper 2015-18.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the "Shaping Futures National Conference" Financial Services Council, Auckland, 7 September 2018.
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Geopolitics, New Zealand and the Winds of Change A speech delivered to the ‘Shaping Futures National Conference’ Financial Services Council in Auckland On 7 September 2018 By Adrian Orr, Governor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Kia orana tātou kātoatoa Tēnā koutou katoa Welcome all Thanks for the opportunity to speak today on such a far reaching topic. It is a pleasure and a privilege, especially in front of such a large and important audience who impact the lives and financial security of so many New Zealanders. It is also timely to chat about financial issues given it is ‘Money Week’, the annual awareness week championed by the Commission for Financial Capability. I know many people will be thinking, ‘what has the Reserve Bank Governor got to say about anything long-term? Doesn’t the Bank just sit and watch for outbreaks of inflation – shifting the official interest rate on a needs-be basis? Some will even comment publicly, ‘How dare the Governor speak outside of their 1 to 3 percent inflation mandate!’ I hope to convince you we have a strong vested interest in, and influence on, the long-term economic wellbeing of New Zealand. The long-term issues are critical to our task of maintaining low and stable consumer price inflation, promoting a sound and dynamic financial system, and meeting the currency needs of the public. First, what do I see as the long-term challenges facing the globe? I summarise the key plague on economic society as ‘short-termism’. This is the overt focus on the next day, week, or reporting cycle. In contrast, by long-term, I mean anything that ranges from ‘outcomes’ over the next few years, through to an ‘idealised vision’ that could last inter-generationally. A short-term focus can be driven by the need to survive from day-to-day. However, it is too often driven by the desire to consume at an unsustainable rate. The desire for instant gratification or reward can often leave behind a trail of unintended consequences. Some of these consequences may impact on us personally, but we too often assume we won’t be the one affected. An often-posted analogy of short-termism is the seasonal over-imbibing at the staff Christmas party, and all of the personal and societal consequences that follow. Let’s get more tangible. We strive in business every day to achieve economic growth – or economic security and wealth. We also aspire to use this wealth in a pleasant, sustainable, natural environment that we can call home. We also aspire to live and bring our families up in a safe place, of social cohesion, being accepted and appreciated. And, we want to live in a place where everyone can participate despite our differences, a ‘diversification dividend’ not cost. Wow, what a cool place that would be. Where do I buy the ticket? A virtuous, wealthy, and rich society. Too often, however, due to short-termism, we view economic growth as something that comes at the expense of a sustainable environment, or social cohesion and cultural acceptance. How does this ‘vicious’ circle manifest itself so often around the world and through time? The financial system plays a significant role. A financial system works best – is sound and efficient – when all relevant risks are adequately identified, priced, and allocated to those who can best manage them. These are the risks, in large part, that may lead you to consume/spend today, rather than save/invest for the future. You are either unconvinced you will be compensated sufficiently for the risks that could arise through time, or you haven’t thought that far ahead or that well. The problem is that focusing on the short-term means that many risks are neither identified or priced, and often allocated to those who are least aware of them and unable to manage them. Our financial systems are struggling globally to identify, price, and allocate risk. What have we witnessed over the last couple-of-hundred years or so? Incredible per-capita economic growth. Millions of people have been lifted out of poverty, and there has been a rapid increase in the human population and our longevity. This period represents an unprecedented rise in many positive economic welfare measures. The growth in productivity – output per person – is amazing. But is all well, or at least as good as it could be? What are our big challenges – globally and at home in New Zealand? There has been a rapid rise for many out of subsistence and into emerging or First-World income status. But we continue to experience massive challenges that are, too often, resolved through financial crises, wars or civil unrest; or at the cost of someone else or something, such as the environment. At present we experience challenges such as: Environmental degradation, with climate change now well accepted as a significant impact on economies worldwide. The impacts are physical through nature, and financial through changes in consumer and investor preferences, and regulation. Mass urbanisation and all of the challenges this brings is accelerating globally, quite the opposite to what I was taught would happen when I was in school. Computers would mean we all lived on lifestyle blocks in a paperless world. Yeah right. I have seen global estimates from the World Economic Forum that some 60 percent of the world population, within the next couple of decades, will live in cities with populations greater than 10 million people, many of these in current Emerging Market nations. The challenges this brings to resources, infrastructure, and social cohesion are immense – unprecedented. And we complain about Auckland traffic. Ageing populations are also dominating the outlook for the next 30-plus years, with Japan being the canary for us all to watch. Their population is on the decline due to their demographic profile weighted so much to the elderly. Savings and consumption patterns are changing simply due to this population swing. The older have the savings and are demanding less in goods, but more in services, especially human contact. Loneliness is a significant and growing disease. Yet the owners of capital are struggling to create careers out of caring for the elderly, at least at incomes that attract and retain the people needed. The same could be said for tourism in New Zealand. Mass migration (in addition to urbanisation) pressures are also growing globally, driven by the factors mentioned above. Climate change means people must leave and find new homes, witness the Sahara-African peoples virtually swimming to Europe. Social cohesion is being challenged as national boundaries and beliefs are being threatened with change. Which brings me to the income and wealth inequalities that come and go through economic history – with the global economy currently testing fresh cyclical boundaries. What do I mean by inequality? Well, even if the economic ‘pie’ has grown in total, the rewards are always skewed one way or another. Over recent decades, the rewards to the owners of capital (profits) have outstripped the owners of labour (wages) more than throughout economic history. In addition, wage growth both within, and more so between, firms has become more dispersed. Supposed low-skilled jobs have been far out-paced by high skilled jobs. Now we also have the rise of ‘superstar companies’ that are in the ‘winner take all (or most)’ of an entire industry. These superstar firms generally have lower ‘wages-to-profit’ ratios than their competitors, accentuating the income divergence. How do they manage this? Through superior economies of scale driven by technology and brand advantages that are not easily replicable. Witness Facebook, Amazon, Google, Alibaba and so on. This is also true within the financial sector, where big banks gain significant economies of scale, leaving smaller banks struggling to compete. This would be fine if it didn’t lead to other problems such as ‘too big to fail’ and excessive risk taking incentives. We are not immune to these issues locally, not by any sense of the word. But, we do have opportunities to lead the globe in positive change if we can become more long-term in our economic activity. In New Zealand, we are being challenged on the environmental consequences of our efforts. We also have significant ongoing migration and urbanisation, as people want to be part of our place and together. We have creaking infrastructure and suffer from over-exuberant asset (house) prices. We also have persistent and stubborn unemployment and low-income challenges. This is especially so amongst Pasifika and Māori, despite their significant contribution to our economic and cultural wellbeing, and despite the current labour shortages. And, we have a rapidly ageing, and too often lonely, population. Underlying these challenges is New Zealand’s persistently low productivity growth – or economic output-per-person. The reasoning behind the low productivity is well understood but, apparently, difficult to combat in a coordinated, persistent, manner. An excellent paper by our own Productivity Commission,1 outlines succinctly the problem of low productivity and the causes in New Zealand. In large part, our low output-per-person is due to the ‘capital-shallowness’ of much our economic activity. This refers both to physical and human (knowledge) capital. New Zealanders have low savings rates (personal capital), meaning they don’t tend to draw advantage from profits (the returns to capital). Likewise, many of our larger companies are driven to pay dividends (often offshore due to their ownership) rather than re-invest in their own company, or New Zealand more broadly. These challenges are compounded by the relatively small scale of New Zealand firms, and by a low level of technology and knowledge dispersion between firms. Paul Conway challenges us all, including policymakers: assist small, remote, firms into the global economy; improve the matching of jobs and skills; use immigration wisely to lift human capital; make investment easier and more effective; moderate the pace of population growth to encourage capital-deepening; improve competition in the services sector; and strengthen the economic returns from science and innovation. So with problem identification and solutions outlined, wouldn’t we just move on to resolution? Short-termism challenges us always and everywhere. Paul Conway, (2018), ‘Can the Kiwi Fly? Achieving productivity lift-off in New Zealand’, International Productivity Monitor, No. 34, Spring 2018. Why do we run into roadblocks to long-termism? Capitalism is necessary, and a marvel, driving human welfare in a strongly positive direction for a few centuries now. But we all know – even Adam Smith, the godfather of free markets knew – that capitalism is not perfect. Markets can, and do, fail for a variety of well researched and understood reasons. Otherwise, why would we need government, regulators, and a central bank? A significant challenge is human myopia, the inability and/or unwillingness to think about the long-term. After all, ‘she’ll be right’. Myopia is actually incentivised in many of our contracts – the drive to shorter deadlines and frequent reporting for rapid personal gratification. This shorter horizon is a perverse outcome. Annual bonuses for example can lead to excessive risk taking, lack of concern for unintended consequences, and a desire for short-term cost cutting and lack of reinvestment. However, the bonus was implemented with the intent of ‘buying the employee in’ to the business for long-term gain. The myopia challenge is further enforced by what is known as the ‘principal-agent problem’. The advent of the remarkable limited-liability company structure has liberated economic activity. These legal structures allow people to take risks with their and others capital, but with more limited personal financial consequences. The limited liability structures do, however, mean that responsibility for all of the outcomes of business activity can be compromised. Hence the list of rules, regulations, and company directorship codes that exist. The line between the owner of the capital (the principal) and the manager of the capital (the agent) is lengthened. ‘Who owns a company?’ is a tough question.2 This principal-agent separation gets even harder now that we have investment portfolios as our way of investing in ‘growth assets’ ie, in business. The link is now the saver (owner of the capital), the investment manager (who may even outsource parts of this), and then the company agent. Principal-agent-agent. This represents in large part the industry structure that most of the people in this audience operate in. What does it mean? How responsible is each of the agents for the long-term preservation of the principal’s capital – and how can the principal insist on this responsibility to the level that matters to them – financially, ethically and otherwise? The asymmetry of information that exists in favour of each of the agents in this chain dwarfs the principal’s knowledge. Hence the drive for transparency and burden of proof in business. Fortunately – in some ways – the growth of portfolio diversification means that a principal is not overly exposed to any one ‘rogue agent’ or unfortunate event. A Kiwisaver investor, for example, owns several hundred, if not thousands, of companies in small proportions. For every idiot company (or idiosyncratic risk) in a portfolio, there is likely to be an offsetting genius. Unfortunately, in other ways, the portfolio diversification even further reduces the drive, willingness, and ability of the investor to demand disciplines on the companies they are 2 Andrew G. Haldane, (2015), ‘Who owns a company?’, speech by Mr Andrew G Haldane, Executive Director and Chief Economist of the Bank of England, at the University of Edinburgh Corporate Finance Conference, Edinburgh, 22 May 2015. invested in. You have to cluster the investment managers to demand excellence from some of the firms in these portfolios – to care about the long-term. I won’t labour a significant additional challenge too much, but let’s not forget that investment managers are likewise incentivised to behave in a short-term manner too often also. The outcome of their behaviour leads to the pro-cyclical nature of investing, including institutional ‘herding’ and locking in losses, rather than benefiting from bargain price opportunities. Such institutional (and business confidence) herding destroys wealth, increases financial volatility, and kills long-term strategies.3 As Frankie Howerd, the British comedian, said: ‘there’s nowt so queer as folk’. Another challenge is that of ‘externalities’ – the tragedy of the commons (and also the horizon). Too many risks are not priced (or managed) by any individual, and hence underinvested in, or not owned or managed. Why would I, for example, spend all my money cleaning a river that everyone else can benefit from and/or continue to pollute? I can’t capture all of the reward I am owed. I am reminded of the first economics text book I was given at school (Samuelson) – posing the question on page one to entice my mind into the cut and thrust of economics (yawn, stare out the window). ‘Why are diamonds expensive and water is free?’ After all, you can live without the first (perhaps as a bachelor), but not without the latter. The answer was meant to be ‘scarcity’. Diamonds are rare and water is everywhere. Oh how quick things change. The answer now is that diamonds are sold in part under a cartel and marketed well, while water has never been properly priced – and hence too often misused and polluted, with drastic current consequences globally. What are we left with from short-termism? Misallocated capital, under invested labour, pollution, and challenged societies. This is not the fault of capitalism. It is the reality of human nature. By the way, these thoughts are not the rantings of a single Governor of a central bank. The issues are well understood. They in fact dominated the recent Kansas Federal Reserve Bank Economic Symposium I attended in Jackson Hole, Wyoming, only a couple of weeks ago. This is a prestigious annual gathering of wise economists, and me this time. What were the Jackson Hole topics? Awareness of technology disruption and the rise of the ‘superstar firms’ – winner takes all/most. Rising industry concentration of firms, in the US especially. Economies of scale and ‘intangible’ capital that is excludable and hard to replicate assisting this concentration. Rising inequality as people move to low wage/profit firms away from high wage/profit firms. There was even a discussion of apparent monopsony wage-setting behaviour by some firms, especially amongst franchise chains. Can we get better at this capitalism thing? Yes we can. Deliberate strategies exist to force savers/investors to behave more long-term. I refer you to the New Zealand Superannuation Fund’s website, where simple instructive examples (and speeches) exist on how to be ‘long-term’ in behaviour. Understand your purpose, your Jukka Pelhman and Han van der Hoorn, (2010), ‘Procyclicality in Central Bank Reserve Management’, IMF Working Paper 10/150, June. endowments (your relative natural advantages), your investment beliefs, and then stick to the strategies that best exploit all of the above. They’ve got it down to one page of instruction – say it simple, stupid.4 Also instructive, and critical, are the rapidly growing clusters of global capital concerned with better managing the failures that can arise from ‘short-termism’. Trillions of dollars of capital are now joining efforts under various umbrellas. One cluster is the United Nations efforts around: Principles of Responsible Investing; Carbon Disclosure Projects; Sustainable Development Goals; and the Global Compact for Work practices. There are also private sector and ‘NGO’ groupings. For example: Focusing Capital on the Long-Term; Inclusive Capitalism; and One Planet, a spinoff from the CoPP22 global climate change agreement signed in Paris in 2016 (to which New Zealand committed). And, the International Forum of Sovereign Wealth Funds led the way in developing guiding principles (“the Santiago Principles”) for the long-term management of sovereign funds. Directly in the Reserve Bank’s camp, the G20 have established a Financial Stability Taskforce effort focusing on carbon reduction management. Likewise, there is a newly established Central Banks and Supervisors Network for Greening the Financial System, as well as a rapidly growing green-bond market. Where is all of this leading? Hopefully, these efforts will in part head off the usual manner in which we ‘reset the clock’, through some kind of crisis or unrest. Significant global firms, investors, regulators and representatives of civil society are banding together to work hard on resolving the perils of short-termism. If company boards and managers have a longenough horizon, then there are no externalities – all issues are endogenous to their actions (eg, pollution, employment, inclusion, and sustainable profit). A personally heart-warming recent local example is the group of New Zealand firms that have signed up to a joint effort to reduce their carbon footprint, under the Climate Leaders Coalition. This group has recognised that consumers are increasingly demanding intergenerational justice, investors want to be properly rewarded for all of the risks they are taking, insurers are increasingly concerned about the cost and ability to insure against climate volatility, and regulators are getting very itchy across many activities – building codes, firm behaviours and so on. Where does New Zealand sit on the global stage for these long-term efforts? I could argue that we are so small, no matter what we did across most of these issues, it wouldn’t impact global outcomes. But I would prefer to argue that the world often looks to places like New Zealand for leadership (or at least hope and safety). I also note that we are a small island nation, agriculturally dependent, live mostly on the coastline, have significant foreign-country dependency for capital and insurance, and sell a ‘clean experience’ to tourists. Hence, we rely heavily on our reputation and management of the long-term issues such as climate change, social cohesion, and inclusion of all. The great news is we are small, young of nation, lightly populated, green, kaitiaki (caretaking) of spirit, not dependent on the export of fossil fuels, and have a strong rule of law and sound moral compass. Significant and bold leadership is in our grasp. 4 New Zealand Superannuation Fund, ‘White Paper’ series, www.nzsuperfund.nz What are the long-term challenges facing the Reserve Bank? At the Bank we tell the story of Te Pūtea Matua (our Māori name) more often as that of the Tāne Mahuta of New Zealand’s financial system. In Māori mythology, Tāne Mahuta is the god of the forest and birds. Tāne Mahuta’s greatest feat was that he separated Papatūānuku (the earth mother) and Ranginui (the skyfather) so that sunlight could shine into his garden and grow independent of his parents. The Reserve Bank rose for a similar purpose back in 1934, to enable New Zealanders to better grow the New Zealand economy independent of foreign banks’ and economies’ credit cycles – particularly Britain and Australia. You will hear a lot more of this in coming weeks. Why? First, storytelling is fun and helps people connect to their daily tasks at the Bank. Second, the Bank is an ecosystem of many activities, just as Tāne Mahuta is, especially with the wider garden (financial system). Severing a root, trunk, or branch will have full ecosystem implications. Finally, we are embarking on a Te Ao Māori strategy at the Bank to help us with diversity and inclusion in thought, and to ensure we are operating effectively given the growing significance of Māori economic activity within New Zealand’s financial landscape. Te Pūtea Matua is in good stead for the future, but not without its challenges. These are driven by technology, economic development, global connectedness, and broader government, public, and employee expectations. It is an exciting and challenging time for the team. Our current priorities outline the scope of change underway for Tāne Mahuta: our legislation (our roots) is under review, with the idea of modernising and refreshing our scope and capabilities, including broader decision making committees. Witness our new dual mandate for inflation targeting and contributing to maximising sustainable employment; the production and movement of our money (our sap) is under review, with new storage and distribution models, and the role of digital currency, being considered; our payment and settlement systems and digital capability (our trunk) are being renewed, with a view to ongoing reliability, security from cyber-risks, and a move to the ‘cloud’; our regulated financial institutions (the branches grafted on to Tāne Mahuta) are under review, including our relationship management with them, and our expectations of their business conduct, capital needs, failure management capabilities, and efficiency metrics; and our people (the caretakers or kaitiaki) are being reinvigorated, with a focus on developing A Great Team, Best Central Bank vision. Focusing on the long-term is core business for Te Pūtea Matua – the Reserve Bank. The maintenance of low and stable inflation is a necessary condition of sustainable economic growth. We were pioneers in inflation targeting, with the goal decided by society (1-3% annual inflation), and then the Bank being operationally independent to do its work. This operational independence is critical – that is what ensures we do not suffer from shorttermism. New Zealand, and much of the developed world, has a history of high and rising inflation due to over-weighting near-term demands. We also understand the importance of our financial stability and currency issue roles. We need to prudentially regulate in a manner that is both sound and efficient in all its forms – cost, allocative, and dynamic efficiency. This means we ‘bridge the principal-agent gap’. Doing so means we can be unpopular with the regulated industries (the agents), which can be noisy at times. We insist on an adequate capital buffer to absorb losses, internal capability to manage the shop, and ‘skin in the game’ via directors attesting to these factors. We also insist on transparency so that customers and competitors can keep an eye on each other. Likewise, for the large, systemically important, banks we insist on failure management capabilities – where we can step in and keep the bank going so that the whole system doesn’t fail. We can also be unpopular with wider New Zealand, as shifting interest rates and/or implementing and altering the loan-to-value ratio that banks are allowed to lend at, are often not immediate vote winners. These activities directly cut across our human instinct for instant gratification, despite in the long-run maintaining a stable financial system and reducing the scale of financial volatility and/or crises. We aren’t here to win votes, but we are aware that our stakeholders are demanding more from us, and we are responding. As a result, we have developed a new vision for the Bank, we want to be A Great Team, Best Central Bank. All of our strategic priorities work towards this goal. We have visualised ‘our island’ that we will always move towards on the horizon, one that all New Zealanders can be proud of and that Tāne Mahuta – our Bank – can stand tall on. To reach ‘our island’, we need to be aware of the long-term forces shaping the global economy, the very things we have just been talking about. These factors will have a significant impact on the allocation of resources, and the future wellbeing and stability of the New Zealand economy. We are embarking on, amongst other things, our own climate change strategy – focused on our own activities as well as our regulatory duties with concern for financial stability. We need to factor climate change issues into our concern for financial stability and efficiency. To be most effective, we are committed to working cooperatively on these issues, in particular harnessing the New Zealand Council of Financial Regulators (COFR) to provide longer-term leadership. COFR includes the Bank, the Treasury, the Financial Markets Authority, and the Ministry of Business, Innovation and Employment. As part of our commitment, the COFR are discussing their own ‘island’ or vision, so as to best identify work effort and prioritisation – moving beyond a ‘show and tell’ group. And we will continue to use our strong international reputation and connectedness to work with other central banks, international financial institutions, and global regulators to further our understanding and, perhaps even, show leadership in places such as the South Pacific. Collaboration and a long-term vision are critical to growing the wider financial ecosystem that lies beneath the branches of Tāne Mahuta. At present, the systemically-important banks dominate Tāne Mahuta’s ecosystem. The important insurance sector is also patchy, both in customer coverage and competitiveness. Life insurance, for example, has a low coverage rate across New Zealanders and a high premium-cost compared internationally. Meanwhile, general insurance has better coverage, but the industry is heavily concentrated in the number of providers. Health insurance is also complex, with the state-owned Accident Compensation Commission providing some cover, with the rest of this sector’s insurance provision highly concentrated. Industry concentration, low coverage, and high costs are not the greatest look for an efficient system. In 2007, I co-authored a speech with Dr Alan Bollard, the then Governor. We outlined the important role of the financial system and the unique challenges and weaknesses of New Zealand. Since then, and following the Capital Market Taskforce, led by our late-friend Rob Cameron, some things have changed and improved, much hasn’t. The growth of the NZ Super Fund, the depth of the Kiwisaver funds, and enhanced financial market regulation (with the birth of the Financial markets Authority) are great outcomes. Likewise, it is positive to see the Treasury committing to deeper bond issuance over a longer horizon, to keep New Zealand in the market and providing a yield curve benchmark. And it is encouraging that the Reserve Bank insisted on core liquidity measures for the banking system, as well as robust capital levels, and failure management capabilities. In addition, the insurance sector has a clearer regulatory regime. However, much has not changed. Our listed equity market remains small relative to the economy, banks remain dominant in intermediation, and it is difficult to invest outside of the listed market in any scale with access limited. We still concentrate most of our investment in housing equity – rather than productive equity – relying on leverage from offshore borrowing. This is not a formula that will create ‘capital deepening’ in our economic efforts. A vibrant and healthy financial ecosystem requires deep capital markets, with a long-term horizon, to best allocate capital in Aotearoa. We have much to work on to remain sustainably prosperous, but we are committed and long-term focused. Meitaki Bibliography Bollard, Dr Alan and Adrian Orr, (2007), ‘Delivering sound and innovative financial services for New Zealand’, Background Paper for an address to the Canterbury Employers’ Chamber of Commerce, https://www.rbnz.govt.nz/research-andpublications/speeches/2007/speech2007-01-26 Cameron, Rob, (2009), ‘Capital Markets Matter: summary report of the Capital Market Development Task Force’, December. Conway, Paul, (2018), ‘Can the Kiwi Fly? Achieving productivity lift-off in New Zealand’, International Productivity Monitor, No. 34, Spring 2018. Haldane, Andrew G., (2015), ‘Who owns a company?’ Speech by Mr Andrew G Haldane, Executive Director and Chief Economist of the Bank of England, at the University of Edinburgh Corporate Finance Conference, Edinburgh, 22 May 2015. Jukka Pelhman and Han van der Hoorn, (2010), ‘Pro-cyclicality in Central Bank Reserves management’, IMF Working Paper 10/150, June. Federal Reserve Bank of Kansas City (2018), ‘Changing market structures and implications for monetary policy’, symposium 23-25 August 2018, Jackson Hole, Wyoming. New Zealand Superannuation Fund, ‘White Paper’ series, www.nzsuperfund.nz Reserve Bank of New Zealand (2018), Statement of Intent 2018-2021, Wellington, June. The Treasury (2018), website https://treasury.govt.nz/news-and-events/reviewsconsultation/reviewing-reserve-bank-act Reserve Bank of New Zealand (2018), ‘Policy Targets Agreement 2018’, https://www.rbnz.govt.nz/monetary-policy/policy-targets-agreements/pta2018
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Financial Stability of the Reserve Bank of New Zealand, to the UBS Australasia Conference 2018, Sydney, 13 November 2018.
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Financial stability – risky, safe, or just right? A speech delivered to UBS Australasia Conference 2018 Sydney, Australia By Geoff Bascand, Deputy Governor and Head of Financial Stability 13 November 2018 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction1 Thank you for the opportunity to speak with you. For the first time in 30 years, New Zealand is fundamentally reviewing the role and powers of the Reserve Bank as they relate to financial stability. The Government’s review is not in response to a crisis. The fact that it’s 10 years since the Global Financial Crisis (GFC), 20 years since the Asian financial crisis, and 30 years since New Zealand’s share-market crash and our own financial crisis is surely just a coincidence! The aim of the review is to test whether our financial policy framework is fit for purpose and whether it needs modernising. It makes sense to test that the regime is well founded for the next 30 years. The financial system has grown in size, complexity and interconnectedness. It continues to change with institutional, technological and financial innovations generating new products, services, rewards – and risks. The Reserve Bank, or Te Pūtea Matua, is the big tree, Tāne Mahuta, that sits at the centre of New Zealand’s financial ecosystem. Our challenge is to ensure that the various elements of this financial ecosystem work together to deliver a sound and efficient financial system for all New Zealanders. And that we deliver soundness, don’t stifle desirable innovation and minimise unnecessary friction between borrowers, savers and investors. A thriving financial system provides huge benefits: enabling payments, financing investment, facilitating borrowing, and yielding returns to savers. When it falters or freezes up, costs are large and pain is felt throughout society. In common with most central banks we are responsible for the stability of our financial system. Our role is to manage risks to New Zealand’s stability and to mitigate the consequences if they are realised. Today I am going to focus on our risk tolerance and how we determine it. I want to address two main topics: First, why financial stability matters and what threatens it? Second, and most importantly, how do we pursue our financial stability objective? This key point can be thought of in terms of three questions: o what is our risk tolerance; how safe do we think the financial system should be?; o how do we strike the right balance between soundness and efficiency?; and o how do we adapt as risks to financial stability emerge? Why does financial stability matter for New Zealanders? First, why does financial stability matter? The answer is that bank crises are frequent and bank crises hurt. Since the mid-1970s there have been over 140 banking crises2 around the world. And they have had large costs for the affected economies and societies. 1 I am very grateful to Piers Ovenden for considerable assistance in the preparation of this speech, along with valuable comments from other Reserve Bank colleagues. 2 Laeven and Valencia define a banking crisis as systemic if two conditions are met: (1) significant signs of financial distress in the banking system (as indicated by significant bank runs, losses in the banking On average a bank crisis costs a country 23% of its GDP, while public debt increases by around 12 percent.3 The amounts are higher for advanced economies. And as a rule, the deeper the banking system, the larger the disruption and the higher the costs.4 Recessions associated with financial crises are deeper than recessions that are not. The consequences in terms of employment are also severe. After the GFC, Ireland’s unemployment rate rose from 4.6 percent in 2006 to 15 per cent in 2012,5 with youth unemployment even higher. In addition there can be broad welfare consequences in terms of declining physical and mental health, regardless of whether an individual is directly affected by job, income or housing loss.6 The impact of a crisis on the wider economy is also long lasting. Recovery can take a decade or more and is halting in nature.7 We have seen in the aftermath of the GFC, monetary and fiscal policy responses –bail-outs and quantitative easing – have important implications for transfers of wealth between the private and public sector, social inequality and inter-generational welfare. So financial stability matters – and not just to the depositors, creditors and counter-parties of an affected institution. It matters to the economy and society as a whole. This isn’t something that we can count on observing from the global sidelines. New Zealand is clearly not immune to crises. In the late 1980s the Bank of New Zealand had to be recapitalised twice by its government and private sector shareholders. More recently, between May 2006 and the end of 2012, we witnessed the collapse of finance companies. As the GFC unfolded the New Zealand government introduced a guarantee scheme that covered up to $133 billion in deposits and investor funds. By the time the scheme was withdrawn, the Crown had paid out approximately $2 billion to depositors for losses from failed entities.8 system, and/or bank liquidations); and (2) significant banking policy intervention measures in response to significant losses in the banking system. See ‘Systemic Banking Crises Database: An Update’, IMF Working Paper, by Laeven and Valencia, 2012. 3 Output losses are calculated as deviations of actual GDP from its trend and increases in public debt is measured as the change in the public debt-to-GDP ratio over the four year period beginning with the crisis. See ‘Systemic Banking Crises Database: An Update’, IMF Working Paper, by Laeven and Valencia, 2012. 4 The costs of banking crises can vary markedly. The gross fiscal cost of the crisis in Iceland – a small, open and financially integrated country like New Zealand – mainly in terms of bank recapitalisations and asset purchases, was 44% of GDP. In Ireland the pre-crisis boom in construction and subsequent collapse of the local banking system, resulted in a government bail-out amounting to approximately 40% of GDP. Iceland and Ireland also feature among the ten costliest banking crises in terms of overall increases in public debt – at more than 70% of GDP within four years. See ‘Systemic Banking Crises Database: An Update’, by Laeven and Valencia, 2012. 5 See ‘Seasonally Adjusted Standardised Unemployment Rates’, Central Statistics Office at https://www.cso.ie/en/statistics/labourmarket/principalstatistics/seasonallyadjustedstandardisedune mploymentratessur/ 6 See ‘Health Impacts of the Great Recession: A Critical Review’, by Margerison-Zilko, et al., 2017. 7 World Economic Outlook, IMF, October 2018; and ‘Recovery from Financial Crises: Evidence from 100 Episodes’ by Reinhart and Rogoff, American Economic Review, 2014. 8 Office of the Auditor-General, 2011. Serious incidents (that could have led to a crisis) are more common than people realise. Over the years various institutions have suffered significant losses and either had to raise additional funds from the market or be supported by the government. The scale and impact of these events is much wider and greater than the immediate costs to the affected institution. When Development Finance Corporation (DFC) failed in 1989, it was the 7th largest financial institution in NZ, was not a settlement bank and had only a small amount of retail funding. Yet it turned into a major event that knocked confidence in the financial system and affected views of New Zealand held by international investors for some time. Ultimately the risk of a crisis in New Zealand is determined by whether the many risks in the global ether are relevant to us. Snake bites are unpleasant but not very pertinent to most New Zealanders. So what does New Zealand’s financial ecosystem look like and what are its vulnerabilities? Figure 1 Size of financial sectors in New Zealand New Zealand’s banking system is large relative to the size of our economy and our financial system, with banking system assets worth $527 billion, or 186 percent of GDP (figure 1). It reaches almost all New Zealanders, with over 99 percent of us having bank accounts. An important feature is that it is highly concentrated: of the 26 registered banks in New Zealand, four banks – all Australian owned – account for more than 85 percent of bank assets. From one perspective we are well placed, compared to say, the Eurozone, where large banks operate across national boundaries as branches, under a single currency. We have an effective home-host relationship with APRA and our four largest banks are all locally incorporated. Their size and dominance of our banking sector is an important consideration for our regulatory approach: they must be able to stand on their own in New Zealand. Other parts of the ecosystem include insurers, payment and settlement systems, capital markets and non-bank lending institutions. Although these sectors are small in comparison to the banking sector, they play an important role in the financial system: ensuring that companies can operate with confidence and manage their risks, facilitating smooth and efficient payments within the economy, and providing capital to particular market segments.9 We have seen risks emerge from the “shadow banking” sector before and remain alert to developments in the wider financial sector. What threatens our financial system? New Zealand’s financial system has two main vulnerabilities: our high levels of indebtedness (in the household and dairy sectors) and our reliance on foreign sources of funding. Given the nature of the New Zealand economy and our financial system these risks are not going away. Our next assessment of them will be detailed in the Financial Stability Report to be published 28 November. High levels and concentrations of debt The majority of bank lending is to the household sector – at 58 percent – and secured against housing assets. Household sector indebtedness represents the New Zealand financial system’s single largest vulnerability. 9 The insurance sector has around $70 billion in total assets, equivalent to 25 percent of GDP. The unlicensed sector is made up of the government-owned Accident Compensation Corporation (ACC), the Earthquake Commission (EQC) and the Southern Response Earthquake Services – a government owned insurer resulting from the government bail-out of AMI following the Canterbury earthquakes – as well as some small private insurers. NZX’s market capitalisation is around $135 billion, while the total value of the domestic bond market is around $131 billion (excluding government debt). The fund management sector has around $125 billion of assets (both domestic and offshore) under management. The Non-Bank Lending Institutions (NBLI) sector provides around a third of consumer lending to New Zealanders but it remains small relative to the rest of the financial system. Mortgage lending from NBLI is around 3 percent of the total across the financial system. Of the NBLI, 25 are licensed Non-Bank Deposit Takers (NBDTs) – financial firms that accept deposits but are not registered banks – with total assets worth $2.5 billion. Other lenders that do not take deposits, and therefore are neither banks nor NBDTs, have total assets of $9.7 billion. The Reserve Bank operates the Exchange Settlement Account System (ESAS), which settles all interbank payments, and NZClear, which settles trades of securities. Two thirds of systemic banking crises around the world have been preceded by a housing boom and bust.10 Highly indebted households are vulnerable to shocks, such as higher interest rates or unemployment, that reduce their debt servicing capacity. This can lead to households cutting their consumption, selling their house or, if the shock is severe enough, defaulting on their loans. Household indebtedness has increased dramatically in New Zealand in the last 30 years. In 1988, the average household owed around $16,000 in debt and had an income of around $35,000 – a debt-to-income ratio of 46 percent. By the end of 2017, this ratio had risen to 168 percent, following a ten-fold increase in average household debt to nearly $160,000, while average incomes had only slightly less than tripled to $95,000. Credit extended to households in New Zealand as a percentage of GDP has risen from 27.9 percent in 1990 – relatively low compared to other countries – to 92.2 percent (figure 2). Figure 2 Credit to Households as a percentage of GDP % % Australia Canada United Kingdom Japan New Zealand Sweden United States Source: Bank for International Settlements. Note: Credit to households and NPISHs from all sectors at market value. Of course, systemic crises can emanate from different sectors. The level and concentration of dairy sector debt has increased significantly in recently decades, to become the next largest share of bank lending after housing. And a relatively large proportion of bank losses in past financial crises are estimated to have come from loans to the commercial property 10 See ‘How to deal with real estate booms: Lessons from country experiences’ by Crowe, Dell’Ariccia, Denis, Rabanal, IMF Working Paper, 2011, referred to in ‘Financial stability risks from housing market cycles’ by Thornley, RBNZ Bulletin, July 2016. sector.11 Problems in these sectors would not threaten financial stability on their own,12 but could significantly amplify losses to the banking system during a severe macroeconomic downturn. Foreign funding New Zealand’s other main vulnerability is foreign funding. We rely on the willingness of foreigners to lend to us, and to continue to lend to us, in order to fund our homes and our businesses. New Zealand’s net foreign liabilities – the difference between what we owe the rest of the world (our liabilities) and what the rest of the world owes us (our assets) – are high relative to most other developed economies. While most of our offshore funding is hedged we are vulnerable to disruptions in global financial markets. An increase in interest rates overseas can rapidly flow through to retail rates in New Zealand if bank funding is rolled over at higher prices. These fluctuations in funding costs are illustrated in figure 3. Perhaps more worrying is the risk of a market seizure where rollover is simply not feasible in the necessary timeframe, and credit has to be severely curtailed to address liquidity constraints. Figure 3 Offshore funding costs and market uncertainty bps Index Offshore funding spread VIX (RHS) Source: Bloomberg. Note: The offshore funding spread is the NZD cost of one of the largest four banks issuing a 5-year bond in the US relative to the 5-year NZ swap rate. The VIX index is an indicator of the market’s expectation of the 30-day volatility in the S&P 500 equity index. Banks have actively reduced their reliance on offshore funding since the GFC – particularly at short maturities – in order to reduce risk and respond to regulatory changes, such as our liquidity policy.13 However our reliance on foreign funding remains a significant vulnerability and is not going to go away while New Zealand remains a net borrower from overseas. 11 ‘Financial stability risks from housing market cycles’, Thornley, BRBNZ Bulletin, July 2016. Lending to the agriculture sector in New Zealand accounts for around 14 percent of total lending, of which the dairy sector accounts about for two-thirds. Loans to the commercial property sector comprise 8 percent of total bank lending in New Zealand. 13 The Reserve Bank introduced a Core Funding Ratio requirement for banks in 2010 that required them to hold more long-term foreign funding plus retail deposits, a ratio that was then increased in 2013. Soundness and efficiency; finding an appropriate standard of resilience for the financial system Given the structure of our financial system, its vulnerabilities and risks, how safe should we aim to make it? If Goldilocks visited our ecosystem, what would be too risky, too safe and just right? Our financial policy objective is to ‘promote the maintenance of a sound and efficient financial system’. The soundness goal means promoting the resilience of the financial system as a whole and intervening to mitigate risks to it. The efficiency goal means different things in different contexts: we minimise compliance costs; we support innovation and operate a regime that is open to new entrants; we avoid creating unnecessary frictions in the supply of credit to the economy; and we ensure that financial resources are allocated in a productive (and not harmful) way to maximise long term economic growth. A key goal of Phase 2 of the Government’s review is to clarify the scope and meaning of ‘sound’ and ‘efficient’; and whether these are still the right terms. Taken together, soundness and efficiency are akin to the financial stability mandates of other central banks. They empower and obligate the Reserve Bank to ensure the financial system works effectively in support of the prosperity and wellbeing of New Zealanders and contribute to a productive and sustainable economy. Along with our price stability and maximum sustainable employment objectives, they empower the Bank to stabilise the financial cycle and to mitigate the booms and busts that are inefficient in terms of society’s economic welfare. The costs of banking crises mentioned earlier make it clear that financial stability is important; prevention is better than cure and we should err on the side of caution. Our focus on achieving financial stability has been, and remains, primarily systemic rather than on individual institutions. We do not run a zero-failure regime (i.e. financial institutions can fail), and we expect all participants to do their part. We pursue our financial stability goal by using the levers and tools that are available to us. Some of these are baseline standards, others are relevant as risks emerge or eventuate (figure 4). The key is that we don’t think of each one in isolation and calibrate each one accordingly. Figure 4 Institutional rules Transparency Financial requirements Funding & liquidity Infrastructure Monitoring Enforcement Monetary policy Crisis management RBNZ tools Governance Risk management Attestations Licensing & NZ incorporation Outsourcing Disclosure Minimum capital requirements/solvency standards Conservation & counter cyclical buffers Sectoral Capital Requirements Core Funding Ratio Loan to value restrictions Liquidity standards Collateral standards / RMOs LoLR Foreign exchange intervention FMI rules and powers Financial Stability Report Stress testing Supervision & engagement Thematic reviews Investigations Directions OCR OBR Statutory management Self Mkt Reg Permanent Time varying Event Our three pillar approach to supervision emphasises self and market discipline, alongside regulatory discipline. We place a strong emphasis on sound corporate governance, ensuring (where possible) that individual institutions have incentives to manage their own risks; and on disclosure14 enabling investors to monitor risks to financial institutions. The risk of market failure means we must also have a robust regulatory pillar. Given the externalities at play in the financial system, the systemic costs of financial instability will not be addressed through self and market discipline alone. When an individual bank chooses to reduce its resilience, it will only face the private cost of its decision. The social cost will include, for example, the bank aggravating a boom-bust cycle by unduly relaxing lending standards. The perverse incentives are compounded if it is difficult for market participants to detect an increase in risk-taking (asymmetric information). We agree with the IMF’s FSAP report that the regulatory pillar should be stronger, and that we should adopt a more intensive approach to supervision. We are strengthening our supervision of individual institutions. We are making more frequent use of thematic reviews on areas of heightened risk, and we continue to strengthen our collaboration with APRA. We recently released our joint report with the FMA on Bank Conduct and Culture. As the IMF pointed out, increasing supervisory resources for all financial sectors is key to boosting effectiveness and responsiveness. We have sought additional resourcing to do this – a point that will be considered by the Government as part of Phase 2 of its review. Within this framework the key question is how we establish a rigorous and fair baseline of resilience for prudential regulation. Again it’s the goldilocks question, what is too risky, too safe, and just right? In the end it is a judgement based on experience, analysis and consultation. For example, we require non-life insurers to hold sufficient capital reserves or reinsurance to cover liabilities for a 1 in 1,000 year catastrophe event. We have set the bar high relative to global insurance standards due to New Zealand’s vulnerability to natural disasters and to promote public confidence in our insurers.15 Capital review In the case of banks we are currently reviewing the capital adequacy framework. The aim of the capital review is to identify the most appropriate framework for setting bank capital requirements – the amount of capital banks have to absorb losses – taking into account both how our current framework has operated and international developments. There are several guiding principles. One is that capital requirements should be conservative, reflecting the importance to New Zealand of sound credit ratings, given our reliance on offshore borrowing and susceptibility to international shocks. Another is that capital requirements should be set in relation to the risk of bank exposures. This is particularly important for New Zealand, where banking sector assets account for the majority of total financial system assets and are concentrated in housing and agricultural lending. 14 Earlier this year the Reserve Bank launched the Bank Financial Strength Dashboard. It allows financial information to be compared across banks. The aim is for the Dashboard to improve bank disclosure and public awareness and to make it easier for banks to benchmark themselves against each other. 15 On the other hand, our monitoring and oversight of insurance company risk-taking and compliance is limited. We have only 10 supervisors and actuaries overseeing around 90 insurance companies. Our aim in setting minimum capital ratios and buffers is to ensure that the banking sector can absorb shocks, maintain market confidence, and continue to supply credit during times of economic stress. In other words, we take a systemic and through-the-cycle view of prudential regulation. This reduces the risk of spillover from the financial sector to the real economy. Soundness is not easily translated into a single, quantifiable benchmark against which performance can be monitored. The academic literature and various countries’ prudential reforms since the GFC suggest there is a wide range of views on the optimal quantity and quality of capital for a banking system. Indeed, the literature generally suggests that ‘optimal’ capital is not only higher than regulatory minimums, but can also span quite a wide range. The literature is therefore helpful in pointing to the direction that regulatory capital should travel, but not the destination. We are naturally cautious in how we think about risk to the banking sector. We operate in the uncertain: the origin of the next crisis is unknown. And as alluded to earlier, a banking crisis would have significant costs for ordinary New Zealanders that would persist for years, in terms of economic output, public debt, employment and welfare. There is a good argument that there are soundness and efficiency gains to be made by requiring banks to hold more capital – within reason. More capital would help deliver both greater certainty, and higher expected output (before and after a crisis). This is illustrated by figure 5, where the level of financial stability is measured on the X axis and the expected output is measured on the Y axis. At some point more certainty comes at a cost, though this may be justifiable if we desire greater certainty. However based on the literature and the views of other regulators it would seem that we are a long way from that trade off. Some will argue that certainty comes at a price – that share capital is a more expensive form of funding than debt. There is a debate as to how high that price really is. And we need to weigh those private costs against the social costs of a crisis. Figure 5 A framework for thinking about our policy goal Output Financial Stability Low High The question remains, how much certainty do we want, how risky do we want our financial system to be in the long-term? Goldilocks returns with the same question what level of financial stability is too risky, too safe, or just right? To answer this we need to think about our risk tolerance for crises. Stress tests One input into informing the Reserve Bank’s risk tolerance is stress testing. We ask banks to consider what would happen in the event of a severe but plausible hypothetical scenario, with macro-economic outcomes that are broadly similar to the financial crises discussed earlier.16 By quantifying the impact of this scenario on bank balance sheets and profitability, the stress tests help us to understand whether the amount of capital banks hold is enough to absorb losses under that scenario and to better understand risks to financial stability. They are also used to support banks in developing their own risk management practices. Stress tests are an important lens on both the capital adequacy of banks and on our own risk tolerance. They can help us to explain to the public the sorts of tail events that we worry about, and assist participants and the public in understanding the resilience of individual institutions, and the financial system as a whole, to those risks. That said, there is no direct link between stress tests and our banks’ capital requirements. Interpreting their implications for system resilience requires many judgements, including on the levels of capital necessary for individual banks to maintain market confidence. Stress tests can’t cover all risks, or the right risks happening at the same time to all banks. It is just one scenario. And banks know how the stress scenario will play out in advance, which makes it more contained than it would be in practice. The GFC taught us that a synchronised global downturn can happen very quickly and what was thought truly exceptional (ie the Great Depression) might not be so improbable. It is difficult to capture the real-world complexities of a financial crisis within formal modelling approaches used for stress testing. Liquidity The GFC also demonstrated that the dangers to our banks may not lie just in the quality of their asset portfolios but in their ability to roll-over their funding, and at what cost. In other words liquidity can be the catalyst for financial stability risk. Our liquidity policy requires banks to maintain specified ratios of expected net cash inflow or outflow. It is intended to reduce the likelihood that an individual bank needs to call on us as the lender of last resort, and ultimately reduce the risk of a bank failure. Our minimum standards for liquidity risk also reflect the highly concentrated nature of our banking system and its reliance on foreign funding. We intend to review our liquidity standards next year, in light of new Basel Committee liquidity requirements. 16 To date these exercises have centred on the four largest New Zealand banks – reflecting that they account for around 90% of banking system assets. The scenario we used for the stress test in 2017 set a high bar. It asked banks to consider how they would fare if there was a downturn in the Chinese economy, collapse in demand for commodity exports, a rapid increase in unemployment, a 35% fall in house prices, a two notch downgrade in their credit rating downgrade, a spike in funding costs, and a significant misconduct event related to residential mortgages. The results of the 2017 stress test suggest that the four main New Zealand banks could absorb material losses in a downturn while remaining solvent. Adapting to emerging risks Establishing a baseline standard of resilience is not a set-and-forget exercise. It needs to be re-visited from time to time to ensure it is still appropriate – as we are doing with our capital review and as we will with our liquidity review next year. We also need to remain aware of changes in risks across the financial system – for example, when intense competition leads to dilution in lending standards, or irrational exuberance leads to credit and asset booms. We need a macro view of emerging risks that reinforces the baseline prudential settings. Credit-fuelled housing booms are a good example of this elevation of risk. They have been common in the lead-up to financial crises in advanced economies in recent decades.17 The purpose of macro-prudential policy is to lean against these time-varying risks. Our objective is to address emerging systemic risks by increasing the resilience of the domestic financial system and countering instability that arises from credit, asset price or liquidity shocks. As agreed with the Minister of Finance in the 2013 Memorandum of Understanding, we have four tools to implement macro-prudential policy: the countercyclical capital buffer, sectoral capital requirements, the core funding ratio and loan-to-value restrictions (LVRs) (see figure 4). The first three tools increase the resilience of banks directly. Mortgage lending policies like LVRs – and Debt-to-Income (DTI) ratios, which are yet to be included in our toolkit – limit the amount of lending banks can do within defined parameters in order to promote soundness. As for baseline standards, the use of macro-prudential tools may require trade-offs between soundness and efficiency,18 between financial stability and output. And as for the baseline standards we operate in conditions of considerable uncertainty. During an economic boom, it is often hard to tell whether easing lending standards or rapid credit growth is justified by strong economic fundamentals and whether swings in capital allocation are efficient or not. We aim to deploy and calibrate the right macro-prudential tool to address both the perceived risk and the efficiency implications, whether by changes to banks’ capital requirements or influencing lending behaviour. To date we have only deployed the LVR tool, in response to rapid house price growth and the sharp increase in the provision of high LVR loans – that is loans with relatively small deposits. The Reserve Bank’s speed limit on high-LVR loans has been an important mitigant to the significant increase in financial system risks associated with mortgage loans over the past five years. By improving the resilience of household balance sheets, the policy is expected to lower the numbers of households that are forced to sell their house or significantly reduce expenditure in a severe downturn. 17 In the five years prior to the start of the GFC, house prices increased about 60 percent in the UK and 40 percent in the US. In the following five years, prices fell about 15 percent in the UK and 36 percent in the US. 18 Measures may improve both efficiency and stability. In the case of ‘irrational over-investment’, externality costs exist with consumers and investors taking insufficient account of costs imposed on others from the increased risks of failure or recession, while capital misallocation also occurs. In this case stability and efficiency would both be increased through macro-prudential measures. Our risk tolerance for the recent housing and credit boom is implied by our calibration of the LVR restrictions.19 We keep these settings under review and will publish our next assessment of them in the upcoming FSR. The question we are assessing is whether the same restrictions are needed in the current environment where debt levels remain high but are not deteriorating, now that bank lending standards have tightened significantly and rapid growth in credit and house prices have stabilised. If these conditions continue, we expect to gradually ease the policy in coming years. The other macro-prudential tools also have an important role to play. For example, a counter-cyclical capital buffer would increase bank capital, and thereby improve banks’ resilience to a crisis when risks are heightened; and reduce the extent of deleveraging by banks in a downturn, thus improving efficiency by mitigating the effects of the boom-bust cycle on the wider economy. The role of counter-cyclical buffers in supporting our financial stability objective overlaps with, and is a part of, the work we are doing in our capital review, as it is important that the prudential and macro-prudential capital framework support each other and operate harmoniously. Our thinking on these macro-prudential tools continues to evolve. We are also refreshing our macro-prudential strategy drawing on our experience since the MOU was put in place. The aim of this refresh is to clarify when and why we would use the different tools. We intend to communicate clearly and consistently on macro-prudential policy in order to improve people’s understanding and expectations, and to support our accountability for the implementation of macro-prudential policy and its effects. Emerging risks to financial stability Unsurprisingly our focus in recent times has been on our main vulnerabilities: household indebtedness, the dairy sector and our foreign liabilities. But the financial system can become exposed to many other types of risks over time, in response to structural changes in regulation, technology, market structure or the physical environment. Some examples include conduct, cyber, climate change and FinTech. As we have seen in the UK and the US in the wake of the GFC, conduct and operational risk can have significant prudential impacts. In New Zealand our 2017 stress test scenario demonstrated the potentially significant impact that a failure to comply with responsible lending obligations could have for local banks. The reputational and financial impacts of misconduct are now playing out in Australia in the wake of the Australian Royal Commission into misconduct in the banking, superannuation and financial services industry. Our own Culture & Conduct Review, carried out jointly with the FMA, is an example of how we understand and manage these risks adequately. Cyber attacks are another dimension of operational risk. They pose a significant threat to the global financial system, as shown by the ‘WannaCry’ ransom-ware attack, the ‘Notpetya’ attack and the cyber-heist of the Central Bank of Bangladesh. We continue to work with banks, whose interests in this area are aligned with our own. Given this, and the pace of change, we are not developing policy specifically for the control of cyber risk. Our focus is on 19 At the time the LVR restrictions were introduced, high (>80%) LVR loans exceeded 20 percent of all outstanding loans, while nearly one in three new loans were high LVR loans. We consider those proportions implied excessive risk. We have slightly relaxed the rules such that they currently permit banks to make up to 15% of their new lending to owner occupiers with a deposit of 20% or less, and 5% to investors with a deposit of 35% or less. the resilience and business continuity dimensions of bank operations, and the security of the payment and settlement systems that the Reserve Bank operates. Climate change presents significant financial stability risks both through the direct implications of physical events for insurers, farmers and households, the indirect effects on insurance availability and property values, and through the potential social and economic disruption it promises.20 We are working on developing a climate change strategy, which will be informed by discussions with banks and insurers in due course. Our role as a regulator is to try to ensure that financial institutions are adequately managing these risks, even though the horizon for their realisation could be decades away. FinTech presents opportunities for banks and consumers as well as for financial stability. We are engaging with industry and we are willing to help where we can. FinTech can contribute to both the soundness and efficiency of the financial system, whether through improved payment systems or a greater diversity of institutions, and by implication fewer systemically important entities. Consumer benefits could be substantial as a result of increased availability and speed of services, greater competition and reduced costs of payments. However, initiatives like open banking also create risk – some financial institutions may not adapt to the new environment as quickly as others; and liquidity could become more volatile. We also need to be on guard against the emergence of a shadow banking sector, structured to sit outside our regulatory perimeter, and on the need to have the right powers and tools – an ongoing issue for financial market infrastructures. As the regulator we need to remain aware of these risks, watch for those emerging, and react appropriately so as not to forestall desirable innovation. Conclusion Financial stability matters a lot. Crises have significant costs for the financial system, the wider economy and all New Zealanders. Small open economies can be overwhelmed by large and volatile capital flows and they can be stifled when markets freeze up. New Zealand has fared better than most over the last thirty years and the Reserve Bank’s independence and price and financial stability objectives have been a key contributor to that. We believe our risks are manageable, should a downturn occur. But the risks to our financial system are none the less real. We take a fairly cautious and long-term view to achieve both soundness and efficiency. In doing so, we do not want to stifle innovation or new entrants. And we do not operate a zerofailure regime. We must remain alert to our structural vulnerabilities: our high levels of household indebtedness, our exposure to commodity prices and our banks’ reliance on overseas funding. Our role and oversight of the financial system mean that we are well placed to do this. Last year’s FSAP endorsed much of what we do while also recommending we strengthen our supervisory approach – which we have started to do through thematic reviews. It 20 A forthcoming RBNZ Bulletin article will survey these risks. recommended bolstering our macro-prudential framework by including a debt-to-income (DTI) tool. And Phase 2 of the Government’s review is an opportunity for all New Zealanders to consider the Reserve Bank’s mandate, its powers, governance and independence. The capital review gives us all an opportunity to think again about our risk tolerance – how safe we want our banking system to be; how we balance soundness and efficiency; what gains we can make, both in terms of financial stability and output; and how we allocate private and social costs. It may be that the legislation underpinning our mandate can be enhanced, for example, by formal guidance from government or another governance body, on the level of risk of a financial crisis that society is willing to tolerate. So what is too risky, too safe and just right? Answering that question is undoubtedly challenging. It needs to be constantly considered. The costs of crises may seem theoretical while the benefits from stability accrue over the long-term and are not easily quantifiable. But it is important to address these challenges front on, openly and transparently to ensure we can fulfil our financial stability objective and all New Zealanders benefit from us getting the answer just right. Thank you. References Barro, RJ, ‘Rare disasters, asset prices, and welfare costs’, NBER Working Paper series, 2007. Bollard, A and Ng, T, ‘Learnings from the Global Financial Crisis’, a speech delivered to ANU in Canberra, 2012. Bollard, A, Hunt, C and Hodgetts, B, ‘The role of banks in the economy – improving performance of the New Zealand banking system after the global financial crisis’, a speech delivered to NZSA in Tauranga, 2011. Fiennes, T, ‘Regulation and the Financial System’, a speech delivered to LEANZ in Wellington, 2013.] Fiennes, T, ‘The Reserve Bank, cyber security and the regulatory framework’, a speech delivered to the Future of Financial Services conference in Auckland, 2017. Gai, P, ‘The Design, Implementation, and Governance of Macroprudential Policy’, University of Auckland, 2017. Gambacorta, L and Shin HS, ‘Why bank capital works for monetary policy’, BIS Working Papers No 558, 2016. Hoskin, K, Nield, I, Richardson, J, ‘The Reserve Bank’s new liquidity policy for banks’, RBNZ Bulletin, 2009. Hunt, C, ‘Banking crises in New Zealand – an historical perspective’, RBNZ Bulletin, 2009. Laeven, L and Valencia, F, ‘Systemic Banking Crises Database: An Update’, IMF Working Paper, 2012. Margerison-Zilko, C, Goldman-Mellor, S, Falconi, A, and Downing, J, ‘Health Impacts of the Great Recession: A Critical Review’, Current Epidemiology Reports, March 2016. Office of the Auditor-General, ‘The Treasury: Implementing and managing the Crown Retail Deposit Guarantee Scheme, Performance audit report’, 2011. Reinhart, CM and Rogoff, KS, ‘Recovery from financial crises: evidence from 100 episodes’, American Economic Review, 2014. Thornley, M, ‘Financial stability risks from housing market cycles’, RBNZ Bulletin, 2016.
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Notes from an address by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to Business NZ CEO Forum, Auckland, 30 November 2018.
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Higher capital better for banking system and NZ Notes from an address delivered to Business NZ CEO Forum in Auckland On 30 November 2018 By Adrian Orr, Governor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz The Reserve Bank is tasked with ensuring the banking system is both sound and efficient. To achieve our task we have a range of tools (see Table 1). The most important tool in our kit is ensuring banks hold sufficient capital (equity) to be able to absorb unanticipated events. The level of capital reflects the bank owners’ commitment – or skin in the game - to ensure they can operate in all business conditions, bringing public confidence. Given its importance, we have been undertaking a review of the optimal level of capital for the New Zealand system. We conclude that more capital is better. We are sharing our work with the banking sector and public, and expect to hear one side of the story loud and clear, that capital costs banks. We need to hear a broader perspective than that, to best reflect New Zealand’s risk appetite. What have we done in practice? The Reserve Bank needs to ensure there is sufficient capital in the banking “system” to match the public’s “risk tolerance”. This is because it is the New Zealand public – both current and future citizens - who would bear the social brunt of a banking mess We know one thing for sure, the public’s risk tolerance will be less than bank owners’ risk tolerance. How do we know this? Surely the more capital a bank has the safer it is and the more it can lend. Why don’t banks hold as much capital as they can? First, there is cost associated with holding capital, being what the capital could earn if it was invested elsewhere. Second, bank owners can earn a greater return on their investment by using less of their own money and borrowing more - leverage. And, the most a bank owner can lose is their capital. The wider public loses a lot more (see Figure 2). Hence, we need to impose capital standards on banks that matches the public’s risk tolerance. We have been reassessing the capital level in the banking sector that minimises the cost to society of a bank failure, while ensuring the banking system remains profitable. Ref #7821869 v2.0 The stylised diagram in Figure 3 highlights where we have got to. Our assessment is that we can improve the soundness of the New Zealand banking system with additional capital with no trade-off to efficiency. In making this assessment, our recent work makes the explicit assumption that New Zealand is not prepared to tolerate a system-wide banking crisis more than once every 200 years. We have calibrated our ‘sweet spot’ thinking about economic ‘output’ and financial stability benefits. How did we arrive at this position? Current levels of capital are based on international standards, and are not optimal for any one country. The standards are also a minimum. There is a clear expectation that individual countries tailor the standards to their financial system’s needs. Banks also hold more capital than their regulatory minimums, to achieve a credit rating to do business. The ratings agencies are fallible however, given they operate with as much ‘art’ as ‘science’. Bank failures also happen more often and be more devastating than bank owners – and credit ratings agencies – tend to remember. The costs are spread across the public and through time. Many large banks are foreign owned – especially in New Zealand. Their ‘parents’ are subject to capital requirements in their home and host country. This creates continuous tension as to who gets the lion’s share of capital and failure management support. It would be naïve to expect a foreign taxpayer to bail out a domestic banking crisis. Hence, New Zealand needs to assess its own risk tolerance, and decide who pays to clean up any mess and the scale of that mess. A word of caution. Output or GDP are glib proxies for economic wellbeing – the end goal of our economic policy purpose. When confronted with widespread unemployment, falling wages, collapsing house prices, and many other manifestations of a banking crisis, wellbeing is threatened. Much recent literature suggests a loss of confidence is one cause Ref #7821869 v2.0 of societal ills such as poor mental and physical health, and a loss of social cohesion. If we believe we can tolerate bank system failures more frequently than once-every-200 years, then this must be an explicit decision made with full understanding of the consequences. Table 1: The Reserve Bank’s tool kit RBNZ tools Institutional rules Transparency Financial requirements Funding & liquidity Self Market Regulatory Permanent Governance Risk management Attestations Licensing & NZ incorporation Outsourcing Disclosure Minimum capital requirements/solvency standards Conservation & counter cyclical buffers Sectoral Capital Requirements Core Funding Ratio Loan to value restrictions Liquidity standards Collateral standards / RMOs LoLR Foreign exchange intervention Infrastructure FMI rules and powers Monitoring Financial Stability Report Stress testing Supervision & engagement Thematic reviews Enforcement Investigations Directions Monetary OCR policy Crisis OBR management Statutory management Ref #7821869 v2.0 Time Event varying Figure 2: The cost of recent bank failures on society Fiscal cost as % of banking system assets Uruguay Korea Greece Finland Czech Japan Iceland Ireland Netherlands Slovenia Sweden UK Norway USA Belgium Austria Spain Denmark Germany France Luxembourg Italy Portugal Source: IMF (2013) Systemic Banking Crisis Database 0.0 5.0 10.0 15.0 20.0 % of banking system assets Figure 3: The capital-output ‘sweet spot’ Ref #7821869 v2.0 25.0 30.0 35.0
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Financial Stability of the Reserve Bank of New Zealand, to the Institute for Governance and Policy Studies, Victoria University, Wellington, 26 February 2019.
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Safer banks for greater wellbeing A speech delivered to the Institute for Governance and Policy Studies, Victoria University in Wellington, New Zealand On 26 February 2019 By Geoff Bascand, Deputy Governor and General Manager Financial Stability 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Good afternoon, It is a pleasure to be able to speak about the Reserve Bank’s recent proposals to increase minimum capital requirements for banks to such a diverse audience at Victoria University that includes academics, students, government officials, bankers, and members of the public. While perhaps not obvious on the surface, these proposals, if implemented – in whole or in part – are likely to have impacts on all New Zealanders. The Reserve Bank of New Zealand has been tasked by Parliament with promoting the maintenance of a sound and efficient financial system and exercising its powers to avoid significant damage to the financial system that could result from the failure of a registered bank. These responsibilities, among others, such as those related to monetary policy, are set out in the Reserve Bank of New Zealand Act (1989).1 It is therefore our job at the Reserve Bank to carry out these legislated responsibilities to the best of our abilities each and every day, for the benefit of improving the wellbeing of all New Zealanders. Today I’d like to talk about how we are proposing to improve the lives of all New Zealanders by making New Zealand’s banking system safer, and how the recent proposals by the Reserve Bank with respect to minimum capital requirements will do just that. History of Bank Failures in New Zealand In order to set the stage on this topic, I would like to start by looking at the history of bank failures in New Zealand. As New Zealanders, we are in the fortunate position of having very little experience with bank failures. This is undoubtedly a good place to be. Since the late 19th century, New Zealand has only experienced two banking crises, one in the late 1880s and early 1890s, which resulted from a credit-fuelled rural land boom in the 1870s, while the other occurred in the late 1980s and resulted in the Bank of New Zealand having to be recapitalised by the government and its shareholders.2 The first episode in the late 1800s occurred well before my time, though as a manager in Treasury during the 1 The government is currently reviewing this Act, which may result in changes to the Reserve Bank’s statutory objectives. More information on this review can be found here: https://treasury.govt.nz/news-and-events/reviews-consultation/reviewing-reserve-bank-act 2 Chris Hunt, “Banking crises in New Zealand – an historical perspective”, Reserve Bank of New Zealand: Bulletin, Vol. 72, No. 4, December 2009. https://www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2009/rbb2009-72-04-04 second episode, I fully remember the stresses of the 1980s/early 1990s, and contributing to the subsequent fiscal and social policy adjustment. Perhaps one banking crisis per lifetime is one too many?3 For those of you that remember the events surrounding the Bank of New Zealand in the late 1980s, as challenging as that time was for the country, it would have been much worse had the bank not received the financial assistance it needed to avoid an outright failure. Had the Bank of New Zealand failed and gone through New Zealand’s liquidation process, it would have almost certainly created a massive disruption to its depositors, placed great stress on New Zealand’s banking system, and (even more severely) damaged confidence in New Zealand’s economy. While New Zealand’s history with bank failures is limited, we all know that the past is not necessarily a good predictor of the future – so we must view bank failures in New Zealand as a real possibility and ensure that banks in New Zealand are resilient enough to withstand severe losses. The Potential Impact Given our limited first-hand experience with bank failures, allow me to describe what we think some of the impacts of bank failures might be under New Zealand’s financial system framework. As the resolution authority for banks, the Reserve Bank is responsible for providing advice regarding when and how to resolve a failed bank.4 The Reserve Bank has several options for resolving a failed bank. Under any of these options, there would likely be at least some level of disruption to the banking system as depositors would lose access – at least temporarily – to some or all of their deposits. It is also possible that depositors may never recover the full value of their original deposits.5 We would expect that the impact of bank failures would be broader and harsher the larger and more intertwined the failed banks are with New Zealand’s economy. Not only do New Zealand’s large banks employ a significant number of New Zealanders, but these banks also It is also useful to recall that in 1989, the Development Finance Corporation, which was New Zealand’s seventh largest financial institution at the time (but not a bank), was placed into statutory management and ultimately liquidated. New Zealand also suffered from widespread finance company failures in the mid-late 2000s, devastating the savings of many New Zealanders and damaging confidence in the financial system. 4 Under the Reserve Bank of New Zealand Act, the Governor General, on the advice of the Minister of Finance, may appoint a statutory manager to carry out the resolution of a registered bank. The Reserve Bank can also issue directions to the statutory manager. 5 The Review of the Reserve Bank Act is considering whether increased protection of deposits, perhaps through a deposit insurance framework, would be beneficial. provide the vast majority of financing for individuals and businesses in New Zealand. And because bank failures, and even ‘near failures’, usually result in significant credit tightening (as banks begin to strengthen their balance sheet by restricting credit to only the most creditworthy borrowers), it could be expected that some New Zealanders and New Zealand businesses would not have access to the same level of credit as before. This could mean that it may be more difficult for individuals to borrow to buy a car or home or pursue further education, and businesses may have trouble borrowing to meet their short-term cash flow needs. The decrease in available credit could have disastrous impacts on New Zealand’s economy. While it is likely that the Reserve Bank would intervene to resolve a failing bank before it is in a negative capital position (i.e., the Reserve Bank would begin the resolution process when the value of assets exceeds liabilities), it is difficult to determine exactly how the bank’s remaining value (and losses) would be allocated among creditors (including depositors) and shareholders. However, what is known with greater certainty is that creditors (including depositors) will realise more value in the failed bank if the bank has a greater proportion of shareholder capital. Social Costs of Bank Failures International agencies like the World Bank, the World Health Organization, and the United Nations have investigated the economic and social impacts of financial crises. They report that banking crises almost always lead to a general downturn in the economy, associated with rising unemployment and lost output, with consequential societal effects.6 These impacts go beyond the financial realm as they affect the health and quality of life, often of people who had little involvement in creating the crisis. The Global Financial Crisis of 2008/2009 was a prime example, as this crisis led to a widespread global downturn and higher rates of unemployment. While many countries have since fully recovered from this crisis, or are on the path to recovery, some countries are still trying to find their footing. Since the 1970s, there have been more than 140 banking crises around the world. And they have had large costs to affected economies and societies.7 Unemployment rates and GDP figures are the more easily quantifiable impacts of banking crises. But what can sometimes get lost in the discussion surrounding bank failures is the deep personal impacts they can have, not only on those directly impacted, but also on those indirectly impacted. Economic models and statistics can only go so far in telling this story, which is why I want to spend some time on the impacts of banking crises on wellbeing. 6 Otker-Robe I, and Podpiera A M: The social impact of financial crises; Evidence from the Global Financial Crisis, Policy Research Working paper, No. WPS 6703, World Bank, 2013. 7 See the discussion of costs and references in G. Bascand, “Financial stability – risky, safe, or just right?” A speech delivered to UBS Australasia Conference 2018, Sydney, Australia, 13 November 2018. If you ask someone who’s lived through a banking crisis, they’ll likely tell you that the impacts were not only significant, but lasting. Perhaps the person you talk to may have lost their job as a result of the crisis, and if not, it might have been their spouse, a friend, or a neighbour. Maybe you speak to a young couple that had purchased their first home just prior to the crisis, only to see its value decline by 30% in the months following the crisis, forever altering their outlook on the economy and their willingness to make another significant investment. Or maybe you speak to someone who just graduated from university prior to the crisis, only to enter a depressed labour market, and forced to accept work well below their educational qualifications and abilities, forever altering their desired career path. Talk to these people, and I think they will tell you that banking crises have altered their lives in ways they wished it hadn’t. I think they will also tell you that banking crises should not be accepted as an unavoidable fact of life. For those that lived through the recession we experienced here in the early 1990s, you will recall that some industries were decimated, and a generation of workers lost. Many of these workers were not able to re-enter the workforce easily and lost valuable skills while trying to find suitable employment. And while recessions sometimes occur in the absence of a banking crisis, it is common for banking crises to ultimately result in recessions. While shocks to the banking system cannot be avoided, particularly those that originate from outside our borders, we believe that by making some changes to our banking rules, we can improve the prospects that our banks will survive those shocks and be able to continue lending.8 And by doing so, we can improve the economic and social wellbeing of all New Zealanders. Bank Capital – What it is and isn’t When we talk about ‘bank capital’, what are we talking about? I ask this question because bank capital is a complex subject that is widely misunderstood. When we talk about bank capital, we are talking about where a bank gets its money. 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’. 8 BIS Working Papers: Why Bank Capital Matters for Monetary Policy, Leonardo Gambacorta and Hyun Song Shin, April 2016. 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%.9 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.10 Figure 1: Shareholder equity to asset ratios, New Zealand banks, non-bank businesses and NZX-listed property trusts % of assets Equity (capital) Debt New Zealand banks non-bank New Zealand NZX-listed property trusts businesses Source: Registered banks’ Disclosure Statements, Statistics New Zealand, company reports Note: NZX-listed property trusts is an aggregate of the balance sheets of Kiwi Property Group, Goodman Property Trust, Precinct Properties New Zealand Limited, Argosy Property Limited, Property For Industry Limited, Stride Property Limited, as at the most recently available balance date. It is not clear to me why this discrepancy between banks and other businesses is so large, but perhaps at least part of it can be explained by the fact that, historically, governments have been much more reluctant to allow a bank to fail than other types of businesses, which may lead banks to operate closer to the edge. We believe that this balance of funding sources is not in the best interests of New Zealanders, which is why we are proposing change. I will explain why. 9 We have included a chart in the Appendix to reflect this disparity; this chart also includes NZX-listed property trusts as an industry with some similarities in its business model to banking. The Appendix also contains several other charts, tables, and figures related to the Reserve Bank’s capital proposals. 10 Information on bank capital adequacy, and other financial measures, can be found on the Reserve Bank’s Financial Strength Dashboard here (please note, however, that capital measures on the Dashboard will differ to the figure cited here as capital measures on the Dashboard are ‘risk-weighted’): https://bankdashboard.rbnz.govt.nz/summary ‘Skin in the Game’ As I mentioned, the Reserve Bank has recently proposed an increase to the minimum capital requirement for banks. We have proposed this increase for a number of very important reasons, and one of them is to require banks to put more of their own chips – not yours – into the pot. The Reserve Bank, like other banking regulators around the world, requires bank owners to put some of their own money into the bank. While bank owners will, on their own, contribute some of their own money into the bank, banking regulators set minimum requirements in this area to ensure that it is enough. This is what I referred to earlier as the bank’s capital, which acts as the bank’s ‘skin in the game’. What is ‘skin in the game’ and why is it important? Put simply, skin in the game refers to the concept of having to bear the consequences of one’s own decision-making. An example of skin in the game can be found at your local pool. As you are likely aware, pools are required to frequently test the water in the pool to ensure that it remains safe to swim in. If the person who tests the pool water also swims in the pool every day, then they have some extra incentive – some ‘skin in the game’ – to ensure that the water remains safe. By having minimum ‘skin in the game’ requirements, banking regulators ensure that the owners of a bank have something at stake, something to lose. I would like to note that banks themselves lend on these very same ‘skin in the game’ principles, for example, by requiring mortgage borrowers to provide a deposit. At one time, the owners of a bank had plenty more ‘skin in the game’ than they do today.11 However, over the last century, banks have started to use less of their own money and more of other people’s. While we are not attempting to turn back the clock a hundred years, we want to swing the pendulum back in the other direction a little bit. 11 Andrew Haldane, “Control Rights (and Wrongs)”, Bank of England, 2011. We believe that more ‘skin in the game’ for banks will result in: Banks being better able to absorb large, unexpected losses. Losses reduce the value of a bank’s assets, but have no effect on the value of the bank’s debts. If the assets fall in value so far as to be insufficient to cover what the bank owes, the bank is insolvent. Society being less at risk from banking crises. Because more capital means banks are more likely to survive large unexpected shocks, society is also less at risk from the economic and social fallout that usually accompany bank failures. Reduced fiscal risk. When the probability of a banking crises is reduced, so is fiscal risk. As the Global Financial Crisis illustrated, when banks fail there can be a severe domino effect that puts pressure on governments to step in with financial support. The provision of a government guarantee on deposits during our own finance company crisis a decade ago is an example. Bank shareholders and management being less inclined to take excessive risks. Owners Lose First Bank capital serves several purposes, but its primary job is to absorb losses. When a bank loses money, it is the owner’s money that is lost first, as it should be. Borrowing a poker analogy12, if the bank’s skill and luck runs sour, it is the owners’ chips that are lost first, not the chips they borrowed. In a bank’s case, the borrowed chips are the deposits and other money it has borrowed. Why, then, do banks operate with so few of their own chips at the table? While I will let banks answer that question for themselves, I will only say that an individual bank’s own goals and objectives do not necessarily line up with wider society’s. In any event, we have proposed that banks come to the table with more of their own chips, and less of other people’s, which will reduce the risk of them folding and reduce the risk of the New Zealand taxpayer ever having to step in to save them. 12 Note that I am not attempting to draw a direct comparison between banking and the game of poker, other than to highlight that both involve risk-taking. The Capital Review The economic and social cost dimensions of bank failures are readily understood. The links to bank capital and the Reserve Bank’s regulatory requirements are perhaps less familiar. The Reserve Bank of New Zealand has been undertaking a review of its capital framework for New Zealand banks since March 2017. The purpose of the review is to identify the most appropriate capital framework for New Zealand banks in order to best enhance the long-term welfare of New Zealanders. Prior to undertaking this review, we set out these following six key principles for the review: 1. Capital must readily absorb bank losses ahead of creditors and depositors. 2. Capital requirements should be set in relation to the risk of bank exposures. 3. Where there are multiple methods for determining capital requirements, outcomes should not vary substantially between methods. 4. Reflecting the risks inherent in New Zealand financial system and the Reserve Bank’s regulatory approach, New Zealand bank capital requirements should be conservative relative to international peers. 5. The capital framework should be practical to administer, minimise unnecessary complexity and compliance costs, and take into consideration relationships with home-country regulators. 6. The capital framework should be transparent to enable effective market discipline. The magnitude of this review led us to separate it into different phases. The first phase of the review determined the scope of the main issues that would be considered as part of the review. The second phase of the review looked at the numerator – the nature and quality of bank’s capital. The third phase looked at the denominator – the bank’s assets and their measurement or weighting. We are now in the midst of the fourth and final phase of the review, which focuses on the capital ratio (the ratio of the bank’s capital to its assets), and what the minimum level of this ratio should be. As a matter of practice, before we change the rules for banks in New Zealand, we ask them and the wider public what they think. And we did just that when we released our fourth consultation paper on 14 December 2018. In that consultation paper, we proposed that New Zealand’s banks bear a greater share of the financial system’s risks by increasing their minimum capital requirements. We will be accepting comments on these proposals until 3 May 2019. The consultation document can be found on the Reserve Bank’s website; I would encourage all of you to take a look at it.13 And for those of you that find even the thought of wading through a long and technical paper on bank capital entirely unappealing, we have included a shorter, non-technical summary that captures the main concepts of our proposals and can be read in only a few minutes. While I do not wish to pre-judge the input we will receive from this consultation, I do not believe I am making too bold a prediction in saying that we expect to hear strong opposition to these proposals from some banks. While we expect to receive formal submissions from the banks and the banking industry closer to the 3 May comment deadline, we have already heard quite a bit from various market commenters, both within and outside New Zealand. I think it’s fair to say that the reaction from these commentators has been mixed – some commentators believe our proposals are entirely reasonable and justified, while others believe that our proposals are too extreme. Let me once again say that all feedback on our proposals, whether short or long, supporting or dissenting, from whatever level of financial sophistication, is welcome. We will review all of it carefully. While we recognise that these proposals may not align with the interests of banks’ shareholders, the key question is whether they are aligned with the best interests and wellbeing of New Zealanders. Our Proposals It is now time to dig into the weeds a little. What exactly have we proposed? As I stated earlier, banks in New Zealand, like banks around the world, are required to have minimum levels of capital. This means that a minimum percentage of all a bank’s money must come from its owners. In New Zealand, at the moment, the Reserve Bank has set this minimum amount at 10.5% for total capital, which is consistent with total minimum capital requirements set by the Basel Committee on Banking Supervision (BCBS), a group of international banking regulators and central banks.14 We are proposing to increase this total minimum capital requirement from 13 All the aforementioned consultation papers on the Reserve Bank’s Capital Review, including papers that were used as inputs and released under the Official Information Act 1982, can be found here: https://www.rbnz.govt.nz/regulation-and-supervision/banks/consultations-and-policy-initiatives/active-policydevelopment/review-of-the-capital-adequacy-framework-registered-banks 14 BCBS members include organisations with direct banking supervisory authority and central banks. The BCBS is the primary global standard setter for the prudential regulation of banks and provides a forum for cooperation on banking supervisory matters. Its mandate is to strengthen the regulation, supervision and practices of banks worldwide with the purpose of enhancing financial stability. the current 10.5% to 18% for banks that are identified as ‘systemically important’ and 17% for all other banks.15 Within this proposed increase from 10.5% to 18%, we are proposing to increase the minimum capital requirement for ‘Tier 1’ capital – a form of higher quality capital that can better absorb a bank’s losses – from 8.5% to 16% for banks that are identified as ‘systemically important’ and 15% for all other banks. Tier 1 capital is what we regulators refer to as ‘going-concern’ capital, meaning that it helps absorb a bank’s losses while the bank is a ‘going-concern’ – in layman’s terms, while the bank is ‘still alive’. It is this high quality capital in particular that would achieve our objective of making New Zealand’s banks more resilient to severe shocks. The Reserve Bank also has a minimum capital requirement of 2% for ‘Tier 2’ capital, which we regulators refer to as ‘gone-concern’ capital, as it is only effective in absorbing a bank’s losses after a bank is ‘gone’ (after the bank has failed). Given that we are proposing to increase minimum requirements for the highest quality Tier 1 capital from 8.5% to 16% or 15%, our most recent consultation paper asks the question of whether this lower quality Tier 2 capital is needed as part of the capital framework at all. And to dig even further into the weeds, of the proposed minimum Tier 1 capital requirement of 16%, the first 6% will consist of a regulatory minimum that banks are not to breach (to do so would trigger resolution or failure options), with the 10% that sits above that being what we call a capital buffer. We are proposing that the top 1.5% of this 10% capital buffer consist of a ‘counter-cyclical capital buffer’, which would be removed in the event of a large economic stress so that banks could continue to lend to support the economy during this stress period (provided of course that the bank was fundamentally healthy). While on the surface the proposed increase may look dramatic – indeed, it has been described by some as “radical” – the actual increase for banks would not be quite as high. The reason for this is that banks, for the most part, are currently operating well above the existing 8.5% minimum requirement for high quality capital. On average, banks in New Zealand are operating with approximately 12% of such capital16. As such, our proposed increase to minimum requirements may not be as large as it appears on the surface. 15 The Reserve Bank will be consulting on a framework to identify ‘domestic systemically important banks’ (DSIBs) in the near future. 16 This 12% figure includes the estimated impact of proposed changes to the internal-ratings based approach in the most recent consultation paper. Figure 2: Tier 1 capital, four largest locally incorporated banks, aggregate of other locally incorporated banks Large banks Other banks $12.5b 16% 14.1% $0.4b 15% 11.8% Current outcome (comparable basis) Net Tier 1 capital needed ^ Proposed minimum Current outcome Net Tier 1 capital needed Proposed minimum Source: RBNZ Balance Sheet Survey, RBNZ estimates ^: Tier 1 capital needed to meet the proposed minimum capital levels, not including the replacement of outstanding Tier 1 capital that would no longer qualify under the proposed changes to the capital framework (approximately $6bn for large banks, $150m for other banks). Does not include any voluntary capital surplus banks may choose to operate with, above the proposed minimum. Note: Data as at November 2018. Current outcome (comparable basis) incorporates proposed changes to the calibration of the internal ratings based approach to credit risk used by the four largest banks. Banks have several options for meeting the new requirements, which include retaining a greater proportion of their earnings rather than paying them out as dividends, issuing shares or other eligible instruments that would qualify as capital, or possibly reducing lending in certain markets. While it would be up to individual banks to decide how to meet any increased minimum requirement, we believe these are all viable options. For example, we estimate that the large four banks could meet these new requirements by retaining about 70% of their expected profits over the proposed five-year transition period, with no need to slow down the rate at which they have grown their lending in recent years. How We Got Here It is reasonable for the banking industry, and others, to ask why we have specifically proposed a minimum total capital requirement of 18% (or 17% for ‘non-systemically important’ banks). Allow me to elaborate on how we arrived at this number. First, we began with the international standards set by the Basel Committee. These set the minimum total capital ratio requirements at 10.5%, which is the level of New Zealand’s current minimum total capital requirements. However, it is common to see other jurisdictions go above and beyond these standards to suit their particular circumstances. This is where our journey really begins, and it starts with the question: What are the correct capital requirements for New Zealand? We started with our legislative mandate of ‘promoting the maintenance of a sound and efficient financial system’ to guide our approach to answering this question. Our overall approach was to use what we call a ‘risk appetite framework’. The framework combines ideas about the impact of capital on the likelihood of a banking crisis, the impact of capital on output, and society’s tolerance for banking crises. We applied a risk-tolerance concept to the policy problem, “How can we deliver a sound financial system for all stakeholders, not just the banks?” We then considered whether any extra gains could be made in the long-term by increasing capital (by reducing the likelihood or impact of bank failure on GDP). This reflected the efficiency limb of our ‘soundness and efficiency’ objective. This meant that, where there was an opportunity to improve the stability of the financial system (and thus mitigate societal costs of crises) without economic costs, we would take it. Several lines of analysis underpinned this policy approach. One of them was quantitative modelling. This required us to adopt a specific representation of society’s risk appetite. We could have carried this out in a complex way, however, this would have only given an illusion of certainty. Instead, we opted to adopt a simple decision rule – set capital to cap the probability of a systemic crisis at a low level – once in every two hundred years.17 By setting a one in two hundred year risk appetite, we aimed to reflect the significant uncertainty involved in estimating capital requirements as well as achieve our aim of a sound financial system. Allow me to put this one in two hundred year assumption into better context for New Zealanders by relating it to the all too frequent earthquakes we experience right here at home. As we all know, we experience small earthquakes quite frequently, most of which are not felt by most of us. However, what everyone worries about is the ‘big one’ (i.e., the one in five hundred year earthquake). We don’t know when the ‘one in five hundred’ will happen, but we know that when it does happen, it will be big. That’s the basic concept behind the one in two hundred concept we’re talking about in this current capital consultation. 17 The one percentage point lower capital requirement for ‘non-systemically important’ banks recognises that they can fail somewhat more frequently with lesser social cost, that we have approximated as perhaps once in every one hundred years or so. However, the quantification of risk is less precise for these banks. This may sound like a high-bar to set, but it’s important to remember just how damaging bank failures can be, not just in economic terms, but more broadly in terms of mental and physical health, and general societal wellbeing. It’s also important to remember that the societal impacts tend to go well beyond the initial year of a banking crisis. Such an approach is also common in international standards. Once every two hundred years is the risk tolerance adopted in Europe by regulators of insurers. The Basel international standards, and current New Zealand framework for that matter, use a once in a thousand year basis for determining the relative riskiness of different types of lending. As part of our risk appetite framework, the relationship between capital and output was also considered. It is generally accepted that there will be some impact on interest rates and, ultimately, output. The relationship between capital, output, and wellbeing is more dynamic than it may seem at first, as I will allude to shortly. For now though, I will say that we believe that there are few efficiency gains to be made by going beyond the current proposal of 18% (or 17%). The level of capital we think is needed to meet our soundness objective has also addressed the potential to increase stability without adversely impacting on long-term output. There were other threads of analysis that supported our proposals. A comprehensive review of the international literature told us that we were within the range of capital ratios that were appropriate. Furthermore, building on analysis that began in 2012, we looked at the implications of representing society’s risk appetite differently. This analysis took into account New Zealand specific factors and captured household risk-aversion.18 As with findings from similar types of analysis in the international literature, there is a wide range of plausible calibrations. However, this analysis ultimately showed that a capital ratio of 18% (or 17%) is in the mid-point of our range of estimates for the ‘optimal capital ratio’ for New Zealand. We were therefore comfortable that most, if not all, of the gains were being reaped for the economy at the 18% (or 17%) minimum capital requirement proposed from our risk-appetite framework. Going far beyond this point could not guarantee additional benefits for the economy, and similarly going far below left much to be desired in terms of potential efficiency (expected output) and financial stability gains. We are consulting on proposals that we think we have about right. The soundness lens we use to think about capital considers the impact of capital on the likelihood of a crisis and the consequent fallout. The efficiency lens tells us that there are few, if any, output gains to be made from varying the level of capital from what is justified on soundness grounds. I would like to reiterate that we are currently consulting on our proposed minimum capital requirements, including the risk appetite setting that we have chosen. As I have previously 18 The analysis focused on Tier 1 capital and suggested in its base case a Tier 1 ratio of 18.4%. stated, it is ultimately society that will bear the wider costs of a financial crisis. As such, we would like to hear New Zealanders’ views on whether the one in two hundred year risk appetite setting is appropriate for New Zealand. The Costs We propose increasing capital in the banking system to make the system safer because we believe the economic and social benefits outweigh the costs. I have already described some of the many benefits that would be derived from increasing capital in the banking system, so in fairness, I must now address the costs. Increasing capital requirements is expected to result in an increase in banks’ average funding costs. This is because shareholders generally require a higher rate of return from their investment than depositors and other creditors. Since we’re proposing that banks rely more on this more expensive form of funding, banks’ total funding costs could be expected to increase somewhat. Of course, since the banks would also be safer (have less risk), shareholders, depositors, and other creditors, could be expected to lower their expected returns (relative to what they expect today), which would moderate the impact of the increase in capital on average funding costs. When banks face an increase in costs, they can be expected to try to pass these costs on through various means, including to their borrowers through higher lending rates and to depositors and other creditors through lower deposit rates. However, we expect that competitive pressures may limit banks’ ability to fully pass these costs on to others. Taking into account the safer investment in banks for shareholders, and competitive pressures in the market, we think the increase in lending margins (the difference between bank lending and borrowing rates) due to our proposals will be in the vicinity of 20 to 40 basis points (less than half of one percent), which assumes that bank shareholders demand a lower return on equity on account of their bank’s lower risk. This 20 to 40 basis points change represents a combination of deposit (and other creditor) rates falling and lending rates increasing. That is, interest rates on deposits and other bank liabilities could fall to make up some of this margin, with lending rates for borrowers rising to make up the remainder. Higher lending rates can dampen investment and lead to lower potential output. However, in the short-term our own models suggest that the impact on lending rates will be little more than ‘noise’, something that will likely be drowned out by wider economic factors. Looking at this from a longer horizon, the international literature implies that the cumulative (and present value) impact of an increase in lending rates of less than half of one percent could be equivalent to a one-off reduction in the long-run level of output of around the same amount (i.e., equivalent to a one-off impact on output of less than half a percent). The expansion in lending rates that we expect, of course, is less than this due to the potential for lower deposit rates to contribute to the margin expansion. The very small impact of capital on potential output needs to be measured against the reduced probability of a crisis, and all the economic and social chaos that accompanies it. Levelling the Playing Field We are also proposing to level the playing field between banks that use their own models to determine their capital requirements and banks that use models prescribed by regulators to determine capital requirements. Banks that use their own models to determine capital requirements are known as ‘internal models’ banks and currently consist of the large four New Zealand banks. All other banks in New Zealand currently use what is known as the ‘standardised approach’. For many years, we have observed that banks using their own internal models produce lower capital requirements relative to the other banks, which provides them with a competitive advantage that we don’t think can be fully justified based on differences in their underlying risk profiles. Figure 3: Estimated Tier 1 capital per $100 of residential mortgage lending, current values and proposed minimum amounts $ $ Current outcome Proposed minimum (estimate) ANZ ASB BNZ Westpac Kiwibank Source: Registered Bank Disclosure Statements, RBNZ calculations. Other banks Technical note: Current capital outcomes are calculated using most recent quarter Tier 1 capital ratios and riskweighted asset (RWA) amounts, representing the actual capital on banks’ balance sheets including any voluntary capital banks operate with above current regulatory requirements. Proposed minimum outcomes are calculated based on a 16 (15) percent Tier 1 ratio for large (small) banks. The impact of proposed changes to the calibration of the IRB approach are assumed in this analysis to result in IRB RWA amounts that are the maximum of 1.2/1.06 times banks’ current IRB RWA amounts, or 32 percent of banks’ current EAD (an approximate value for RWA if an 85 percent floor relative to the standardised approach is binding)). For IRB banks, both current and proposed capital outcomes also include the value of an average expected loss deduction equal 0.1 percent of EAD, based on an average of banks’ private reporting. To provide a comparable amount of Tier 1 capital per $100 of lending, IRB minimum capital requirements per dollar of EAD are divided by 1.037, as EAD (as calculated under IRB) is on average estimated to be equivalent to 1.037 times the ‘exposure amount’ that would be calculated under the standardised approach. Analysis covers non-defaulted mortgages only. As such, we are proposing to limit this gap by capping the reduction in capital that banks using their own internal models can achieve relative to all other banks. This is commonly referred to as a ‘capital floor’. We are proposing to set this floor and adjust another aspect of the calibration such that internal models banks risk-weighted assets will be around 90 percent of the level calculated via the standardised method.19 Going Above and Beyond No doubt one of the criticisms we expect to receive is that our proposals are not consistent with agreed international principles, commonly known as “Basel III”. I beg to differ. Following the Global Financial Crisis, members of the BCBS agreed to a revised set of minimum capital requirements that both increased the quantity, but also the quality, of bank capital.20 These minimum capital requirements are just that – minimums. They are the baseline capital requirements agreed to by BCBS member jurisdictions, and provide those jurisdictions with the freedom to set their own requirements at higher levels to suit their particular needs and circumstances. In fact, allow me to quote directly from the Basel Committee Charter21: “The BCBS sets standards for the prudential regulation and supervision of banks. The BCBS expects full implementation of its standards by BCBS members and their internationally active banks. However, BCBS standards constitute minimum requirements and BCBS members may decide to go beyond them.” 19 The impact of this for mortgage loans, when combined with the new minimum requirements, can be seen in a chart in the Appendix. 20 The Reserve Bank of New Zealand is not a member of the Basel Committee on Banking Supervision. 21 Basel Committee Charter, Section 12: https://www.bis.org/bcbs/charter.htm The Reserve Bank has historically taken a more conservative approach to capital regulation, so it should not come as a surprise that the capital requirements we are proposing are also more conservative than internationally agreed minimums. It should also be noted that ‘headline’ capital requirements are not always as they appear. International comparisons of capital ratios are inherently difficult to make due to differing regulatory frameworks, which are sometimes not fully transparent. For example, many regulators apply capital ‘add-ons’ that are not visible to the market. Notwithstanding these difficulties, there are many different endeavours to compare capital ratios. I will provide two. Figure 4: BCBS Impact Assessment of Final Basel III Standards Source: Basel III Monitoring Report (October 2018) The Basel Committee has published tables of capital ratios for a group of large banks operating in its member jurisdictions. Credit rating agencies are another source. For example, Standard & Poor’s calculates its own risk-adjusted capital ratios for many banks around the world, using a methodology that attempts to reduce the influence of differing national applications of the Basel framework while still taking into account the different risk profiles of the countries in which each bank operates. Figure 5: Standard & Poor’s Risk-Adjusted Capital ratio by country, four large New Zealand banks under current and proposed requirements, and international peers S&P Risk18 Adjusted Capital ratio (%) Range Median FI NO CZ NZ SE HK DK PL (p) Source: Standard & Poor’s, RBNZ estimates IE NL MY IL AU AT SG NZ Notes: Most recently available S&P RAC ratio. NZ (p) shows an estimate of the four large New Zealand banks’ S&P RAC ratios assuming a Tier 1 (Basel) ratio of 17 percent, to account for potential voluntary capital buffers banks will operate with above the proposed minimum of 16 percent. Peer group largely aligns with Appendix D in PwC study, “International comparability of the capital ratios of New Zealand’s major banks”, October 2017. Peer group comprises Erste Bank, Raiffeisen Austria (AT), ANZ, Bank of Queensland, Bendigo and Adelaide, CBA, NAB, WBC (AU), ČSOB, Komercni, Ceska Sporitelna (CZ), Danske Bank, Jyske Bank, Nykredit Realkredit (DK), Aktia Bank, OP Corporate Bank (FI), Bank of China HK, Bank of East Asia, Hang Seng Bank, Standard Chartered HK (HK), Allied Irish Banks, Bank of Ireland Group (IE), Leumi, Hapoalim, Discount Bank (IL), Maybank, Public Bank, CIMB Bank (MY), ABN AMRO Bank NV, ING Bank NV (NL), DNB Bank ASA (NO), ANZ NZ, ASB, BNZ, Westpac NZ (NZ), Pekao, mBank (PL), Lansforsakringar Bank, Nordea Bank, SBAB Bank, Skandinaviska Enskilda, Svenska Handelsbanken, Swedbank (SE), DBS, OCBC, UOB (SG). While these cross country studies have not played much role in our analysis of determining what we think is the appropriate capital calibration for New Zealand, they do demonstrate that our proposals are by no means extreme. Instead, they move us towards our goal, expressed back in 2017, of capital requirements that are conservative relative to our peers. In the final analysis, we must have a capital framework that is suited to the specific conditions and risks of New Zealand, not other jurisdictions. Conclusion Ensuring the soundness and efficiency of New Zealand’s banking system is a core responsibility of the Reserve Bank of New Zealand, and one to which we devote great time and effort. It is difficult to imagine a strong New Zealand economy without a strong New Zealand banking sector. And we can’t have a strong banking sector if it is not a safe one. We are proposing to make New Zealand’s banks even safer by requiring them to use more of their own money, and less of depositors, and possibly taxpayers, should something go wrong. This small change will go a long way to improving the wellbeing of current and future generations of New Zealanders, which is also a key priority of our current government. Capital isn’t everything, but in our view it is the single most important feature of the financial sector’s regulatory regime. Disclosure and transparency, governance, risk management, and supervision all have roles to play in the safety of our financial institutions, and they all work better when owners have more skin in the game. My colleagues and I look forward to hearing your feedback by 3 May 2019. We will consider this feedback carefully, with the best interests of New Zealanders in mind. Thank you.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at an event, Wellington, 29 March 2019.
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In service to society New Zealand’s revised monetary policy framework and the imperative for institutional change A speech delivered at Wharewaka Function Centre, Wellington, New Zealand On 29 March 2019 By Adrian Orr, Governor Written with Omar Aziz, Economic Advisor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tēna koutou katoa. Thank you for joining us today to discuss New Zealand’s new monetary policy framework. The recent amendment to the Reserve Bank’s legislation sets up a Monetary Policy Committee that is responsible for a new dual mandate of keeping consumer price inflation low and stable, and supporting maximum sustainable employment. The Committee’s deliberation process will ensure that all decisions benefit from a diverse range of views, and offer greater transparency and accountability to monetary policy decisionmaking. Before I outline the features of the new framework and its underlying principles, I would like to paint the backdrop to this institutional change. The business of central banking is evolving as circumstances change. Some of the change is favourable, some is confronting. On the favourable side, we have low and stable inflation, low unemployment, and broad financial stability. This advantageous position must never be taken for granted. I thank all of the wise people – past and present – who have worked hard on creating the current environment. On the challenging side, in addition to maintaining the status quo, we have new and significant long-term economic challenges among which central banks operate. For example, in the financial system alone, we must deal with global economic inter-dependence, dominant financial institutions, significant debt burdens, technological change that challenges employment and financial inclusion norms, climate change, and much more. The list is long and the challenges have intergenerational implications. I spoke about many of these issues in a recent speech about the dangers of short-term thinking.1 The refreshed Reserve Bank Act and monetary policy practices, and the ongoing reviews of our legislation, position us to adapt to these changes. The aim is to ensure that the Reserve Bank can continue to achieve its fundamental purpose, which is “to promote the prosperity and well-being of New Zealanders, and contribute to a sustainable and productive economy”.2 Institutions, Legitimacy & Identity Let’s take a step back and talk about the backdrop to recent and pending changes to the Reserve Bank’s frameworks. The key role of a public institution is to bring to life the terms of a contract that arises between society and its representative government. This ‘social contract’ will always evolve, with its terms negotiated via the democratic process. 1 Orr, A., (2018), Geopolitics, New Zealand and the Winds of Change, Reserve Bank of New Zealand speech delivered to the "Shaping Futures National Conference" Financial Services Council in Auckland, 7 September 2018 2 Reserve Bank of New Zealand Act (1989). Page 2 of 11 Institutions must therefore adapt in keeping with shifting political, economic, environmental, and social realities, so as to serve the well–being of the people. After all, it is from people that institutions derive their ‘social license’ to operate - their legitimacy. Earning and retaining institutional legitimacy is an evolving challenge. Similar institutions may serve similar functions across countries, but they operate in a unique national and cultural context. Hence, they best earn local legitimacy when they appeal to a collective national identity. It is therefore important to reflect on the national and cultural context in which the Reserve Bank of New Zealand exists.3 This is why we have chosen the significant Māori legend of Tāne Mahuta to tell our story during these times of change. Central to the Māori belief system is the narrative of the earth mother / Papatūānuku and the sky father / Ranginui who needed to be separated to allow the sun to shine in so that life could flourish. Tāne Mahuta – the god of the forest and birds – stepped up to the task and, after some false starts, achieved this with help from his wider whānau (family).4 A life of economic, social, cultural and environmental sustainability took hold. Knowledge, trade and exchange flourished, and Māori found affinity with the land, the sea, and the native flora and fauna around them.5 Thereafter, Tāne Mahuta served as the kaitiaki (guardian) of this ecosystem – protecting it against threats to its existence, and enhancing the well-being of all within it. What does this story say about the role of the Reserve Bank and the journey of change it has embarked on? No, we are not anointing ourselves a god. Instead we are using the legend of Tāne Mahuta to tell a story. The establishment of the Reserve Bank of New Zealand in 1934 gave our country the flexibility and benefits of its own currency, monetary policy and financial system. Sunshine was allowed into New Zealand’s own monetary and financial system, and the Bank was given the responsibility to act as a guardian of this system.6 I draw two significant lessons from the legend of Tāne Mahuta. First, while we all love progress, we resist change. Just as Tāne Mahuta struggled to create change, we recognise there are many hurdles to overcome, many interests to balance, and many compromises needed to reach a collective greater good. Sometimes change means letting go of, or carefully scrutinising, that which has worked in the past - so that we are more resilient for the future. 3 The Journey of Te Pūtea Matua: Our Tāne Mahuta, Reserve Bank of New Zealand, September 2018, https://www.rbnz.govt.nz/news/2018/09/the-journey-of-te-putea-matua-our-tane-mahuta 4 Ibid. 5 Ibid. 6 For further historical background, see Wright (2006), The Policy Origins of the Reserve Bank of New Zealand, RBNZ Bulletin, Vol. 69. No. 3. Sep 2006 https://www.rbnz.govt.nz/research-andpublications/reserve-bank-bulletin/2006/rbb2006-69-03-01 Page 3 of 11 Second, just like Tāne Mahuta, change cannot happen in isolation. The role of a kaitiaki is to protect. However, the fulfilment of that role depends on the approval and help of others. The Reserve Bank has a social license to serve as a guardian of our monetary and financial system because it is unique to the identity and heritage of New Zealand. Te Pūtea Matua. It is New Zealand’s central bank. The Changing Landscape of Central Banking Let’s tie this discussion about legitimacy and institutional change to the current landscape of central banking. Over the past decade, countries have looked to central banks to mitigate the dire consequences of the global financial crisis (GFC). During, and after, the GFC, central banks around the world rallied to stabilise financial systems and provide renewed vigour to damaged economies. This challenge remains, and securing sustainable prosperity for all requires our continued attention. In the world today, the dynamics of global and national economies are interacting to a greater extent and, at times, working at cross-purposes. Underlying these interactions are social and political movements driven by a desire for greater well-being, both for current and future generations. More recently we have been confronted with the issue of climate change, and its complex and powerful economic and financial impact. We have barely scratched the surface in understanding the intergenerational impacts of these developments. This desire for well-being is regularly reflected in discontent along the lines of economic, gender, racial, and intergenerational inequities - to name just a few. Therefore, ensuring social inclusion as a way forward in capitalist societies is necessary. As such, these developments continuously alter the landscape in which central banks conduct their business. This is why we have been led to ponder the impact the Reserve Bank can have in securing the well-being of New Zealand’s current and future generations. It is also useful to do so while the pervasive ill-effects of the GFC remain in our memories and continue to shape the policy landscape. The success that central banks had in addressing the early impacts of the GFC, and their effectiveness during earlier decades in transitioning economies from high- to stable-inflation regimes, is due in large part to their ability to act decisively, within a clearly defined remit. They must continue to be empowered to do so. The challenge for us now is a more nuanced one:7 7 In New Zealand, the scope of this debate, is informed by the Bank’s remit and the letter of expectations (LoE) from the Minister of Finance to the Governor of the Reserve Bank outlining broad expectations of the Bank's relationship with the Minister and areas of particular interest. LoE 2018/19: https://www.rbnz.govt.nz/about-us/letters-of-expectations/letter-of-expectations-2018 Page 4 of 11 Do the remits of central banks reflect the objectives most important to the welfare of their societies in the post-GFC world? And do they have the requisite policy instruments to address these objectives? 8 Are central banks using their influence in an inclusive and transparent manner befitting of the trust societies have invested in them? Are central banks fulfilling their role as stewards of sound and efficient financial systems by creating effective regulatory regimes? And is there alignment across a country’s economic policy establishment to offer a coherent and unified response to future crises? 9 These are hard questions that we continue to confront. At the Reserve Bank we believe that it is timely to review our policy frameworks and the role we play in wider society to ensure we remain fit for purpose. Over the past year, we have embarked on several review and public consultation processes. These processes – some of which are still underway – have spanned our monetary and financial policy frameworks, as well as the role of physical currency. We are not alone in conducting such reviews. Our counterparts in Sweden (Riksbank) and Norway (Norges Bank) recently have, or currently are, undertaking reviews of their monetary policy frameworks and legislation.10 11 The US Federal Reserve has initiated a review of 8 Historically, central banking objectives have evolved with the wider political economy concerns faced by countries. See Smith, C, O. Aziz (2019), Monetary Policy Objectives, Reserve Bank of New Zealand Bulletin, Vol. 82, No. 2 (forthcoming). Paul Tucker argues that “[a] central bank regime for all seasons cannot be designed without a good fiscal constitution existing too. Setting boundaries to the authority of central banking needs to factor in what is on the other side of the border”, The Governance of Monetary & Financial Stability Policy, Banking Perspective, Quarter 2 2018 (http://paultucker.me/the-governance-of-monetary-and-financialstability-policy/) The Riksbank’s monetary policy was reviewed by Marvin Goodfriend and Martin King over 2010 – 2015 and a report published in 2016. The review was commissioned by the Committee on Finance of the Riksdag and made several recommendations. Following this review the Riksbank Executive Board has made several changes to its framework in May 2017, the rationale for these changes are further explained in a memorandum produced by the executive Board, and in the Riksbank Economic review. In addition, a parliamentary review of the Riksbank Act has been initiated. The recommendations from the Riksbank Act review are due no later than 31 May 2019. The Norges Bank has had two reviews which have translated into changes in the Norges Bank Act, and the Regulation on Monetary Policy. The Gjedrem review was an external review conducted by the Norwegian Law Commission and chaired by a previous Governor Sevin Gjedrem. ReFIT (Review of Flexible Inflation Targeting) was an internal review over 2013 to 2017 and explored possible improvements to the monetary policy framework in Norway. See: https://www.norgesbank.no/en/about/Research/ReFIT--Review-of-Flexible-Inflation-Targeting/ And https://www.regjeringen.no/en/aktuelt/report-of-the-law-commission-on-the-act-relating-to-norgesbank-and-the-monetary-system/id2558679/ Page 5 of 11 “strategies, tools and communication practices” that service its dual mandate.12 And, the Bank of Canada is well into a regular five-yearly review of its “inflation control agreement”. 13 14 Beyond this, calls to build further resilience in the financial system – especially in its interface with the wider economy – is an emerging theme on the international agenda.15 The first review of the Reserve Bank of New Zealand Act 1989 to be completed was that of monetary policy. Now enacted in law, New Zealand’s new monetary policy framework is being formally introduced on 1 April 2019. I will now elaborate on the specifics of the revised monetary policy framework with reference to its history, locating it in the wider context of other external policy reviews and consultation processes that the Bank is involved in. Reserve Bank Act 1989: Objectives & Accountability The Reserve Bank Act of 1989 was introduced at a time when there was great uncertainty about economic conditions in New Zealand. In the 1970s and 80s, our country, like many others, had adopted a variety of strategies to deal with high and volatile inflation; none were successful. The 1989 Act gave the Reserve Bank operational independence to achieve the objective of price stability. A single decision maker model was introduced making the Governor responsible and singularly accountable for the substance of monetary policy. The Policy Targets Agreement (PTA) between the Minister of Finance and the Governor set explicit goals for monetary policy to pursue.16 An agreement between a single decision maker and the government provided sufficient flexibility to make the appropriate revisions to the inflation target as we adjusted from high to low inflation. Over time, there have been several revisions to the inflation target, settling in recent times on a band of 1 – 3 percent with a focus on the 2 percent midpoint.17 12 Federal Reserve to review strategies, tools, and communication practices it uses to pursue its mandate of maximum employment and price stability, Press Release, 15 November 2018, (https://www.federalreserve.gov/newsevents/pressreleases/monetary20181115a.htm) Wilkins, C., A., Choosing the Best Monetary Policy Framework for Canada, Speech, 20 November 2018 https://www.bankofcanada.ca/2018/11/choosing-best-monetary-policy-framework-canada/ https://www.bankofcanada.ca/toward-2021-reviewing-the-monetary-policy-framework/ 15 Lagarde, C., The Financial Sector: Redefining a Broader Sense of Purpose, 32nd World Traders' Tacitus Lecture, London, United Kingdom, February 28, 2019 16 PTA’s were renegotiated between the Minister and Governor each time the latter was appointed or reappointed, although there is precedence to revisit the terms of the agreement during a change of government as well. 13 PTA’s were signed from 1990 onwards, each ratification reflecting incremental adjustments to inflation targets. See Wadsworth (2017), “An international comparison of inflation targeting frameworks”, RBNZ Bulletin 80(8) for more information. In the versions of the PTA from 1990 to 1992, annual inflation was to be kept within a target band, initially 3 - 5 percent, then 1.5 – 3.5 percent before settling on 0 – 2 percent as inflation was initially Page 6 of 11 When you look at the contrast between inflation in the years before and after 1989 (figure 1), the Reserve Bank’s record of servicing its price stability objectives over the last 30 years stands on its own merit. Figure 1: Annual CPI Inflation (target range shaded) Source: Statistics New Zealand Such has been the success and influence of New Zealand’s inflation targeting regime, that in 2014 – on the eve of the 25th anniversary of the Reserve Bank Act – the New York Times declared it to be “virtually an economic religion” and “global economic gospel” among the international central banking community.18 Amendment to the Reserve Bank Act We have prospered in the certainty and security of a low and stable inflation regime for the past 30 years. What then is the imperative for any change to the way monetary policy is conducted in New Zealand? Simply put: our Act has been amended to address emerging policy challenges, and to operate with greater transparency and accountability. To reinforce our societal legitimacy. The Reserve Bank Act now sets monetary policy with a dual mandate: to maintain price stability and support maximum sustainable employment. The remit – which replaces the earlier PTA – provides the Bank with its specific inflation target and direction on how to consider its contribution to maximum sustainable employment.19 While unemployment is currently low in New Zealand, it is, and will continue to be, one of the defining issues of any society. brought under control. Through the mid-90’s onwards, 0 – 3 percent, then up to 1 – 3 percent (our current target) in 2002. The focus on the 2 percent midpoint was added in 2012. 18 Irwin, N., Of Kiwis and Currencies: How a 2% Inflation Target Became Global Economic Gospel, New York Times, Dec. 19, 2014. 19 The remit and charter can be accessed at: https://www.rbnz.govt.nz/monetary-policy/aboutmonetary-policy/monetary-policy-framework. Page 7 of 11 Labour market dynamics both within and across countries have changed significantly as a consequence of recent rapid globalisation, the impact of the GFC, and as ongoing technological developments have reshaped the needs of the workforce. Likewise, concerns about income and wealth inequities, low productivity growth, and the impact of population ageing, all intersect at some level with the functioning of the labour market. Historically, the Bank has always taken labour market developments into account while formulating monetary policy. Over time, “this has been encouraged by our increasingly flexible approach” to inflation targeting.20 The shift to a dual mandate is to acknowledge the impact monetary policy has on employment and economic activity, and also the prominence given to labour market outcomes when the Bank is formulating monetary policy.21 Our new mandate means the Bank is legally obliged to provide a more detailed assessment of, and outlook for, the labour market.22 This obligation recognises that ‘maximum sustainable employment’ cannot be measured using a single metric, and that there are limits to the degree to which monetary policy can affect employment outcomes. Let’s now talk process. The changes enacted as part of the phase 1 review of the Reserve Bank Act made the processes and principles underlying the Bank’s earlier monetary policy decisions explicit. I mentioned that up until now the Bank had operated with a single decision maker model for monetary policy. In reality however, successive Governors relied on internal advisory committees consisting of senior members within the ranks to discuss ideas, build consensus and guide decisions on monetary policy.23 The amendment to the Act formalises a Monetary Policy Committee (MPC) consisting of members internal and external to the Bank.24 A committee structure will add further rigour to monetary policy decisions, drawing on the diverse views and perspectives of its members. McDermott & Williams (2018), “Inflation targeting in New Zealand: An experience in evolution”, speech delivered to the Reserve Bank of Australia conference on central bank frameworks, in Sydney 12 April 2018. 21 The former being the stabilisation role of monetary policy. 22 Ibid. For example, the Bank has dedicated a chapter to output and employment in each Monetary Policy Statement since May 2018, and has also included tables and discussion of indicators of maximum sustainable employment. 23 This was formalised in practice, if not it law, by the creation of a Governing Committee in 2013. See Wheeler (2013) “Decision making in the Reserve Bank of New Zealand”, speech delivered to the University of Auckland Business School on 7 March 2013, and Richardson (2016) “Behind the scenes of an OCR decision in New Zealand”, RBNZ Bulletin 79(11). 24 With the majority internal (and including the Governor and Deputy Governor ex officio). Page 8 of 11 Figure 2: Secondary Instruments to Direct the MPC Reserve Bank of New Zealand Act Remit Charter Code of conduct The Act and remit set out the economic and operational objectives for the MPC respectively. The charter governs the committee’s decision-making and ensures accountability. The charter emphasises that the MPC should aim to reach decisions by consensus, informed by rigorous discussion taking into account a diverse range of views and perspectives on emerging issues. In the event consensus cannot be reached, each member has an equal vote to determine a decision.25 Furthermore, accompanying the remit and charter, is a code of conduct that sets the standards of ethical and professional conduct that must be adhered to by the Committee.26 All this sounds very technical, but these instruments bring to life the principles that underpin the Bank’s major monetary policy decisions. An MPC with a diverse set of opinions that is committed to inclusive and constructive debate about important policy issues, will ultimately be of great service to New Zealand society.27 Interconnectedness of Institutions & Policy Regimes The story of Tāne Mahuta is a metaphor for change, but also one for interconnectedness. This is a theme I would like to end with. Each year, the Minister of Finance issues a Letter of Expectations that sets out the strategic priorities for the Reserve Bank. 28 In 2018, the Bank was given a renewed strategic direction underscoring the imperative for institutional change. As the letter states, in fulfilling its monetary policy mandate, the Bank is expected to “support sustainable and inclusive growth”. And in promoting a sound and efficient financial system, the Bank is expected to contribute “to the living standards of New Zealanders by being a conscientious, high performing regulator”.29 25 The charter refers to the provision in the Act for each member to have an equal vote to determine a decision. 26 Monetary Policy Framework, https://www.rbnz.govt.nz/monetary-policy/about-monetarypolicy/monetary-policy-framework Principles and processes behind monetary policy committee deliberation at the RBNZ, Forthcoming RBNZ Bulletin, Price, G., & Wadsworth, A., 2019 28 Letter of Expectations 2018/19: https://www.rbnz.govt.nz/about-us/letters-of-expectations/letter-of- expectations-2018 29 Ibid. Page 9 of 11 The flagship strategic projects on the Bank’s current work agenda all align with the “Government’s broader economic objectives while maintaining the Bank’s operational independence”. 30 These ongoing projects at the Bank include: - the implementation of our new monetary policy framework the review of the Bank’s prudential and regulatory functions the bank capital adequacy consultation that is currently underway, and exploratory work on the emerging impact of technology on the Bank’s currency functions and research on digital currencies The imperative for this work program also arises from the global policy environment that central banks are presented with: that is, balancing uncertain growth and continued low nominal interest rates - against inflated central bank balance sheets, and the ever-present threat of asset price bubbles. More specifically, as a small, open economy New Zealand is especially vulnerable to downturns in its trading partner economies. And with a high reliance on banks for overseas borrowing, we are vulnerable to the transmission of financial instability through the banking system. This is why we are thinking holistically at the Reserve Bank about the collective impact of our various monetary, financial, and currency policy initiatives. For example, What effect do low nominal interest rates have on wider financial stability? How can monetary-fiscal coordination be better managed, and in a low interest rate environment, what role will fiscal policy play in the event of a downturn? And, Recognising that the “impact of bank failures would be broader and harsher the larger and more intertwined the failed banks are with New Zealand’s economy” what regulatory and prudential settings would mitigate the risk of failure?31 These are all immediate challenges being confronted by your team working at Te Pūtea Matua. Furthermore, our mandate, to support sustainable and inclusive growth, and higher living standards, necessitates the Bank to work more interactively with wider society and public institutions. We will do so without loss of focus on our core activities. Our Te Ao Māori strategy includes engagement with the ‘Māori economy’, which has undergone a rapid renaissance.32 This work is necessary and a gateway into assisting wider financial inclusion in New Zealand and the region. We remain focused on our role in our region and the wider international economy. The Bank is currently refreshing its international engagement strategy to give greater focus to New Zealand’s bilateral and multilateral engagements.33 We are working on our contribution to 30 Ibid. 31 Bascand (2019), “Safer Banks for Greater Wellbeing”, speech delivered to the Institute for Governance and Policy Studies, Victoria University in Wellington, 26 February 2019 RBNZ’s Strategic Approach to Te Ao Māori, Forthcoming RBNZ Bulletin, 2019 33 One example being contributing to New Zealand’s progress towards the UN Sustainable Development Goals (SDGs). In 2019, New Zealand is presenting its first progress report (Voluntary Page 10 of 11 building capacity and capability in central banks through our region – including the central banks of the South Pacific and East Asia. Finally, underscoring our need to be a good global citizen, we have embarked on our climate change strategy, playing our part in the link between necessary global climate action and the role of the financial system.34 I want to assure you all that the Reserve Bank – Te Pūtea Matua – remains grounded and has not lost focus on its core business. We are committed to meeting the currency needs of the people, ensuring low and stable inflation, maximising sustainable employment, and promoting a sound and efficient financial system. These activities are necessary for economic well-being. But, I also want to assure you we will work beyond just the ‘necessary’. We will ensure that both ‘necessary’ and ‘sufficient’ work is done so that the Bank is best able “to promote the prosperity and well-being of New Zealanders, and contribute to a sustainable and productive economy”.35 I am told that the first step to running a marathon is to tell everyone of your intentions. Commit. You have just been told of our intentions to work collectively – locally, regionally, and globally – in pursuit of maximising our mandate. We desire to be a great team and the world’s best central bank. The resounding results that past and present people at the Reserve Bank have achieved provides a fantastic platform to progress this work. Me mahi tahi tātou mo te oranga o te katoa. Work together for the wellbeing of everyone Meitaki Thank you National Review) on the national implementation of the SDGs. Several SDG targets can be mapped to the core functions of central banks, for instance: inclusive access to banking, insurance and financial services (target 8.10), regulation and monitoring of global financial markets (10.5), reducing transaction costs of migrant remittances (target 10.c), reducing illicit financial flows (16.4), enhancing macroeconomic stability (17.13) and providing data capacity-building support to developing countries (17.18) (https://unstats.un.org/sdgs/indicators/indicators-list/) 34 Reserve Bank Climate Change Strategy, https://www.rbnz.govt.nz/financial-stability/climatechange/strategy 35 Reserve Bank of New Zealand Act (1989). Page 11 of 11
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Panel remarks by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to the Bank for International Settlements forum at the Bangko Sentral ng Pilipinas (BSP, the central bank of the Philippines), Manila, 20 August 2019.
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Inflation Dynamics: Upside Down Down Under? Panel remarks delivered to Bank for International Settlements forum at the Bangko Sentral ng Pilipinas, Manila On 20 August 2019 By Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking Prepared with Cameron Haworth 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tēnā koutou katoa, Thank you for the opportunity to join the panel. Thirty years after the Reserve Bank of New Zealand first adopted an inflation targeting regime to deal with inflation that was too high, central banks now have a different problem: inflation being too low. One of the key challenges of our time is for central banks, academics and financial markets to comprehend this new environment and deliver the appropriate policy response. It is testing our understanding of what is normal and welcome for policymakers when it comes to inflation, interest rates, wage growth, and fiscal spending. So I would firstly like to thank the organisers and the presenters at this conference for their efforts as we explore “Inflation dynamics in Asia and the Pacific”. In these panel remarks, I will talk about the New Zealand experience, specifically: Our assessment of what has caused this period of low inflation; What we have learnt as policymakers about inflation dynamics, and how much that has changed our approach to setting monetary policy; and How we are applying all this to our monetary policy outlook for 2019. While some past long-standing empirical relationships have been turned upside down, others have not. In particular, our assessment is that monetary policy is still effective in influencing inflation in New Zealand. This motivates our continuing determination to set policy to achieve our dual mandate of price stability and maximum sustainable employment. Low inflation has been a common challenge globally Inflation has been low around the world since the Global Financial Crisis (GFC), consistently undershooting forecasts and often undershooting inflation targets. While headline inflation has briefly reached 2 percent in some inflation-targeting countries, in many places it has been a fleeting experience, as in New Zealand (figure 1). It is no wonder that the question of why inflation has been so low is one of the more-pressing areas of research in contemporary macroeconomics worldwide. Figure 1: Annual inflation in New Zealand Source: Stats NZ, Reserve Bank of New Zealand estimates. Note: In the December quarter 2010, GST (a sales tax) was increased by 2 percentage points. The drivers of low inflation There are a number of usual suspects cited for what is causing low inflation. Many of them are slow-burning structural changes taking place throughout the world, some of which have been covered in depth at this conference: Globalisation: Global supply chain integration has lowered the costs of manufactured goods.1 Technological changes: New technologies and low-cost software services are continually driving down prices for these goods and services.2 Demographics: Populations are ageing in many countries, increasing savings and decreasing inflationary pressures.3 Labour market dynamics: Labour markets and work practices are evolving around the world, creating more capacity and less wage pressure than in the past.4 These are deep and fundamental issues that deserve further research to truly understand their contribution to low inflation, and the policy implications for central bankers. However, while these types of structural factors are likely to explain part of the reason why inflation has been low, they cannot explain the whole story. 1 Auer, Borio, and Filardo (2017). 2 Spencer (2017). 3 Liu and Westelius(2016). 4 Duca (2018); Bracha and Burke (2017). This is because many of these issues are long-term developments that have been playing out over decades. So they struggle to explain the relatively abrupt weakness in inflation since the GFC or during the period of 2012 to 2016 when inflation was particularly low in New Zealand. This suggests that there have also been more short-to-medium-term cyclical factors keeping inflation low. Our analysis of the New Zealand business cycle highlighted a number of global factors that kept inflation lower than expected through this post GFC period, including:5 Global growth: Underlying demand in advanced economies has been weaker than expected following the GFC, resulting in excess spare capacity and less inflationary pressure. NZ dollar: The extent of monetary stimulus from foreign central banks required to offset this economic weakness put upward pressure on the New Zealand dollar (figure 2), resulting in weaker tradables inflation. (More broadly, this factor raised questions about the ability of small open economies to operate independent monetary policy during the low-inflation period.) Commodity prices: Global commodity prices were weak during this time (figure 2), with both weak import commodity prices (especially oil prices) weighing on tradables inflation, and periods of weak export commodity prices (especially dairy) weighing on domestic incomes. Figure 2: US dollar and commodity price weakness Source: Bloomberg. Some factors were unique to New Zealand. The rebuild of our second-largest city following a major earthquake in 2011, and high inward migration, were both less inflationary than we expected. These were material factors that contributed alongside the global issues facing many other countries in the Asia Pacific region. Consistent with our dual mandate, our research agenda has also placed a particular focus on understanding the labour market. This work is ongoing, but has already provided some further insights. For example, we have found that large-firm bargaining power is not responsible for low wage inflation in New Zealand.6 However, a fall in job-to-job flows may provide one 5 Williams (2017). 6 Ball (forthcoming). explanation for weaker inflationary pressure, as fewer employees are switching employers for pay-rises.7 Policy implications of changing inflation dynamics So if those structural and cyclical stories capture our understanding of why inflation has been so low, what changes have we made as policy makers in our approach to setting monetary policy? I would like to talk about two changes to inflation dynamics that we have incorporated into our approach over recent years, and one area where our assessment is that inflation dynamics have not changed – the effectiveness of monetary policy. The neutral interest rate The first change is that we have lowered our estimate of the neutral interest rate. The neutral rate is the theoretical rate of interest that is neither expansionary nor contractionary, supporting full employment with inflationary pressures balanced at target. It helps us gauge whether our monetary policy stance is boosting or weighing on the economy. The fall in the neutral rate reflects many of the structural changes touched on earlier. We publish a suite of indicators for the neutral interest rate in our Monetary Policy Statements that capture the range of different estimation approaches.8 Our current estimate of the neutral Official Cash Rate is a wide range centred on 3.25 percent, down from around 5 percent before the GFC (figure 3). Figure 3: Neutral interest rate estimates Source: Reserve Bank of New Zealand estimates. See Richardson and Williams (2015) for discussion of the various estimation approaches. Note: Data availability means that the full suite of indicators cannot be provided in the latest quarter. 7 Ball, Groshenny, Karagedikli, Ozbilgin, and Robinson (forthcoming). 8 Reserve Bank of New Zealand (2019). We have treated this gradual movement lower in neutral interest rates as largely mechanical in our modelling of the economy, rather than a significant policy choice or policy judgement at any one particular meeting. However, a lower neutral rate does have implications for the level of stimulus provided in the economy.9 All else equal, a lower neutral rate implies that we need to set our Official Cash Rate lower to deliver the same amount of monetary stimulus to the economy. Adjustments to our inflation forecast assumptions The second change that we have made is to our assumptions for inflation expectations, making them more influenced by past inflation. Domestically-generated non-tradables inflation is typically driven by rising capacity pressure (when unemployment is low, and actual output is greater than its long-run potential) and by inflation expectations. For New Zealand, we have found that past inflation, rather than surveyed expectations, has been a better forecaster of inflation both before and after the GFC.10 In effect, this has meant that the global factors suppressing imported inflation have also spilled over into lower domestically-generated inflation. Based on this, we have in recent years assumed firms and households put greater weight on past inflation outcomes. After we consistently overestimated domestic inflationary pressure through 2012 to 2015, this change in our approach has generated a more reliable gauge on future inflation (figure 4). Figure 4: RBNZ forecasts of annual non-tradables inflation Source: Statistics New Zealand, Reserve Bank of New Zealand estimates. Rather than undermining the importance of keeping inflation expectations anchored, this highlights the importance of getting inflation close to target and avoiding a long-lasting undershoot, as was experienced in Japan and Europe. 9 McDermott (2017). 10Karagedikli and McDermott (2018); McDonald (2017). All else equal, this finding suggests a more active and decisive approach is needed from monetary policy, to ensure that actual inflation and therefore inflation expectations are well anchored at target. Effectiveness of monetary policy As well as identifying where inflation dynamics have changed, it is equally important to be clear where we have made a conscious judgement that long-standing relationships remain intact. One such area is the effectiveness of monetary policy. Many commentators have questioned whether monetary policy still works in the current environment.11 Some cite the low level of interest rates globally as a sign of ineffectiveness. Others highlight the relationship between economic activity and inflation outcomes (the Phillips Curve) being weaker than in the past, suggesting this points to a fundamental change in dynamics (figure 5). Figure 5: Apparent flattening of the NZ Phillips Curve: 1996–2019 Source: Statistics New Zealand, Reserve Bank of New Zealand estimates. Some of these arguments have an element of intuitive appeal – in particular, the idea that households and businesses may have reached debt constraints, limiting the historically important debt channel of monetary policy transmission. Testing empirically whether the effectiveness of monetary policy has changed is no easy task. It requires well-measured economic data, a sufficiently long sample that can be tested for a change in the relationship, and a sophisticated approach to hold all other influencing factors constant to extract the unique impact of monetary policy. We have recently published research that tackles this question in the most robust way we believe we can, using two Vector Autoregression (VAR) models and a Dynamic Stochastic 11 Borio and Hoffmann (2017). General Equilibrium (DSGE) model, each using data from 1993 with evolving estimates as the sample size expands through time.12 These models both estimate how a change in short-term interest rates affects future inflation. At face value, two approaches find that the relationship is unchanged; the other actually finds that monetary policy has become even more effective (figure 6). As all these estimates come with wide error bands, the safest conclusion is that we have found no evidence of any change in the effectiveness of monetary policy in New Zealand in the past 25 years. Figure 6: Peak impact of a 25 basis point fall in the 90-day rate on annual CPI inflation This finding also aligns with similar research from the Reserve Bank of Australia on the effectiveness of monetary policy in Australia.13 Indeed, it fits with a number of other pieces of the puzzle. First, it fits with research we published earlier this year on the flattening in the observable Phillips Curve – that is, how inflation appears to have become less responsive to falling unemployment and rising capacity pressure. Our research shows this to be driven by an increase in the volatility of business cycle surprises on the supply-side, rather than the demand-side.14 This reinforces the idea that supply-side shocks have been more responsible for low inflation than in the past, masking the underlying and continuing positive relationship between demand-led activity and inflation. Second, it fits intuitively that monetary policy should still be effective to some extent. Even if debt constraints in certain sectors end up restraining parts of the transmission from interest rates to activity and inflation, the beauty of monetary policy is that it works through multiple channels (Figure 7). 12 Culling, Jacob, Richardson, Truong, and Vehbi (2019). 13 Kent (2015); Kent (2019). 14 Jacob and van Florenstein Mulder (2019). Figure 7: Monetary Policy Transmission15 OCR New Zealand dollar exchange rate Market interest rates Lending rates Inflation expectations Deposit rates Import prices Debt servicing costs Imports Exports House prices Saving Borrowing Consumption Investment GDP Employment Inflation Source: Reserve Bank of New Zealand, Monetary Policy Handbook. Even with the same debt levels, lower interest rates reduce servicing costs and free up cashflow. Lower interest rates will also be associated with higher asset prices, creating a wealth effect through to consumption.16 Furthermore, many of the other channels, such as the exchange rate channel, will still work regardless of debt levels. Finally, it fits with recent experience that monetary policy does still have bite even in this low interest rate world. In New Zealand, we lifted the Official Cash Rate by 100 basis points over the course of the first half of 2014 to head off an expected increase in inflationary pressure. When this did not arrive as expected, the tightening in monetary policy ended up being one factor that contributed to the slowing in the economy into 2015. Internationally, we have also seen the US Federal Reserve tighten monetary policy through to 2018, and this is one factor that has contributed to the moderation in US growth and inflationary pressure into 2019. These are ongoing examples of monetary policy continuing to play a key role in inflation dynamics. So if we think that inflation dynamics are changing and that monetary policy is still an effective tool, how are we applying that in New Zealand’s current economic environment? 15 More on the transmission mechanism and other topics can be found in the Monetary Policy Handbook, available at https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/monetary-policyhandbook. 16 Wong, (2017). Our August 2019 Monetary Policy Statement As our Monetary Policy Committee met earlier this month, our starting point was a New Zealand economy where the labour market was operating near maximum sustainable employment, but annual core inflation remained persistently below the 2 percent mid-point of our target range. We discussed the slowdown in global growth and global risks that lay ahead, and how this might affect New Zealand. We also addressed the loss of momentum in the domestic economy since mid-2018, through both tempered household spending and restrained business investment. As part of the assessment, our discussion also touched on the decline that had occurred in both survey measures of inflation expectations and market-based measures, such as nominal and inflation linked bonds in global markets (figure 8). Figure 8. Global government bond yields in decline Source: Bloomberg. We also discussed our secondary considerations, including having regard to the implications of any decision for financial stability, and seeking to avoid unnecessary instability in output, interest rates or the exchange rate. The Committee reached a consensus that, relative to the May Monetary Policy Statement, a lower path for the Official Cash Rate (OCR) over the projection period was appropriate. A key part of this judgement was a view that changes in the stance of monetary policy remain just as effective to influence growth and inflation in periods of low interest rates as they did in the period before the GFC with higher interest rates. In particular, changes in the OCR were still translating through to movement in the interest rates for households and businesses, and eventually into economic activity and inflation. With the OCR at 1.50 percent before the decision, the Committee noted the limited space still available to use our conventional tool. While not our core projection, as a contingency the Bank is undertaking further preparatory work on unconventional monetary policy tools.17 No 17 The Bank’s published work on unconventional tools to date can be found in Drought, Perry and Richardson (2018). future options have been ruled out, with foreign central banks having used a variety of tools, including negative interest rates, forward guidance, foreign exchange intervention, and a range of government and non-government asset purchase programmes. We debated the relative benefits of reducing the OCR by 25 basis points and communicating an easing bias versus reducing the OCR by 50 basis points now. A key part of the final consensus decision to cut the OCR by 50 basis points to 1.0 percent was that the larger initial monetary stimulus would best ensure the Committee continues to meet its inflation and employment objectives. In particular, it would demonstrate our ongoing commitment to ensure inflation increases to the mid-point of the target. This commitment would support a lift in inflation expectations and thus an eventual impact on actual inflation. On balance, we judged that it would be better to do too much too early, than do too little too late. The alternative approach risked inflation remaining stubbornly below target, with little room to lift inflation expectations later with conventional tools in the face of a downside shock. By contrast, a more decisive action now gave inflation the best chance to lift earlier, reducing the probability that unconventional tools would be needed in the response to any future adverse shock. Conclusion I hope that sharing our experience in New Zealand has helped advance the discussion of inflation dynamics in the Asia Pacific region, and the role of central banks in this evolving story. Thirty years ago the Reserve Bank adopted an inflation targeting regime to deal with inflation that was too high, and we spent the next twenty years largely focused on the challenge of ensuring inflation remained down at its target. In more recent times, it feels like everything that central banks learnt and practised in those early years has been flipped upside down: the challenge now is to lift inflation, not bring it down; interest rates in several countries are negative, not positive; fiscal stimulus can be welcomed as supporting our monetary policy goals, not criticised as conflicting; higher wage growth can be greeted as a natural consequence of stimulatory monetary policy, rather than the spectre of a wage-price spiral; and rising inflation expectations can be seen as a sign of success, not an indicator of failure. While some of these elements of inflation targeting feel like they have been flipped around, we believe that some core elements of inflation dynamics have remained just the same. In particular, our assessment is that monetary policy is still effective in influencing inflation in New Zealand, through a number of channels. This is one of the factors that motivates our continuing determination to set policy, whether with conventional tools or unconventional tools, to achieve our dual mandate of price stability and maximum sustainable employment. Kia ora tātou. Thank you. References Auer, R., C. Borio and A. Filardo (2017), ‘The globalisation of inflation: the growing importance of global value chains’, Globalisation and Monetary Policy Institute Working Paper, No. 300. Ball, C. (forthcoming), ‘Employer concentration and income growth in New Zealand’. Ball, C., N. Groshenny, Ö. Karagedikli, M. Ozbilgin and F. Robinson (forthcoming), ‘Low wage growth and job-to-job transitions: evidence from the administrative data in New Zealand. Borio, C. and B. Hoffmann (2017), ‘Is monetary policy less effective when interest rates are persistently low?’, BIS Working Paper, No. 628. Bracha, A. and M. A. Burke (2017), ‘Wage inflation and informal work’, Federal Reserve Bank of Boston: Current Policy Perspectives, No. 18-2. Culling, J., P. Jacob, A. Richardson, E. Truong and T. Vehbi (2019), ‘Have the effects of monetary policy on inflation and economic activity in New Zealand changed over time?’, Reserve Bank of New Zealand Analytical Note, AN2019/10. Drought, S., R. Perry and A. Richardson (2018), ‘Aspects of implementing unconventional monetary policy in New Zealand’, Reserve Bank of New Zealand Bulletin, 81(4). Duca, J. V. (2018), ‘Inflation and the Gig Economy: Have the Rise of Online Retailing and Self-Employment Disrupted the Phillips Curve?’, Federal Reserve Bank of Dallas Working Paper, No. 1814. Jacob, P., and T. van Florenstein Mulder (2019), ’The flattening of the Phillips cruve: Rounding up the suspects’, Reserve Bank of New Zealand Analytical Note, AN2019/06. Karagedikli, Ö., and J. McDermott (2018), ‘Inflation expectations and low inflation in New Zealand’, New Zealand Economic Papers, 52(3), pp. 277–288. Kent, C. (2015), ‘Monetary policy transmission – what’s known and what's changed’, public lecture at the Australian National University on 15 June 2015. Kent, C. (2019), ‘The usual transmission - monetary policy and financial conditions’, public address to Finance & Treasury Association on 13 August 2019. Liu, Y. and N. Westelius (2016), ‘The Impact of Demographics on Productivity and Inflation in Japan’, IMF Working Paper, No 16/237. McDermott, J. (2017), ‘Looking at the Stars’, speech delivered to HiFX in Auckland on 26 July 2017. McDonald, C. (2017), ‘Does past inflation predict the future?’, Reserve Bank of New Zealand Analytical Note, AN2017/04. Reserve Bank of New Zealand (2019), August 2019 Monetary Policy Statement. Richardson, A., and R. Williams (2015), ‘Estimating New Zealand’s neutral interest rate’, Reserve Bank of New Zealand Analytical Note, AN2015/05. Spencer, G. (2017), ‘Low inflation and its implications for monetary policy’, speech delivered to the Institute of Directors in Auckland on 5 December 2017. Williams, R. (2017), ‘Characterising the current economic expansion: 2009 to present day’, Reserve Bank of New Zealand Bulletin, 80(3). Wong, M. (2017), ‘Revisiting the wealth effect on consumption in New Zealand’, Reserve Bank of New Zealand Analytical Note, AN2017/03.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Financial Services Institute of Australasia, Auckland, 11 July 2019.
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The evolving Reserve Bank – the view from Tāne Māhuta A speech delivered to the Financial Services Institute of Australasia, Auckland. By Adrian Orr, Governor and Chief Executive 11 July 2019 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz The evolving Reserve Bank – the view from Tāne Māhuta Introduction Tēnā koutou katoa, welcome everyone. I am privileged to have been in the Governor role for a little over a year to date. During that time we have evolved considerably, and will continue to do so in the years ahead. Over the recent period we have committed to our vision to be ‘a great team and the best central bank’, and we have embedded our new Monetary Policy Committee and policy mandate. In addition, we have reorganised our operating structure, and have been investing in our people, our stakeholder relationships home and abroad, our supervision capability and activities, our digital capability, and our payment systems and the future of cash. Change is now business as usual for the Reserve Bank and I sincerely thank my colleagues for managing through this period of renewal. There is of course more change to come. Just over two weeks ago, the Prime Minister and the Minister of Finance made some important announcements about progress with the government’s review of our statutory framework for financial system regulation. They announced some in-principle decisions – including introducing a deposit insurance scheme – and set out further questions for a consultation, which is going on now. So this is a good time discuss the future of the Reserve Bank, and how the changes under consideration might promote the prosperity and wellbeing of New Zealanders and contribute to a sustainable and productive economy. Those phrases, by the way, are not my own. They come from the Reserve Bank Act and express the overarching purpose of the Reserve Bank’s many functions. As the review progresses, we are thinking broadly about our role and functions. Geoff Bascand – the Deputy Governor – recently gave two speeches on our approach to financial stability1 and the role that macroprudential policy plays in the management of financial stability2. Our approach is evolving, becoming more intensive in terms of regulation, and more intrusive in terms of supervision, in order to better monitor the system, enhance its resilience, and manage the consequences of the distress or failure of individual institutions, if and when they occur. If you want to know more, I encourage you to look up these speeches on our website. But my focus today is on some of the other changes currently under consideration as part of the review, how they will affect the way the Reserve Bank operates in the future, and how I want to take advantage of them to create a more transparent and far-sighted Reserve Bank. Bascand G, (2019) ‘Renewing the RBNZ's approach to financial stability’, speech delivered to 15th Financial Markets Law Conference in Auckland, 26 June, https://www.rbnz.govt.nz/research-andpublications/speeches/2019/speech2019-06-26 Bascand G, (2019) 'Macroprudential policy: past, present and future', speech delivered to 54th University of Otago Foreign Policy School, Dunedin, 30 June, https://www.rbnz.govt.nz/research-andpublications/speeches/2019/speech2019-06-30 Ref #8108464 v6.6 The different views from Tāne Māhuta We use the Māori legend of Tāne Māhuta to tell the story of the Reserve Bank. Tāne Māhuta – the god of the forest and birds – separated the earth mother (Papatūānuku) and the sky father (Ranginui) so that the sun could shine in and life could flourish. Thereafter, Tāne Māhuta served as the kaitiaki (guardian) of the forest ecosystem – protecting it against threats, and enhancing the wellbeing of everyone within it. The legend helps tell the story of the Reserve Bank – founded 85 years ago to give New Zealand the flexibility and benefits of its own currency, monetary policy and financial system. Since then the Reserve Bank has had the responsibility to act as one of the guardians of the system. It is also a legend about growth. To retain our legitimacy as New Zealand’s central bank we have to evolve along with the economy, the financial system and society. This means working closely with stakeholders. It means an ongoing conversation with New Zealanders, speaking in terms that we all recognise, quite literally in some cases. We are developing our Te Ao Māori strategy in recognition of the increasingly important and diverse Māori economy. But it is not only an inward looking view. We take an international view as well. We are placing greater focus on New Zealand’s bilateral and multilateral arrangements. We already have close relations with our neighbours in Australia but we are also helping to build capacity and capability in central banks throughout the South Pacific and East Asia. It is also a forward looking view. We are developing a climate change strategy which recognises the role of the financial system in contributing to global action and dealing with the risks that climate change might pose. This means looking at ourselves, how we are going to change and how the Reserve Bank will work differently. Our Statement of Intent and the longer term We set out our plans and commitments in our latest Statement of Intent3, which covers the years 2019-22. We published this on the same day the government set out the next stage of consultation on the operational part of our financial and prudential policy. And, since then we have published our own vision4 that complements the government’s view. We have taken a different approach with the Statement of Intent this year. It has always been an important communications tool, but we are trying harder to communicate with our stakeholders, not just meet the statutory requirements. By the time we get to the end of the Statement of Intent period, we will be operating in a very different environment. We are facing a backdrop of significant change – globally, culturally as an institution, and in the government’s and public’s expectations of us. We are continuing to build our capability to respond to, influence and lead our rapidly changing environment. Reserve Bank Statement of Intent 2019-22 Our Vision, the future of the Reserve Bank of New Zealand Ref #8108464 v6.6 I have previously talked about our vision as being an island we are journeying towards. Our vision is to be a great team, and the best central bank. This involves our activities, our people and our stakeholders. With the government’s latest consultation, the destination in terms of our activities is now looking a lot clearer. Review of the Reserve Bank Act I have already mentioned the review of the Reserve Bank Act which is currently under way. Phase 1 of the review focused on monetary policy. The outcome was a new objective to support maximum sustainable employment as well as achieving price stability. There is also a new Monetary Policy Committee5, which is now in place and delivering. The Committee has made two decisions on the Official Cash Rate so far. There has been some talk in the context of these new arrangements that I am no longer the ‘single decision maker.’ In reality, whatever the legislation says, I probably never was. I always worked with others to make the final decision. This is now formalised and I value the insights that all members of the MPC bring to their important role. That was Phase 1 of the review. Phase 2 is looking at the Reserve Bank’s financial stability function. The process started last year and will run through until the middle of next year, when legislation is due to be introduced to the House. It will continue beyond that, as there will be more detail to work out and implementation to be planned. After the first round of consultation, the government has made a series of in-principle decisions. We will continue to be a “full service” central bank The government has decided to keep responsibility for prudential regulation with the Reserve Bank. This makes sense given New Zealand’s size. However, this regulatory model is not just about being cost-effective. In our story of the Reserve Bank as the Tāne Māhuta of New Zealand’s financial system, our money and foreign reserves are the sap, and our payment and settlement systems allow money to flow round the system, and support our regulated financial institutions – our grafted branches. Keeping prudential regulation and supervision in the same institution as monetary policy, currency issuance, our payment and settlements systems and our markets functions, means we maximise the synergies between the different areas. As a full service central bank we can leverage our different tools and market functions and adapt our response as circumstances dictate. We are reviewing the production and movement of our money through the ‘Future of Cash’ project6 – Te Moni Anamata – to make sure that New Zealanders, the financial system and the Reserve Bank are ready and resilient to changing uses and demands for cash. We see a ‘less cash’ not ‘cashless’ society evolving rapidly. Why not cashless? There are many reasons, in particular financial inclusion and business continuity, that cash plays an important role in promoting. New RBNZ monetary policy committee remit reiterates focus on price stability and employment What's the future for cash in New Zealand? Ref #8108464 v6.6 We are also renewing our payment and settlements systems to enhance their reliability and security and better meet our customers’ needs. Banking the banks is a 24/7 task globally, and we must ensure the highest of operational standards. We are already increasing our capability to deliver effective prudential supervision, as the IMF FSAP and Trowbridge report on CBL Insurance suggested we should. This means more skilled people on the ground. It also means building the right analytical frameworks, taking a more sceptical view, and being more willing to act. Banks and insurers can expect us to be more intrusive in our supervisory approach. This is already underway. We promote financial stability across our monetary and financial system The government has announced a new high level objective for the Reserve Bank – to maintain and enhance the stability of the financial system. ‘Financial stability’ has the advantage of clarity of purpose. It does not mean we abandon the principle of regulatory efficiency: as a good regulatory steward we consider the cost-benefit of all our policies. It also means we continue to promote a dynamic and efficient financial system. Financial stability means that we have markets and participants that are able and willing to identify, price, allocate and manage risks appropriately.7 Regulation and supervision have an important role to play where they cannot internalise the costs to society of their actions. This is the best way to achieve financial stability in the long run and to contribute to a sustainable and productive economy and the prosperity and wellbeing of New Zealanders. A new regime for deposit-takers The government has announced that there will be a new ‘deposit takers’ regime – combining the current separate regime for banks and non-bank deposit takers. There will be a new deposit insurance scheme, with a proposed limit of between $30$50,000 per customer, per institution. This will be an important element in the regulatory toolbox. Our governance will be modernised The government has also decided that our activities will be overseen by a new Board of Directors. This will be a corporate board, of the type many of you will be familiar with. It is a well tried model across the public and private sector. The Board will set the strategic direction and risk appetite for the Reserve Bank. Like any board, it will be responsible for the Reserve Bank’s decisions and actions, but will delegate the exercise of many of its functions and powers to the Governor and the management team, and empower them to manage the Reserve Bank. The new governance Board could also take on the responsibility of overseeing our spending decisions and exercising appropriate accountability for our activities and our use of public resources. Our people Being a great team, best central bank, involves building the capability of the people in our team – the caretakers or kaitiaki of the financial system. This involves sourcing an increasingly diverse workforce, giving staff the skills and tools they need, and building our Orr A, (2006) ‘Towards a framework for promoting financial stability in New Zealand’, speech presented to the Institution of Professional Engineers New Zealand, March 22, https://www.rbnz.govt.nz/research-andpublications/speeches/2006/speech2006-03-22 Ref #8108464 v6.6 leadership capability framework. Our challenge is to attract, retain and motivate people to lead the Reserve Bank in a fulfilling career. Our Te Ao Māori strategy is a critical part of accepting diversity and inclusion. So is upgrading our data management systems and strengthening our digital security. All these elements will make us a constructive, future-focused employer, and support us in delivering our objectives successfully. We will build and improve our relationships with our stakeholders The final part of our strategy is building our relationships with stakeholders. We want to continue to foster co-operation, transparency and mutual trust among our domestic coregulators, wider stakeholders and global peers. We are a member of the Council of Financial Regulators. We work with the Financial Markets Authority (FMA), The Treasury, MBIE and more recently, the Commerce Commission to ensure that we identify system-wide risks and issues, and that we manage and address them in a timely manner. We have recently committed to a joint vision for our collective. Recent examples have been working with the FMA on the conduct and culture reviews of banks and life insurers; working on capital markets developments with NZX and MBIE; sharing performance and culture efforts with the Treasury; and working with the Productivity Commission on financial stability and dynamic efficient markets. We have close relationships with our Australian counterparts, both bilaterally with APRA and the RBA and more broadly through the Trans-Tasman Council on Banking Supervision, the TTBC, which also includes the Australian Treasury and ASIC. We also aspire to build the best regulator/regulated supervisory relationships in accordance with the commitments we have made in our relationship charter. We work hard to understand the impacts of our actions and decisions on the range of stakeholders we serve. We also want to make sure that our stakeholders understand what we do, have trust in our work and have confidence in our decision making. We are seeking to be transparent, open, consultative and respectful in our engagements with all stakeholders. …including the Minister of Finance Of course, as I have already recognised, our key stakeholder is the Minister of Finance. To get the best out of that relationship, we need to continue to understand government priorities and our contribution to the broader economic wellbeing of New Zealanders. But we also want the Minister to understand and support our objectives, respect the Reserve Bank for its advice, and hold us to account for our performance. Our role is to make sure the Minister has the information he needs to do that. This is also means working closely with the Treasury who will be acting as monitor on the Minister’s behalf. Conclusion The view from Tāne Māhuta is of a garden that continues to grow and evolve. We have to adapt and evolve with it – in terms of our inclusiveness, our commitment to fostering honest, professional and constructive relationships with our stakeholders, in identifying emerging risks like climate change, and working with our international partners. Ref #8108464 v6.6 At the same time, the government is modernising our legislative framework. Our new financial stability objective gives clarity to our prudential purpose: a dynamic and efficient financial system that contributes to a sustainable and productive economy and promotes the prosperity and wellbeing of New Zealanders. The creation of a new governance Board will increase transparency and accountability. It will also increase the diversity of thought that goes into our decisions. The Board will delegate responsibility to the Governor and management, establish the framework of expenditure and investment delegations to management and hold management to account for achieving the vision. As Governor and Chief Executive, I will certainly feel the difference – being answerable directly to a Board with the formal responsibility for all the work of the Reserve Bank, except the decisions of the Monetary Policy Committee. Our staff can be proud to be part of the best team, in a great central bank. A Reserve Bank that recognises their experience and backgrounds, supports them in developing their skills, and encourages them to work together to build strong and respected relationships with our stakeholders. I hope stakeholders like you will also notice the difference. The new governance Board will be clear about what the organisation is trying to achieve. Importantly this means setting the strategic direction and risk appetite of the Reserve Bank across all our functions. As mentioned earlier, our regulated population can expect us to be more intensive in our regulation and more intrusive in our supervision. I have been happy to outline this vision for the Reserve Bank this morning. Please share yours too. The latest consultation is now open until 16 August 2019. It sets out more questions about the tools and powers we have to do our job. I encourage you all to review the material on the Treasury website and make contributions based on your own experience. Ref #8108464 v6.6
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Speech by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the 54th University of Otago Foreign Policy School, Dunedin, 30 June 2019.
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Macroprudential Policy: Past, Present and Future A speech delivered to 54th University of Otago Foreign Policy School in Dunedin On 30 June 2019 (9:00 am) By Geoff Bascand, Deputy Governor & General Manager of Financial Stability 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Macroprudential Policy: Past, Present and Future Kia ora tatou, it is great to be here with you today to talk about the important role of macroprudential policy in the management of financial stability.1 It is six years now since macroprudential policy was established in New Zealand via a policy memorandum with the government in May 2013, and loan-to-value ratio (LVR) restrictions were first implemented in October 2013.2 At its introduction, we committed to reviewing the policy’s efficacy after five years; most of my talk today is drawing on that recently completed review and the lessons we drew for how we use macroprudential policy in the future.3 Macroprudential policy in some ways is new wine in old vessels. Direct restrictions on the borrowing capacity of households, such as the LVR instrument, are novel for New Zealand’s recent history. More than 30 years ago the removal of a wide range of restrictions on borrowing, including interest rate controls and government directives on bank lending to various industries, led to significant improvements in the efficiency of the financial system. We don’t want to undo the fruits of these reforms, so why did we bring lending restrictions back? International experience and research has demonstrated that good regulations – including macroprudential policy such as targeted borrower restrictions – are beneficial for promoting financial stability. And financial stability is very worthwhile, because wellbeing is seriously harmed by financial crises. With evidence from over 140 banking crisis around the world over the past fifty years to draw on, we can clearly see the immense impact those countries experience in terms of lost economic growth, increased public debt and unemployment rates. Furthermore, these adverse economic impacts tend to be more severe for the most vulnerable in society, which ultimately translates into a deterioration in social cohesion and the quality of life. While in New Zealand the lack of recent severe downturns could cloud our sense of risks, the international evidence demonstrates their profound economic impacts and serves as a lesson for us too. My speech from earlier this week outlined the Reserve Bank’s overall prudential framework for safeguarding financial stability.4 Macroprudential policy is one key part of this prudential framework. We want to use macroprudential tools when risks are particularly high, to build resilience among banks and households, and to mitigate the economic cost of a future crisis.5 My talk will cover three broad issues. Firstly, how does macroprudential policy mitigate risks to the financial system? Secondly, looking back, has the Reserve Bank’s macroprudential policy enhanced I am very grateful to Bruce Lu for considerable assistance in the preparation of this speech, along with valuable comments from other Reserve Bank colleagues. The loan-to-value ratio is a measure of the size of the loan relative to the value of the borrower’s collateral held against the loan, usually expressed as a percentage. Lu (2019) assesses the effectiveness of loan-to-value restrictions in enhancing financial stability, and looks for any side effects. Ovenden (2019) discusses the Reserve Bank’s strategy for operating macroprudential policy. Bascand (2019). Macroprudential policy in the New Zealand context refers to policies with a time-varying dimension, although internationally the term is broadly used to refer to prudential policies that are focused on the financial system. financial stability, and were there any side effects? Lastly, I want to discuss how macroprudential policy should be governed, and the Reserve Bank’s approach to using the tools. Part 1 – The role of macroprudential policy To start with, let’s take a look at how systemic risks are created from the boom and bust in the financial cycle, and how macroprudential policy can increase resilience of banks and households when those risks are high. When the economy is doing well, banks face competitive pressure to relax their lending standards. When homeowners experience house price inflation, their access to credit will generally increase. As a result, lending to less credit-worthy borrows can increase to an extent that is harmful to society (figure 1), without individual lenders bearing the full cost of higher debt levels. It’s no surprise that those dynamics can apply in reverse when the economy weakens: as household incomes fall, the ability of borrowers to service debt is undermined, and defaults increase. This produces losses in the banking system and can trigger a fire-sale of housing, which compounds the downturn in house prices. In this situation, the banks respond by become significantly less willing to lend, making the downturn in the economy more severe and the recovery slower than it need be. Figure 1: Boom-bust financial cycles Reduced lending Greater lending Banks adopt same strategy Lending standad falls Asset prices go up Bank funding costs go up Boom m Asset prices go down Bust Banks need more capital Defaults go down Defaults go up Based on a large sample of downturns across many countries, we understand that the occurrence of a house price bubble and strong credit growth in the upswing of a financial cycle tend to be followed by deeper recessions, in terms of lost GDP per capita and increased unemployment (figure 2).6 Jorda at al. (2013), Bridges et al. (2017), and Aikman et al. (2018). For an overview of financial stability risks from housing market cycles, see Thornley (2016). Figure 2 shows that a recession tends to be more severe, in terms of lost GDP per capita, if it is immediately preceded by an asset price bubble, and be even more severe if preceded by both an asset price bubble and strong credit growth. Figure 2: The role of asset bubbles and credit in the severity of recessions (1870-2013) Percentage change in real GDP per capita Recession Bubble, low credit Bubble, high credit -2 -2 -4 -4 -6 -6 Years from crisis Source: Jorda et al Our prudential framework for safeguarding financial stability is more than just our macroprudential policy (Table 1).7 Our framework includes a minimum level of capital and liquid assets that banks must hold, to ensure they remain solvent and can retain market confidence during periods of severe stress. We call these our baseline prudential buffers. In cases of bank distress or failure, there are procedures in place to carefully manage the situation and limit the impact. We use macroprudential policy to build an additional layer of protection if risks are particularly high at a point in time. It’s important to remember that macroprudential tools are complementary to a strong set of baseline prudential buffers, and will be ineffective at promoting lending during hard times if banks are unable to remain solvent or retain market confidence. And prompt use of macroprudential tools reduces the likelihood that prudential buffers are drawn on. The Reserve Bank’s LVR policy, that’s our loan-to-value ratio policy, is the most well-known tool of macroprudential policy and upholds lending standards during the credit upturn, thereby lowering the debt burden of households ahead of a downturn. In the macroprudential toolkit8, we also have capital and liquidity tools that build additional buffers for banks, putting them in a better position to keep lending to the economy when things turn sour. While the liquidity tool – minimum core funding requirements – is in place, we haven’t adjusted it so far to limit risks to financial stability. So in practice our active use of macroprudential policy pertains only to LVRs. In addition to its financial stability role, the Reserve Bank also has responsibility for price stability. Macroprudential policy and monetary policy are set for different objectives, but they do interact. For example, the official cash rate (OCR) may be raised in response to an upturn in the economic cycle, which generally helps with the macroprudential objective by moderating credit and house price growth. However, the impact of macroprudential policy on inflation is much smaller than the OCR, and the policy is not a lever for achieving inflation or employment goals. In general, macroprudential policy and monetary policy tend to be complementary, and together will maximise both financial stability and price stability. Bascand (2019) explains in more detail how our regulatory tools fit together and complement one another. A memorandum of understanding between the Reserve Bank and the Minister of Finance lists four macroprudential instruments. These are the core funding ratio, the countercyclical capital buffer, the sectoral capital requirements, and the LVR restrictions (English and Wheeler, 2013). Purpose Relevant instruments Macroprudential policy Borrower restrictions (LVRs) Reduce risk that the financial system amplifies a severe economic downturn Prudential policy Maintain baseline resilience of the financial system Impact on financial system resilience Impact on wider economy More resilient households and banks reduces potential severity of an economic downturn Reduced losses in a severe economic downturn Capital and liquidity instruments (CCyB/SCR) Lowers incentives on banks to deleverage in a downturn; supports higher credit supply and economic activity Capital buffers Banks remain solvent through the economic cycle Maintains market confidence and lowers risk of sudden increases in funding costs for households, businesses and the economy Banks remain functioning parts of financial system Maintains availability of credit and banking services necessary for economic activity Liquidity policy Management Governance and local incorporation Manage and limit impact of distress or failure Collateral standards Outsourcing Mitigates costs for creditors and taxpayers OBR Minimum capital Losses absorbed by shareholders first Supervision, oversight and disclosure Prevention Table 1: Macroprudential policy and baseline prudential requirements As with all interventions, the financial stability benefits of macroprudential tools need to be weighed against their potential cost to efficiency. As such, it’s vital to review such tools, and publish the results to increase accountability and transparency, and to build lasting legitimacy in the eyes of the public. Part 2 – Have the LVR restrictions enhanced financial stability? New Zealand was among the leaders in macroprudential policy when the LVR restrictions were first introduced, and since 2013, borrower-based tools have gained greater acceptance internationally, including in the UK, Ireland and Canada. While a few Southeast Asian countries have used the LVR tool since the 1990s, it was the global financial crisis - referred to as the GFC - that made the world more conscious of financial stability risks, leading to a greater acceptance of mortgage lending restrictions. And that takes me to our review of the LVR policy and its effectiveness by looking at the implications for financial stability, financial system efficiency and other public policy objectives.9 Our analysis showed that as a result of introducing the LVR policy, resilience of the banking system has increased. And while it’s more difficult to pinpoint, we also found that the policy has had a significant benefit in mitigating the risk to the economy from financial cycles. As you might expect, the restrictions have lowered the LVRs of mortgage borrowers. The share of the stock of mortgages with a LVR of above 80 percent has declined from 20 percent in 2013 to an average of 7.5 percent in the past two and a half years (figure 3). This fall has reduced the proportion of loans that would be in negative equity given a house price decline, meaning that the credit losses on banks’ mortgage portfolio would be lower in a stress event. Figure 3: Share of the mortgage stock with LVR above 80, by value % % Introduction of restrictions on high-LVR lending 80 < LVR ≤ 90 90 < LVR Sources: RBNZ LVR Lending Positions Survey Not only that, the policy has lowered the magnitude of a potential house price correction, which further mitigates potential credit losses. It has achieved this by reducing the number of distressed borrowers who would be forced to sell their homes and by lowering house price inflation during the housing market upswing, thereby bringing house prices more in line with economic fundamentals. Lu, 2019. We estimate that, had we not imposed the LVR restrictions, mortgage losses in a severe economic downturn involving a fall in house prices would absorb nearly all the capital banks hold against their housing loans (figure 4). Under the current environment, mortgage losses in a severe downturn are estimated to be lower, showing that the LVR policy has improved the resilience of the banking system. Figure 4: Modelled credit losses as a share of housing capital requirement % % Current Counterfactual Source: Lu and Bloor (2019). Improving the resilience of banks is only one objective of the LVR policy – the other goal is to reduce the potential for the financial cycle to impair economic performance. International evidence show that economies with high household debts relative to disposable incomes have suffered larger declines in consumption during the GFC than less indebted economies.10 The other major factor driving the collapse in consumption in many economies is the large fall in house prices. These dynamics have worsened the impact of the GFC. A more severe economic downturn will weigh on wellbeing, but will also lead to a deterioration in banks’ non-mortgage assets. For example, in Ireland private consumption fell sharply over the GFC with retail sales declining by almost 20 percent annually by 2009, which led to widespread defaults on business loans. By 2013, more than 40 percent of SME loans in Ireland were in default. Our modelling suggests that the LVR policy has slowed the growth in household debt in New Zealand. A lower level of household debt and more durable house prices should insulate domestic demand, and the wider economy, against financial instability. Side effects of LVR intervention Up to now, I’ve talked about the benefits of the LVR policy, but we need to acknowledge that all regulations have the potential for unintended impacts in the process of achieving their objectives. The LVR restrictions have the potential to undermine financial system efficiency by restricting lending to some borrowers who are able to comfortably service the loan, but who have insufficient housing equity to meet the LVR requirements. This is why the Reserve Bank allows a speed limit of high-LVR loans under the policy, which are available to borrowers at the discretion of their bank. Floden, 2014 and Cecchetti et al., 2011. The LVR policy can also work against the social objective of housing affordability. To be clear, the Reserve Bank does not have housing affordability as an objective, but it is sensible to be aware of the impact of our actions on the other goals of the government. A uniform calibration for the LVR restrictions, as was the case in late 2013 and 2014, is likely to restrict the access to credit for first home buyers, who tend to have less savings for a deposit and have not benefitted from previous house price appreciation. These controls that restrained first home buyers were necessary to protect the financial system, and to stop buyers from taking on too much debt and becoming distressed. In contrast, the effect on investors from a uniform LVR policy tends to be weaker in a rising market. We’ve recalibrated the LVR restrictions over time to target the riskier forms of investor lending, as the emerging evidence points to greater risks associated with highly leveraged investors. This also had the effect of rebalancing the burden of policy away from first home buyers. The share of new mortgages going to first home buyers has risen from 10 percent in 2014 to 17 percent by the end of 2018, a historically healthy level. In the recent years, first home buyers have accounted for the lion’s share of the high-LVR lending permitted under the policy (figure 5). Housing affordability remains an important challenge for public policy, and structural reforms are necessary to improve affordability in the long term. The LVR restrictions are for the purpose of enhancing financial stability, and aren’t suitable for addressing broader social challenges. Figure 5: First home buyer high-LVR lending % % Share of all first home buyer lending Share of all high-LVR lending Exemptions can be used to mitigate the tension between the LVR and other public policies, so long as they do not undermine the financial stability objective. For example, the exemption on construction finance has helped to address concerns that the LVR policy is hindering new housing supply. The Reserve Bank’s consultation with stakeholders in all macroprudential policy interventions helps to inform the design of policy, including the exemptions. Between November 2015 and September 2016, the Reserve Bank implemented targeted LVR restrictions for Auckland borrowers, owing to high risks of a severe house price decline in Auckland that would heavily affect the financial system. This move was effective in moderating the risk in Auckland. However, market intelligence suggested that Auckland investors increasingly purchased in other regions, which contributed to housing market exuberance in the rest of New Zealand. With high risk lending continuing to rise elsewhere, this tells us that a regional policy may be ineffective at reducing vulnerabilities at the national level. The likely spill-over effects would need to be considered carefully before using a regional policy in the future. Figure 6: Annual house price inflation in urban areas Whangarei Auckland Hamilton Tauranga Napier Palmerston North Wellington Nelson Christchurch Queenstown Dunedin Invercargill Aug-15 Dec-16 % Source: Real Estate Institute of New Zealand An underlying concern we had with the LVR policy is that risky lending could shift from banks to nonbank lenders who are not constrained by the policy. While there has been some growth in mortgage lending by non-bank lenders since 2014, their funding of purchases in the housing market remains very low. Non-bank deposit takers account for less than one percent of total mortgages with an LVR of more than 80 percent (figure 7). This evidence suggests that the LVR restrictions policy has remained effective for a longer period than we had initially thought. Figure 7: NBDT mortgage stock by LVR, and NBDT share of total high-LVR mortgages <70 LVR 70-80 LVR 80-90 LVR 90+ LVR Other NBDT share of total LVR>80 loans $m 1,200 1,000 % 1.6 1.4 1.2 0.8 0.6 0.4 0.2 Mar-19 Jul-18 Nov-18 Mar-18 Jul-17 Nov-17 Mar-17 Jul-16 Nov-16 Mar-16 Jul-15 Nov-15 Mar-15 Nov-14 Jul-14 Part 3 – Strategy for macroprudential policy The experience we have had in operating macroprudential policy is invaluable for developing an effective policy strategy. I want to touch on the principles of good governance, before discussing our operational strategy, and the outlook for macroprudential policy. Principles of good governance In this context, governance relates to the process for making macroprudential decisions, and mechanisms for holding decision-makers to account for those decisions. The Phase 2 Review of the Reserve Bank Act is considering the suitable governance framework for macroprudential policy. The operational independence of the Reserve Bank is a guiding principle of the Phase 2 review, and we strongly agree that this is important for a functioning governance framework. The cost of a macroprudential intervention, in terms of reduced credit availability, are highly visible, while the longer-term financial stability benefit is hard to measure. Clearly, deploying macroprudential policy when it is needed does not make you popular, and therefore elected politicians may have difficulty committing to what is required for a long-term financial stability objective. Internationally, macroprudential tools are used far less actively in jurisdictions where the government is heavily involved in decision-making.11 We think that operational independence is key for all macroprudential instruments. The Phase 2 review raised the option of political oversight for borrower-based tools, like the LVR restrictions. The rationale is that, because these tools incur a direct distributional cost on affected households, elected politicians are needed to maintain legitimacy. However, in the Reserve Bank’s view, the controversial nature of these tools strengthens the case for operational independence, to ensure that the tool can be used promptly when necessary. That said, the accountability and transparency of decision-makers plays a particularly important role in macroprudential policy, because financial stability is inherently difficult to quantify as an objective. The Reserve Bank has been transparent in explaining its policy decisions in consultations and the Financial Stability Reports, although transparency was more limited prior to policy action. To fill this gap, the Reserve Bank has recently published a macroprudential framework document that explains our strategy for using the tools. The government has recently announced an in-principle decision to change the governance framework for prudential policy. We agree that the governance framework can be improved by moving from the single decision-maker model, where all powers related to prudential policy rest with the Governor, to a governance board. A governance board allows for more rigorous testing of decisions from a diverse range of perspectives, provides for more external input, and can insure against extreme preferences by individuals - the board model is also widely understood and used. We can see the Reserve Bank Board taking responsibility for the macroprudential framework and scrutinising the operation of macroprudential policy by the Governor and his staff for which the Board will ultimately be responsible. As I have acknowledged earlier, macroprudential policy can produce tension with other objectives of public policy. This reinforces the importance of consultation with the government, in line with our current practice, although there needs to be a clear boundary between consultation and decisionmaking. The Phase 2 review raised the option of assigning a formal advisory role to an interagency committee, which could be well placed to consider the potential tension between macroprudential policy and other government policies. However, in our view, an interagency committee runs the risk of undermining accountability, and its added value may be limited given that the Reserve Bank already consults extensively on macroprudential decisions. The Phase 2 review of the Reserve Bank Act will have a significant bearing on the future of New Zealand’s financial system, and it’s important that you have a say - I encourage you to take a look at the consultation material on the Treasury’s website. Edge and Liang, 2017. Decision making for macroprudential policy So how do we operationalise our macroprudential policy in line with the principles of transparency, accountability and rigorous decisions? Well, the Reserve Bank’s decision-making follows three steps (figure 8). Figure 8: Operation of macroprudential policy 1. Systemic risk monitoring • Probability of a correction • Resilience • Feedback effect 2. Policy choice • Capital and liquidity tools? • Borrower tools? 3. Policy assessment • Consultation • Decision • Ongoing assessment Firstly, we assess the nature of the risks facing the financial system, or systemic risk monitoring, by using a range of quantitative indicators. We look at the probability of a correction in the credit cycle. A number of studies have identified house price overvaluation and household debt as reliable predictors of a correction in the credit cycle.12 Next, we assess the current resilience of the financial system to a correction. To do this, we monitor banks’ lending portfolios, their capital positions, and undertake stress tests of banks. Finally, we examine the feedback effect of the identified risk with the wider economy. The main indicator for this assessment is bank lending standards, which could undermine the resilience of the financial system over time, and increase vulnerabilities in the housing market and wider economy. After considering all this information, we can judge whether these risks fall into the purview of macroprudential policy. That said, no set of indicators can mechanically capture the nature of risks, and reasoned judgements will always form a part of our decision-making. The second step is policy choice, where we consider what an appropriate policy response might look like. Macroprudential instruments can be categorised into capital and liquidity tools that are focused on improving bank balance sheets, and borrower-based tools that improve household resilience. Three capital and liquidity instruments are available, including the countercyclical capital buffer, the sectoral capital requirement and the core funding ratio. These tools build additional buffers for the banking system to absorb adverse shocks. In a downturn, these buffers reduce the risk of bank failure or deleveraging, and can be cut to support the supply of credit to the economy. The single borrower-based instrument we have is the LVR restrictions. In our view, a debt-to-income (DTI) tool would be a useful addition to our macroprudential toolkit. The Phase 2 review will consider the appropriate instruments to be included in the Reserve Bank’s future toolkit. Borio et al. (2018) and Aikman et al. (2018). Our choice of tools depends on the risk we face. On the one hand, if we are concerned with low resilience on bank balance sheets, capital-based instruments may be the most effective tool. On the other hand, the LVR restrictions are more effective at restraining exuberance in the housing market and household debt, and at insulating the economy against adverse shocks. It's worth noting that all tools come with possible costs to financial system efficiency. For example, capital and liquidity tools increase the cost of credit provision for banks, while borrower-based tools curtail credit availability. Both of these effects could reduce short-run economic growth. We need to choose the right tool for the job to have confidence that the benefits to financial stability exceed any costs to efficiency. The final step in our decision-making is policy assessment, which includes consultation, a final decision and ongoing assessment. The consultation will typically consider several policy responses and settle on a favoured option. However, we listen carefully to our stakeholders and, should we find their arguments persuasive, we will change our views. Once a macroprudential tool has been deployed, the Reserve Bank will continue to assess its effect in the six-monthly Financial Stability Report. This asks whether there are unintended consequences, and whether the policy intervention remains optimal. Our ongoing assessment of the impact of the LVR policy has informed each adjustment in its calibration. The good news is that declining risks have allowed us to ease the LVR restrictions, starting in 2017. The outlook for macroprudential policy We left the LVR policy unchanged in the May Financial Stability Report, in order to monitor the effect of our recent easing and the recent fall in mortgage rates. Looking ahead, we are comfortable with further easing in the LVR policy over time, but this is predicated on risks continuing to abate. Specifically, we want to see household debt levels remaining stable relative to incomes, prudent lending standards from banks, and moderate house price inflation. If these conditions are met, we are inclined to continue easing the restrictions. In the long term, we face a choice between removing the LVR restrictions and maintaining a permissive setting. A full removal would of course eliminate any efficiency cost, and could be done alongside the deployment of a less intrusive tool if we are still worried about residual risks. But on the flip side a permanent LVR setting will continue to guard against the very risky forms of lending, and may better prepare the banking system to adapt to a more restrictive calibration if risks reemerge. The efficacy of a permanent LVR setting is an important policy question for future research. As you may know, the Reserve Bank has proposed a material increase to banks’ capital requirements to increase the resilience of the financial system. The proposals include a more prominent role for the counter-cyclical buffer, providing more certainty that this buffer will be built prior to a downturn in the financial cycle, in order to support lending during a systemic crisis.13 As a consequence, macroprudential tools, including the LVR restrictions, may need to be used less actively. That said, The counter cyclical buffer would be released during a systemic downturn to support lending. In contrast, it is unlikely that easing LVRs during a downturn would have the same benefit, as banks will be reluctant to undertake high-LVR lending when under stress. different tools are effective for addressing different risks, and there will still be a role for borrowerbased tools to more directly address risks associated with household debt. Part 4 – Conclusion In conclusion, financial stability is important for the wellbeing of New Zealanders, and macroprudential policy is a key line of defence for safeguarding financial stability. Baseline prudential tools ensure that potential threats to the financial system can be absorbed and the damage repaired. Macroprudential policy reduces the likelihood and severity of the threat, and mitigates the adverse impact on the economy. To inform our strategy for macroprudential policy, we have reviewed our operation of the LVR restrictions policy since 2013 and the growing research on macroprudential policy internationally. We found that the LVR restrictions policy has significantly improved the resilience of the banking system. We have also gained a broader understanding of the side effect of the LVR policy on other public policy areas, of ways to mitigate the potential policy tensions, and of the limitations of macroprudential policy. Our experience in LVR restrictions has helped to shape our strategy for using macroprudential policy. Our strategy broadly follows a three-step process of systemic risk monitoring, policy choice, and policy assessment, including evaluation after implementing the macroprudential tools. We are transparent and accountable, both in outlining how the tools will be used and in making the case for their implementation. The government is reviewing the role and powers of the Reserve Bank as they relate to financial stability, including whether our macroprudential framework remains fit for purpose. The principles of good governance I have touched on, and our refreshed macroprudential strategy, form an anchor, and should be compatible with a range of outcomes of the review. I hope our refreshed strategy on macroprudential policy has contributed to the understanding, accountability, and lasting legitimacy for the framework. References Aikman, D., Bridges, J., Burgess, S., Galletly, R., Levina, I., O’Neill, C., and A. Varadi (2018). “Measuring Risks to UK Financial Stability”, Bank of England Staff Working Paper no. 738. Bascand, G. (2019). “Renewing the RBNZ’s Approach to Financial Stability.” Borio, C., Aldasoro, I., and M. Drehmann (2018). “Early Warning Indicators of Banking Crises: Expanding the Family”, BIS Quarterly Review, March 2018. Bridges, J., Jackson, C., and D. McGregor (2017). “Down in the Slumps: the Role of Credit in Five Decades of Recessions.” Bank of England Staff Working Paper No 659. Cecchetti, S., Mohanty, M., and F. Zampolli (2011), “The real effects of debt”, Bank of International Settlements Working Paper no. 352. Edge, R., and N. Liang (2017). “New Financial Stability Governance Structures and Central Banks.” Hutchins Centre Working Paper no. 32, Brookings Institution. English, B., and G. Wheeler (2013). “Memorandum of Understanding between the Minister of Finance and the Governor of the Reserve Bank of New Zealand.”, available at https://www.rbnz.govt.nz/financial-stability/macro-prudential-policy/mou-between-minister-offinance-and-governor-of-rbnz. Floden, M. (2014), “Did household debt mater in the Great Recession?”, supplement to Blog Post on ekonomistas.se. Jorda, O., Schularick, M., and A. Taylor (2013). “When Credit Bites Back.” Journal of Money, Credit and Banking, 45(S2), 3-28. Jorda, O., Schularick, M., and A. Taylor (2015). “Leveraged Bubbles.” Journal of Monetary Economics, 76. Lu, B. (2019). “Review of the Reserve Bank’s Loan-to-value Ratio Policy.” Reserve Bank of New Zealand Bulletin, 82(6). Bloor, C., and B. Lu (2019). “Have the LVR Restrictions Improved Banking System Resilience?” Reserve Bank of New Zealand Analytical Note. Ovenden, P. (2019). “Macroprudential policy framework: mitigating the likelihood and severity of boom-bust cycles.”, available at https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Background%20papers/Macroprudential-policyframework.pdf?revision=02bcd033-70a7-4d28-829f-ee28d71fa7cb&la=en. Thornley, M. (2016). “Financial Stability Risks from Housing Market Cycles.” Reserve Bank of New Zealand Bulletin, 79(12).
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Speech by Mr Geoff Bascand, Deputy Governor and Head of Operations of the Reserve Bank of New Zealand, to the 15th Financial Markets Law Conference, Auckland, 26 June 2019.
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Renewing the RBNZ’s approach to financial stability A speech delivered to 15th Financial Markets Law Conference in Auckland On 26 June 2019 (2:10pm) By Geoff Bascand, Deputy Governor & Head of Operations 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Renewing the RBNZ’s approach to financial stability Good afternoon, it’s good to be here today. I’m going to talk about the Reserve Bank’s role in ensuring financial stability and how our approach to prudential regulation and supervision is evolving in line with our own, and society’s, risk tolerance.1 You’ll hear me talk about how the Bank’s approach is expanding and becoming more intensive, so that we are more active in addressing vulnerabilities in the financial sector. This is in response to our own experience, and a publicly identified need in formal reviews of our approach.2 We are building our capabilities to undertake deeper analysis of risks to the financial system and shift to a more intensive supervisory model. It’s a busy time at the Bank as we also undertake with Treasury a fundamental review of the statutory framework for delivering financial stability. The government has announced inprinciple decisions to modernise how the Reserve Bank is governed and its objectives, powers and regulatory perimeter. These decisions strengthen our financial stability focus and set the foundations for enhanced performance, capability and accountability of our financial stability functions. Our ‘soundness and efficiency’ objective is to be replaced with an explicit financial stability objective. The single decision-maker model is to be replaced with a governance board responsible for financial policy. And the artificial distinction between banks and non-bank deposit takers is set to be removed. Meanwhile, we are reviewing key aspects of the regulatory system, for example upgrading the capital framework for banks and commencing a review of insurance legislation and solvency standards, while the government has declared its intention to introduce deposit insurance. These significant developments raise the question: how do the different parts of our financial stability regime fit together? Answering that question is not easy – financial stability is complex and we use a large number of tools to promote it. And there is no single, quantifiable numerical target like the inflation target for monetary policy. Hopefully on conclusion of my speech you will have a greater understanding of the Reserve Bank’s role and where we are heading in terms of how the components of our regulatory and supervisory regime fit together. First I’ll outline why financial stability is important, the risks to the financial system and the market failures that create the need for regulation and supervision. Next I’ll set out the Bank’s role, alongside regulated entities and other agencies, in supporting a dynamic and sustainable financial system and economy. Finally I’ll focus on the Bank’s approach to financial stability, and the outlook in terms of regulation, supervision, strategy and the ongoing modernisation of the Reserve Bank, before covering off some recent announcements that will change the way we work. I am very grateful to Piers Ovenden for considerable assistance in the preparation of this speech, along with valuable comments from other Reserve Bank colleagues. For example the IMF’s FSAP recommendations. Ref #8022722 v2.0 Part 1 – Why we regulate and supervise Financial stability is important The financial system has a critical role in supporting economic activity. Households and businesses need avenues for saving and credit to fund consumption and investment, payment systems to facilitate local and international transactions, and insurance to manage their risks. In order to facilitate economic growth, the public need to be confident that banks, non-bank deposit takers (NBDTs) and insurers can and will continue to provide these services, and that the payment and settlement systems will work as expected. The continued and reliable provision of financial services to the economy is a pre-condition for ensuring that the financial system makes its maximum contribution to the prosperity and wellbeing of all New Zealanders. Financial stability means having a resilient financial system that can withstand severe but plausible shocks and continue to provide the financial services we all rely on. It is something we tend to take for granted – financial crises have been uncommon in this country. But evidence from a wide range of countries over many decades shows us that when they do happen, crises are damaging with long-lasting effects. They impact businesses and households, with reduced economic activity and lost output. They result in increased unemployment and costs for taxpayers. Not only that, recovery can take over a decade and is often halting in nature. Put another way, financial instability creates inefficiency and waste on a large scale. Reducing the likelihood and severity of these episodes is therefore at the heart of our mission. Our aim is for New Zealand to have a dynamic and efficient financial system that contributes to a sustainable and productive economy. The financial system is exposed to risks… Risks to financial stability come from a wide range of sources. External – New Zealand’s financial system is heavily reliant on external funding, which makes us vulnerable to dislocation in overseas funding markets. Domestic – risks related to lending to our dairy industry and to our already highly indebted households. And our most recent Financial Stability Report notes the risks from technology disruptions, misconduct and cybercrime, insurance affordability and climate change. We also have to consider the vulnerabilities of our financial system. It is relatively small, and is dominated by a handful of institutions that have similar underlying business models. That means the distress or failure of one of the major institutions is likely to have significant implications for the system as a whole. And we have to remain alert to new risks. History tells us that there are a wide variety of triggers for financial instability. Every financial crisis is different. …and is subject to market failures Financial stability is a common resource that benefits us all. But because it is a common resource, it is also prone to the tragedy of the commons – the risk that it is abused and degraded by individual agents who do not have the right incentives to look after it, or at least to internalise the cost that instability imposes on others. Viewed through this lens, Ref #8022722 v2.0 maintaining financial stability depends on market participants being willing and able to identify, price, allocate and manage their risks appropriately.3 Information asymmetries – where one party to a transaction knows more than the other – exacerbate this free-riding problem. Small retail savers are likely to find it difficult to detect and price for higher risk-taking at a financial institution, although wholesale investors will exert discipline. In addition there are factors that limit the incentive for financial institutions to internalise the costs to society of a financial crisis. For example, moral hazard can result if institutions believe the taxpayer will bail them out in the event of a crisis. The larger the scale of this distortion, the greater the risk to financial stability and the greater the risk to other regulated entities, investors, depositors and ultimately taxpayers. These structural market failures tend to be reinforced by behavioural factors. It is well recognised that individually rational people make decisions on the basis of other people’s credit and risk assessments.4 This herd behaviour can create market momentum that drives the price away from the underlying risks and returns. In the absence of objective information about the fundamental economic value of an asset or trade, this reinforces the mis-pricing of risk. Alongside herd behaviour, add myopic decision making and irrational exuberance and we are well on our way to boom-bust cycles. If asset prices rise, people borrow more and invest more heavily in that asset class. For a time, this becomes a self-fulfilling prophecy. However this also increases the risk of contagion and fire sale dynamics once market sentiment turns. As I said, financial stability is complex. Part 2 – The Reserve Bank’s role The importance of financial stability as a common resource and the risks and market failures that it is prone to, create the need for prudential regulation and supervision. Nonetheless there is an important role for both the regulator and the regulated in ensuring that the financial stability regime is operating effectively as intended. The three pillars remain relevant… The three, inter-dependent, pillars of self-, market- and regulatory discipline remain relevant to our role as prudential regulator. Our regulatory actions do not occur in a vacuum, and there is an important role for regulated entities and market participants in supporting financial stability. Market discipline refers to the influence that market participants have on a regulated entity’s behaviour and risk-taking, where influence is exerted by market participants changing the cost or amount of funding they are willing to provide based on financial and other information about the entity. In a functioning market this creates an incentive for regulated entities to manage their risks appropriately. Transparency initiatives, such as the Financial Strength Dashboard and mandatory disclosure statements support market discipline5. Self-discipline refers to a regulated entity’s own processes and risk management frameworks, the responsibility for which lie primarily with its directors and senior managers. It See Orr, A, ‘Towards a framework for promoting financial stability in New Zealand’, March 2006, https://www.rbnz.govt.nz/research-and-publications/speeches/2006/speech2006-03-22 See Orr (2006). As noted earlier, market discipline works best at the wholesale level, and is less meaningful for ‘Mom and Pop’ savers. Ref #8022722 v2.0 remains the starting point of the Reserve Bank’s supervisory philosophy. However as the conduct and culture review, the Reserve Bank’s attestation review, and various regulatory incidents demonstrate, we cannot assume that it is operating as intended and that selfdiscipline is effective. Even when market and self-discipline are effective, they are not enough on their own because of market failures.6 Regulatory discipline – the imposition of requirements on regulated entities – is necessary to improve the effectiveness of market and self-discipline, and to minimise the costs of that could be visited on the financial stability commons. Our role as regulator means setting robust requirements that are fit for purpose – that address risks and market failures at source, taking into account the costs of regulation and of supervision on our regulated entities and the wider economy. Setting rigorous but not too stringent requirements is our challenge, informed by research, experience and feedback.7 We need to understand New Zealanders’ appetite for risk, analyse the costs and benefits of regulatory requirements, and have processes for decisionmaking that provide confidence that in high quality decisions being made. …and we do not run a zero failure regime Achieving financial stability does not mean eliminating all risks. This would create inefficiencies of its own – it would potentially stifle new entrants, and remove the incentives for growth, innovation and healthy risk-taking. So we do not run a zero failure regime. Allowing institutions to fail provides the incentives for self- and market-discipline to operate effectively. However, in order to allow individual institutions to fail we need a robust financial system that can continue to function even when individual entities are experiencing distress or failure. In those situations the Bank is tasked with minimising the impact of distress or failure of an institution on the financial system and the economy. Our role is dynamic By necessity our role is a dynamic. The financial system is constantly evolving, as are the risks and challenges. This means that establishing baseline standards is not a set-and-forget exercise. Our requirements and expectations of regulated entities continue to evolve. While it is impossible to predict the future, it is incumbent upon us, when we do impose requirements and set expectations, to think about their effect, and how they might be adapted, in different states of the world. We monitor the financial system… We continuously monitor the financial system in order to identify and assess: • • Structural risks: ever-present risks related to the composition of the financial system, in terms of its institutions, and their assets and funding. New Zealand is exposed to external shocks and standards must recognise these risks and shield the domestic system and economy. Emerging risks: risks related to traditional areas of focus like credit or funding risks, or to new and emerging technologies or to climate change. We are particularly Fiennes, T, ‘New Zealand’s evolving approach to prudential supervision’, September 2016, https://www.rbnz.govt.nz/research-and-publications/speeches/2016/speech2016-09-01 See Bascand, G, ‘Financial Stability – risky, safe or just right?’, November 2018, https://www.rbnz.govt.nz/news/2018/11/financial-stability-risky-safe-or-just-right. Ref #8022722 v2.0 • focused on innovation that presents risks to the regulatory perimeter – whether institutions are operating inside or outside our supervisory and regulatory reach, and whether this is appropriate. Cyclical risks: the risk that boom-bust cycles are amplified by, and to the detriment of, the financial system, due to the procyclicality of credit and asset price growth, when the failure of participants to account for the broader economic and social costs of their actions is exaggerated. We publish our assessment of risks in the Financial Stability Report both to increase awareness and so that institutions can adapt and develop resilience, and improve their selfdiscipline. Supervision has a key role to play both in helping us understand risks to individual institutions, and question whether banks are managing those risks adequately. Our thematic reviews, where we delve into the detail of specific issues, help us and our regulated entities better understand specific risks. Our periodic stress testing, where we subject individual institutions to a significant yet plausible downturn in the economy and distressed funding markets, help us to understand the system’s resilience to macro risks. Financial stability approach Monitor the financial system Enhance the resilience of the financial system Manage distress or failure Identify and monitor risks; support effective self and market discipline Establish rigorous baseline requirements, and adapt as necessary Minimise the costs of institutional distress or failure …enhance the resilience of the financial system… We enhance the resilience of the financial system by establishing rigorous baseline requirements and ensuring these are complied with through supervision. Our baseline requirements address enduring and identifiable sources of risk to the financial system, with the aim of achieving resilience to most probable shocks or adverse events. We then adapt our regulatory and supervisory approach to reflect newly emerging and/or cyclical risks and the impact they could have on the financial system. Ref #8022722 v2.0 For example, we require banks to meet prescribed capital and liquidity ratios to minimise the risk of insolvency due to sudden losses or a disruption in funding markets (We have been consulting on whether baseline requirements should be set to ensure solvency of the banking system in all but the rarest occasions (a 1:200 year event) or only sufficient for something more frequent). If cyclical risks become excessively heightened we can enhance resilience by increasing capital and/or liquidity ratios. We can tighten loan-to-value ratio (LVR) restrictions if we are concerned about banks’ lending standards and the growth of household credit together with the risk of a correction in the housing market. Our regulatory requirements aim to support effective self and market discipline by providing a basis for directors and the market to assess the well-being of individual institutions. Again, supervision has a key role to play, in verifying that regulated entities are complying with regulations and that self and market discipline are operating as intended. …and manage the impact of distress or failure Prevention is best, and most of our effort is focused there. Nevertheless, despite our efforts to monitor and enhance the resilience of the financial system, institutions may become distressed and even fail. This means we need to be well placed, in terms of information and regulatory tools, to manage these events if and when they do occur. Supervision is crucial in helping us understand the balance sheets, operations and the risks facing institutions. This means working closely with firms on their recovery and resolution plans and having a clearly articulated ladder of supervisory intervention. The Reserve Bank also stands ready to act as the lender of last resort in situations where a liquidity shortfall threatens the viability of solvent banks and causes a significant tightening in credit supply. And a new element of our resolution framework is being proposed. The government has stated its intention to introduce a deposit protection regime that, in the event of failure of a deposit taking institution, would provide that deposits in the range of $30,000- $50,000 were insured. While protecting bank customers and taxpayers, this could make it easier to close down a failing institution, sharpen incentives on wholesale investors to exert market discipline, and help reduce the likelihood of financial instability through ‘runs’ on banks. The Reserve Bank is uniquely placed… As a full service central bank we are uniquely placed to fulfil our role in maintaining financial stability. That means that, alongside our regulatory and supervisory function, we undertake monetary policy, we oversee payment and settlement systems, and we stand ready to use our markets functions to provide liquidity in exceptional circumstances. We also have a role in promoting a vibrant and healthy financial ecosystem. This relies on the input of a wide range of stakeholders, regulators and regulated, as well as the consumers and businesses who rely on the financial system. As a member of the Council of Financial Regulators, we work with Treasury, the FMA, the Commerce Commission and the Ministry of Business, Innovation and Employment to identify, manage and address issues, risks and gaps in the financial system, so that it is both safe and efficient. We welcome the ten year review of New Zealand’s capital markets by the FMA and NZX.8 Capital markets are a key component of a sound and efficient financial system – they NZX and the FMA have initiated an industry-led review of New Zealand’s capital markets. Capital Markets 2029 is designed to deliver a ten-year vision and growth agenda for the sector. See Ref #8022722 v2.0 diversify the funding sources that businesses rely on, and they perform a crucial function in regulated entities identifying, pricing, allocating and managing risk appropriately. That is more likely to occur when capital markets are liquid and accurately capture the fundamental value of assets. Part 3 – Our approach to financial stability Our approach to financial stability is expanding and becoming more intensive, in terms of both regulation and supervision. How do we operationalise our financial stability role, and what aspects of this role are changing? Our regulatory approach We choose the appropriate regulatory tool to address the identified risk to financial stability, bearing in mind efficiency costs, the level of effective self and market discipline, and the regulatory framework as a whole. Our requirements are complementary, with some substitutability at the margin – we view them as a package. And as I mentioned earlier, our baseline settings are not set-and-forget, we adapt them as risks and the resilience of the financial system evolve. We are bolstering the regulatory pillar through a wide range of initiatives. Most notably we are consulting on a material increase in bank capital requirements. Bank capital is a crucially important component of the regulatory framework for banks. ‘Skin in the game’ reinforces self-discipline – the responsibility on boards and senior managers to manage and disclose risks appropriately. Our proposals reflect our experience and the evidence on the consequences of financial crises. However, capital is not a complete mitigant. Our other initiatives reflect that banks can fail for many reasons. And it is not efficient to require banks to hold more and more capital in order to address all the different sources of risk. That’s why we have a range of policies that aim to address potential problems at source. For example, liquidity standards are important in ensuring banks can meet their cash flow demands; outsourcing requirements are needed so that banks can continue to operate in a situation where a key service provider fails; and macroprudential interventions may be necessary during periods of excessive credit and asset price growth. Other regulatory initiatives include new legislation to grant us more extensive powers to supervise FMIs. Given our dependence on payment and settlement systems, their lightweight regulation and supervision is a crucial vulnerability. We are working with banks and other stakeholders on a new mortgage bond standard, which will provide banks with an additional funding source, as well as provide banks and investors with a new tradeable instrument. It will also create a larger pool of standardised and transparent securities that the Reserve Bank can lend against as lender of last resort. Phase 2 of the review of the Reserve Bank of New Zealand Act is looking in more detail at our macroprudential and crisis management tools. The table below illustrates how our prudential banking tools work together to deliver financial stability. Each of our policies contributes to financial stability by addressing a separate risk, with its own transmission channel. Some are more targeted at prevention (limiting the likelihood of a financial crisis) while others are more targeted at management (mitigating the impact of a crisis if it does occur). https://www.fma.govt.nz/news-and-resources/media-releases/nzx-and-fma-initiate-industry-review-capitalmarkets-2029/ Ref #8022722 v2.0 Purpose Relevant tools Macroprudential policy Borrower restrictions (LVRs) Reduce risk that the financial system amplifies a severe economic downturn Impact on financial system resilience Impact on wider economy More resilient households and banks reduce potential severity of an economic downturn Reduced losses in a severe economic downturn Lowers incentives on banks to deleverage in a downturn; supports higher credit supply and economic activity Capital and liquidity instruments (CCyB/SCR) Capital buffers Prudential policy Crisis Management Maintain baseline resilience of the financial system Liquidity policy Banks remain solvent through the economic cycle Maintains market confidence and lowers risk of sudden increases in funding costs for households, businesses and the economy Banks remain functioning parts of financial system Maintains availability of credit and banking services necessary for economic activity Governance and local incorporation Collateral standards Manage and limit impact of distress or failure Outsourcing Open Bank Resolution Mitigates costs for creditors9 and taxpayers Minimum capital Losses absorbed first by shareholders The government has announced its ‘in-principle’ decision to introduce deposit insurance. Ref #8022722 v2.0 Supervision, oversight and disclosure Crisis Prevention There may, at the margin, be some substitutability between our different regulatory tools and settings. However, as I’ve said, our regulatory tools are intended to be complementary. For example, even if we have higher bank capital ratios, LVRs will continue to have a role to play if there is excessive credit growth in household balance sheets. Our supervisory approach – a tougher stance While a robust regulatory approach gives us confidence in the financial system and its stability, it does not imply a lower level of supervisory intensity or that we can shirk our supervisory role. Our supervisory approach is intended to complement our regulatory approach in terms of its reach, and its intensity. Supervision plays a key role in monitoring, and deepening our understanding of, the financial system and the risks it faces; in enhancing resilience by verifying that our requirements are operating as intended, and enforcing them as necessary. Supervision provides us with the necessary intelligence to manage the consequences of distress or failure of individual institutions. Effective self-discipline is the starting point of our supervisory philosophy. Firms must want to achieve good outcomes for their customers and owners, not because regulators wish them to. We aim to leverage the incentives on directors, senior managers and shareholders to improve the soundness of institutions, and by extension the resilience of the system as a whole, as efficiently as possible. However, our experience over the last decade has been that regulations have not always been well applied or complied with, and that tells us that we cannot rely solely on selfdiscipline. Crucially, it is not just the fact of non-compliance that concerns us – regulated entities have not been as proactive as we would have liked in identifying and remedying issues before the risks become more significant. Last year’s conduct and culture review (run jointly with the FMA) highlighted specific shortcomings in governance and risk management at banks and insurers, notably in relation to sales incentives. The court judgement on CBLI’s liquidation stated that “aspects of CBLI’s management had indicated a lack of commercial probity”. And “a lack of candour in dealing with the company’s auditors and the regulator”. More recently we revoked ANZ’s accreditation to model its own operational risk capital requirement because of persistent failures in its controls and attestation process. It is clear that institutional self-discipline has been lacking. There is therefore a strong case for further increasing the intensity of our supervisory model in line with the recommendations from the IMF’s Financial Sector Assessment Program (FSAP) assessment of New Zealand.10 This applies even if, on paper, individual regulated entities appear to be sound. Banks should expect our more intensive supervisory approach to apply even if capital requirements are increased as a result of the ongoing Capital Review. Regulated entities can expect our supervision to be more intrusive, in seeking evidence that attestations are merited and verifying compliance, and that we will intervene and enforce our requirements. We will be more pro-active in holding directors and managers to account, particularly in areas where we have already identified shortcomings. Our regulated population can expect us to continue with our thematic reviews in order to enhance self-discipline and our own understanding of risks. In the near future there will be a See https://www.imf.org/en/Publications/CR/Issues/2017/05/08/New-Zealand-Financial-SectorAssessment-Program-Financial-System-Stability-Assessment-44886 Ref #8022722 v2.0 thematic review on banks’ liquidity standards and another on the appointed actuary regime in the insurance sector. We will continue to periodically stress test the banking system. We are working towards more transparency about how our supervisory response would escalate if institutions come under stress. As part of the Capital Review we have sought feedback on the proposed supervisory consequences for banks if they breach their capital buffers. The starting principle is that our response will vary depending on the extent to which a bank needs to use its capital buffers to absorb losses. A minor breach of the proposed capital buffers would result in increased monitoring and potentially a formal request for the bank to submit a capital plan detailing how it planned to remedy the breach and by when. More significant breaches could result in increasingly restrictive supervisory actions and requirements. Figure: Stylised escalated supervisory response We continue to boost core supervisory capability in order to deliver on our supervisory approach. This means more skilled resource but it also means building and maintaining the necessary monitoring and supervisory frameworks, and it means being analytically strong, suitably sceptical, and willing to act. Being clear and up-front on our supervisory approach – on our greater willingness to intervene and to enforce our requirements – is desirable not only in terms of transparency but also accountability. Setting out our approach publicly, which we will do in more detail in coming months, will help build confidence and commitment to our enhanced supervisory model. A more intensive approach also means working more closely with industry. We are committed to establishing a ‘best regulator-regulated’ relationship; to open, knowledgeable and constructive discussions, recognising that that there can be a divergence of views and interests. Ref #8022722 v2.0 Modernising the financial stability framework Our Statement of Intent (released yesterday) outlines how we are implementing our financial stability approach within the Bank. Our vision of ‘great team, best central bank’ means we use and maintain rigorous and up-to-date frameworks for regulatory policy development and supervisory decisions. In doing so we take into account the best theory and evidence available. We act as responsible steward of the rules and policies which we create and apply to regulated entities. We consult openly and are committed to communicating our approach in a timely and accessible manner. We work hard to raise awareness across our regulated populations about our objectives, priorities and expectations. We foster co-operation and mutual trust among our domestic co-regulators, wider stakeholders and global peers. Earlier this week the government announced the ‘in-principle’ decisions to (a) replace the Reserve Bank’s ‘soundness’ and ‘efficiency’ objective with a high-level financial stability objective, (b) establish a new governance board for the Reserve Bank with statutory responsibility for financial policy, (c) merge New Zealand’s two existing prudential regimes for regulating banks and non-bank deposit takers into a single regime, and (d) introduce a deposit insurance scheme. Further changes are being consulted on in the documents just released by Treasury. The Governor is scheduled to talk on 11 July about the government’s review and what that means for the future of the Reserve Bank and the prosperity and wellbeing of New Zealanders. Financial stability objective The new financial stability objective is consistent with how the Reserve Bank has interpreted its responsibilities to date and with our increasingly intensive approach to regulation and supervision. Financial stability – the soundness or resilience of the financial system – relates directly to the existing purpose of our prudential philosophy and is consistent with our intent to have a dynamic regulatory framework; a framework with rigorous and adaptable baseline standards and a more searching approach to supervision. ‘Financial stability’ has the advantage of clarity, providing a sharp focus for the Reserve Bank, but potentially downplays the importance of efficiency and dynamism that are equally relevant to our over-arching purpose: contributing to a sustainable and productive economy and the prosperity and wellbeing of New Zealanders. Aspects of efficiency – regulatory efficiency and promoting innovation and competition – are expected to be recognised through sub-objectives that are also being consulted on. Increased transparency and accountability for decision-making will also serve to ensure good regulatory decisions are made. RBNZ Governance board The Reserve Bank will have a new governance board, with statutory responsibility for financial policy. The board will be accountable for all prudential decisions, including regulation, supervision and enforcement, as well as crisis management. It is expected that the board will be able to delegate powers and the exercise of day-to-day functions and powers to the Governor, and in turn Reserve Bank staff (supported by internal committees as at present). The board will set our risk appetite and scrutinise management’s efforts to implement it. The new governance structure supports our vision and objectives of being a transparent and accountable organisation. Not only will the new board bring diversity of perspectives and experience to key decisions, it will set our strategic direction (our risk appetite, our policy frameworks) and explain its decisions and regulatory outcomes to a broad audience, from Ref #8022722 v2.0 the Minister of Finance and Treasury, through to regulated entities and the general public. It will also create more robust accountability by creating a clearer distinction between governance and management functions, and establishing a delegation framework. ADI perimeter The government’s decision to merge our regimes for regulating banks and non-bank deposit takers into a single regime for deposit takers will create a simpler, more unified regime, more clearly aligned with our financial stability objective. It will minimise duplication and treat similar activities on the same basis, while continuing to allow our risk-based approach to supervision. It will also help future-proof the regime against a shift in lending and deposittaking activity from banks to finance companies that are currently outside of our banking perimeter, although in a sector as dynamic as the finance industry perimeter issues will never be settled entirely. More work will be required to design the details of this new regime, particularly to ensure that it can be applied proportionately to the biggest Australian-owned bank or the smallest credit union. Deposit insurance The government has proposed introducing a depositor insurance scheme with a coverage limit in the range of $30,000 to $50,000. There is still a great deal of detail to work through in terms of how the scheme will be funded and operate but we expect the scheme will complement our role as resolution authority. As we work through the details, we will consider the consequences of the scheme for self- and market-discipline, and the need to adapt other aspects of our regulatory and supervisory framework accordingly. Part 4 – Conclusion Financial stability is important for New Zealand and all New Zealanders. The cost of a financial crisis would be significant and wide-ranging. Its effects – in terms of lost output and unemployment – would persist, likely for a decade or more. This means focusing not just on risks to our financial system but on the market failures that can exacerbate these risks and undermine financial stability. The Reserve Bank’s approach to maintaining and promoting financial stability in New Zealand is expanding and becoming more intensive, in terms of both regulation and supervision. We are recalibrating the rules and our enforcement of them. This is in response to our own experience and a publicly perceived need for us to do more, and better. By necessity our approach is dynamic: we monitor and enhance the resilience of the financial system and intervene in times of crisis in order to manage the fallout. We do this through fit-for-purpose regulation and risk-based supervision. And we do so in a way where each of the moving parts is complementary in creating a financial system that is sound and efficient. The Reserve Bank is uniquely placed to do this. As a full service central bank we can leverage our different tools and market functions. That means that, not only can we adapt our regulatory or supervisory response as circumstances dictate, we can also use our markets functions to provide liquidity to the financial system at times of stress. We work with other agencies to promote a dynamic and healthy financial system. We are working hard to set robust requirements that address structural, cyclical and emerging risks in the financial system. Our requirements are not set and forget – we adapt them as vulnerabilities evolve and as risks emerge (and recede). Supervision has a crucial role to play in complementing the regulatory regime, and will continue to intensify. Regulated Ref #8022722 v2.0 entities can expect us to verify that self, market and regulatory discipline are operating as intended, and to take enforcement action in cases of non-compliance. The government’s ‘in principle’ decisions to modernise the Reserve Bank and our financial stability framework give us a clearer objective, a simpler perimeter and strengthen resolution options. The new governance framework, with a board responsible for our regulatory and supervisory approaches, will make us more transparent and accountable in how we deliver on our financial stability objective. These and other changes are being consulted on now and I encourage everyone to read the Phase 2 consultation documents on the Treasury’s website and to have their say.11 We are increasing our capability to deliver our approach and our vision for financial stability within this new architecture. We expect that together these initiatives will provide the basis for a dynamic and efficient financial system that contributes to a sustainable and productive economy and promotes the prosperity and wellbeing of all New Zealanders. See https://treasury.govt.nz/news-and-events/reviews-consultation/reviewing-reserve-bank-act Ref #8022722 v2.0
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Panel remarks by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to the Institute for Monetary and Economic Studies (Bank of Japan), Tokyo, 30 May 2019.
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Maintaining credibility in times of change Panel remarks delivered to the Institute for Monetary and Economic Studies (Bank of Japan) in Tokyo On 30 May 2019 By Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking Prepared with Cameron Haworth and Omar Aziz 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tena koutou katoa Thank you for the opportunity to talk about the Reserve Bank of New Zealand and the changes we are making to maintain our credibility in times of change. I would like to focus on two building blocks of credibility: • renewing a social licence to operate by aligning our objectives with the needs of the public; and • achieving those objectives through good decision making enabled by a framework of good governance. A common theme is the importance of transparency. The imperative for change: Central banks in the 21st century The first building block of credibility is the renewal of a social licence to operate—by this I mean the legitimacy an institution earns by serving the public interest. It is granted by the public when an institution is seen to fulfil its social obligations.1 New Zealand was the first country to officially adopt inflation targeting in 1989, with a number of central banks around the world following the example.2 Under a single-decision-maker model, we brought inflation down from around twenty percent to two percent in five years. In doing so, we helped build our credibility during the high-inflation environment of the times.3 Fast-forward to 2019, and monetary policy in New Zealand has undergone major change. Firstly, we have adopted a dual mandate, focused on achieving price stability and supporting maximum sustainable employment. Secondly, we have adopted a committee structure for decision making, and are delivering greater transparency in our decision making. Why the change? The reform of our framework was not merely a simple choice based on technical performance. As you can see in figure 1, when it comes to inflation and growth, over the past 30 years inflation-targeting central banks (e.g. New Zealand and the United Kingdom) have a pretty similar track record to central banks with a dual mandate (e.g. Australia and the United States).4 The imperative for change comes from more than examining our history; it comes from our expectations of the future, and the present we find ourselves in. Our policy framework changed because times are changing. For the Reserve Bank to maintain its credibility and relevance, we must change too. 1 Orr, A. (2019), In service to society: New Zealand’s revised monetary framework and the imperative for institutional change. https://www.rbnz.govt.nz/research-andpublications/speeches/2019/speech2019-03-29 2 Irwin, N., Of Kiwis and Currencies: How a 2% Inflation Target Became Global Economic Gospel, New York Times, Dec. 19, 2014. 3 McDermott, J. and R. Williams (2018), Inflation targeting in New Zealand: An experience in evolution. https://www.rbnz.govt.nz/research-and-publications/speeches/2018/speech2018-04-12. 4 See also Jacob, P. and A. Wadsworth (2018). Ref #8058027 v1.4 Figure 1: Inflation, and GDP growth across monetary policy frameworks5 Wellbeing of our people Inflation has been low and stable in New Zealand for nearly 30 years. There is a greater appreciation that low inflation is a means to an end, and not the end itself. In the fight to lower inflation that was perhaps easy to forget. The end goal is, of course, improving the wellbeing of our people.6 For many in the general public, employment is one tangible measure of wellbeing. Employment can provide an opportunity to earn your own wage, contribute to society, and live a fulfilling life. It is in this light that the Reserve Bank Act (1989) has been amended to include a dual mandate with an employment objective alongside our price stability goal. Incorporating the objective of supporting maximum sustainable employment, and equally weighting it alongside inflation, emphasises our long-term goal of improving New Zealanders’ wellbeing. This aligns us with the needs of the public. And it helps us renew our social licence to operate—the first building block for maintaining our credibility. But it is not enough for the public to believe in and understand our objectives. We must also prove to them that they can be achieved. This brings us to the second building block necessary for maintaining credibility: establishing modern governance principles for dealing with modern problems, and translating good governance into good decisions. Good governance In preparing for our dual mandate, and a formal Monetary Policy Committee (MPC), we have updated the principles and processes that form our governance framework for monetary policy. 5 Inflation data: NZ: Consumer Price Index (CPI) excl. food & energy; UK: CPI excl. food & energy; AUS: Trimmed mean CPI; USA: Personal Consumption Expenditure (PCE) excl. food & energy. 6 Grimes, Oxley, and Tarrant (2012). Ref #8058027 v1.4 In pursuit of greater transparency, we have also published these principles and processes in a comprehensive Monetary Policy Handbook (the Handbook).7 This is an essential document, for everyone from school students to MPC members. Importantly, it is also a living document that will evolve as our understanding evolves. Principles The first part of the Handbook I would like to cover is the section on MPC deliberation principles.8 Figure 2: MPC deliberation principles Principle Clear objectives Diversity Process implications Each meeting has a defined purpose an agenda. Inclusive of different intellectual and personal styles. Information and deliberation meetings are expert-led. Inclusion of information Initial focus on understanding and discussing information; decision meetings clearly separated from information and deliberation meetings. Decision meetings chaired by Governor. Inclusion of people Deliberation meetings allocated enough time for discussion. Clear avenues provided for expressing minority views. There are three principles which guide the deliberations within the MPC. I’ve talked already about providing clarity around our objectives—the equal weighting of our employment and inflation goals. This is the first of our three principles. The second, is diversity—diversity in the skills, experiences, thoughts, and personal characteristics of the MPC members. The third, is inclusion—inclusion of information and people, ensuring decisions are made on the basis of all the available insights, and reflecting the views of all of the committee members. Why are diversity and inclusion so important? The governance literature shows that diversity and inclusion improves the pool of committee knowledge, insures against extreme views, and reduces groupthink.9 These principles drive the committee towards an unbiased policy decision—the best that is possible given existing information. Think about this from a practical perspective. Modern monetary policy is confronted by diverse issues such as climate, technological, and other structural and social changes. A sole decision 7 The Handbook explains everything the public needs to know about making a monetary policy decision, and is available at: https://www.rbnz.govt.nz/monetary-policy/about-monetarypolicy/monetary-policy-handbook 8 Chapter two of the Handbook. 9 See Blinder (2006), Gerlach-Kirsten (2006), Maier (2010), and Sibert (2005). Ref #8058027 v1.4 maker or uniform committee cannot possibly hope to possess the broad range of insights necessary to consider these issues. A diverse committee operating in an inclusive environment can. It is these additional insights that improve collective understanding, and lead to better monetary policy decisions. So you see these principles are not simply rhetorical devices. They are carefully chosen pillars to support our credibility though good decision making in achieving our dual mandate. Good decision making Processes Our principles of good governance have directly influenced the policy-setting process of the MPC.10 This is a process that has been designed with consensus-based decision making front and centre, consistent with the agreement with the Minister of Finance.11 Figure 3: The structure of the forecast week for quarterly Monetary Policy Statements Day 1 Day 2 Day 3 Day 4 Day 5 Day 6 Day 7 Staff present recent developments, issues, and risks. Staff present outlook and strategy. MPS discusses risks and external messages. MPC discusses strategy and tactics. MPC decides on strategy and tactics. MPC finalises risks and external messages. MPC decides level and direction of policy instrument. MPS release. Information pooling. MPC deliberations. MPC decision making. (Staff as presenters) (Staff as advisers) (Staff not present) We begin with information pooling, which flows through to MPC deliberations, and culminates in the final decision making meeting. As you can see, the policy-setting framework is highly collaborative and deliberate. Deliberate in the sense that the process inspires lively debate, giving MPC members every possible chance to challenge assumptions, critique policy judgements and assess a range of policy strategies to achieve our dual mandate objectives. A crucial part of this is that the MPC members hold back their views on the decision until the final stages, rather than starting with them. This supports evidence-based decision making and guards against confirmation bias. The process begins with open information pooling on recent developments and the outlook for the economy. Here, the MPC have the opportunity to investigate and challenge the assumptions made in the staff’s initial forecasts. This is where the MPC member’s judgement enters the picture, and where creative tensions improve collective understanding. 10 Chapter three of the Handbook. 11 Consensus-based decision making is requested in section 1b of the charter, available: https://www.rbnz.govt.nz//media/ReserveBank/Files/Monetary%20policy/About%20monetary%20policy/Monetary-PolicyCommittee-Charter-April-2019.pdf Ref #8058027 v1.4 While the MPC members may enter the room with different insights and questions about the economy, at the end of the information pooling stage the committee shares a common reference point for the economic outlook. There are numerous opportunities to discuss and reflect on key issues, judgements, risks, strategy, and communication throughout the week. There are also a number of anonymous internal surveys we perform to gauge collective opinion among staff and MPC members.12 By the end of the week-and-a-half, the final monetary policy decision reflects the greater momentum of the MPC’s discussion. We publish the final Official Cash Rate (OCR) decision, a Monetary Policy Statement (MPS), and a Summary Record of Meeting at the same time. The Summary Record of Meeting captures the key judgements and risks underpinning the central forecasts and decision, as well as indicating where members of the MPC had different views. We identify any differing views, and communicate where the most significant uncertainties lie in our baseline forecasts.13 If consensus cannot be reached, a vote by simple majority would be carried out, and the reasoning behind different stances disclosed in the Summary Record of Meeting. Our desire is that the transparency provided in the Handbook can help the public understand how the Bank’s collective ‘mind’ works. If the public can see the analytical rigour in our decision making, they should have greater confidence in the MPC’s conclusions, and thus more faith in the Reserve Bank. Our credibility will be supported in the long run if the decisions made by the MPC are unbiased and effective ones. Our results will speak louder than our words. Monetary policy strategy and our May decision So far I’ve talked about the principles and processes we follow in setting policy. Now I’m going to cover how we ‘walk the talk’ in formulating our monetary policy decisions.14 Sound and effective monetary policy strategy requires more than just deciding whether the OCR should go up or down on any given day; instead central banks need to be transparent about their views of the economy over the medium-term and how monetary policy might respond to a changing economic landscape. In this regard, around twenty years ago, the Reserve Bank became a pioneer in another way. When publishing our interest rate decisions, we also began to publish a forward (and endogenous) projection of interest rates in the future. We use this to capture the overall stance of monetary policy. One of the specific tools we use are surveys of staff and MPC opinions on the balance of risks in the forecasts. This indicates both collective opinion, and quantifies the results. This greatly enhances the productivity of the MPC, as they don’t have to spend time discussing everything if they are already in agreement, and those who disagree with the majority can speak up and explain their position. 13 We don’t attribute the views to particular members. This can add noise to the summary, with the attribution distracting readers from appreciating the substance of the material. 14 Chapter seven of the Handbook describes the Reserve Bank’s approach to monetary policy strategy. Ref #8058027 v1.4 This tool remains integral to how the MPC sets monetary policy and understands the potential trade-offs with a dual mandate. The first monetary policy decision of the new MPC occurred last month, in May. Our starting point was a New Zealand economy where the labour market was operating near maximum sustainable employment, and annual core inflation pressures were within our 1 to 3 percent target range but below the 2 percent mid-point. We discussed the slowdown in global growth, and how this might affect New Zealand. We also addressed the recent loss of domestic economy momentum since mid-2018, through both tempered household spending and restrained business investment. In order to continue achieving our policy objectives, we agreed that additional monetary stimulus was needed to help bring inflation back to the 2 percent mid-point and support maximum sustainable employment. We then turned to the question of the magnitude of stimulus we wanted to adopt (the stance) and the timing and means by which we would try to deliver this (the tactics). Figures 4–6 show how different OCR paths could have been used to achieve our objectives. While each path was consistent with meeting our objectives, they each offered different tradeoffs.15 Figure 4: Official Cash Rate (OCR) paths to achieve alternative monetary policy stances % % Baseline Lower OCR Higher OCR Svensson (2014) suggests that central banks should take a balanced approach to inflation and employment objectives. If you can’t keep both objectives at target at the same time, you should aim to have inflation and employment gaps with opposite signs. i.e., slightly undershooting on one metric, and slightly overshooting with the other. If you try to keep one objective at target with a gap in the other, it signifies that you are prioritising one of the objectives over the other. Ref #8058027 v1.4 Figures 5–6: Inflation, and employment gap under alternative OCR paths Inflation Employment gap Annual % % Annual % 4.0 4.0 1.5 Baseline 3.5 Baseline Lower OCR Higher OCR 1.0 3.0 3.0 2.5 2.5 2.0 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 Lower OCR 3.5 Higher OCR % 1.5 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 -1.0 -1.0 -1.5 -1.5 If we kept rates unchanged (the higher OCR path), our projections suggested that it would have taken a number of years for inflation to return to target, and employment would have fallen below the maximum sustainable level. If we lowered the OCR by around 75 basis points over the next 12 months (the lower OCR path), our projections suggested it would result is a situation where both inflation and employment would be overshooting their targets. By contrast, the baseline (our final published projection), with the OCR around 40 basis points lower over the next 12 months, brought inflation back to target in a reasonable time period, with employment remaining near the maximum sustainable level. We decided this path captured our preferred strategy, and was robust to the key risks we had discussed. After agreeing on the appropriate stance of monetary policy, MPC turned to the tactical decision of where to set the OCR at the May meeting, and decided to cut the OCR by 25 basis points to provide a more balanced outlook for interest rates. This brings us to discuss the future. Maintaining credibility in the future Our central view is that New Zealand’s interest rates will remain broadly around current levels for the foreseeable future. However, we need to be ready to adapt to changing conditions, to meet our objectives even when confronted with unforeseen developments. An issue that policymakers and academics are grappling with around the world is the role of both monetary and fiscal stimulus in a world of low interest rates. There is emerging consensus that coordination is necessary for an optimal response of broader macroeconomic policy.16 For central banks, operational independence does not have to mean operational isolation. Rather, collaboration with government can be done in a way that builds and reinforces the social licence to operate, by showing a willingness to work with other partners to do whatever is necessary to achieve the broader objective—improving public wellbeing. 16 For a recent and accessible read, see Eichengreen (2019). Ref #8058027 v1.4 Even with coordination between monetary and fiscal policy, if further macroeconomic stimulus is needed quickly, the first line of defence will still inevitably fall upon central banks.17 In New Zealand, we are in the strong position of having further room to provide conventional monetary stimulus if required (using the OCR). Having effective unconventional policy options expands the toolbox of a central bank, which is naturally more relevant in a low interest rate environment. In this spirit, we published a Bulletin article last year on the practicalities of unconventional monetary tools in a New Zealand context, and we continue to learn from the lessons of our central banking cousins.18 It’s better to have a tool and not need it, than need one and not have it. Conclusion In the Handbook, we explore the history of central banking objectives, and see how dramatically they have evolved over time.19 We haven’t always had a mandate to support maximum sustainable employment, or to achieve price stability, or even control over interest rates or the money supply. Nothing lasts forever, and it is possible that the role of central banks may change again in the future. Our Handbook will inevitably change. We need to be ready to adapt when changes beckon. And it is not enough to grudgingly adapt. In order to maintain credibility, central banks must embrace change and prove to the public that they are capable of delivering on their objectives. To remain credible is to remain relevant. Central banks should keep their eyes open, and be ready to change tack. Our destination—a world with improved wellbeing for our citizens—may not change, but the best route for getting there may. We must adapt. We must continue to improve the wellbeing of our citizens. We must remain credible. Meitaki. Thank you. 17 Monetary policy can be adjusted more rapidly than fiscal policy, and have some immediate effects on financial conditions during a crisis (Romer, 2011). 18 Drought, Perry, & Richardson, 2018 19 Chapter four of the Handbook. Ref #8058027 v1.4 References Blinder, A. (2006). Monetary policy by committee: why and how. DNB Working Paper No 92. Drought, S., Perry, R., & Richardson, A. (2018). Aspects of implementing unconventional monetary policy in New Zealand. Reserve Bank of New Zealand Bulletin, 81(4). Eichengreen, B. (2019, May 13). The Return of Fiscal Policy. Project Syndicate. Retrieved from https://www.project-syndicate.org/commentary/return-of-fiscal-policy-by-barryeichengreen-2019-05. Gerlach-Kristen, P. (2003). Monetary policy committees and the benefits of deliberation. University of Basel. Grimes, A., Oxley L. and N. Tarrant (2012) Does Money Buy Me Love? Testing Alternative Measures of National Wellbeing. Motu Working Paper 12–09. Irwin, N. (2014, December 19). Of Kiwis and Currencies: How a 2% Inflation Target Became Global Economic Gospel. New York Times. Jacob, P. and A. Wadsworth (2018), Estimated policy rules for different monetary regimes: Flexible inflation targeting versus a dual mandate, Reserve Bank of New Zealand Analytical Note AN2018/11. McDermott, J. and R. Williams (2018). Inflation targeting in New Zealand: An experience in evolution. Speech delivered to the Reserve Bank of Australia conference on central bank frameworks, in Sydney 12 April 2018. Orr, A., & Aziz, O. (2019, March 29). In Service to Society: New Zealand's revised monetary framework and the imperative for institutional change. Retrieved from https://www.rbnz.govt.nz/research-and-publications/speeches/2019/speech2019-0329. Romer, D. (2011). What Have We Learned about Fiscal Policy from the Crisis? IMF Conference on Macro and Growth Policies in the Wake of the Crisis. Sibert, A. (2005). Is the structure of the ECB adequate to the new challenge? Challenges for Central Banks in an Enlarged EMU, 97-117. Svensson, L. E. (2014). How to Weigh Unemployment Relative to Inflation in Monetary Policy? Journal of Money, Credit and Banking, 46(S2), 183-188. Wadsworth, A., & Price, G. (Forthcoming). Effective Monetary Policy Committee Deliberation in New Zealand. Reserve Bank of New Zealand Bulletin article. Williams, R., Aziz, O., Kendall, R., Price, G., Ratcliffe, J., Richardson, A., . . . Wadsworth, A. (2019). Monetary Policy Handbook. Retrieved from https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/monetary-policyhandbook. Ref #8058027 v1.4 Appendix— Extracts from the May Monetary Policy Statement Press Release Tena koutou katoa, welcome all. The Official Cash Rate (OCR) has been reduced to 1.5 percent. The Monetary Policy Committee decided a lower OCR is necessary to support the outlook for employment and inflation consistent with its policy remit. Global economic growth has slowed since mid-2018, easing demand for New Zealand’s goods and services. This lower global growth has prompted foreign central banks to ease their monetary policy stances, supporting growth prospects. However, there is uncertainty about the global economic outlook. Trade concerns remain, while some other indicators suggest trading-partner growth is stabilising. Domestic growth slowed from the second half of 2018. Reduced population growth through lower net immigration, and continuing house price softness in some areas, has tempered the growth in household spending. Ongoing low business sentiment, tighter profit margins, and competition for resources has restrained investment. Employment is near its maximum sustainable level. However, the outlook for employment growth is more subdued and capacity pressure is expected to ease slightly in 2019. Consequently, inflationary pressure is projected to rise only slowly. Given this employment and inflation outlook, a lower OCR now is most consistent with achieving our objectives and provides a more balanced outlook for interest rates. Meitaki, thanks. Summary Record of Meeting The Monetary Policy Committee agreed on the economic projections outlined in the May 2019 Statement in order to provide a sound basis on which to form its OCR decision. The Committee noted that inflation is currently slightly below the mid-point of the inflation target, and that employment is broadly at the targeted maximum sustainable level. However, the members agreed that given the recent weaker domestic spending, and projected ongoing growth and employment headwinds, there was a need for further monetary stimulus to meet its objectives. The Committee agreed that the risks to achieving its consumer price inflation and maximum sustainable employment objectives were broadly balanced around the projection. Possible alternative outcomes were noted on the upside and downside. A key downside risk relating to the growth projections was a larger than anticipated slowdown in global economic growth, particularly in China and Australia, New Zealand's largest trading partners. The Committee agreed that the projections adequately captured the observed global slowdown and its impact on domestic employment and inflation. The Committee noted that additional stimulus from central banks had underpinned growth and reduced the likelihood of a more-pronounced slowdown. With some indicators of global growth improving in recent months, a faster recovery in global growth was possible. However, on balance, the Committee was more concerned about a continued slowdown rather than a faster recovery. The Committee discussed other potential risks to domestic spending. The members acknowledged the importance of additional spending from households, businesses, and the Ref #8058027 v1.4 government, to meet their inflation and employment targets. However, they noted several important uncertainties. The Committee noted upside and downside risks to the investment outlook. Capacity pressure could see investment increase faster than assumed. On the downside, if sentiment remained low as profitability remains squeezed, investment might not increase as anticipated over the medium term. It was also noted that firms' ability to invest is constrained by the current competition for resources. A potential source of additional demand discussed by the Committee included government spending being higher than currently projected, in view of the current strength of the Crown balance sheet. This view was balanced by the impact of any increase in government investment being delayed, for example due to timing of the implementation of new initiatives and current capacity constraints in the construction sector. The implications for monetary policy remain to be seen. Some members noted that with lower mortgage rates and easing of loan-to-value requirements, any possible pick-up in the housing market could support household spending growth more than anticipated. The Committee noted that employment is currently near its maximum sustainable level. However, it was agreed that the outlook for employment growth is more subdued and capacity pressure is expected to ease slightly in 2019. The Committee agreed that overall risks to the inflation projection were balanced. The Committee noted the outlook for inflation is below the target mid-point for longer than projected in the February Statement. The recent period of rising domestic inflation was discussed. The Committee noted that the near-term outlook was more subdued due to lower capacity pressure. It was also noted that cost pressures remain elevated, and that there is a risk firms may pass these costs on as higher consumer prices by more than assumed. However, it was agreed that inflation expectations remain well anchored at the mid-point of the target range. The Committee also noted the relatively subdued private sector wage growth, despite businesses suggesting that the inability to find labour is a significant constraint on their growth. The Committee noted the limited pass-through of the nominal wage growth to consumer price inflation. Some members noted slower global growth reducing imported inflation was a downside risk to the inflation outlook. The Committee reached a consensus that, relative to the February Statement, a lower path for the OCR over the projection period was appropriate. The lower path reflected the economic projections and the balance of risks discussed, and is consistent with both inflation and employment remaining near the Committee's objectives. After discussing the relative benefits of holding the OCR and committing to a downward bias, versus cutting the OCR now so as to establish a more balanced outlook for interest rates, the Committee reached a consensus to cut the OCR to 1.50 percent. Attendees Reserve Bank staff: Adrian Orr, Geoff Bascand, Christian Hawkesby, Yuong Ha External: Bob Buckle, Peter Harris Observer: Gabriel Makhlouf Secretary: Chris McDonald Apologies: Caroline Saunders Ref #8058027 v1.4
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Comment by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, 28 August 2019.
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Adrian Orr: We are not alone with monetary policy Comment by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, 28 August 2019. * * * It was clear that even in the remote mountain region of the US state of Wyoming we were among the crowd. The annual August Kansas Federal Reserve’s summit of many of the world’s central bankers vividly highlighted our commonality. Inflation has been low and stable, and many labour markets are near their peak loading. New Zealand included. Independent central banks have successfully achieved their inflation goals, promoting economic wellbeing. Yet, there was no vigorous back patting. There were mostly furrowed brows. A slowing global economic outlook, increasingly prompted by pockets of volatile politics, is keeping the world’s central bankers busy. In response to the economic chill, central banks around the world have lowered interest rates – often to record lows – to promote investment and spending. They continue to pursue their mandated low inflation goals. That’s our job. We aim to keep inflation low and stable and contribute to maximum sustainable employment. This is the best we can do as a central bank to promote economic wellbeing. We have the one main instrument – the interest rate lever or price of money – and we use this tool with our best view of what’s on the horizon. We provide forward guidance on our expected activity, but remain flexible to incoming data. Monetary policy remains as effective as ever, and for small open economies like New Zealand, the exchange rate plays a significant additional role in competitiveness. Our research gives us confidence that even at these low levels of interest rates, monetary policy remains as effective as ever at providing timely economic stimulus. As the Governor of the Swedish central bank noted – those who think that monetary policy is losing its vigour should think of the alternative. Higher interest rates over recent times would have meant we undershot our inflation and employment goals, have significant weaker activity, and a rising domestic exchange rate – until it was unsustainable. But there are natural limitations to what central banks can achieve with their tools, and if operating alone. Global integration, productivity and technology, governments’ fiscal and regulatory policies, changing demographics, consumer preferences and climate, and unanticipated events – including political volatility – play the dominant role in long-term prosperity. Central banks operate within this context and need all policy levers working. My colleagues at the summit were very humble as to our influence over long-term economic growth prospects beyond our stable inflation contributions. Undoubtedly we are in new low inflation and interest rate territory collectively. Colleagues were interested to hear about each others’ experiences and our recent decision to cut the Official Cash Rate by 50 basis points – as were most New Zealanders. First, the interest rate lever is blunt. It is not personalised. Savers (investors) and consumers are treated equally, and are often the same person doing various activities. We make our interest rate decision to best bring about prosperity and wellbeing of all New Zealanders in the long-term. This decision is repeated frequently – aimed at the same inflation and employment goal – as circumstances change. 1/2 BIS central bankers' speeches Our recent OCR cut reflected an expected decline in trading partner growth, lower NZ inflation expectations, and a global swing to lower interest rates. It also reflected the ongoing funk global and domestic business confidence is in. Geopolitical uncertainty is paralysing decision making in major business centres – trade tensions, Brexit, Hong Kong, North Korea and so on – have all meant investment is lower than normal. The NZ waka is tied off to the global ‘risk free’ interest rate wharf. When the global rate declines, we need more rope – or face a rising exchange rate and tighter financial conditions than needed. Second, how you respond to lower interest rates is personal. Lower interest rates stimulate investment (funding costs are lower as are expected hurdle rates of return). Income derived from passive savings in the bank is lower – prompting more active investment decisions. Asset prices rise as the present value of their future earnings rises. And spending – both government and the public – becomes more affordable, at least until consumer prices start to rise again. And a lower than otherwise NZ dollar will promote export earnings. So how you feel about low nominal interest rates personally comes down to which of the activities you may be involved in. The central bank can only focus on the long-term wellbeing of all. There are different outcomes for different people. Home owners may feel wealthier, those outside of this asset market would be facing a higher price to buy but at more affordable servicing costs. Savers in low risk deposits will need to invest more actively – and so on. Finally, a key concern amongst my international colleagues is that central banks are being tasked with more and more challenges – and public expectations continue to rise also. The discussion was clear. Monetary policy (the domain of central banks) has its limitations and needs to be partnered with broader fiscal and structural economic policy (the domain of the government of the day). Likewise, business people need to consider a much longer-term horizon when investing, looking through the omnipresent political uncertainties de jour. We are not alone in the Aotearoa waka. Other economic levers need to be utilised effectively to enhance social cohesion and wellbeing. The Bank’s regulatory activity includes promoting financial stability. We have our prudential tools set to ensure our financial institutions are robust financially and culturally. This is our best lever into financial soundness and inclusion. Providing certainty in uncertain times is a great skill to have, and central bankers world-wide are working hard to do just that. They are being challenged on communication – what they can and can’t influence and how they are doing this. We understand that lower interest rates do not remove the global political uncertainty. But they do offer greater certainty on the financial and investment front. Businesses and governments should be re-assessing their hurdle rates on their investment projects. Low and stable global interest rates mean that what was once costly may now be a sound investment for the future. The Reserve Bank is among the global central banking crowd – we are not alone. But we need other actors to assist and understand. Kia kaha. 2/2 BIS central bankers' speeches
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the NZX Issuer Forum, Auckland, 26 September 2019.
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Adrian Orr: Opportunity or risk? Our choice Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the NZX Issuer Forum, Auckland, 26 September 2019. * * * Tēnā koutou katoa, Welcome everyone and thank you for inviting me to come and speak to you today at the NZX Issuer Forum. I want to talk about some of the near-unprecedented challenges facing monetary policy, and how longer-term thinking can assist in our efforts to meet these challenges. The fact that we are celebrating the 150th anniversary of the NZX this year is a great prompt for longer-term thinking. First, the here and now. Yesterday’s Official Cash Rate announcement follows the Monetary Policy Committee’s August decision to reduce the OCR by 50 basis points to 1.0 percent, the lowest rate since the OCR was introduced in March 1999. When we made our August announcement we were rightly challenged by some commentators as to whether we knew something more than the conventional economic indicators have been showing? Our answer remains – no we don’t. We operate in a transparent manner with primarily public data, but it is our job to be forward-looking. In making our decision, we assessed that the impact on the New Zealand economy from slowing global economic growth and persistently low inflation necessitated further monetary stimulus – so as to maintain our inflation and employment objectives. We also judged that it would be better to move early and large, rather than risk doing too little too late. A more tentative easing of monetary policy risked inflation expectations remaining stubbornly below our inflation target, making our work that much more difficult in the future. We are pleased with the outcome of our decision to date. Interest rates have declined across the board, as retail banks have passed lower lending rates to many businesses and consumers. The New Zealand dollar exchange rate also eased, and the cumulative impact of the easier monetary conditions is now working through the economy. Lower interest rates alter peoples’ investment decisions, especially with the confidence that interests rates will stay low for a long time ahead. In forming our policy position we spend significant effort monitoring domestic and international economic trends. Over recent weeks, for example, we have visited and listened to a wide group of New Zealand business people. What we heard is that demand for New Zealand’s goods and services remains sound. However, there is a multitude of business concerns and challenges. A common concern was that business capacity remains stretched, with some firms struggling to fill vacant roles or even find accommodation for their workers in the same region. Likewise there was a strong need to invest to expand capacity and productivity, but access to resources – land, capability, and equipment – was difficult. These are signs of an economy with ongoing momentum. However, there was also discussion of rising economic headwinds from slowing global growth, and continued challenges to domestic business margins or profits. Many factors were sighted for the margin squeeze – global competition, low global inflation, and rising input costs as labour and capital resources become more scare. There were also plenty of stories of economic policy uncertainty, as global expectations rise with regard to environmental security, trade access, and climate change action. For a small trading nation, these issues impact confidence and investment. 1/5 BIS central bankers' speeches Overall, we heard about an economy that is maintaining momentum, but demanding more policy certainty and business confidence, so that firms will invest for the long-term. These are quality business challenges. We also spend a lot of effort assessing global economic developments. And this is where we are most challenged, but not alone. Global interest rates are now at a secular low level, in part for positive reasons and, in part, providing reason for concern. The low level of interest rates globally over recent years primarily reflects low and stable inflation rates – a deliberate and desired outcome of monetary policy. This should be celebrated and not forgotten. We must not fall into the ‘vaccination trap’, where, for example, people observe that outbreaks of diseases are less frequent, and hence conclude there is less reason for continued vaccination. Monetary policy has and remains effective when it comes to determining aggregate consumer price inflation. Recently, in this restored low inflation environment, central banks across the world have faced a new challenge – inflation that is too low, and running consistently below inflation targets. This has prompted the need to reduce policy rates so as to stimulate spending and demand. However, given the low interest rate starting levels, some major central banks have had to implement negative interest rates and/or directly buy assets (increasing their balance sheets) so as to free up cash for the economy. Understanding why inflationary pressures have eased so much is important as it helps us to calibrate our policy actions. As is often the case, there appear to be many reasons which we must balance. The low inflation pressures are in part due to the slowdown in global economic growth, a regular cyclical event that central banks are well practiced in responding to. But there are also structural factors dampening inflation pressure and/or altering the impact of lower interest rates on investment and spending. Some examples of structural changes include the changing nature of how we produce goods and services, with more reliance on global technology which is often delivered by a handful of global suppliers at single global prices. We are also producing more services, rather than physical goods as a proportion of total output, reducing our relative reliance on capital equipment and reducing our sensitivity to the cost of investment. Production locations are also mobile, and labour is highly mobile internationally, making wage bargaining harder even if there are domestic labour shortages. And, populations are ageing, as people live longer, leading to different preferences to save rather than consume. By definition, these structural factors are slow moving, meaning they will anchor the historically low interest rates for some time to come. Meanwhile, central banks will continue to vary policy rates in response to cyclical factors, but rates will vary from a lower average, and possibly within a lower range than in the past. In New Zealand, for example, we believe the neutral interest rate – the OCR that is neither contractionary nor expansionary for the economy – has drifted lower in recent decades. This is from a mid-point estimate of around 5 percent in the early 2000s, to around 3 percent today, with plenty of uncertainty around these mid-points. The obvious challenge for many central banks, including us, is that the decline in the neutral rate means we have less room to manoeuvre our policy interest rates without concern for the zero per cent lower bound. What happens if we hit zero? Should the OCR go negative, and/or should we embark on direct asset purchase programme, and what other monetary policy strategies 2/5 BIS central bankers' speeches could be implemented? We are currently thinking hard about these questions, because it makes sense to do so as a precaution – it’s best to put the roof on when the sun is shining. Our current view is that we are unlikely to need ‘unconventional’ monetary policy tools. But we would be remiss not to be prepared. We are in a good position to learn what to do, and not to do, from other central banks globally. Of course, one size does not fit all. New Zealand is a small, open, economy with a floating exchange rate, and a concentrated banking system. Hence, we need to tailor our own precautionary solutions, and understand intended and unintended consequences of different monetary policy tools. We are certainly aware that the current low interest rates impact sectors of the economy differently. However, the dominant force to stimulate activity, employment and inflation across the economy as a whole is to bring forward spending and investment. In terms of distributional impacts, low interest rates support employment opportunities and bolster asset prices and reduce the return on bank deposits. The opposite is true when interest rates are high and the net impact on household balance sheets will depend on the mix of assets they hold. Our role as a central bank is to contribute to overall economic prosperity by delivering an environment where inflation is low and stable. Of course, there will be scenarios where monetary policy – whether conventional or unconventional – reaches its limits, and can no longer generate sufficient additional demand, or can only do so with undesirable or untenable side effects. This is why many central bankers globally have said ‘monetary policy needs friends’. The friends of central banks are government fiscal policy (taxes and public spending and investment) growth supportive structural policies, and the business confidence and capability to invest in productivityenhancing infrastructure. The good news for New Zealand, unlike many other OECD economies, is that our government’s books are in good shape and there is already a strong fiscal impulse underway from public spending and investment. We have the trifecta of sound government finances, clear infrastructure demands, and low hurdle rates for investing. The same can be said for corporate balance sheets in New Zealand, with relatively low levels of debt, and a strong demand for goods and services, our businesses are well placed to perform. So what is holding businesses and government back from further increasing investment and expenditure? New Zealand’s economic ‘problem definition’ appears well advanced, and the good news is the solutions sit largely with us as New Zealanders. We have the macroeconomic stabilisers in place – well-established monetary policy practices and sound long-term fiscal parameters. However, there remains a loud call from all quarters of the country for leaders to better signal investment intent, and ensure we have the policy and goodwill to facilitate access to capital and resources to execute. This call for investment-intent is to all collectively-owned (e.g., Iwi), Crown-owned (i.e., central and local government), and co-operatively owned (e.g., traditional primary sector) sectors. It is not just to traditional businesses, or any one party. Easily said, harder to do without a clear desire to work together over an agreed horizon. The Reserve Bank is working on a few long-term projects itself to ensure that our financial 3/5 BIS central bankers' speeches system is more resilient to economic slowdowns. Our Annual Report will be made public on Monday, outlining a wide range of investment activities. Most importantly, we are acting to ensure New Zealand remains less susceptible to short-term, sometimes only fair-weather, funding that creates pockets of excess debt and exacerbates economic cycles. We acknowledge that our actions at time may look confusing to the casual central bank observer. On the one had we have set low interest rates to deliberately encourage investment and spending, which may be funded with higher debt. This is how monetary policy works. On the other hand we are saying we are concerned about some pockets of debt – especially in some highly leveraged households (residential mortgages), and in some pockets of dairy farming (rural lending). So how can we achieve more investment and more resilience at the same time? The good news is we have more than one tool at the central bank, and these tools work over different horizons and achieve different purposes. For example, by now you should all be aware of the Reserve Bank’s Capital Review proposal. Our proposals would see significant increases in shareholder capital in banks. With banks having more of their own ‘skin in the game’, the owners will sharpen their long-term customer focus, and it will reduce the chance of a bank failure and the cost on society as a whole should a bank fail. These outcomes are highly desirable for the long-term economic health of New Zealand, and should promote deeper and more liquid local equity and debt markets. We finalise our decisions in early-December this year. Whatever our final decisions, we will be insisting on transition to higher capital at a sensible pace. But we will be talking more and better quality capital. How have some lenders (banks) responded to date? Many of the large banks have spent the past 10 or so years lending aggressively to households and the dairy sector during the good times. They have also spent the last 12 months or so revisiting this wisdom, and have been raising their lending margins and/or making credit much harder to access for some customers – especially rural customers. Such bank activity is pro-cyclical, fair weather, behaviour that leads to misallocated capital, industry booms and busts, and larger economic hardship on broad society – not the bank shareholders themselves. Over the last 12 months or so – as we have been working with all stakeholders on our capital proposals – we have reduced the OCR by more than the banks’ estimated costs of the higher capital requirements. Yet, for some sectors of the economy, such as agriculture, their borrowing costs have risen. This can only happen if banks are significantly raising their margins. This is not a sign of long-term thinking when it comes to bank borrowing and lending, and it is not a sign of a highly competitive banking services in core sectors of the New Zealand economy. We are monitoring this behaviour, to assess the degree of any ‘front-loading’ of our capital proposals, and I encourage all customers to question their banks on issues of competition. I have covered a lot of ground. Why are interest rates so low? Why is this a global issue? What does it mean for New Zealand business and the Reserve Bank? What else can we do to take advantage of these low interest rates? And how can we better bolster the financial system to be more long-term in its capital allocation? In summary, we are not alone in the low interest rate environment, this is a global phenomenon. 4/5 BIS central bankers' speeches However, what we do have is more policy and business opportunities than most OECD economies and this is something that we need to take advantage of. We will need to be longterm in our planning and investing, and now is a good time to get ahead – given the trifecta of sound balance sheets in business and government, infrastructure gaps, and low hurdle rates to invest. Meitaki, thank you 5/5 BIS central bankers' speeches
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Federation of Māori Authorities (FOMA) annual conference, Nelson, 27 September 2019.
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Emerging Challenges and Lessons from the Māori Economic Renaissance A speech delivered to the Federation of Māori Authorities (FOMA) annual conference in Nelson 27 September 2019 By Adrian Orr, Governor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Ma tini ma mano ka rapa te whai. Tihei mauri ora! To our tīpuna, those past and present gathered here for this paramount kaupapa. Tēnā koutou katoa Thank you for inviting me to speak at your conference. It is a privilege to return to this fine annual occasion. I’d like to acknowledge Wakatū whānau and Te Tau Ihu, and also the FOMA Board, especially Traci Houpapa (chair) and FOMA members present. I have been involved in many FOMA events over the years wearing a variety of hats. I have always relished the experience and found it fun and challenging, and I am very proud of you all for the progress made over recent decades. As FOMA members you represent an important segment of Māori in business in Aotearoa, and Aotearoa business, full stop. Many of you have been at the forefront of the relatively recent Māori economic renaissance following your very long period of – often forced – alienation from the business world. Your businesses are based primarily on your whenua assets, and as a result most of you are heavily engaged in the fishing, forestry, and/or farming industries – throughout the industries value-chains. You also operate under a variety of legal frameworks, from iwi or hapū Land Trusts and Corporations, through to individual title. Each governance framework has a unique history, as well as strengths and weaknesses for attracting and retaining business capability, accepting and managing risk, and retaining whenua ownership. However, across these industries and ownership structures, you have been persistent and innovative in returning your resources to sustainable and productive use. There are growing and impressive statistics that are becoming more widely known and celebrated. For example, 10% of primary sector assets are Māori owned, with a total value of $13 billion from New Zealand’s agriculture, forestry and fishing asset base1. The Māori economic asset base is also diversifying, with new investment areas including geothermal, digital, services, education, tourism and housing2 – moving with the New 1 MBIE & KPMG Māori Economy Investor Guide, 2017. The Māori Economy – New Zealand Foreign Affairs & Trade Ref #8528795 Zealand economy and leading in some areas such as brand development. The Māori economic asset base now adds-up to multi-billions of dollars, representing an important part of the pūtea of Aotearoa. However, measuring the contribution of Māori to the economic wellbeing of Aoteroa by asset size alone is a dis-service. Māori culture, and the challenges Māori and Pākehā have faced together since the 1800s, continue to mold how we do business in New Zealand, and how we are viewed by the rest of the world.3 In 2018, the New Zealand Ministry of Foreign Affairs and Trade recognised Māori as being key to international trade.4 We also champion the past and ongoing Māori economic contribution in our story The Journey of Te Pūtea Matua5, starting with the arrival of your tīpuna in the 1400s, or thereabouts. The economic practices of your tīpuna are well known to have been, and continue to be, long-term and inter-generational. Your investments aim to be values-based in the interests of your mokopuna and their mokopuna. You strive to show more New Zealanders how manaakitanga and kaitiakitanga are integral to running a business. It’s important to not only recognise the value Māori business brings to Aotearoa but to also encourage and protect that contribution. It is a vital resource that should not be overused. This is similar to a desirable ‘virtuous circle’ of business activity, one that self-supports economic profit, environmental sustainability, social inclusion, and cultural diversity.6 The alternative is the ‘vicious circle’ that sees any one of these outcomes only being achieved at the cost of another. Often the difference between the vicious and virtuous circle is simply the time horizon over which people are incentivised to operate. Te Pūtea Matua has a lot to learn from you, as do business owners globally. A real-life example of business based on long-term values. This is, in part, why we have introduced a Te Ao Māori strategy7 at Te Pūtea Matua. Our role is to think and operate for the long-term, and to be successful we need to be relevant and draw on the broadest insights. It is also in part to support and guide our Climate Change strategy8, which we see as a key long-term risk to financial stability globally. Te Ara The Encyclopedia of New Zealand 4 Annual Report 2017-2019 Ministry of Foreign Affairs and Trade 5 https://www.rbnz.govt.nz/news/2018/09/the-journey-of-te-putea-matua-our-tane-mahuta 6 Geopolitics, New Zealand and the Winds of Change speech by Orr 2018 https://www.rbnz.govt.nz/about-us/te-ao-maori-strategy https://www.rbnz.govt.nz/financial-stability/climate-change/strategy Ref #8528795 Perhaps there is a place for a ‘Kaitiaki Pledge’ for businesses more broadly, better ensuring that we capture the ‘virtuous circle’ of long-term economic growth, using the insights from tangata whenua. What a powerful position for Aotearoa business internationally – a unique monopoly-selling strength to the heart of current and future consumers and investors. Of course such a pledge would impose significant commitment, so as to be most recognised and valued internationally. All Māori business would need to ‘walk the talk’ of long-term governance and leadership. An example of such a commitment relevant to this audience could be better committing Māori economic entities to work together to provide access to under-utilised resources on scale, so that relevant expertise can be sourced and investments made with full ‘kaitiaki confidence’. This concept is part of the kaupapa that underpin FOMA, Poutama Trust9, and the more recently developed collective direct investment vehicle Te Pūia Tāpapa Fund10. Mahi tahi overcomes the fact that no one person or group has a monopoly access to resources, capability, and capital – the three ingredients of an investment opportunity. Mahi tahi will bring this together under the umbrella of shared values. I have used the concepts of manaakitanga and kaitiakitanga to describe some of Māori business value drivers. However, it is important to acknowledge that these concepts are increasingly mainstream in international business, under a variety of headings but with similar goals. For investment, there is a growing cluster of managers of global capital concerned with better managing long-term investment outcomes, rather than shorter-term financial reward alone. For example, there are organisations such as: Focusing Capital on the Long-Term11; the United Nations Principles of Responsible Investing12, CPD (formerly Carbon Disclosure Projects)13; and Global Compact14; the One Planet Sovereign Wealth Funds15; the Global Network for Greening the Financial System16; the Paris Accord on Climate Change17; and locally Transparency International New Zealand18; the Climate Leaders Coalition19, The Aotearoa Circle20, and more. 9 www.poutama.co.nz 10 www.tepuiatapapa.co.nz 11 https://www.fcltglobal.org/ 12 https://www.unpri.org/ 13 https://www.cdp.net/en 14 https://www.unglobalcompact.org/ 15 https://oneplanetswfs.org/ 16 https://www.banque-france.fr/en/financial-stability/international-role/network-greening-financial-system 17 https://unfccc.int/process-and-meetings/the-paris-agreement/the-paris-agreement 18 https://www.transparency.org.nz/ 19 https://www.climateleaderscoalition.org.nz/ https://www.theaotearoacircle.nz/sustainablefinance/ Ref #8528795 It is great to be talking about Māori economic progress, celebrating success and acknowledging that Māori entities are showing value-based leadership. As always, however, there is more work to be done to make the New Zealand economy more resilient and sustainable. The global investor activities mentioned already imply that standing still in business is not an option - global consumer and investor expectations are changing. Significant trust and investment is going to be needed to ensure the New Zealand economy – and specifically Māori economic activity represented at FOMA – moves sustainably into higher value-add, productive, activities. Internationally, consumer and investor preferences and expectations are changing rapidly, especially so when it comes to issues such as climate change. For example, here in Aotearoa there is recently proposed regulation attempting to transition the agricultural industry towards more long-term thinking. This includes the action plan for water quality developed by industry bodies and local and central government21, and agriculture being brought under the emissions trading scheme22. What ever your views are on the relative merits of these regulations, the fact is, preferences are changing and businesses need to change to remain relevant. Such change takes courage, action and investment. One thing is for sure, however, highly indebted businesses will have the least ability to invest ahead of these societal expectations – and for innovation more generally. Going back a few years to the 1990s and 2000s, New Zealand’s agriculture sector saw widespread conversions from sheep and beef farming to dairy. The number of sheep in New Zealand more than halved, while the number of dairy cattle more than doubled23. This transition was driven by increased global demand for dairy products, which led to higher milk prices24. Meanwhile, wool and meat prices have been less attractive than they once were. These farm conversions required significant investment. Banks helped to fund this investment by lending heavily to the sector. Agriculture debt in New Zealand increased from $5 billion in 1990 to $63 billion today. Two thirds of this debt is owed by dairy farms25. Looking more closely at dairy farming in Aotearoa, debt has grown much faster than output – debt per kilogram of milk solids produced has quadrupled in 15 years26. The rapid increase https://www.mfe.govt.nz/fresh-water/we-all-have-role-play/land 22 https://www.mfe.govt.nz/ets 23 Stats NZ data 24 Global Dairy Trade auction data RBNZ agriculture survey, standard statistical return (SSR) and bank balance sheet (BBS) RBNZ Agriculture Survey, RBNZ Bank Balance Survey and DCANZ production data. Ref #8528795 in agriculture debt has been fuelled by banks’ aggressive and loose lending standards over recent years.27 While bank lending allows businesses to quickly take advantage of new opportunities, high debt comes with high risk. When times get tough, or when capital is needed to grow, highly indebted businesses find it much harder to weather the storm and remain relevant. This is a symptom of short-term thinking that is not sustainable. Banks’ incentives are not the same as the farmers. Banks’ business is to lend, and they are incentivised to manage the risk of their overall portfolio for the long-term, rather than the risk of any individual farm or business. This is why banks are critical and efficient in a modern economy - but debt must be used with care. A bank has a more diversified portfolio, so it will almost certainly survive a resonable sized dairy downturn, but many indebted farms might not. What are we doing, as Te Pūtea Matua, about the challenge of competing horizons and purposes when it comes to ensuring financial stability? On top of keeping inflation low and stable so businesses can focus on the long-term, we also look at other ways to maintain a healthy financial system. It is known that banks will be better incentivised to think about the long-term performance of the businesses they lend to, if they have more of their own equity at stake (i.e. more of their own skin in the game). This is why we are proposing to significantly increase the minimum capital requirements for banks operating in New Zealand28. An increase in bank capital benefits all New Zealanders by creating a safer banking system and longer-term lending consideration. This topic should be of special interest to some of you who are managing collectively owned assets. Since it is difficult for a bank to foreclose on a collectively owned asset, lending to such organisations is considered unsecured, and therefore more expensive. This makes it more difficult for you to get access to bank lending. In the short-term, less access to credit puts businesses with collectively owned assets at a competitive disadvantage to their industry counterparts. They have less funding optionality. These businesses also remain exposed to economic downturns which can be exacerbated by excessive lending to other competitors in the same industry. 27 Based on Credit Conditions Survey and Financial System Analysis Review of the capital adequacy framework for registered banks: how much capital is enough? Ref #8528795 In the longer-term, businesses operating with collectively owned assets have lower leverage ratios than their industry counterparts as a result. Lower leverage brings greater resilience to economic shocks and longer-term sustainability. This means, in the longer-term, Māori businesses with collectively owned assets can have a stabilising effect on the economy as a whole. I know for some of you, any progress to change this situation is too slow. In the meantime, I would encourage you to take advantage of the opportunities that come with greater resilience, and look for partnerships that value long-term outcomes. In summary, the challenges ahead will still test your skills and adaptability: the global economic environment is volatile as trade tensions persists; commodity price swings will continue to test resilience; evolving consumer tastes and preferences are fast-moving and we need to move with those demands. And climate change literally means the changing tide will be closer to the door. Being whenua-based, these challenges will be both a risk and opportunity to all of you, and your ability to adapt and transform remains critical. A challenge I have confidence you will stand up to along the way. I want to acknowledge how you do business and the critical role FOMA has played to bring you all together to have a collective voice on business practices in Aotearoa. There are many examples of success within your membership that encapsulate innovation, increased productivity, and better returns on capital, yet based on long-term sustainable beliefs. That said, I want to thank all the many rangatira gathered here today for continuing to strive for greater outcomes for our collective, whānau, hapū, iwi and Te Ao Māori. Meitaki ma’ata ata. Tēnā koutou, tēnā koutou, tēnā tātou katoa. Māori Word Reference Tihei mauri ora! – Behold the breath of life! Tihei mauri ora! – phrase https://www.otago.ac.nz/maori/world/tikanga/whakapapa/index.html Tīpuna – Ancestors Kaupapa - Issue or topic Tēnā koutou katoa - Greetings to you all Wakatū - Nelson (place) Whānau - Family Te Tau Ihu - Marlborough region Ref #8528795 Aotearoa - New Zealand Whenua - Land Iwi - Tribe Hapū – Sub-tribe Pūtea - Wealth Pākehā - New Zealander of European descent Mokopuna – Grandchild(ren) Manaakitanga – Respect for others Kaitiakitanga - Guardianship Te Pūtea Matua – Reserve Bank of New Zealand Te Ao Māori - Māori world (view) Kaitiaki - Steward Tangata whenua – Indigenous people Mahi tahi - Working togather Rangatira – Leaders (contemporary), Chiefs (traditional) Meitaki ma’ata ata - Cook Island Māori ‘thank you very much’ Tēnā koutou, tēnā koutou, tēnā tātou katoa - Greetings, greetings, greetings to us all Ref #8528795
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Speech by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Citi Australia and New Zealand Investment Conference, Sydney, 16 October 2019.
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Supporting sustainable economic growth through financial stability policy Speech delivered to Citi Australia and New Zealand Investment Conference On 16 October 2019, in Sydney By Geoff Bascand, Deputy Governor and General Manager of Financial Stability Good morning everyone, My thanks to Citi for the invitation for me to come here today and speak with you all - it’s a pleasure to be here. Today I’m going to start by setting the scene to give you an understanding of where the Reserve Bank of New Zealand is currently at in achieving both price and financial stability, and I’m also going to outline the risks that New Zealand is exposed to in a local and global environment. Setting the scene The Reserve Bank of New Zealand’s purpose is to promote the prosperity and wellbeing of New Zealanders, and contribute to a sustainable and productive economy. For this speech I want to mostly focus on how we promote sustainability by delivering on our objectives: price stability, maximum sustainable employment, and financial stability, and the tools we apply to help keep the economy productive. Over the past thirty years, we have seen economic volatility decline following the introduction of inflation targeting, with prices becoming more stable and remaining at relatively lower levels (Figure 1). Figure 1: The decline in inflation volatility during the inflation targeting era in New Zealand Source: Stats NZ, RBNZ calculations. Over this same period we have also seen improvements in economic growth, as well as less volatility in this growth (Figure 2). Figure 2: Quarterly real GDP growth before and during the inflation targeting era Source: Stats NZ, RBNZ calculations. With monetary policy maintaining price stability and supporting maximum sustainable employment, other policies we have are aimed at maintaining financial stability. What we mean by ‘financial stability’ is having a financial system that can withstand severe, yet plausible, shocks and avoid financial crises. These crises can destabilise economic activity and severely impact business and household income. Indeed, evidence from a wide range of countries over many decades shows us that when crises do happen, they are immensely damaging and can have long-lasting effects.1 Usually our price stability and financial stability policies are complementary. However, the low interest rate world we live in complicates achieving both of our objectives, encouraging a build-up of leverage in the financial system. The persistent decline in long-term and shortterm interest rates has supported very high levels of private sector leverage. See the discussion of economic and social costs in Bascand As shown in Figure 3 below, the credit to GDP ratio in New Zealand remains very close to that observed just prior to the Global Financial Crisis (GFC). Figure 3: Declining interest rates and increasing debt levels Source: Stats NZ, RBNZ calculations. Household debt as a proportion of disposable income has risen from 60 percent in the early 1990s to 166 percent across all households, and for households with mortgages, the increase is even larger (Figure 4). Figure 4: Debt to disposable income ratio in New Zealand Source: Stats NZ, RBNZ Household Assets and Liabilities Survey, RBNZ estimates. It’s important to remember that while extremely low interest rates have been commonplace in the developed world for over a decade now, New Zealand’s very low interest rate environment is a more recent phenomenon. The Official Cash Rate (OCR) only dipped below 2 percent (year average) in November 2016. We know that some academic studies suggest that expansionary monetary conditions can encourage lower lending standards and higher levels of leverage in the financial system.2 And, as we transition into this very low interest rate environment, we will continue to monitor such vulnerabilities in New Zealand. We recognise that the risks globally are high, and New Zealand is particularly vulnerable to external events. Our economy is quite small - less than a fifth of the size of the Australian economy, and just like Australia, New Zealand is heavily reliant on commodity exports and is very open to financial capital flows. Commodity price movements in world markets determine the value of our key exports, as well as the price we pay for our imports, particularly those that are fuel-related. Monetary policy moves by foreign central banks may generate unfavourable fluctuations in our exchange rates. However, as Figure 5 demonstrates, the New Zealand economy has responded much more than Australia to downswings in the global economy. In contrast to Australia, economic activity in New Zealand contracted during the Asian crisis in the late 1990s, and the US subprime mortgage crisis of the late 2000s that snowballed into the GFC. This is despite the fact that the Australian terms of trade has been through dramatic escalations and downturns, while New Zealand’s terms of trade has experienced relatively less volatility around an upward trending path (Figure 6). 2 Some of the literature exploring this connection includes Neuenkirch and Nöckelb (2018), Dell’Ariccia, Laeven and Suarez (2017), Jimenez, Ongena, Peydro and Saurina (2014), and Caballero, Hoshi and Kashyap (2008). Figure 5: Economic activity in New Zealand and Australia in the inflation targeting era Source: Haver Analytics, RBNZ calculations. Note: The data has been normalised to 100 in 1990 Q1. In addition to the disruptions in the global economic environment, the New Zealand economy is occasionally affected by weather-related shocks, such as droughts, that constrain the agricultural sector. In the past, we have also suffered severe damage to our infrastructure due to earthquakes. So when the Bank sets monetary and financial stability policy, it needs to balance concerns about these different- and sometimes conflicting - domestic and international influences. Figure 6: The terms of trade in New Zealand and Australia in the inflation targeting era Source: Haver Analytics, RBNZ calculations. Note: The data has been normalised to 100 in 1990 Q1. Mortgage lending in New Zealand is dominated by floating and short one to two-year fixed rate mortgages (Figure 7). This implies that the changes in the domestic policy rate and international bank funding market rates pass through to the effective mortgage rates relatively quickly, and influence the demand for housing and house prices in New Zealand. Figure 7: Time to re-price on housing loans in New Zealand Source: RBNZ Bank Balance Sheet Survey, RBNZ Standard Statistical Return, RBNZ calculations. When interest rates are low, households can accommodate a higher level of debt for given incomes; though they remain susceptible to adverse macroeconomic shocks.3 For example, if bank funding costs escalate due to distressed offshore funding markets, lending rates in New Zealand would rise, and households may find it hard to service debt. On another front, elevated dairy prices encouraged investment in dairy farms, leading to high debt levels in the agricultural sector. It’s worth noting that agricultural debt in New Zealand has increased from $5 billion in 1990 to $63 billion today. Two thirds of this debt is owed by dairy farms. If New Zealand’s agricultural export revenue fell due to a weakening of global See also the Australian case in Ellis and Littrell (2017). demand or a domestic drought, the contraction of economic activity in that sector could spill over to lower income and spending in the household sector, thereby increasing debt defaults. That’s why maintaining financial stability in this highly vulnerable environment is challenging. Minor events appear manageable, but we need to be prepared for major shocks, and it is here that our financial stability policies are centred, including our proposals to increase bank capital requirements. The Reserve Bank of New Zealand’s approach to financial stability Our approach to financial stability is dynamic, and we focus on building financial system resilience (Figure 8). We recently renewed our approach to financial stability4 to recognise that the financial system is constantly evolving, as are the risks and challenges. Our baseline settings are not set-and-forget, we adapt them as risks and the resilience of the financial system evolve. Figure 8: The Reserve Bank’s approach to financial stability Based on our understanding of the financial system, we can enhance resilience by establishing rigorous baseline requirements and adapting them as necessary. Table 1 lists the range of prudential and macro-prudential instruments available to us. For example, we can increase capital buffers for banks, or we can tighten Loan-to-Value Ratios (LVRs) if risks related to household indebtedness are excessively heightened. We can also adjust liquidity requirements for banks to ensure they remain solvent. See Bascand As a central bank, it’s imperative that we have a full range of tools that we can use if needed to ensure the financial system remains stable. Table 1: The Reserve Bank’s prudential toolkit Macroprudential policy Relevant tools Impact on financial system resilience Borrower restrictions (LVRs) Reduce risk that the financial system amplifies a severe economic downturn Impact on wider economy More resilient households and banks reduce potential severity of an economic downturn Reduced losses in a severe economic downturn Lowers incentives on banks to deleverage in a downturn; supports higher credit supply and economic activity Capital and liquidity instruments (CCyB/SCR) Capital buffers Prudential policy Crisis Management Maintain baseline resilience of the financial system Liquidity policy Banks remain solvent through the economic cycle Maintains market confidence and lowers risk of sudden increases in funding costs for households, businesses and the economy Banks remain functioning parts of financial system Maintains availability of credit and banking services necessary for economic activity Governance and local incorporation Collateral standards Manage and limit impact of distress or failure Outsourcing Open Bank Resolution Mitigates costs for creditors and taxpayers Minimum capital Losses absorbed first by shareholders Depending on the situation, we choose the appropriate regulatory tool to address the identified risk to financial stability, bearing in mind efficiency costs, the level of effective self and market discipline, and the regulatory framework as a whole. We adapt tools in response to unsustainable booms in credit and asset prices in order to reduce the likelihood of crises. But crisis prevention is by no means assured. As history tells us, crises come from unexpected sources and are hard to predict. So we need robust standards to maintain resilience. Minimum capital and liquidity requirements are essential tools for this purpose. We also need tools to manage the consequences if our financial institutions are unable to survive a period of stress or crisis – our crisis management regime that is under review as part of Phase 2 of the Review of the Reserve Bank Act. Our holistic approach to macroeconomic and financial stability As I mentioned earlier, the New Zealand economy is in a good space. Since the beginning of inflation targeting, macroeconomic volatility in general has declined. Inflation is just below the mid-point of the target band, and employment remains around its maximum sustainable level. But we are wary of potential challenges to macroeconomic management. Supervision, oversight and disclosure Crisis Prevention Purpose The OCR is currently set at 100 basis points, a historically low level in New Zealand, in order to achieve our monetary policy objectives. Lower rates still may be needed to achieve our inflation and maximum sustainable employment objectives. The Reserve Bank is undertaking further preparatory work on less conventional monetary policy tools5 that are available, in the event that the policy rate is pushed down to its effective lower bound. Novel monetary policy tools, such as large scale asset purchases and targeted term lending that have been previously used in the United States and the United Kingdom, are tailored to support economic activity by strengthening credit growth. However, a highly stimulatory monetary policy stance may lead to over-exuberant levels of credit growth, and as seen in empirical studies in the international literature, may lead to lower lending standards. If looser monitoring standards prevail on the supply of credit, the macroeconomic costs of a severe downturn may be amplified. Macroprudential policy can help to manage the movements in credit so as to ensure that macroeconomic booms and busts are not excessively volatile. Our assessment of financial stability risks is more nuanced than debt levels per se. We look at the distribution of debt as well as its growth rate, and the sustainability of the asset values it is attached to. While we are concerned about the levels of debt in parts of the household and agriculture sectors, there is scope for more borrowing and investment to take place in less leveraged areas. Our restrictions on high loan-to-value ratio (LVR) lending (one measure of high risk lending) are one tool we have that can moderate financial stability risks even while the stock of household debt is rising. More capital is a key part of building New Zealand’s economic resilience In December 2018, we proposed to increase bank capital requirements in New Zealand, to increase the overall resilience of the banking sector to economic shocks. We proposed that the capital framework should be set so that banks have sufficient capital to withstand a 1-in200 year event. Some have questioned why we are proposing this increase in capital, given the perceived impacts it could have. So let me explain - first and foremost, from a societal point of view, setting capital requirements is a long-term game. The benefits of more capital essentially Hawkesby result from avoiding future economic and social costs that would arise from a financial crisis and resulting economic recession (Figure 9). Figure 9: A conceptual framework relating financial stability to economic output Expected economic output (GDP) Capital requirements that maximise expected output (but the level of stability may still be too low) Trading lower expected output for more stability (though expected output still higher than current settings) Stability and output combination implied by current minimum requirements Less stable More stable Financial stability We targeted a high level of resilience to withstand severe shocks because the costs of severe crises are very high, while international evidence indicates that the costs of buying additional insurance are modest. Moreover, we would transition to this higher level of resilience over time. For shareholders, the increased equity funding may result in lower returns per dollar invested, but the flip side for them is a safer investment. Also, it is worth recalling that capital requirements aren’t like other regulations, in that they don’t create an ‘expense’ for banks. Indeed, in an accounting sense, interest expenses would reduce for the same level of funding. And as with most investments, less leveraged businesses earn lower but more stable returns. We anticipate the same for banks to an extent, and past history does indeed suggest there is a relationship (Figure 10). Figure 10: Return on Tier 1 Capital, and Tier 1 Capital to tangible assets (locally incorporated banks) 30% 9.00% 8.00% 25% 7.00% 20% 6.00% 5.00% 15% 4.00% 10% 3.00% 2.00% 5% 1.00% 0% 0.00% Return on Tier 1 Capital 12 month average Tier 1 Capital to Tangible Assets (RHS) 12 month average Source: RBNZ GDS Survey Data, RBNZ calculations. Determining appropriate capital requirements is, of course, more than just counting the benefits. The upsides must be balanced against the downside of higher interest rates. We’ve anticipated that there will be a 20 to 40 basis point increase in bank margins in the long term as a result of these proposals.6 While these are relatively small numbers, they will ultimately have an impact on investment and spending in the New Zealand economy. Our approach from the outset has been to set capital requirements at a level where we can be confident that these costs are outweighed by the benefits of a safer financial system. To calibrate our proposals for New Zealand, we drew on many pieces of analysis. These included international literature, stress test results and historical New Zealand data on bank losses and loan performance. Currently we are reviewing all inputs and modelling assumptions, and carefully assessing submissions, before finalising the plans that will be announced in December. As well as the 6 Two of the External Experts, Dr James Cummings and Professor David Miles, suggest that these estimates may be on the higher side of what is plausible due to the cost of equity being overstated. The summary, as well as their reports, are available on the Capital Review page on the Reserve Bank’s website. overall level of capital, we are also re-examining all other aspects of the Review, such as the quality of capital (capital instruments) and the transition path to the new requirements. A well-capitalised banking system also means that our banks will be able to access global funding markets, even in stressed conditions While higher levels of bank capital cannot stop economic fluctuations, it can help banks with even the more moderate downturns, not just the 1-in-200 year event we calibrate to. Research suggests that well-capitalised banks have easier access to funding than their more leveraged peers during turbulent times. 7 For the economy, this means a weakly capitalised banking system can undermine monetary policy responses to economic downturns as banks may struggle to pass through lower interest rates with their cheaper funding sources drying up. Conversely, a well-capitalised banking system is less likely to face funding issues during these downturns and we would anticipate a much more orthodox response to monetary policy in the economy. Bank capital requirements also can have a more direct role in responding to these economic fluctuations through a counter-cyclical buffer. Having a well-capitalised banking system in New Zealand, given we are a net importer of capital, also means that our banks – and the wider economy - will be able to continue to access global funding markets even in times of financial stress. Of course, we are listening to what others are saying about our proposals. We’ve been consulting with the public and many of our stakeholders to fully understand the impacts they believe an increase to capital requirements will have. We’ve commissioned three internationally recognised experts to review the proposals, which have been published on our website. All of these views have been captured and are being considered, and if we’ve got it wrong, we’ll make adjustments to reflect that because it’s important that we get this right. The international dimension We set our capital requirements according to the New Zealand specific risk environment, but we also acknowledge how we ‘stack up’ internationally, and why we may need a more capitalised banking system than those in other countries. Gambacorta and Shin (2018). We have previously compared our proposed capital levels with Basel Committee estimates and Standard and Poor’s (S&P) methodology, placing our proposals around the top quartile.8 Since September 2019, S&P’s assessment of economic risks in New Zealand has improved. They viewed that the moderation of house prices since 2017 has reduced the likelihood of a severe house price correction and with it, the potential losses banks may face in such a scenario – that’s good news. Our financial stability risks have reduced due to a slowing housing market, and our LVR policy has contributed to that. The improved country rating means that the New Zealand banks’ capital positions using S&P’s risk-adjusted capital (RAC) ratio have improved.9 Our Capital Review proposals would mean that the banks’ S&P RAC ratios would increase further still, towards being among the best capitalised banks across a range of peer countries (Figure 11). Figure 11: S&P RAC ratio – comparison of the four largest New Zealand banks to large banks in peer countries (October 2019) S&P RAC ratio (%) Range Asset-weighted average Source: Standard and Poor’s, RBNZ calculations. Bascand (2019b) 9 S&P calculates its own risk-adjusted Tier 1 capital ratios for many banks around the world, using a methodology that attempts to reduce the influence of differing national applications of the Basel framework while still taking into account the different risk profiles of the countries in which each bank operates. Notes: New Zealand (post-CR) shows an estimate of the RAC ratios of the four largest New Zealand banks assuming the Capital Review proposals are implemented as consulted on, plus a 1% management buffer. Comparator banks include Erste Group, Raiffeisen Bank International, Bank Austria (Austria), ANZ Banking Group, Commonwealth Bank, National Australia Bank, Westpac Banking Corporation (Australia), Česká spořitelna, ČSOB, Komerční (Czechia), Danske Bank, Jyske Bank, Nykredit Realkredit (Denmark), Nordea, OP Corporate (Finland), Bank of East Asia, Bank of China (HK), Hang Seng Bank, Hongkong and Shanghai Banking Corporation, ICBC (Asia), Standard Chartered HK (Hong Kong), Allied Irish Banks, Bank of Ireland, Permanent TSB (Ireland), Hapoalim, Leumi (Israel), Arion, Íslandsbanki, Landsbankinn (Iceland), ABN AMRO, ING, Rabobank (Netherlands), DNB Bank (Norway), ANZ New Zealand, ASB Bank, BNZ, Westpac New Zealand (New Zealand), SEB, Handelsbanken, Swedbank (Sweden), DBS, OCBC, UOB (Singapore). We realise that the slowdown in the New Zealand housing market may be a cyclical rather than a structural change. In the longer term, we remain vulnerable, especially if household indebtedness continues to grow. This is why we need policies that aim to ensure enduring resilience in the financial system. Indeed, in their assessment, S&P note that New Zealand’s economic imbalances remain somewhat elevated because of persistent current account deficits, high external debt, and an economy that is exposed to fluctuations in commodity prices. Relationship with Australia Our conservatism, relative to Australia, in our bank capital proposals reflects the higher macroeconomic volatility that we have endured, as I pointed out earlier. However, we have been, and will continue to work closely with APRA. We continuously update one another on our prudential regulations, we maintain a strong working relationship, and we also respect each other’s objectives as regulators aiming to protect our respective financial systems. Conclusion With New Zealand’s macroeconomic policy framework and strong financial sector soundness, investors can have long-term confidence in New Zealand as an investor destination. The prospects of sustainable and productive growth are enhanced through predictable macroeconomic policy settings and avoidance of financial crises. Economic and other shocks have constrained New Zealand’s economic performance historically. Although our macroeconomic stability has improved in recent decades, we remain vulnerable to external and domestic disturbances. Overall debt levels remain high while the concentration and persistence of high-leverage within segments of the household and agricultural sectors questions the quality of banks’ lending standards. The more enduring that low interest rates are, and the more successful they are in promoting borrowing and investment, the more they are likely to pose challenges to the Reserve Bank’s financial stability objectives. The Reserve Bank has a number of tools it applies to manage financial stability risks, and its LVR policies have a role in limiting the risks that could arise from increasing leverage through inadequate lending standards. More capital is a key part of building New Zealand’s economic resilience for when severe shocks do occur. We are in the process of weighing up the costs and benefits of how much more and the type of capital that is appropriate for the desired level of resilience, and the timeframe to achieve it. Decisions on the Capital Review are expected to be released in the first week of December.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Insurance Council of New Zealand Conference, Auckland, 5 November 2019.
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Building confidence and reducing risks in the insurance sector A speech delivered at the Insurance Council of New Zealand Conference On 5 November 2019, Auckland, New Zealand By Adrian Orr, Governor Ref #8609867 v1.2 Page 2 of 7 “You never know these days. Uninvited guests may force you to take an unplanned trip to an unknown destination; doesn’t hurt to be in your Sunday clothes.” – Anurag Shourie, Half A Shadow Tēnā koutou katoa My thanks to the Insurance Council for inviting me to speak with you this morning. It is a pleasure and privilege to be here. In the almost-decade since Parliament passed the Insurance Act in 20101, the insurance industry has had to deal with the consequences of many ‘uninvited guests’. The Christchurch and Kaikoura earthquakes presented unique ongoing challenges to the industry. So too have other single-firmspecific events, such as the failure and liquidation of CBL Insurance. Furthermore, the findings from the Australian Royal Commission and our recent Conduct and Culture Review - jointly undertaken with the Financial Markets Authority (FMA) - demonstrate the need for ongoing constructive change across the sector. I am going to share with you today the Reserve Bank’s perspectives on some of these events, and about the future direction of our insurance policy and supervision work - including some of the initiatives that we will seek your feedback on in due course. Our desire is to ensure that the insurance sector is financially sound and trusted. We must be in our best ‘Sunday clothes’ all week long. Promoting soundness and confidence is challenging The insurance industry is a crucial part of any modern economy. It is the part of the ecosystem that society relies heavily on to both mitigate risks and/or transfer the risk-burden to those best able to manage it. There are just under 90 licensed insurers operating in New Zealand. Through the Insurance Act, the Reserve Bank is tasked with maintaining the soundness of the insurance sector, and public confidence in the sector. By definition, this task is far from straight forward. The nature of insurance contracts can vary greatly between insurers or insured events, and are often dependent on the individual circumstances of the policy holder. Furthermore, there are significant information-asymmetries between an insurance provider and their customer, and the risks of providing poor or outdated information run in both directions. ‘Who is good for what, and when?’. For example, often there is a long period of time after a customer-relationship has been established. In very difficult circumstances, a customer may find that they do not have the coverage they http://www.legislation.govt.nz/act/public/2010/0111/latest/DLM2478122.html Ref #8609867 v1.2 Page 3 of 7 believed would be available to them. And, on the other side of the ledger, insurers rely on accurate information from customers about their own circumstances. Finally, the Reserve Bank is not tasked with guaranteeing insurers against failure. As we have seen with the collapse of CBL and the bailout of AMI, the failure of an insurer is a significant event. Even if a single-firm-failure does not threaten the financial system as a whole, such events challenge public confidence. Insurance challenges continuously evolve Further complicating the task of promoting a sound and trusted insurance sector is that expectations and circumstances continuously change. Customer expectations of ‘good outcomes’ from insurance are evolving, and there is a heightened awareness across the financial sector as a whole of the importance of good business conduct. Risks also evolve. For example, climate change is leading to more frequent insurance events, and this is driving new ways of thinking about risk. Just as advances in technology are providing more data and insight into insurance risk pricing. The Reserve Bank believes that the insurance sector must ensure that high quality risk management capability is in place, to support appropriate insurance outcomes. We support insurers using the best information to understand their customers and the risks faced by the insurer. We also respect that insurers are free to make their own commercial decisions. Getting your risk management and pricing right is an important foundation to a sound insurance sector. However, we are conscious of the wider implications on the economy and asset prices as insurance providers make their individual business decisions. Orderly and well-articulated changes in insurance and pricing strategies are needed, so that all participants in the financial sector – and wider economy - can adapt their behaviour without creating unintended outcomes. The Reserve Bank will be monitoring the development of insurance risk-based pricing, to ensure we understand the potential wider economic consequences and any impact on New Zealand’s financial stability. We will comment on what we are observing to date in our upcoming Financial Stability Report on 27th November. The Reserve Bank’s policy and supervision challenges also evolve Just as the challenges and complexity of the insurance sector evolve, so must the Reserve Bank’s regulatory activity. Our regulation and supervision of the insurance sector remains based on the same ‘Three Pillars’ philosophy we apply when supervising registered banks and the other financial sector participants: self, market and regulatory discipline. However, over the next year or so we expect to consult with the industry on a range of changes that will look to strengthen each pillar. Self-discipline The first pillar, self-discipline, refers to the strength of governance, processes, and internal controls of a firm. Our view has not changed over the years: directors are ultimately responsible and accountable for ensuring that a firm operates prudently. Ref #8609867 v1.2 Page 4 of 7 Good self-discipline goes hand in hand with the culture of a firm and is key to ensuring high-quality outcomes for customers. Unfortunately, our recent review of life insurer conduct and culture found areas needing significant improvement. I will return to these findings later. Market discipline The second pillar, market discipline, means the way in which a firm is perceived by others (such as investors, clients and competitors) and how this information is acted upon. In 2018 we introduced the Bank Financial Strength Dashboard, to give the public more easily digestible information about the banks they deal with. Our experience indicates that the information has been well received and it is our intention to develop a similar dashboard for insurance firms. Regulatory discipline The third pillar, regulatory discipline, is the rules and regulations overseen by the Reserve Bank and other agencies, established though legislation. Our review of the Insurance Act will commence in earnest in 2020. There are very likely to be some clear areas of read-across from the current review of the Reserve Bank Act.2 For example, there has been focus on a broader range of enforcement tools, and on a new accountability regime for directors and senior executives. Managing the pace of change together We are aware that the pace of change in legislative policy intentions and broader societal expectations is intense. Insurers tell us that they see regulatory change as a key risk to monitor and manage. Our commitment is to ensure that you will have ample opportunities to contribute to these developments, and that there will be ample time for your views to be taken into consideration. As you are aware, the review of the Insurance Act was put on hold while the Reserve Bank Act review took place. The themes and issues that were identified in our 2017 discussion paper3 will be considered further in 2020. We expect to give initial priority to the scope of the Act, in terms of how we adequately cater for innovation, different business models, and new entrants competing with established insurers. We will consider whether we need to make changes to the legislation that better ensures appropriate competition between overseas branches and locally incorporated insurers. And we will look to enhance the enforcement tools available to the Reserve Bank, to better align with our supervisory approach. Additionally, the International Financial Reporting Standard, IFRS 17, is scheduled to take effect in 2022 for most insurers. While it sounds minor and detailed, this is a once-in-a-generation set of changes to the way insurance contracts are accounted for and reported to the market. https://treasury.govt.nz/news-and-events/reviews-consultation/reviewing-reserve-bank-act https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Policy-development/Insurers/IPSAreview/20170911%20Issues%20Paper%20Feedback%20Summary%20Oct%2020174.pdf? Ref #8609867 v1.2 Page 5 of 7 Critically for the Reserve Bank, the standards we set for insurer solvency are based on the information and data generated from these accounting standards. We thus need to review our solvency standards to ensure they are effective and in line with lessons from other jurisdictions, such as Australia. It is too early to say whether or not our review of insurer solvency will lead to the kind of uplift we have proposed for bank capital. However, we do expect that the current ‘black line’ of a single regulatory minimum limit for solvency will be replaced with a more graduated series of thresholds and varied regulatory response options - as we have proposed for banks. Show and tell A criticism identified in the Trowbridge-Scholtens report into our regulation of CBL, was the lack of ‘show us’ challenges we put to CBL. There was a similar, more general, point made in the International Monetary Fund’s (IMF) Financial Sector Assessment Programme 2017 (FSAP) review. When we meet with banks and insurers as the supervisor of their businesses, we have typically relied on the information given by, and word of, decision makers within those businesses. This is because we have wanted to very clearly ensure accountability sits with the directors, and also because these individuals are much closer to their day-to-day operations. The importance of open and honest disclosure from insurers is clear. Sadly, this openness has proven to not always exist. In CBL, we now have an example of a regulated entity that did not engage with the Reserve Bank openly. Justice Courtney’s judgement in the hearing for CBL’s liquidation noted “a lack of candour in dealing with the company’s auditors and the regulator”4 The Reserve Bank’s Relationship Charter5 seeks – in part – to address these kinds of issues in a practical and positive manner. By establishing how we will interact with an institution, we are laying down a clear marker. What does this mean in practical terms? The Reserve Bank needs to more often positively verify the information and assurances it receives from regulated institutions. We will be intensifying our “show me, don’t just tell me” style of engagement with the industry. And, we will be expecting to see a great deal more of this verification activity happening at the senior management and board level. An example of this new approach being applied is our review of the Appointed Actuary regime. You will be aware that this review is ongoing, and some of you have received visits from the Reserve Bank’s team. A sample of 15 insurers were selected for this review, aimed to represent the diversity of the New Zealand insurance industry (e.g., small and large insurers, life and general, branch and locally incorporated, directly employed and external consultant. For those who took part in the interviews or provided us with submissions, we thank you for your time and your open, free and frank discussions. https://forms.justice.govt.nz/search/Documents/pdf/jdo/cc/alfresco/service/api/node/content/workspace/Sp acesStore/193a6a73-1a5b-436e-af77-e6ef7173c9fa/193a6a73-1a5b-436e-af77-e6ef7173c9fa.pdf https://www.rbnz.govt.nz/news/2018/12/reserve-bank-aims-for-best-regulatory-relationships Ref #8609867 v1.2 Page 6 of 7 Appointed actuaries play an important and valuable role to both the industry and the Reserve Bank. We consider the appointed actuary to be a key voice at the table when an insurer is seeking to understand its financial health and future prospects. Our review team expects to make best practice recommendations to insurers and appointed actuaries, as well as provide recommendations to our own policy and supervision teams that will feed into our review of the Insurance Act. The public report of this review is expected to be published in the first quarter of 2020. Putting on our ‘Sunday best’ – closing the conduct gap As already mentioned, earlier this year the FMA and Reserve Bank released a joint report6 called Life Insurer Conduct and Culture. We believe that conduct within financial institutions is a contributing factor to customer outcomes, and can result in a gain or loss of trust and confidence in the industry. Based on our joint analysis, we found: extensive weaknesses in systems and controls for managing conduct risk, coupled with a lack of governance and management oversight; a lack of focus on customer outcomes and limited evidence of customers being adequately considered in product design and sales; that sales incentives were prioritised over good customer outcomes; a serious lack of oversight and monitoring of intermediaries; and a poor and inconsistent approach to dealing with complaints and remediating issues. Since the report was made public, we have worked with life insurers while they develop their action plans for remediating the issues and mitigating the risks we identified. We strongly believe that all insurers - including health and general insurance – should learn from the review and its findings. This is why we have subsequently written to the boards of general insurers setting out our expectations that they will review the culture and governance within their own firms. A “nothing to see here” mentality is not, and never will be, a sensible response to such an array of serious findings in a sister industry. We will be following up with non-life insurers to understand how they are reviewing these issues within their own firms. How a firm monitors and addresses conduct and culture issues will be a part of our ongoing ‘business as usual’ supervision with all insurers. We will also monitor insurers to make sure their planned actions are implemented effectively. Conclusion The public is demanding that both insurers and regulators play a part in providing greater confidence in the health and conduct of the sector. The Reserve Bank’s insurance agenda for the coming year (or years) is thus very full. We are committed to openly communicating our development priorities to insurers and the wider public, so that individuals and firms have the opportunity and ability to be an active participant in the policy development. https://www.rbnz.govt.nz/news/2019/01/fma-and-rbnz-report-on-life-insurer-conduct-and-culture Ref #8609867 v1.2 Page 7 of 7 What we ask of you, is that you engage openly and early with us, and that you heed the lessons of the banking and life insurer conduct and culture reviews. We look forward to working with the industry and other interested parties as we embark upon this next phase of our insurance supervision development. Thank you for your time today, and in the near-future. Ref #8609867 v1.2
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Panel remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Federal Reserve Bank of San Francisco, San Francisco, 14 November 2019.
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Monetary Policy: A Compass Point in Uncertain Times Panel remarks delivered to Federal Reserve Bank of San Francisco On 14 November 2019 By Adrian Orr, Governor1 1 My thanks to Cameron Haworth and Eric Tong for their contribution to these notes. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tēnā koutou katoa, Thank you for inviting me to this panel discussion. It is a pleasure to speak on a topic that is so relevant to a small open economy like New Zealand—the effects of uncertainty and dampened global growth on monetary policy. Heightened global uncertainty and slower international trade have contributed to a weakening in global growth since mid-2018. Much of the uncertainty is related to global developments, such as Brexit and the trade tensions between US and China (figure 1). In New Zealand, although some measures of uncertainty are relatively subdued, this may simply reflect a consensus that low growth is likely to stay in the near future. Figure 1: Uncertainty indices for New Zealand and the world Trade Tensions Brexit Source: Bloomberg, RBNZ estimates (based on Rice, Vehbi, and Wong, 2018). In light of this, it is vital that monetary policy acts as a compass point for decision making. We can do this by: Remaining focused on our core objectives; Adopting a risk-management approach for making monetary policy decisions; and Working in concert with all available policy levers—not as a lone force. For New Zealand, this means setting policy to achieve our price stability target and support maximum sustainable employment. It means acting decisively to prevent an unnecessary worsening in economic conditions and the un-anchoring of long-term inflation expectations. And it means recognising the limits of monetary policy. Monetary policy has been relied on heavily over the past two decades given its success of anchoring inflation expectations and assisting the recovery from the Great Financial Crisis,2 but it is not a long-term growth panacea. 2 See Rogoff (2019). Today I would like to discuss three topics: The impact of uncertainty on the New Zealand economy; How monetary policy in New Zealand is responding to these issues; and How clear communication and open-mindedness to new policy tools may help implementing our broadened mandate. In discussing these topics, I will touch on how, since the Great Financial Crisis, central banks have been tasked with a widened set of objectives. On one hand, we appreciate the constraints faced by other institutes, and the peril that may have resulted from the crisis had central banks not stepped up to the task. On the other hand, central banks are sometimes expected to solve phenomena that are structural in nature, and that do not sit easily within the conventional realm of monetary policy. At the Reserve Bank, we are always exploring new policy options to meet our broadened mandate. In particular, we believe clear and honest communication injects not only certainty for decision makers, but also confidence to the public moving forward. I will elaborate on these points below. Uncertainty and economic slowdown Uncertainty and economic slowdown go hand in hand.3 Uncertainty weighs on business confidence and makes firms hesitant to invest. This slows growth and holds down productive capacity. In our recent business visits, the biggest reported barriers to investment were: Policy uncertainty, particularly for infrastructure projects and environment policy; Regulatory requirements; Construction capacity constraints; and Access to finance.4 Figure 2: Falling business confidence is slowing business investment and GDP Quarterly Survey of Business Confidence, and Stats NZ. 3 See Rice, Vehbi, and Wong (2018) for analytical work on uncertainty. 4 See the November Monetary Policy Statement, Box 1 for the results of our recent business visits. Business uncertainty highlights the importance of forward guidance and transparency when considering and setting economic policy. Even if the message isn’t one that businesses want to hear, decision makers in business appreciate clarity and certainty. In addition to the cyclical impact of uncertainty on business investment, there are also signs of a structural decline in business investment since the Great Financial Crisis.5 If business investment remains low, this has a negative effect on our long-term prosperity. Our capital stock and productivity will struggle to develop, dragging down potential GDP growth. New Zealand’s productivity growth has already been slow for some time.6 Breaking out of this will require greater investment in technology, education, and infrastructure. The Reserve Bank cannot directly make the investments the economy requires—this will have to come from the private sector and government. However, we can play a supportive role, which I will come to shortly. First, let’s finish with the other impacts of uncertainty. From a central bank perspective, uncertainty has one clear impact: it makes our job harder. Good monetary policy depends on reasonable forecasts. High uncertainty makes forecasting harder. There is more noise in the data and forecasts are more subject to revision. A consequence of this is that the Official Cash Rate (OCR) may be less predictable simply because the world in which we are making our decisions is less predictable. Another challenge of uncertainty and low investment both globally and domestically is the downward pressure this creates on the global and domestic neutral interest rate. As a small open economy, our neutral interest rate is heavily driven by the global rate and we cannot escape this. A falling neutral interest rate will increasingly push the Reserve Bank to the limits of conventional monetary policy space, as we need to lower rates by a greater degree in order to achieve the same amount of stimulus as when the neutral rate was higher. So, what can monetary policy do to offset the effects of global uncertainty and support our long-term prosperity? Monetary policy response to uncertainty The Reserve Bank can contribute to a stable economic environment by continuing to focus on fulfilling its dual-mandate. Firstly, maintaining low and stable inflation enables organisations and individuals to carry out meaningful financial planning, by reducing overall uncertainty. This is something that is nearly impossible when prices are high and volatile or falling uncontrollably. Secondly, when employment is near its maximum sustainable level, firms have a stronger incentive to make productivity-enhancing investments that raise their capacity. 5 This is hard to identify precisely, but is partly associated with the ongoing shift from manufacturing to services within the economy, with services contributing relatively lower measureable investment. 6 See Nolan, Pomeroy, and Zheng (2019). Uncertainty can affect the monetary policy response through the execution of this dualmandate. In particular, it is now more suitable for us to take a risk-management approach. In short, this means we look to minimise our regrets. We would rather act quickly and decisively, with a risk that we are too effective, than do too little, too late, and see conditions worsen. This approach was visible in our August OCR decision when we cut the rate by 50 basis points. It was clear that providing more stimulus sooner held little risk of overshooting our objectives—whereas holding the OCR flat ran the risk of needing to provide significantly more stimulus later. We can also address uncertainty through our communication and forward guidance, which are broad-ranging. We reveal our assessment of the economy—good or bad—to the public, so they can make decisions based on the best possible information amid the prevailing uncertainty. We voice the types of policies we believe may be needed to sustain long and prosperous growth—be they monetary, fiscal, or financial policies. We do not shy away from discussing our limitations in solving all economic problems. Ultimately, communication, and coordinated action from the full range of policy levers and policymakers will create the best pathway to a sustainable economy. We are promoting the foundation for this. Ensuring consistency across the broad mandate of the Reserve Bank of New Zealand The Reserve Bank of New Zealand is a full service central bank with a wide range of responsibilities (table 1). Each of these responsibilities comes with different policy levers designed to address specific issues. The OCR is primarily used for monetary policy and bank capital requirements and loan-to-value ratio restrictions (LVRs) are primarily for macroprudential policy. One of the benefits of managing these different policies under one roof is the ability to use the different levers in concert with each other to manage side-effects and spillovers. We will be reviewing our LVRs and bank capital requirements in the context of the low interest rate world we are going to be living in for some time. Table 1: Central Bank functions Source: Adapted from Aldridge and Wood (2014). Beyond conventional monetary policy It is possible that some of the uncertainty in the current economic cycle is due to a question of whether central banks have enough policy space to respond to a future recession; or even if we can continue to service our mandates if inflation remains low. Although this scenario is far from our central projection in New Zealand, it is much better for us to prepare for unconventional monetary policy while the sun is shining. In the near future, we will publish the principles that guide our thinking on unconventional tools, and we are currently working our way through operational considerations of the different options. Having these tools ready, should we need them, will mean we can continue to contribute to a stable economic environment should the OCR reach zero. By getting this work done now and publishing our analysis, we can provide more certainty to the public over our ability to respond to any future downturns. We have also come to appreciate the increasing importance of stepping up our coordination with New Zealand’s fiscal authorities (the New Zealand Treasury) during unconventional times. Since 2018, an observer from Treasury has attended meetings of the Monetary Policy Committee as a non-voting member. The purpose of this initiative is to improve the flow of information between agencies. There are also ongoing conversations between the Reserve Bank and Treasury exploring the optimal arrangement for strengthening our coordinated response to future slowdowns. Fiscal policy, like monetary policy, acts with significant lags. Many of the first-best options for long-term investment have the longest lead times. It is therefore best to set plans in place sooner rather than later, lest a second-best response be rushed out at a later date, with lesser impacts that arrive too late. Applying our risk management approach: there is little downside to investing now, and many downsides if the spending comes too late. When we talk about unconventional monetary policy and fighting slowdowns, it is of course important to take a step back and look through the gloom: we are not in a recession, and we expect the economy to recover over 2020. It is possible that uncertainty could clear up in the coming year if there is closure on the topics of Brexit and trade tensions. We are readying ourselves if we need to act further. Conclusion Monetary policy is one tool. It needs to be seen in the context of all the Reserve Bank’s tools as well as the wider economic levers which have seen less in recent times. In these uncertain times we must continue to communicate and offer forward guidance as to future path of policy. Yes, there is uncertainty. Yes, it is affecting us. No, monetary policy cannot directly resolve this issue. But we can offset its effects and empower others to fuel economic activity that will benefit us in both the short and long-term. There has never been a greater time to make use of accommodative monetary policy for investing in productive assets. Meitaki, thank you. References Aldridge, T., & Wood, A. (2014). Monetary policy decision-making and accountability structures: some cross-country comparisons. Reserve Bank Bulletin, 77(1). Au, J. and Karacaoglu, G. (2018) Beyond GDP Measuring New Zealand’s wellbeing progress. Deloitte New Zealand State of the State Article 2. BIS (2019) Annual Economic Report. Brainard, L. (2018). What Do We Mean by Neutral and What Role Does It Play in Monetary Policy? A speech at the Detroit Economic Club, Detroit, Michigan (No. 1011). Callaghan, M., Cassion, E., Vehbi, T., & Wong, B. (2019). Opening the toolbox: how does the Reserve Bank analyse the world? Reserve Bank Bulletin, 82(4). Feldstein, M. (2017). Underestimating the real growth of GDP, personal income, and productivity. Journal of Economic Perspectives, 31(2), 145-64. Lisack, N., Sajedi, R., & Thwaites, G. (2017). Demographic trends and the real interest rate. Bank of England Working Paper No. 701. Nolan, P., Pomeroy, R., & Zheng, G. (2019). Productivity by the numbers: 2019. New Zealand Productivity Commission. Poloz, S. (2019) Toward 2021: The Power—and Limitations—of Policy. Remarks at The Chamber of Commerce of Metropolitan Montreal, Quebec. Powell, J. (2019) Challenges for Monetary Policy. Remarks at symposium sponsored by the Federal Reserve Bank of Kansas City Jackson Hole, Wyoming. Rice, A., Vehbi, T., & Wong, B. (2018). Measuring uncertainty and its impact on the New Zealand economy. Reserve Bank of New Zealand Analytical Note Series, AN2018/01. Rogoff, K. (2019). Is This the Beginning of the End of Central Bank Independence? G30 Occasional Paper 95. Vlieghe, G. (2019). Monetary Policy: Adapting to a Changed World. Speech given at the 2019 MMF Monetary and Financial Policy Conference. Bloomberg, London.
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Speech by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to the Goldman Sachs Annual Global Macro Conference 2020, Sydney, 29 January 2020.
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The Global Economy and New Zealand A speech delivered to the Goldman Sachs Annual Global Macro Conference 2020 in Sydney, Australia On 29 January 2020 By Christian Hawkesby, Assistant Governor1 1 With many thanks to Cameron Haworth for support. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tēnā koutou katoa. Thank you for inviting me to speak at this conference on a topic that is so relevant to a small open economy like New Zealand: the global economy. Before re-joining the Reserve Bank of New Zealand in March last year, I attended this conference a number of times, so appreciate its role in helping investors consider the global outlook across major regions as the year begins. As global investors, you are already well-informed on the state of the global economy. But I hope to add value by sharing two main insights: • outlining the framework we use at the Reserve Bank to analyse the global economy and its influence on New Zealand,2 and • applying this framework to the developments over 2019, and the risks into 2020. As our Monetary Policy Committee will begin meeting next week for the first time since November, my remarks will largely focus on how we think about the global economy, and do not represent the formal view of the Committee. What I would like to illustrate is that our Monetary Policy Committee work like a team, much like you would in an Investment Committee. You follow an investment process to analyse the global outlook for investment opportunities and risks, to make decisions on how to construct your investment portfolios; we analyse the global economy with an eye to the implications for our policy decisions to achieve our dual mandate for inflation and employment. Our full process is set out in the Monetary Policy Handbook.3 Background on 2019 Before I explain the influence of the global economy on New Zealand, it is useful to provide some brief context on the global economic environment through 2019. Two structural factors characterise the current global economic environment from a central bank perspective: • • low inflation, and low neutral interest rates (Figure 1). These factors have been driven by, among other things, ageing populations, globalisation, the success of inflation targeting, and low inflation expectations.4 Low inflation and low neutral interest rates have in turn pushed central banks to keep policy rates, such as our Official Cash Rate (OCR), low, in order to meet their objectives. 2 See Callaghan, Cassino, Vehbi, & Wong (2019). 3 See the Monetary Policy Handbook (Williams, et al., 2019). 4 See Hawkesby (2019). Inflation Dynamics: Upside Down, Down Under? Figure 1: Estimated real neutral interest rates % % US UK Euro area New Zealand -1 -1 Source: Bloomberg and Reserve Bank of New Zealand In addition to these structural trends, a number of cyclical factors contributed to a moderate global slowdown in 2019. A key factor was persistent policy uncertainty, particularly around Brexit and US-China trade relations. The slowdown experienced by our trading partners began to feed through to New Zealand, and was one part of our decision to lower the OCR by 75 basis points over the course of the year. Now let’s focus on how global slowdowns transmit to New Zealand. Global Transmission Channels: A Framework New Zealand is a small open economy that is tightly integrated with the rest of the world. Our economic growth cycle is highly correlated with those of our trading partners (Figure 2), and our financial system relies on funding from international markets. We are part of a global supply chain, and when global growth slows, so does ours. Figure 2: Annual GDP Growth in New Zealand and trading partners Source: Haver Analytics, Stats NZ, Reserve Bank of New Zealand estimates In aggregate, our internal models suggest that a one percentage point decrease in tradingpartner growth typically translates to a 0.6 percentage point decrease in New Zealand’s growth, and much of this occurs quite rapidly.5 We find it useful to split the impact of global shocks into three transmission channels (Figure 3), which I will address in turn: • • • trade channel; financial market channel; and uncertainty channel. Figure 3: How we analyse the impact of global shocks on the New Zealand Economy Source: Reserve Bank of New Zealand (Callaghan et. al., 2019) The Trade Channel The first channel of transmission is through global trade. When considering global influences on New Zealand exports, we have historically focused more on export prices than volumes. This reflects that in the past New Zealand’s exports have been dominated by primary sector products whose production volumes are relatively insensitive to fluctuations in short-term demand.6 Export prices tend to fall in tandem with the global economy—low global demand should lower prices. However, throughout 2019 several temporary factors held up New Zealand’s commodity prices. African swine fever spread throughout Asia, reducing pork supply and raising the demand and price of imported substitutes such as New Zealand beef and lamb.7 Global dairy production was also low, following dry summers in the rest of the world, which propped up our dairy prices.8 By contrast, our import prices declined in line with the global slowdown. General commodity prices continued their steady decline, while oil prices were relatively low. Overall, there has been a large gap between the commodity prices enjoyed by New Zealand’s exporters 5 See Callaghan, Cassino, Vehbi, & Wong (2019). 6 See Sullivan & Aldridge (2011). 7 See Taplin, Nathaniel (2020); there are early signs that China is starting to contain the crisis, with food price inflation slowing for the first time in ten months—though still at 17% year-on-year. 8 See Clayton (2019). compared to the low prices paid by our importers (Figure 4). This has led to a high terms of trade for New Zealand. Figure 4: Divergence of New Zealand commodity prices vs. global commodity prices Source: ANZ, UBS, Bloomberg, and Reserve Bank of New Zealand Another development worth noting is the increasingly diverse nature of our exports, with the growing importance of our service exports and the growth in the technology sector. Tourism was our number one export in the year ended March 2019, at $16b, marginally ahead of dairy.9 Unlike commodities, service exports are driven more by volume than price. Visitor numbers have flat-lined since the middle of 2019, predominantly due to falling American and Chinese tourists. This provides the most visible impact of US-China trade tensions on New Zealand’s exports. While our exports are still dominated by primary goods and tourism, technology is now New Zealand’s third largest export sector, with exports growing 11% to $8b and venture capital funding nearly tripling since 2016.10 Speaking to exporters through the course of last year, I was struck by how many remained upbeat about the opportunities for their own businesses, despite the global environment and trade tensions. This was often linked to perceived competitive advantages due to innovation or technology; or opening new export channels, rather than being dependent on how the global cycle affected their existing markets. Overall, the global slowdown does not appear to have had the same impact on New Zealand through the trade channel as in the past. The Financial Channel The second transmission channel from the global economy is through financial markets— particularly the credit spreads on offshore funding, and through the New Zealand dollar (NZD) exchange rate. 9 See Statistics New Zealand (2019). 10 Technology Investment Network (2019). This includes a mix of services and high-tech manufacturing. New Zealand is a net-debtor: we spend more than we save, borrowing the balance from the rest of the world. This improves the consumption and investment opportunities for New Zealanders as a whole, but also creates vulnerabilities.11 Changes in the cost of offshore funding can have a sizable influence on the New Zealand economy. Funding costs tend to move in line with risk appetite in global financial markets, with little variance between the four main Australian-owned banks that intermediate most of the borrowing. However, over 2019 offshore funding costs have been broadly steady around ‘normal’ postGFC levels (figure 5). Figure 5: Financial market funding spreads Source: Bloomberg and Reserve Bank of New Zealand The exchange rate is another key financial variable. The NZD tends to move closely with investor sentiment and normally acts as a shock absorber for the New Zealand economy; it appreciates with good global news and depreciates with bad news. When the global economy slows we tend to see a depreciation in the NZD, helping to provide some offsetting support to the net export sector and upward pressure on CPI inflation. As you can see from Figure 6, we moved to an easing stance and cut the OCR slightly ahead of our trading partners in 2019. As a result, our interest rates are now at a lower level relative to others than in the past, putting downwards pressure on our exchange rate. 11 See Bascand (2017) for an analysis of New Zealand’s foreign debt position. Figure 6: Policy Interest Rates Source: Reserve Bank of New Zealand (world rate has 80% weight on US and 20% on Australia) Our assessment is that if domestic interest rates had remained unchanged in 2019, the TWI would have been about 2–3 percent higher between March and November. The Real Trade Weighted Index is currently sitting around its average over the past 20 years (Figure 7). Figure 7: Real New Zealand Dollar exchange rate (Trade Weighted Index) Index Index Real NZD TWI Average 2000-2019Q3 Source: Bloomberg and Reserve Bank of New Zealand In summary, the trade and financial channels do not look like they have been a drag on New Zealand’s growth—if anything, they have helped insulate our economy from the global slowdown, helped in part by our shift to an easing bias in early 2019. The Uncertainty and Confidence Channel This leaves the final channel we consider: global uncertainty and confidence. Uncertainty is an ever-present part of the outlook for economies and markets. It is more a question of how much uncertainty there is, and whether this starts to impact the decision making and confidence of businesses and consumers. In the past, many global uncertainties have been relatively short-lived—particularly geopolitical tensions that have tended to come and go. Many spikes in global uncertainty prior to 2016 (Figure 8) tended to be reasonably temporary, eventually reverting back to more normal levels. What has distinguished the last few years is how these measures of global uncertainty have remained elevated for a prolonged period. Issues like Brexit and US-China trade tensions have persisted for much longer than initially expected, with the uncertainty evolving and changing rather than being fully resolved.12 Figure 8: Global uncertainty Source: Bloomberg Prolonged uncertainty can lead to falling business confidence and investment.13 We saw this globally in 2019 (Figure 9), with measures of business confidence falling in a relatively synchronised way for a number of countries. In New Zealand, business confidence has remained relatively low since 2017. In our latest round of visits across the country, businesses cited a number of domestic factors driving subdued confidence, including uncertainty around environmental policy, infrastructure, regulation and access to finance.14 12 See Orr (2019). 13 See Dixit and Pindyck (1994) for a discussion of business investment under uncertainty. While the effects of uncertainty on the economy are well-understood, the strength of these effects can be difficult to measure. The frameworks which exist for measuring the impact of uncertainty are also focused on shortterm uncertainty shocks and not prolonged periods of uncertainty. 14 See the Monetary Policy Statement, November 2019 (Reserve Bank of New Zealand, 2019a). So low business confidence in New Zealand cannot be entirely attributed to the global environment. However, it is likely to have been a factor that held back domestic business confidence from recovering sooner. The fact that measures of general business confidence in New Zealand have sat below measures of firms’ own activity also reinforces this idea that the global environment is likely to have influenced the general mood of businesses. Figure 9: Business confidence in New Zealand and other major economies Std dev Std dev -1 -1 -2 NZ-QSBO US Germany -3 -4 -5 Australia UK -2 -3 -4 -5 Source: Quarterly Survey of Business Opinion and Bloomberg The Future Outlook As the global economic outlook weakened over 2019, central banks around the world responded by easing policy. The question for us now is whether enough has been done, and how confident we can be of sustainably achieving our dual policy mandate for inflation and employment. Figure 10: Financial market expectations for OCR cuts Source: Bloomberg, Reserve Bank of New Zealand In more recent months, in response to a mix of domestic and global developments, markets have scaled back their pricing of further interest rate cuts in New Zealand (Figure 10). Back in early November, markets placed almost a 90 percent chance that the OCR would be at 0.75 percent by February, with some chance (around 15 percent) it would fall further to 0.50 percent sometime in 2020. Markets are now placing a smaller chance (less than 10 percent) of the OCR being cut to 0.75 percent in February, and a 40 percent of this happening sometime in 2020. Next week we will gather as the Monetary Policy Committee to begin our February round of meetings, working through our in-depth assessment of developments and forecasts, following our approach set out in the Monetary Policy Handbook.15 One of the only certainties when producing a set of economic forecasts is that they are unlikely to be exactly right. For that reason, we will also discuss and consider at length the risks and uncertainties to the economic outlook. A key part of that assessment will be, not only global developments, but how they are transmitted to New Zealand. Applying our threechannel framework will help us with that assessment. There remain a number of short-to-medium-term risks to both the upside and downside. To be clear, this is not intended to be an exhaustive list, but rather an illustration of where relevant issues might be considered: • Trade channel: If factors such as African swine fever and limited global dairy supply continue to support New Zealand’s commodity prices, this might create some upside risk to our terms of trade. However, should these temporary factors fade more quickly than expected, our export prices and terms of trade could fall. Additionally, any escalation of US–Iran tensions could lead to rising oil prices16 from a relatively low base, increasing our import prices and further lowering our terms of trade. • Financial channel: New Zealand credit spreads remained relatively low in 2019, despite heightened global uncertainties. How banks respond to the final decisions of our Capital Review announced at the end of 2019 remains a key uncertainty, with both risks to the upside and downside.17 On the currency front, as always, a key uncertainty will be whether the NZD plays its role as a shock absorber for the New Zealand economy by responding to changes in economic fundamentals; or whether it is driven by other factors. • Uncertainty channel: Brexit and US-China trade tensions were a persistent source of policy uncertainty through 2019. Recent developments—including the UK election and US-China phase one trade deal—have provided financial markets with some relief. If there has been genuine pent up demand, the global economy could rebound strongly as firms catch up with capital spending. By contrast, while financial market sentiment has improved, to the extent that Brexit and US-China trade policy uncertainties remain far from fully resolved, a sense of caution from businesses may continue for some time yet. In recent months, coronavirus is a human tragedy that has emerged that we will need to monitor, through all three channels. The SARS virus in the 2000s provides some potential parallels, particularly through the effects on travel and confidence.18 15 See the Monetary Policy Handbook (Williams, et al., 2019). 16 See DiSavino (2020) for a discussion of the recent volatility in oil markets. 17 See Capital Review Decisions (2019) and the Reserve Banks’s Credit Conditions Survey. 18 See Fan (2003) for the impact of SARS-like viruses. Looking to the longer term, there are a number of other challenges that we will need to consider. More work will need to be done on these issues to understand their impacts as they evolve. There are uncertainties, for example, about the future openness of international trade and labour markets. There has been a growing geopolitical trend globally towards protectionism and lower migration. Rising global protectionism could reduce our export opportunities and lower migration into New Zealand could dampen our growth, but might spur investments in domestic productivity. Climate change is also likely to impact New Zealand’s economy in a number of ways in the future. Growing environmental regulation of the primary sector, for example, could result in an acceleration in the diversification of our export industries. An ageing population may also affect New Zealand’s economy, impacting our savings and investment balance. This may further reduce the neutral interest rate in New Zealand and influence monetary policy. Conclusion As investors, you are trying to make sense of the global economy and the implications for investment opportunities and risks, stripping out the signal from the noise. Using a simple framework with trade, financial, and uncertainty channels helps us try and make sense of a complicated world, and the policy implications for New Zealand. I hope these insights prove useful. Good luck for your big investment calls in 2020. Tēnā koutou, tēnā koutou, tēnā tatou katoa. Thank you. References Bascand, G. (2017, July 17). New Zealand’s net foreign liabilities: What lies beneath, and ahead? A speech delivered to MOTU, at the Royal Society of New Zealand. Retrieved from https://www.rbnz.govt.nz/research-and-publications/speeches/2017 Callaghan, M., Cassino, E., Vehbi, T., & Wong, B. (2019). Opening the toolbox: how does the Reserve Bank analyse the world? Reserve Bank Bulletin, 82(4). Clayton, P. (2019, October 24). No growth in global milk supplies for 2019. Retrieved from Agriculture and Horticulture Development Board (UK): https://ahdb.org.uk/news/nogrowth-in-global-milk-supplies-for-2019 DiSavino, S. (2020, January 14). Oil edges up after five days of losses ahead of U.S.-China trade pact. Retrieved from Reuters: https://www.reuters.com/article/us-global-oil/oilprices-rise-ahead-of-trade-deal-likely-stock-draw-idUSKBN1ZD047 Dixit, A, & Pindyck, R. (1994). Investment under Uncertainty. Princeton University Press. Fan, E. X., (2003). SARS Economic Impacts and Implications. Asian Development Bank Policy Brief No. 15. Hawkesby, C. (2019, August 21). Inflation Dynamics: Upside Down Down Under? Panel remarks delivered to Bank for International Settlements forum at the Bangko Sentral ng Pilipinas. Retrieved from https://www.rbnz.govt.nz/research-andpublications/speeches/2019/speech2019-08-20 Holston, K., Laubach, T., & Williams, J. C. (2017). Measuring the natural rate of interest: International trends and determinants. Journal of International Economics, S57–S75. New Zealand Government. (2019, December 11). $12 billion in extra infrastructure investment. Retrieved from The official website of the New Zealand Government: https://www.beehive.govt.nz/release/12-billion-extra-infrastructure-investment Orr, A. (2019, November 14). Monetary Policy: A Compass Point in Uncertain Times. Panel remarks given to the Federal Reserve Bank of San Francisco. Reserve Bank of New Zealand. (2019a). Monetary Policy Statement November 2019. Reserve Bank of New Zealand. (2019b). Capital Review Decisions. Retrieved from https://www.rbnz.govt.nz/regulation-and-supervision/banks/consultations-and-policyinitiatives/active-policy-development Statistics New Zealand. (2019). Trade Dashboard. Retreieved from: https://statisticsnz.shinyapps.io/trade_dashboard/ Sullivan, R., & Aldridge, T. (2011). The outlook for commodity prices and implications for New Zealand monetary policy. Reserve Bank of New Zealand. Retrieved from https://www.rbnz.govt.nz/research-and-publications/research-programme/additionalresearch Technology Investment Network (TIN). (2019). The Investor's Guide to the New Zealand Technology Sector. Technology Investment Network (TIN) and Ministry of Business, Innovation, and Employment. Williams, R., Aziz, O., Kendall, R., Price, G., Ratcliffe, J., Richardson, A., . . . Wadsworth, A. (2019). Monetary Policy Handbook. Retrieved from https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/monetary-policyhandbook
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Speech by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to the Raising Māori Investment Capability Conference 2020, Tauranga, 13 February 2020.
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Kaitiakitanga: Te Ao Māori o Te Pūtea Matua (Guardianship: The Māori World View of the Reserve Bank) A speech delivered to the Raising Māori Investment Capability Conference 2020 in Tauranga, New Zealand On 13 February 2020 By Christian Hawkesby, Assistant Governor 1 1 With thanks to support from Eric Tong, Ngarangi Haerewa and Ngarimu Parata. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction E nga mana, e nga reo. E nga karanga maha o te wa. Tihei mauri ora! (To all authorities, all voices, to the many chiefs gathered here. Behold the breath of life! ) No Rangiora ahau Ko Waimakariri te awa Ko Aoraki te maunga Kei Poneke ahau e noho ana Kei Te Pūtea Matua ahau e mahi ana Ko Christian Hawkesby toku ingoa Tēnā koutou katoa (Hello, my name is Christian Hawkesby: my home town is Rangiora; my river is the Waimakariri; my mountain is Aoraki/Mt Cook; I reside in Wellington; and I work at the Reserve Bank of New Zealand.) Tauranga Moana, Tauranga Tangata Ngati Ranginui, Ngati Pukenga, Ngai Te Rangi Karanga mai Mihi mai Whakatau mai Tēnā koutou katoa (A sincere thank you to the district and people of Tauranga. I would like to give special thanks to the tribes of Ngati Ranginui, Ngati Pukenga, Ngai Te Rangi who have called us here; who have welcomed us here; who have looked after us here. Thank you very much). Māori investment capability is a topic close to my heart. Before re-joining the Reserve Bank – Te Pūtea Matua – last year, I spent eight years in the funds management industry. This gave me the privilege of working with a range of iwi clients, from the most sophisticated with 20 years’ investment experience, to those with recent Treaty settlements just starting their investment journey. Despite their differences, the common trait among them was a long-term, sustainable focus on inter-generational wealth and wellbeing. It was a culturally rewarding experience, to open my eyes, to build those relationships, and to start a better understanding. The focus of this conference is raising Māori investment capability – whakapiki i te pūtea. As part of that, I look forward to discussing our recent Monetary Policy Statement and Capital Review in the ample time we have for Q&A. Ahead of that, I would like to make a few opening remarks on a topic connected to Māori investment capability. That is, how the Reserve Bank is building its own capability in the Māori world – Te Ao Māori (Figure 1). Figure 1. Our Te Ao Māori approach Source: Reserve Bank of New Zealand I will outline its three elements: • cultural capability, • policy, and • engagement. The obvious opening question is: why does the Reserve Bank need to develop its understanding of Te Ao Māori? The very simple answer is that we are New Zealand’s central bank and Māori values are part of our national identity – how we see ourselves, and how we are viewed by the world. It is something that should mark the Reserve Bank of New Zealand apart as the central bank for Aotearoa. For me it took returning to New Zealand after living overseas for nine years to fully grasp this. While every New Zealander will have their own unique history and whakapapa, as a whole, Māori culture, and the relationship between Māori and Pākehā continue to mould our society. A strong awareness of this at the Reserve Bank is a basic part of our social licence to operate. 2 2 Orr (2019b). In service to society: New Zealand's Revised Monetary Policy Framework and the Imperative for Institutional Change. It is comforting to know that we are not alone as a central bank on this journey. Later this year we are partnering with the Bank of Canada and the Tulo Centre of Indigenous Economics (Canada), in an international symposium to understand indigenous economic issues the world-over. The ultimate goal is to bring this awareness from the periphery to the centre of central banks’ thinking. Cultural capability (Te Reo me ngā Tikanga) The first part of building our own capability is embedding Te Reo Māori (the Māori language) and Māori tikanga (customary practices or behaviours) into our organisational culture. While I am proud to have reached the modest (and slightly ambiguous) Ievel of ‘Advanced Beginner’ in my Te Reo, the most rewarding part of this has been seeing the enthusiasm of my colleagues. In particular, the passion of first and second generation New Zealanders to learn Te Reo. It has reinforced to me that many new New Zealanders see learning Māori culture as a key part of Aotearoa being their home and their identity too. Another key part of embedding Māori culture is developing the art of our storytelling. In that regard, with the approval of Northern hapu Te Roroa 3, we have borrowed the legend of Tāne Mahuta to connect with our stakeholders and tell the story of the Reserve Bank 4 (Figure 2). Figure 2. The journey of Te Pūtea Matua: our Tāne Mahuta 3 Northern hapu Te Roroa is the kaitiaki to Tāne Mahuta, the kauri tree in Waipoua Forest. 4 See RBNZ (2018). The Journey of Te Pūtea Matua: Our Tāne Mahuta. Matauranga Māori tells of when Papatūānuku and Ranginui, the earth mother and the sky father, embraced so tightly that life was shrouded in darkness. Tāne Mahuta came to separate them and let sunlight into the world. In the same vein, the Reserve Bank came into existence so that our unique economy could flourish. In the early 1900s, New Zealand’s currency was issued by foreign-owned banks, resulting in an economy that was foreign-led. To attain economic independence, the Reserve Bank was established in 1934 to issue New Zealand’s official currency and return mana to Aotearoa. In the same way that Tāne Mahuta is part of the forest and guardian – kaitiaki – of the forest, the Reserve Bank is guardian – kaitiaki – of the financial ecosystem. Our kaupapa is to maintain the highest trust in our organisation to ensure that Tāne will not wilt and lose mana. To remind us and our visitors of this metaphor and connection, you will soon start to see subtle physical changes in both our Wellington and Auckland offices. Policymaking (Kaitiakitanga) The second part of building our Te Ao Māori capability is through our policymaking. At the very simplest level, this is about explaining and describing how our mandate aligns with Māori values – in particular, acting as a guardian by taking a sustainable, long-term view of wealth and wellbeing. Let me offer a few examples at the heart of what we do. 1. Monetary policy The name of the Reserve Bank in Māori is Te Pūtea Matua. This literally means the parent or guardian of all the money. Over the past 30 years, we have lived up to that name by protecting the purchasing power of the New Zealand currency. The Reserve Bank was the first central bank in the world to adopt inflation targeting in 1989, with a view to ensuring that long-term inflation expectations are firmly anchored around our target. 5 By creating an environment of low and stable inflation, we aim to give New Zealanders the confidence to make long-term plans for their lives (Figure 3). Lewis et al. (2016). Inflation expectations and the conduct of monetary policy in New Zealand. Figure 3. Inflation and our history of inflation-targeting Source: Reserve Bank of New Zealand Yesterday, the Monetary Policy Committee decided to keep the Official Cash Rate (OCR) at 1 percent. Our decision was guided by our focus on achieving our inflation target and contributing to maximum sustainable employment. 2. Financial stability In addition to our price stability mandate, the Bank is also entrusted with guardianship to protect the efficiency and soundness of our financial system. Late last year, after much consultation, our Financial Stability Committee made the decision to raise the level of capital that banks would be required to hold. 6 Within a transition period of seven years, banks are required to raise the minimum capital from 8 percent to 16 percent (for large banks) or 14 percent (for small banks) of their risk-weighted assets 7 (Figure 4). 6 More is available at https://www.rbnz.govt.nz/regulation-and-supervision/banks/consultations-and- policy-initiatives/active-policy-development/review-of-the-capital-adequacy-framework-registeredbanks. 7 Reserve Bank of New Zealand. (2019a). Capital Review Decisions. Figure 4. Capital requirements before and after the Capital Review Decisions % Tier 2 capital Additional Tier 1 capital Common Equity Tier 1 capital % Old requirements (all banks) New requirements (ANZ, ASB, BNZ, Westpac) New requirements (other banks) Source: RBNZ Capital Review Go-to-Guide 2019 In reaching this decision, we formed the view that we should ensure banks hold enough capital to reduce the probability of a banking crisis to an event that may only happen once every 200 years. At its heart, this reflects an assessment of the deep harm that financial crises cause not only to the economy, but to the fabric of society and wellbeing of our citizens for a prolonged period. In this sense, our determination to safeguard the resilience of the financial system over the long term is comparable to the obligation to protect taonga for future generations. 3. Sustainable finance In recent years, central banks around the world have focused more on climate change and its impact on the financial system. We are part of the Network for Greening the Financial System (NGFS), which comprises a group of 50 central banks and regulators 8 (Figure 5). 8 See the NGFS website: https://www.ngfs.net/en. Figure 5. The Network of Central Banks and Supervisors for Greening the Financial System Source: NGFS website Our involvement has acted as a catalyst to use our role as a kaitiaki and financial regulator to challenge banks and insurance companies about how they are managing risks from climate change. 9 For example, does it make financial sense to lend to a company or industry that is following unsustainable environmental practices? Will that company or industry exist in the long-term to repay its loans, or will it fail and disappear due to new environmental regulations or pressures from broader society? What role can banks and insurers play to influence the companies they interact with, to help ensure they have sustainable long-term futures? In my mind, this shift in approach has strong parallels with the funds management industry. When I first started in funds management 10 years ago, investing according to Environment, Social and Governance (ESG) factors was a niche approach. The perception was ESG investing was a style for those investors who wanted to ‘do the right thing’ for moral reasons, and were willing to accept a lower return by reducing their set of investment opportunities. Roll the clock forward 10 years, and this view has been completely flipped on its head. ESG investing has grown rapidly and become a completely mainstream approach, with investors now asking, “Why would you invest in a company that is less likely to survive in the long-term due to its unsustainable environmental, social or governance practices”? Earlier this year, Larry Fink, the CEO of the world’s largest fund manager, Blackrock, said in his influential annual letter to clients that climate change has bought us to “the edge of a RBNZ climate change strategy - https://www.rbnz.govt.nz/financial-stability/climate-change/strategy. fundamental reshaping of finance” and that Blackrock is committed to “place sustainability at the centre of (its) investment approach”. 10 In many ways, these insights have long been laid out in the Māori world view, with its focus on the environment, sustainability and intergenerational thinking. You could argue that it has been a case of the modern investment world that we know today catching up with a Māori world view, rather than the other way around. At the Reserve Bank, we are aware that to be a good kaitiaki we must lead by example. In regards to our focus on climate change, we have pledged to: • monitor our own carbon footprint – our currency operations are by far the biggest component; • incorporate the impact of climate change on our core functions; and, • lead other institutions through collaboration. Notably, last year we invested US$100 million of our own balance sheet into bonds via the Bank for International Settlement USD Green Bond Investment Pool. 11 By joining other central banks around the world, we hope to help shape the landscape for green investment standards as they develop. In addition to working with central banks in the global arena, at home we have partnered with private and public agencies to tackle issues that reach across the financial system. Last year, we participated in the Sustainable Finance Forum (SFF) hosted by the Aotearoa Circle. The recently released interim report 12 draws upon the Māori world view of Kaitiakitanga, and proposes the principles and practice to reverse the decline of our natural resources. In particular, we endorse the Report’s recommendation to make climate change-related disclosure mandatory. Currently, 60 percent of surveyed banks (and a third of surveyed insurers) already disclose some information on climate risk. To improve data availability and consistency to investors – and to avoid companies ‘cherry-picking’ their ESG disclosures – we support further efforts towards a credible and workable climate reporting framework. There is still a lot more work to be done. We will be responding to the SFF’s call for leadership from government agencies in their own areas of expertise. For our part, the Reserve Bank will lead the Council of Financial Regulators (CoFR) work stream on climate change, to facilitate a smooth transition to a low-carbon and climate-resilient economy, while supporting the soundness and efficiency of the financial system. 13 10 Fink, L. (2020). A Fundamental Reshaping of Finance. Blackrock Letter to the CEOs. 11 Reserve Bank of New Zealand. (2019c). Reserve Bank confirms green bond investment. [Press release] 12 The Aotearoa Circle Sustainable Finance Report 13 Reserve Bank of New Zealand. (2019e). Council of Financial Regulators sets work priorities for 2020. Engagement (Whanaungatanga) The third and final part of building our Te Ao Māori capability is through engagement – both in person and with the economic data on the Māori economy. 1. Engaging in person To build and strengthen our understanding of the economy, we regularly meet with a range of partners and stakeholders to improve our understanding of industry practice and economic conditions. In September last year, Reserve Bank staff spoke with 63 businesses across the country. 14 Among them were 11 Māori organisations. We undertook these visits to better understand Māori businesses and the Māori economy, and start the process of building long-term relationships. From our business visits, we understand that while there are many different types of Māori businesses (Figure 6), they often have a common world view and approach. Māori businesses are often values-driven, and profit is not the only objective. Kaitiakitanga (environmental sustainability), Māoritanga (cultural security), Manaakitanga (social wellbeing), and broader intergenerational outcomes are key considerations. Figure 6. Māori economic ecosystem Source: Reserve Bank of New Zealand 14 Whāngārei, Auckland, Hamilton, Rotorua, Tauranga, Wellington, Christchurch, Queenstown, and Invercargill. Through our conversations with Māori businesses, we recognise that the consequences from climate change may fall disproportionally on the primary industries in which Māori businesses are concentrated. 15 We hear from you that collectively-owned assets pose challenges to accessing bank credit. While this may be seen as a disadvantage in the short term, in the long term, lower leverage can bring greater resilience to economic shocks and longer-term sustainability. This means, in the longer term, Māori businesses with collectively-owned assets may have a stabilising effect on the economy as a whole. This could be an advantage that attracts investment partners. What we see as pivotal is the continued growth of forums where Māori businesses can interact, exchange ideas, and lead the rest of the country. 16 With respect to this, we pay tribute to the Federation of Māori Authorities, Iwi Chairs Forum 17, Pou Taiao and others for their efforts in levelling information asymmetries across far-reaching and diverse networks for all Māori to thrive. 18 2. Engaging with data In addition to getting out to meet and talk with Māori businesses, we are also putting greater effort into analysing disaggregated economic data to build our understanding of the Māori economy. One striking statistic is the demographics of the Māori population (Figure 7). It highlights that Māori are likely to make up a growing proportion of our future population and labour force, and continuing influence on our culture. 15 Particularly fishing, forestry, and farming. 16 For example, the Poutama Trust, Te Puni Kokiri, and other regional Māori business networks. 17 Iwi Chairs Forum 18 See, for example, Pou Taiao Regional Engagement Hui 2018. Figure 7. Population by age and ethnicity 35 % % 35 Māori General Under 15 years 65 years and over Source: Reserve Bank of New Zealand A more sobering and confronting statistic is Māori unemployment. While down significantly from the 1990’s, Māori unemployment is still around twice as high as the national average (Figure 8). Figure 8. Unemployment rate Source: Statistics New Zealand On this, it is encouraging to see that Māori businesses continue to address structural barriers, for example, by bolstering governance capability, developing skills, and encouraging rangatahi (youth) into continuing education and training. Recently, our Governor put forward the idea of a ‘kaitiaki pledge’. It is a commitment towards all aspects of a kaupapa-driven approach to business, and utilises the synergies among economic profits, environmental sustainability, social inclusion, and cultural diversity. If tangata whenua are able to leverage this potential, it would certainly be a unique strength to the heart of current and future consumers and investors. 19 In the past, Business and Economics Research (BERL) have undertaken the most comprehensive studies of the Māori economy. 20 At the Reserve Bank, we need to do more to deepen our understanding of Māori economic statistics in order to achieve our dual mandate. Last year, our mandate was revised to incorporate the objectives of both price stability and contributing to maximum sustainable employment. This provides a direct motivation to better understand the Māori labour market. Te Ao Māori and policy decisions. Some might ask: So, will a focus on Te Ao Māori mean that the Reserve Bank will set the OCR or bank capital requirements differently? My guess is that it is it unlikely to be that stark. Our shift in focus will not be the one thing that prompts us to put up the OCR instead of putting it down; or lower capital requirements instead of raising them. However, we have no doubt that a richer understanding of Te Ao Māori will contribute to better policy making in the long run. Building strong relationships and understanding right across the economy and society helps give us the best chance of making good policy decisions, and enables us to communicate our approach back to our wide range of partners and stakeholders to build confidence and trust. I think the best recent example of this is our recent work on the Future of Cash (Te Moni Anamata). This involved an extensive consultation right across the country on the role of cash in our society, and prompted a huge reaction of over 2,000 responses. 21 We received a clear See ‘Emerging Challenges and Lessons from The Māori Economic Renaissance’ https://www.rbnz.govt.nz/research-and-publications/speeches/2019/speech2019-09-27. 20 See, for instance, Māori Economy in the Greater Wellington Region and Māori Economy in the Waikato Region. 21 Reserve Bank of New Zealand. (2019d). The Future of Cash Use - Te Whakamahinga Moni Anamata. Summary of Responses and Issues Paper. message that while the majority of people no longer use cash as their primary method of payment, there was a strong preference to still have cash as an alternative method for a variety of reasons, including giving koha as a Māori cultural custom. Furthermore, there is a notable segment of society – young, old, rural, isolated, digitally and financially excluded (Figure 9) – that are still reliant on access to cash. Māori are over-represented in this group. Figure 9. Digital inclusion in New Zealand Source: Digital Divide As a result of this work on the Future of Cash, we have proposed that the Reserve Bank is giving a formal stewardship – kaitiaki – role, with clear objectives, powers and tools to ensure New Zealander have an effective cash system and access to cash. Conclusion I’d like to express my thanks to Mana Taiao for hosting this event and for bringing together such an esteemed group. You are here this week as part of your journey to build Māori investment capability. At the Reserve Bank we are on a journey to build our capability and understanding of the Māori world – Te Ao Māori. So far we have learnt that we already have a lot in common. The spirit of kaitiakitanga aligns with the central bank as an enabler and protector. This is not a fad or a fashion. It is about giving us an opportunity to put the New Zealand back into the Reserve Bank of New Zealand, and the best opportunity to fulfil our mandate. In so doing, it bolsters our social licence to operate. Ultimately, this means that Te Pūtea Matua is able to better serve Aotearoa. But we still have a lot to learn. We look forward to building our relationships with you, and going on our journeys together. Nō reira, Rauawatia a Takitimu Kia puta i te ākau (Lash all the boards of the Takitimu canoe together, so that it is strong when out at sea.) Tēnā koutou, tēnā koutou, tēnā tatou katoa. (Greetings to you all. Thank you.) Glossary Aotearoa New Zealand Iwi The largest social units in Māori society. The Māori-language word iwi means "people" or "nation", and is often translated as "tribe", or "a confederation of tribes". Kaitiaki A term used for the concept of guardianship, for the sky, the sea, and the land. A kaitiaki is a guardian, and the process and practices of protecting and looking after the environment are referred to as kaitiakitanga. Kaupapa Values, principles and plans. Mana Mana is often referred to as status; a person with mana had a presence. While mana was inherited, individuals could also acquire, increase or lose it through their actions. Matauranga Māori Traditional Māori knowledge. Mauri An energy that binds and animates all things in the physical world. Mokopuna Grandchildren and future generations. Papatūānuku and Ranginui Papatūānuku and Ranginui are the primordial parents, the earth mother and sky father who lie locked together in a tight embrace. In Māori mythology, the primal couple appears in a creation myth explaining the origin of the world. Pou Taiao The support beam for the Environment (Iwi Chairs Forum Climate Change Group) Rohe The territory or boundaries of iwi. Taonga A treasured possession in Māori culture. Due to the lack of a direct translation to English and the significance of its use in the Treaty of Waitangi, the word has been widely adopted into New Zealand English as a loanword. Te moni anamata The Future of Cash. Te Pūtea Matua The Reserve Bank of New Zealand References Aotearoa Circle. (2019). Sustainable Finance Forum Interim Report 2019. Retrieved from https://www.theaotearoacircle.nz/sustainablefinance. Aziz, O., Kendall, R., Price, G., Ratcliffe, J., Richardson, A., Smith, C., Truong, E., Wadsworth, A., & Williams, R. (Ed.). (2019). Reserve Bank of New Zealand Monetary Policy Handbook. Retrieved from https://www.rbnz.govt.nz/monetary-policy/about-monetarypolicy/monetary-policy-handbook. Business and Economic Research. (2014). Māori Economy in the Waikato Region. Business and Economic Research. (2018). Māori Economy in the Greater Wellington Region. Fink, L. (2020). A Fundamental Reshaping of Finance. Blackrock Letter to the CEOs. Retrieved from https://www.blackrock.com/us/individual/larry-fink-ceoletter?mod=article_inline. Intergovernmental Panel on Climate Change. (2019). Summary for Policymakers. Climate Change and Land: an IPCC special report on climate change, desertification, land degradation, sustainable land management, food security, and greenhouse gas fluxes in terrestrial ecosystems. Lewis, M., McDermott, J., & Richardson, A. (2016). Inflation expectations and the conduct of monetary policy in New Zealand. RBNZ Bulletin. Vol. 79, No. 4. Ministry of Business, Innovation and Employment (2019). From the Knowledge Wave to the Digital Age. Mai I Te Ao Matauranga Ki Te Ao Matihiko Nei. Orr, A. (2019a). Emerging Challenges and Lessons from the Māori Economic Renaissance. Speech delivered to the Federation of Māori Authorities (FOMA) annual conference in Nelson. Orr, A. (2019b). In service to society: New Zealand's Revised Monetary Policy Framework and the Imperative for Institutional Change. Speech delivered at Wharewaka Function Centre, Wellington. Pou Taiao Regional Engagement Hui 2018 Reserve Bank of New Zealand. (2018). The Journey of Te Pūtea Matua: Our Tāne Mahuta. Retrieved from https://www.rbnz.govt.nz/about-us/the-journey-of-te-putea-matua-our-tanemahuta. Reserve Bank of New Zealand. (2019a). Capital Review Decisions. Retrieved from https://www.rbnz.govt.nz/regulation-and-supervision/banks/consultations-and-policyinitiatives/active-policy-development/review-of-the-capital-adequacy-framework-registeredbanks. Reserve Bank of New Zealand. (2019b).Mahi-Tahi agreement (MOU) with Te Taura Whiri I te Reo Māori (Maori Language Commission). Reserve Bank of New Zealand. (2019c). Reserve Bank confirms green bond investment. (27 September 2019). [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2019/09/reserve-bank-confirms-green-bond-investment. Reserve Bank of New Zealand. (2019d). The Future of Cash Use - Te Whakamahinga Moni Anamata. Summary of Responses and Issues Paper. Reserve Bank of New Zealand. (2019e). Council of Financial Regulators sets work priorities for 2020. (29 November 2019). [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2019/11/council-of-financial-regulators-sets-work-prioritiesfor-2020. Reserve Bank of New Zealand. (2019f). Reserve Bank supports Sustainable Finance Forum’s interim report release (31 October 2019). [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2019/10/statement-from-adrian-orr-in-support-of-thesustainable-finance-forums-interim-report-release Reserve Bank of New Zealand. Climate Change Strategy. Retrieved from https://www.rbnz.govt.nz/financial-stability/climate-change/strategy. Reserve Bank of New Zealand. Monetary Policy Statement November 2019. Reserve Bank of New Zealand. Monetary Policy Statement February 2020.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to Canterbury Employers' Chamber of Commerce, Christchurch, 21 February 2020.
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Aiming for Great and Best for Te Pūtea Matua A speech delivered to Canterbury Employers’ Chamber of Commerce in Christchurch On 21 February, 2020 By Adrian Orr, Governor of the Reserve Bank 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Ngai Tahu Karanga mai Ngai Tahu Call us Ngāti Mamoe, Waitaha Mihi mai Ngāti Mamoe, Waitaha greet us Ngai Tuahuriri Whakatau mai Ngai Tū-a-hu-riri Welcome us Aoraki-matatū tau o te katoa Mt Cook the Highest Peak the envy of all Tēnā koutou katoa, welcome everyone. Thank you for inviting me here again. It’s always good to be in Christchurch. Our board held a meeting here last year, and I was hosted by the Chamber for a speaking event last year too. Every time I return I admire the resilience and long–term strategic vision being shown, and truly sense your well-founded community spirit. It’s now two years since I was given the opportunity to lead the team at the Reserve Bank – Te Pūtea Matua. You may also sense my pride in the role and the Bank. For many people, their understanding of the role of the Reserve Bank is limited to setting the level of the Official Cash Rate and/or providing notes and coins for New Zealand. However, our remit and goals are much broader than just those important functions. I will outline some of these tasks and challenges today. Shortly after I joined the Bank we outlined our ambitious vision to be a ‘Great Team and the Best Central Bank’.1,2 They say the first step to running a marathon is to tell everyone of your intention. This is our marathon. It was apparent that the Bank needed to evolve – as do all businesses – to be able to meet new challenges, risks, and opportunities. These challenges ranged across, for example, record low international interest rates, changing societal expectations of business conduct and culture, a broader regulatory remit, new and emerging technologies and, of course, climate change. Reserve Bank Vision. https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/about/ReserveBank-Vision-Statement.pdf?revision=e45876a4-8538-41f7-8883-8a179d619931&la=en Statement of Intent 2018-2021, https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Statements%20of%20Intent/soi-2018.pdf?revision=7501d6f8-74204f48-b161-cdd10c86698e The Bank’s’ legislation, and core functions and capabilities, were established over 30 years ago. Over time they have become increasingly stretched to continue to best promote the prosperity and wellbeing of all New Zealanders. Good progress has been made over the past two years to modernise our legislation, and update the Bank’s governance and accountability settings. Of course, there is still much work to be done to ‘dot the i and cross the t’ on the important details of these settings and how they are to be implemented. As kaitiaki (guardians) of Te Pūtea Matua, we have a unique opportunity to inform the design and deliver the current and future legislative changes. We are working closely with our New Zealand Treasury colleagues on this important challenge. At the same time we have also embarked on getting the Bank into shape to manage this transformation. We are focused on investing in the capability and capacity of our team and systems, so as to be a high performing ‘Great Team’. I want to acknowledge the support, guidance, and expertise of my colleagues. It’s a privilege to work with such a wide range of talented and committed people. It certainly makes my job a lot easier. Tāne Mahuta – telling the Bank’s story We are working for all current and future New Zealanders. Hence it is important for our legitimacy and reputation that a broad cross-section of New Zealanders – not just a narrow field of technical experts and regulated institutions – are interested in and understand our activities. Where your central bank fits, what we do, and what we don’t do. The tagline on our website says that the Reserve Bank – Te Pūtea Matua – manages monetary policy to maintain price stability, promotes the maintenance of a sound and efficient financial system, and supplies New Zealand banknotes and coins. While accurate, it doesn’t exactly foster intrigue or do justice to the role the Central Bank plays in New Zealand’s society. To improve on public awareness and in partnership with northern hapu Te Roroa,3 we recently chose to tell our story – the story of Te Pūtea Matua – using the Māori legend of Tāne Mahuta.4 The Reserve Bank has long adopted a role akin to the being the Tāne Mahuta of New Zealand’s financial landscape. Our roots are our legislation, outlining our purpose and giving us strength (legality and operational rights) and well-being (resourcing). The money we print and circulate for New Zealand is the sap that flows through Te Pūtea Matua, ensuring New Zealanders have a means of exchange, a store of value, and a currency that is hard to replicate. Our monetary policy actions – keeping consumer price inflation low and stable – are to ensure that our currency retains its store of value. The complex payment and settlement systems we operate – which effectively bank the banks and broader financial institutions – are our trunk. They in large part allow the money to flow to the branches of Te Pūtea Matua, which are the financial institutions that have chosen and are allowed to operate in Aotearoa, New Zealand. These financial institutions are so important that we need to establish rules and supervision to ensure they are of appropriate quality and robustness to remain grafted to Te Pūtea Matua. Some of the banks are so large that, should they fail, they could bring our whole system down. For this reason we need to ensure the systemically important banks remain grafted on and can keep working even if the current owners are gone. These closely interrelated functions enable Te Pūtea Matua to protect, nurture and grow New Zealand’s wider financial ecosystem for the greater benefit of all New Zealanders. Being able to tell a story about our purpose and activities brings several advantages. Our own team is reminded of how all of our tasks are connected - creating a supportive culture. We are able to relate the complex story of central banking and financial stability to a broader audience. We are reminded of our interconnectedness to the wider financial ecosystem of The Bank visited Te Roroa in 2018 for permission to use the visage and story of Tāne Mahuta, the kauri tree. The Journey of Te Pūtea Matua Our Tāne Mahuta, 2018, https://www.rbnz.govt.nz//media/ReserveBank/Files/the-journey-of-te-putea-matua/The-Journey-of-Te-Putea-Matua-Our-TaneMahuta.pdf?la=en&revision=1506f281-753d-4206-ba0c-dd5f1f556131 New Zealand, as well as other regulator colleagues. And, we are made to think a lot harder about what makes Te Pūtea Matua unique – we are New Zealand’s central bank. This is why we support our Tāne Mahuta narrative with a broader Te Ao Māori undertaking at the Bank. We need to understand and respect our history, and we can gain unique insights into the New Zealand economy, such as the benefits of longer-term thinking. Our team work to enable a virtuous circle economic prosperity, environmental sustainability, financial inclusion, and cultural diversity in Aotearoa, New Zealand. Our Te Ao Māori strategy is helping inform our policy programmes, broaden our external stakeholder engagement, and grow our internal cultural capabilities.5 Navigating a challenging monetary environment – developing our roots The Government’s review of the Reserve Bank’s legislation has been underway for the past two years. The first leg of this work is completed and is operating well.6 This work established a dual mandate for monetary policy of low and stable inflation, and contributing to maximum sustainable employment. The work also established a Monetary Policy Committee that is responsible for interest rate decisions. We have now made six Official Cash Rate (OCR) decisions – as a committee. We have managed robust discussion and come to consensus decisions. The nature of these discussions is published as a ‘Record of the Meeting’ for all to see. We also won this year’s Central Bank award for transparency in how we operate.7 I am proud to note that consumer price inflation is currently very near the mid-point of the target range (at 1.9%) and that employment is at, if not slightly above, our current broad estimate of maximum sustainable employment.8 5 RBNZ Speech – Federation of Māori Authorities (FOMA), Sep, 2019 https://www.rbnz.govt.nz/- /media/ReserveBank/Files/Publications/Speeches/2019/speech2019-09-27.pdf?revision=75976566-d7b944a0-9d6b-94a876a96a00; RBNZ Speech – Raising Māori Investment Capability Conference, Feb 2020, https://www.rbnz.govt.nz/research-and-publications/speeches/2020/speech2020-02-13 Monetary Policy Statement, Feb 2020, https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Monetary%20policy%20statements/2020/mpsfeb20.pdf?revision=119 0300f-2716-47e2-a5cf-44bc5daba049&la=en; Reserve Bank of New Zealand (Monetary Policy) Amendment Bill http://legislation.govt.nz/bill/government/2018/0079/latest/LMS65426.html?src=qs RBNZ Media Release - https://www.rbnz.govt.nz/news/2020/02/rbnz-monetary-policy-handbookinternationally-recognised-for-transparency 8 Monetary Policy Statement, Feb 2020, https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Monetary%20policy%20statements/2020/mpsfeb20.pdf?revision=119 0300f-2716-47e2-a5cf-44bc5daba049&la=en Of course we are forward-looking, given the lags between setting monetary conditions and then observing the inflation and employment outcomes. Our recent February Monetary Policy Statement outlined that we intend to keep the OCR at a low level for some time to come so as to best ensure we continue to deliver our mandate. We have highlighted the risks associated with our outlook for economic activity, and hence inflation and employment, in particular noting the evolving disruption that the spread and severity of the COVID-19 virus is causing to international production and spending. Looking ahead, there remains much for us to learn about New Zealand’s unique labour market, and how we can best support and meet our employment objective. Likewise, there is much to learn about operating monetary policy in the current, unprecedented, low interest rate environment. We are in a relatively favourable position at present, given our current positive inflation and employment outcomes, and with the OCR at 1 percent, above many of our OECD central bank colleagues. But we need to be prepared for the unanticipated. In partnership with the Treasury, we continue to assess how we can effectively and efficiently operate monetary policy should interest rates reach zero. You will hear more about this in weeks to come, but business will continue as usual. The next leg of the Reserve Bank’s legislative review is also well advanced – refreshing our broad mandate and our institutional governance arrangements. The Government’s recent decisions on the Bank’s future governance arrangements involves a more legally empowered Board that is responsible for all of the Bank’s functions other than those undertaken by the Monetary Policy Committee.9 The Bank will also have a broader financial stability mandate, better clarifying our regulatory purposes and powers, and financial crisis management processes. These are positive changes and we are preparing for the new regime. However, there are still significant details and important decisions to be made. A final round of public consultation will occur soon, as we look to establish key aspects of our regulatory perimeter, crisis management, and enforcement tools.10 I encourage your interest as we need your insight and support. RBNZ Media Release - https://www.rbnz.govt.nz/news/2019/12/reserve-bank-welcomes-governmentdecision-on-banks-future-objectives Phase 2 Review - https://treasury.govt.nz/news-and-events/reviews-consultation/reviewing-reserve-bankact Of special interest to me, as a CEO, is that there is appropriate arrangements between governance and management. We are currently working on a framework that includes: clarity of purpose, a bank-wide ‘Risk Appetite Statement’, agreed strategies, appropriate delegations, and measurable goals that will enable a smooth transition. Futureproofing our ‘sap’ – the cash We are the sole provider of New Zealand banknotes and coins, as well as overseeing all, and operating some, of the countries payment and settlement systems.11 These roles are increasingly challenging as the dynamics of cash use change, payment systems technology evolves, and our physical equipment (including vaults) depreciate and need upgrading. We are obliged to consider and embrace innovative solutions to ensure that all New Zealanders’ currency and transactional needs are met in an efficient and secure manner. And, we want to ensure these innovations retain and promote financial inclusion. Work is underway to address these challenges with our ‘Future of Cash’ programme – Te Moni Anamata – to make sure that New Zealanders, the financial system, and the Reserve Bank are ready and resilient to changing uses and demands for cash.12 Our work to date has led us to expect a ‘less cash’ not ‘cashless’ society evolving rapidly. Why not cashless? There are many reasons, in particular cash plays a critical role in ensuring financial inclusion and enabling business continuity. We have heard loud and clear that the public insist on cash remaining as a payments option, even though the economics are evolving. Over coming months we need to make decisions on our safe keeping and distribution of cash. This will require legislative and industry collaboration to support the wider public good. Another important milestone will soon be reached. This is a full replacement of our Payment and Settlement Systems. This is the sharp end of a multiyear project that looks to renew New Zealand’s inter-bank settlement system and central securities depository.13 Reserve Bank – What We Do - https://www.rbnz.govt.nz/about-us/what-we-do Reserve Bank Future of Cash - https://www.rbnz.govt.nz/notes-and-coins/future-of-cash Reserve Bank Payments System Replacement - https://www.rbnz.govt.nz/markets-andpayments/payments-system-replacement The Reserve Bank has both an oversight and operational role in the payment system in New Zealand. The operational activities of the payment system include the provision of currency and a range of payment and settlement services. The Bank also has an important role to play in supporting the financial sector’s cyber resilience. Cyber-attacks globally are rapidly evolving and highly contagious. Our role as the central bank means we can promote and enable the sharing of financial industry information and coordinate responses to improve system resilience. Our work ahead in the near-term is to embed industry guidelines, standards, and practices in the financial sector so we can best work together in the interests of all New Zealanders. Raising industry standards – Growing our ‘branches’ The branches of Te Pūtea Matua are the regulated financial institutions that have chosen to do business in New Zealand, and have been registered consistent with our rules and expectations.14 This includes 26 registered banks and more than a hundred insurers and non-bank deposit takers. To sustain New Zealand’s financial stability, it is important that people – customers, service providers and regulators – are able and willing to identify, price, allocate, and manage their financial risks appropriately. This is both difficult to say and ensure. It requires sound conduct and culture by all financial institution participants, self-discipline to ‘do the right thing’ or face consequences, and transparency so that good behaviours are evident and rewarded, and bad practices driven out. Institutions can and will fail for a host of reasons. Likewise, people will make mistakes, operate on limited or misunderstood information, and act in their short-term interests rather than their long-term wellbeing. We as the ‘prudential’ regulator, supervisor, and enforcement agency of New Zealand’s financial system have a critical role to play. We are looking to lift our game as the challenge becomes more complex with time.15 Register of banks -https://www.rbnz.govt.nz/regulation-and-supervision/banks/register; Register of non-bank-deposit takers - https://www.rbnz.govt.nz/regulation-and-supervision/non-bank-deposittakers/register; and Register of licensed insurers - https://www.rbnz.govt.nz/regulation-and-supervision/insurers/licensing/register Media release – Relationship Charter https://www.rbnz.govt.nz/news/2018/12/reserve-bank-aims-for-bestregulatory-relationships We have signalled that we have more regulatory and supervisory work to do in the insurance sector, as well as completing a long list of multi-year projects amongst the banking and broader deposit taking sector.16 The insurance sector is that part of the ecosystem that society relies heavily on to both mitigate risks, and/or transfer the risk-burden to those best able to manage it. However, our most recent analysis revealed ongoing challenges related to the solvency and customerservice focus of some sectors of the insurance industry.17 We need to enable appropriate insurance cover to be available and delivered in New Zealand, and ensure that insurance providers’ have the ability to meet customer requirements in the event of adverse shocks.18 We’ll be focusing our efforts this year to address these issues as part of our review of New Zealand’s Insurance Act.19 Another key challenge for the Bank will be calibrating a more intensive supervision and enforcement regime, as well as increasing the capability and capacity of our team to undertake this work. Our focus on building our resources in Auckland – where a significant number of our regulated institutions have their head office – reflects our intention to lift our oversight. We will also continue to engage with banks and other deposit takers on their risk-assurance processes and, if necessary, work with banks to strengthen these controls and commitments. We are proud of our long and thorough consultation process and, final decision making on the appropriate level of capital banks should hold, to ensure they are sound in the New Zealand environment.20 We must now ensure that these requirements are achieved on ongoing basis. Given the fundamental importance of accurate capital and liquidity calculations, the Reserve Bank expects directors to continue to focus on these as part of their attestation process. Reserve Bank Statement of Intent 2019-22, https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Statements%20of%20Intent/soi-2019.pdf?revision=c2dfbe83-e6aa4bd2-9923-a3240a40d0ce Reserve Bank Bulletin, An overview of the life insurance sector in New Zealand Vol. 83, No. 1, January 2020, https://www.rbnz.govt.nz/media/ReserveBank/Files/Publications/Bulletins/2020/rbb2020-8301.pdf?revision=ae2e8917-076f-45ec-9d48-b65135bb74d5 Reserve Bank Financial Stability Report, Nov 2019, https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Financial%20stability%20reports/2019/fsr-nov2019.pdf?revision=f6f207b0-9248-46a2-91bb-79519010b566 Review of the Insurance Prudential Supervision Act 2010 https://www.rbnz.govt.nz/regulation-andsupervision/insurers/consultations-and-policy-development-for-insurers/active-policy-development/reviewof-the-insurance-prudential-supervision-act-2010 20 RBNZ Media release – Capital Review announcement https://www.rbnz.govt.nz/news/2019/12/higherbank-capital-means-safer-banking-system-for-all-new-zealanders Equally, we have our own work to do to ensure that the information we release is accessible, relevant, and easy to understand. We’ve made good progress in some areas. An example of this is the financial strength Dashboard providing more meaningful information about New Zealand’s banking business and its relative risks.21 But, we need to take a broader approach, working with other agencies, to improve financial literacy and improve participation and inclusion in New Zealand’s financial system. A key area we are advancing is the relevance and effectiveness of the Council of Financial Regulators (CoFR).22 This cross-agency forum is committed to developing a collective view on longer-term priorities for our financial system and deliver collaborative solutions. We have a list of seven priorities that includes climate change, financial inclusion, conduct and governance and FinTech.23 Amongst the issues we are working collaboratively on at COFR is the economic risks imposed by climate change. Climate change will continue to have a significant effect on New Zealand’s economy and financial system.24 Our overarching objective is to contribute to the Government’s objective of a sustainable, productive and inclusive economy, and to facilitate, where possible, a smooth transition to a low carbon economy. Climate change presents the banking and insurance sectors with immediate and critical challenges. For this reason we are involved in many different pieces of climate-related work – from assisting our Treasury colleagues, to working with industry group ‘The Sustainable Finance Forum’ on sustainable finance initiatives, to helping our domestic agencies finalise proposals to enhance New Zealand’s reporting and disclosure framework.25 We are also part of the central bank ‘Global Network for Greening the Financial System’, which provides us with access to the latest policy thinking and guidance for central banks and regulators around the world. Bank Financial Strength Dashboard - https://bankdashboard.rbnz.govt.nz/summary RBNZ Media Release – COFR Terms of Reference, https://www.rbnz.govt.nz/regulation-andsupervision/banks/relationships/council-of-financial-regulators-terms-of-reference RBNZ Media Release – COFR Work Priorities - https://www.rbnz.govt.nz/news/2019/11/council-of-financialregulators-sets-work-priorities-for-2020 RBNZ Climate Change - https://www.rbnz.govt.nz/financial-stability/climate-change RBNZ Financial Stability Report, https://www.rbnz.govt.nz/financial-stability/financial-stability-report/fsrnovember-2018/the-impact-of-climate-change-on-new-zealands-financial-system The investment implications of climate change is also a topic that we are looking at and contributing to policy and regulatory discussions on. We will look for more opportunities to further support sustainability through our own investments.26 Building a modern fit for purpose central bank As is evident from this long list of ‘to dos’, for us to continue to be successful we need to grow our capability and capacity, and improve on what we do. There are real operational, legal, financial, and reputational risks to the Bank, and New Zealand’s financial landscape, if we don’t make the appropriate investments in a timely manner. The direct and opportunity costs of falling behind on investment are significant – witness the cost of bank failures, and financial volatility and uncertainty, in recent history and ongoing today in some countries. At the very least we must meet international regulatory standards, which are viewed as a license to operate internationally. We have had this made clear to us from the International Monetary Fund, the Financial Action Task Force, and the Bank for International Settlements, amongst others. We need to enable New Zealand businesses on the international stage, and minimise the chance of organised criminal and terrorists groups trying to exploit New Zealand's financial system.27 We also want to enable New Zealand’s leadership role in our own region of the world while managing financial risks. A good example is our growing role in the Pacific. New Zealand is a relatively small economy by global standards, but we are an important part of a region of many, much smaller, Pacific economies. Our Pacific neighbours depend heavily on remittances from people working and living in New Zealand and Australia. The average cost of remittance is 10 – 12 percent. This is higher than the global average cost of 7 percent and the UN’s sustainable development goal of 3% globally.28 As such, it is important that we gain confidence in the efficient working of this market with a view to seeing this price come down. Many firms and/or individuals struggle to get the necessary bank accounts in New Zealand to be able to lower this cost, with this challenge exacerbated by international requirements established to counter money laundering and the financing of terrorism. This combination of circumstances has prompted us to work closely with the Reserve Bank of Australia, our RBNZ Media Release - https://www.rbnz.govt.nz/news/2019/09/reserve-bank-confirms-green-bondinvestment AML / CFT - https://www.rbnz.govt.nz/regulation-and-supervision/anti-money-laundering/guidance-andpublications The World Bank https://remittanceprices.worldbank.org/en respective Foreign Affairs agencies, and with other Pacific nations’ central banks and international agencies to find a solution. A key part of any solution is getting the region’s retail banks to work with us. Success will take a collective effort – as the returns to any one party do not justify the effort alone. The Bank is proud to be providing capability and leadership.29 There are also significant one-off operational risks and costs if we continue to try and make do with outdated technology that is not effective, efficient, or safe. Digital ‘cloud-based’ operations are now benchmark tools for people to operate effectively and manage risks. We must remain on the frontier of technology development and risk mitigation. Likewise the safe storage and distribution of cash in New Zealand should be a basic hygiene issue for us, not something we risk through underinvestment. Finally, and perhaps most importantly, we need to be able to attract and retain the appropriate talent that can lead the Bank into the future. Our people capability and capacity continues to rise, as does our diversity and inclusion. These features should be selfreinforcing. Clarity of purpose and appropriate resource and equipment are key to ensuring we are an attractive workplace. In addition we are also embracing our unique cultural history through our Te Ao Māori strategy, as well as ensuring we are open-minded and unbiased in our employment strategies, to gain access to the best skills and capabilities available to ensure we continue to succeed. Realising our vision ‘Great Team, Best Central Bank’ In summary, I have stated our drive to be a Great Team and Best Central Bank. To monitor our progress we need people to understand what we are doing and why, and be encouraged and enabled to provide constructive advice. This is why we are deliberately revamping our engagement capability. All marathon runners need encouragement and direction. I am confident the work the Bank has embarked on is necessary, timely, appropriately ambitious, and challenging. We have a strong belief in the long-term benefit of our work for all New Zealanders, and given the tools and resources necessary to do the job, I am also confident we will succeed. Meitaki ma’ata Tēnā koutou, tēnā koutou, tēnā koutou katoa RBNZ Media Release – Joint Statement from South Pacific Governor’s Meeting https://www.rbnz.govt.nz/news/2018/11/joint-statement-from-the-south-pacific-governors-meeting
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Reserve Bank of New Zealand Museum and Education Centre, Wellington, 10 March 2020.
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Navigating at Low Altitude: Monetary Policy with Very Low Interest Rates A speech delivered at the Reserve Bank of New Zealand Museum and Education Centre On 10 March 2020 By Adrian Orr, Governor1 With deep appreciation of the dedicated team which has worked on these principles and tools. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Navigating at Low Altitude: Monetary Policy with Very Low Interest Rates Introduction The Reserve Bank of New Zealand, Te Pūtea Matua, is tasked with promoting a sound and dynamic monetary and financial system. 2 We enable New Zealanders to get on with their daily lives with the maximum confidence possible about their means of exchange (money), its purchasing power here and abroad, and the reliability and efficiency of critical financial services they rely on. This is our contribution to Aotearoa, New Zealand, to “promote the prosperity and well-being of New Zealanders, and contribute to a sustainable and productive economy.” 3 As kaitiaki (caretakers) of Te Pūtea Matua, our activities involve continuous policy assessment as to the most effective monetary policy and financial stability tools, and their best application. This is highlighted by the ongoing Reserve Bank Act Review, which is aimed at ensuring we have a modern monetary and financial policy framework. 4 The optimal frameworks can change over time based on global economic activity, changing technology, and evolving consumer and investor preferences as to how they transact and engage with the financial system. We must be able to identify and respond to circumstances in an optimal fashion to continue to meet our mandate for Aotearoa, New Zealand. A significant change is confronting our work at present, namely the low global (consumer) price inflation which has led to unprecedentedly low global nominal interest rates. Our monetary policy framework needs to operate effectively and efficiently in this low inflation and interest rate world, and we must be aware of the intended and unintended consequences of our policy actions for inflation, employment, and financial stability and efficiency. Today, I wish to outline how we got here, what the implications are for economic policy choices – including monetary and fiscal policy - and how Te Pūtea Matua has prepared itself to succeed. This speech is about making sure our monetary policy framework remains effective. I do not discuss the outlook for our Official Cash Rate (OCR) as this is the task of our Monetary Policy Committee. Their next assessment of the OCR is scheduled for March 25. We also have no immediate intention to use the alternative monetary policy tools discussed in this speech. Any perceived monetary policy signals in this speech are thus in the eyes of the reader only and not intended by the author. Reserve Bank of New Zealand Act 1989 (RBNZ Act), http://www.legislation.govt.nz/act/public/1989/0157/latest/DLM199364.html The purpose of the Reserve Bank, as set out in the RBNZ Act. Treasury webpage on the Reserve Bank Act Review, https://treasury.govt.nz/news-andevents/reviews-consultation/reviewing-reserve-bank-act I appreciate the heightened interest in our activities in the current economic environment and want you to rest assured that Te Pūtea Matua is fulfilling its broad role including ensuring a well-functioning financial system. The monetary policy mandate of Te Pūtea Matua The Reserve Bank is legally mandated to achieve and maintain stability in the general level of prices over the medium-term, and support maximum sustainable employment. When achieving these outcomes we must also have regard to the efficiency and soundness of the financial system, seek to avoid unnecessary instability in output, employment, interest rates and the exchange rate, and set policy with a medium-term orientation. 5 Our mandate is an outcome of decades of economic research and practical experience both here and abroad. It reflects the significant economic costs of high and variable inflation, the importance of having an operationally independent central bank with capability to achieve and manage stability in general prices, and the economic trade-offs that will occur as economic conditions change through time. Our monetary policy – as in the majority of OECD countries – is typically implemented by controlling the short-term policy rate, in New Zealand the OCR. This operates through a simple principle: higher interest rates tend to lead to lower economic activity in the short-term and hence lower employment and inflation than would otherwise be the case. For lower interest rates, the opposite is true. Of course, this is simple but not easy. Underlying the relationship are complex transmission mechanisms that link the level of interest rates to inflation and employment. The Reserve Bank’s Monetary Policy Handbook provides a stylised guide to the monetary policy transmission mechanism. 6 Figure 1 provides a walk-through of the five main channels from shifting the OCR through to employment and inflation. These channels are savings and investment decisions; cash-flow access; asset prices and wealth; the NZ dollar exchange rate; and inflation expectations. Remit for the Monetary Policy Committee April 2019, https://www.rbnz.govt.nz//media/ReserveBank/Files/Monetary policy/About monetary policy/Remit-for-the-Monetary-PolicyCommittee-April-2019.pdf Monetary Policy Handbook, https://www.rbnz.govt.nz/monetary-policy/about-monetarypolicy/monetary-policy-handbook Figure 1: The monetary policy transmission mechanism Source: RBNZ. All of the monetary policy channels discussed are affected by one significant consideration for the economy of Aotearoa. New Zealand’s economy is small and open to the swings and roundabouts of global economic activity through our trade, capital flows, and migration. Global economic, political, and financial market developments have a significant impact on our domestic economic activities – and hence the appropriate monetary policy setting to meet our mandate. Unprecedented low global interest rates Largely since post the ‘Great Financial Crisis (GFC)’ of 2008, global inflation and interest rates have been remarkably low. New Zealand’s neutral interest rate (i.e., the rate that, on average over time, would be consistent with no over- or under-utilisation of resources and stable inflation) has declined considerably (Figure 2), and we have had downward pressure on domestic inflation. Figure 2: Neutral interest rate estimates % % Suite of neutral interest rate estimates Official Cash Rate Suite (mean) Source: RBNZ. Global inflation has been declining for a variety of reasons over recent decades (Figure 3). 7 In part the low and stable inflation rates are a sign of success of central banks’ focus of monetary policy on achieving and maintaining this goal. Hawkesby, C. (2019). ‘Inflation Dynamics: Upside Down Down Under’, speech delivered at the BIS forum at the Bangko Sentral ng Pilipinas in Manila on 21 August 2019. Figure 3: Inflation in select advanced economies % New Zealand Australia United Kingdom United States Euro area % -5 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 Source: World Bank. -5 In addition, positive productivity shocks – through innovation and technology – has reduced the prices of many manufactured consumer goods. Likewise, the advent of open global trade and ‘single price’ discovery via the internet has led to competition and further reductions in price levels and inflation. Finally, there have been significant influences on the level of ‘neutral interest rates’ globally, including ageing populations with less propensity to consume, reduced wage bargaining leverage for workers as labour mobility and product sourcing has broadened, and declining productivity growth as technologies have matured. On top of these long-term trends towards lower rates, adverse cyclical events - especially during and post the GFC - have driven many central banks to reduce interest rates to their effective lower bound (Figure 4) as a means to stimulate demand i.e., to continue to meet their inflation mandate. Figure 4: Central bank policy rates in select advanced economies Source: Bloomberg. Monetary policy instruments in times of record low interest rates As central banks’ policy rates approached their effective lower bounds, they have had to find other ways to influence peoples’ spending/saving habits, the exchange rate, the slope of yield curve, and the flow of credit through their economies. A growing number of central banks have gradually introduced a set of new monetary policy measures – that are coined as ‘unconventional monetary policy tools’ – to continue to meet their inflation mandate (Table 1). These tools came under the general headings of: negative interest rate policies; lending operations to banks; large scale asset purchase programmes (otherwise known as ‘quantitative easing’); and forward guidance (telling people what the central bank intends to do and for how long). Table 1: Summary of unconventional monetary policy interventions (Date of first implementation in parenthesis) Negative Term lending Asset purchase interest rates programmes ECB United Kingdom United States Japan Switzerland Sweden Denmark Canada Forward guidance Sources: BIS (2019), Unconventional monetary policy issues: a cross-country analysis, CGFS Papers, No 63; and relevant central banks. The selection of the particular instruments was dependent on each countries’ issues (i.e., were they aiming to boost demand and/or manage a specific market disruption) and their financial market structure (e.g., what assets are on offer to purchase). For example, the Bank of International Settlements (BIS) report that around 18 asset purchase programmes were initiated by central banks between 2009 and 2016. 8 Central banks bought a host of public and private sector bonds, specific agency mortgage backed securities, and other ‘asset backed’ securities (Table 2). They did so to swap central bank cash for other peoples’ assets, thereby generating liquidity and lowering interest rates. BIS (2019). ‘Unconventional monetary policy issues: a cross-country analysis’, CGFS Papers, No 63, October 2019. Table 2: Large-scale asset purchases by type (as % of GDP) Type of assets purchased Government bonds1 Euro area Mortgagebacked securities2 Corporate bonds Equities Japan Sweden United Kingdom United States 1 Numbers in parentheses are the maximum share of government bonds outstanding that the central bank held. 2 The ECB purchased covered bonds; the Fed purchased RMBS and agency debt. Sources: BIS (2019), Unconventional monetary policy issues: a cross-country analysis, CGFS Papers, No 63; and Gagnon and Sack (2018), QE: A User's Guide, Peterson Institute Policy Brief, PB18-19. The key outcomes were that interest rates on government bonds and corporate debt instruments did decline, stimulating spending. There was also a smaller, but positive, impact on credit availability. Monetary policy has been effective at stimulating economic activity even when the effective lower bound on interest rates has been met. 9 Being prepared at Te Pūtea Matua At present inflation in New Zealand is near the mid-point of our target range of 1 to 3 percent annual CPI inflation. The level of employment is also at, if not slightly above, our estimate of the maximum sustainable level. Achieving these targets has in large part been down to our setting of the OCR at 1.0 percent, well below our estimate of the ‘neutral rate’ of around 3 percent. In our February Monetary Policy Statement we also outlined our thoughts for the economy ahead, noting good economic support from both monetary and fiscal policy, household wealth and spending, and New Zealand’s strong terms of trade. 10 Of course, we also remain humble as to our ability to predict the future, and I reiterate that on the basis of our historical forecast errors, the chance that the short-term interest rate in Ibid. The BIS study found that “central banks judged that negative policy rates contributed to the achievement of their policy goals”, albeit “transmission effects could be weaker … should more deeply negative rates be implemented”. Monetary Policy Statement Feb 2020, https://www.rbnz.govt.nz/monetary-policy/monetarypolicy-statement/mps-february-2020 New Zealand could be 1 percent lower than now in two years’ time is around 20 percent. That means while an effective zero bound for interest rate is far from the most likely outcome in New Zealand, it can’t be ruled out. This is not a prediction, just a statistical observation outlining the challenges of setting monetary policy. An inability to predict what might happen next is no excuse for not preparing for what could happen. That’s true for businesses, governments and central banks. It is in light of both economic theory and recent global experience that we have been assessing what alternative monetary policy tools may be available to the Reserve Bank of New Zealand – and their relative desirability. We are fortunate, unlike many other OECD economies, to have the time to prepare for such possible needs. The work we have been pursuing has involved: • Identifying the suite of possible ‘unconventional monetary policy tools’ available to us; • Defining and making explicit the criteria we would assess these tools with, against both each other and also alternative policies all together (e.g., fiscal policy options); • Considering the relative benefits and costs of the tools, so as to operate on a ‘least surprise’ basis, and to ensure we are working in collaboration and with the agreement of the fiscal authorities; • Considering not just the monetary policy efficacy of the tools, but also broader considerations related to our financial stability and efficiency mandate; and • Ensuring the tools are actually able to be utilised, including working with the important financial institutions that make up our system. Recent international experience Our work, outlined later, has been informed by much research and recent experience internationally, which has highlighted desirable and less desirable (sometimes unanticipated) outcomes. There are consequences of using monetary policy – conventional and unconventional – with different impacts on different people (e.g., savers versus borrowers). These consequences can become more significant the longer interest rates remain low. Evidence on the side-effects of unconventional monetary policy is emerging slowly and is sometimes inconclusive. What is certain is that the use of unconventional policy puts the spotlight on the central bank. First, there are implementation questions around the selection of tools and their use. For example, large scale asset purchases introduce the central bank into more targeted ‘picking winners’ compared to the blunt interest rate instrument. We need to assess which assets are up for sale to the central bank and why. Borrowers and savers continue to be impacted differently as per conventional monetary policy, however the choice of which assets to purchase significantly impacts specific parts of the financial markets and sectors of society. The selection criteria for specific assets also needs to be clear. There is a choice to be made between public or private assets, and then which assets. As an example, there has recently been increasing discussion of favouring ‘green’ bonds over other bonds. Second, central banks have also recently bought assets that have a long duration. Even if they stopped now, the assets will sit on the central bank balance sheets for a long time to come unless sold before maturity. Some of the assets may become impaired while the central bank owns them, creating market and credit risk for the central banks’ balance sheets. Third, central bank balance sheets (which are effectively the government’s balance sheet) have expanded greatly with the purchased assets and issued liabilities (see Table 2 for the scale of central bank asset purchases as a proportion of GDP). The persistence of these purchase programmes has also been far longer than anticipated at their outset, given the ongoing low inflation pressures. The marginal impact on interest rates of new purchases is now reducing in some countries. Fourth, while targeted direct intervention is often positive for specific market functioning, the unprecedented growth in central banks’ balance sheets can also have unintended detrimental impacts. 11 Some challenging factors include the scarcity of bonds available for investors to buy, squeezed liquidity in some asset markets, and fewer market operators actively trading. Fifth, a possibly unsurprising outcome of persistently low global interest rates and the use of unconventional monetary policy tools has been rising asset prices. This outcome has meant increased wealth for some, e.g., home owners and equity investors (Figure 5). Figure 5: Global asset prices Index New Zealand Advanced economies Index China Houses Shares 2019 2011 Source: OECD, Real Estate Institute of New Zealand, RBNZ. Note: House prices for OECD members serve as a proxy for advanced economies. BIS (2019). ‘Large central bank balance sheets and market functioning’. Market Committee Papers, October 2019. However, the overall impact of unconventional monetary policy on wider wealth and income equality is currently unclear. Some studies find that unconventional monetary policy, particularly large scale asset purchases, increase inequality more significantly than conventional monetary policy. 12 Other studies find the unconventional policies have had a limited or positive impact on reducing income inequality, e.g., by supporting the income of low income families by supporting employment. 13 These possible effects need to be considered in the context of broader fiscal policy settings. Finally, there has been significant spill-over effects to other smaller open economies including New Zealand. This is primarily driven by inward capital flows as investors search for higher yields around the globe. These capital inflows have led global bond yields lower – including in New Zealand. The low imported interest rates have necessitated a variety of economic policy responses across many countries – including the lowering of central bank policy rates to stem the inflow, introducing macroprudential tools aimed at curbing excess lending, and purchasing foreign assets to slow down upward pressure on domestic currency values. At Te Pūtea Matua we have undertaken the first two of these responses so as to continue to meet our inflation and employment mandate, as well as mitigate the risks of excessive debt/lending on broader financial stability (e.g., the introduction and use of our Loan-to-Value Ratios). 14 The set of choices for Te Pūtea Matua The Reserve Bank team is using international and domestic experience to assess the full suite of monetary policy tools available to New Zealand. Today we published a short document that outlines the framework we would follow if we had to use unconventional monetary policy tools. 15 Publishing this framework provides greater transparency about how we might use these tools. This work is about being prepared for any range of potential eventualities, it is not a prediction of whether additional monetary policy tools will be needed. Table 3 outlines the principles we would use to guide the use of the tools. For example, Evgendis, A., & Fasianos, A. (2019). ‘Monetary policy and wealth inequality in Great Britain: Assessing the role of unconventional policies for a decade of household data’. arXiv:1912.09702. Colciago, A., Samarina, A. & de Hann, J. (2019). ‘Central bank policies and income and wealth inequality: a survey’. Journal of Economic Surveys, 0(0), 1-33. RBNZ webpage on the use of loan-to-value restrictions, https://www.rbnz.govt.nz/regulation-andsupervision/banks/macro-prudential-policy/loan-to-valuation-ratio-restrictions RBNZ (2020). ‘Principles for Using Unconventional Monetary Policy in New Zealand’, https://www.rbnz.govt.nz/monetary-policy/unconventional-monetary-policy Table 3: Principles for using unconventional monetary policy MPC Remit principles Effectiveness Tools would be designed to provide a strong influence over inflation and employment, to ensure that the monetary policy objectives are achieved. Efficiency The Committee would take into account the distortionary impact of the tools on the efficient allocation of resources within the economy, including between various groups and sectors of the economy. Financial system The Committee would take into account the impact of the tools on soundness financial system risks, to avoid the costs of financial crises. Operational principles Public balance The Committee would take into account the financial risks that the tools sheet risk would create for the Reserve Bank and Crown balance sheets, to protect public funds and central bank independence. Operational readiness Use of the tools would take into account the operational readiness of each tool, to ensure the transmission channels function as expected. This includes the readiness of the Reserve Bank to implement each tool and the readiness of financial markets and the New Zealand public to respond appropriately to the tools. Source: RBNZ. Table 4 provides short descriptions of the tools themselves. Our assessments are based on our own knowledge of the workings of New Zealand’s financial markets, as well as international experience and academic insight. We will provide our full analysis of each of these tools against the principles we hold in coming weeks – so that people can fully understand our thinking and, of course, provide input. Table 4: Unconventional monetary policy tools under consideration Tools Description Forward guidance This would differ from our current approach of publishing our OCR forecast. It may involve publishing a forecast of the shadow short rate, which shows the combined stimulus from the OCR and other monetary policy tools through interest rates. It could also involve the MPC announcing a commitment to keep monetary policy expansionary, in order to hit our monetary policy targets in the medium term, even if the MPC expect this to eventually push inflation above 2% or employment above its sustainable level. Negative OCR Reduction of the OCR to the effective lower bound (the point at which further OCR cuts become ineffective), which may be below zero. The Reserve Bank could consider changes to the cash system to mitigate cash hoarding if lower deposit rates led to significant hoarding. Interest rate An interest rate swap is a contract where one stream of future swaps interest payments is exchanged for another. The Reserve Bank could enter into interest rate swaps to reinforce forward guidance. We would receive fixed rates and pay floating rates to financial market participants. This would reduce market interest rates. Large Scale Asset The Reserve Bank could purchase domestic government bonds to Purchases lower interest rates and contribute to a flattening of the yield curve (LSAPs) through the main channels of policy signalling and portfolio balancing. Unlike the OCR, LSAPs would have more of an effect on longer-term interest rates (2+ years), which are important for mortgage and business lending. Foreign asset The purchase of foreign currency or assets to reduce the NZD purchases exchange rate and, if desired, to increase NZD liquidity. This could include the systematic purchase of foreign assets or buying fixed quantities on set dates. Term lending The provision of collateralised long-term loans to banks in order to support monetary policy transmission through the banking sector. The loans could be provided with conditions that require banks to increase their credit supply. Source: RBNZ. The monetary policy tools considered all vary as to their effectiveness, efficiency and impact on financial soundness. They are also at various stages of readiness to be utilised. Perhaps one of the simplest means of outlining why the tools have various levels of usefulness is to refer back to our discussion on the transmission of monetary policy from shifting the OCR to influencing inflation and employment. Figure 6 expands on this transmission framework by adding in some new tools – namely forward guidance, interest rate swaps, term lending, and large scale asset purchase programmes (of domestic or foreign assets). The end outcomes are similar in intent, but vary through the channels of the financial system with different degrees of impact. Figure 6: The channels through which monetary policy tools affect inflation and employment (This diagram shows the different channels through which different tools ultimately end up affecting inflation and employment. It builds on the monetary policy transmission mechanism shown in the Monetary Policy Handbook (p52)) Source: RBNZ. In light of recent international experience, some of the key considerations we now have are: • What is the optimal sequencing of these tools if monetary policy is increasingly called upon to stimulate the economy? We are near ready to be able to implement a zero or slightly negative interest rates in our operations, and forward guidance around our future actions is standard practice for us. But we also must decide at what point we use additional tools and in what order. • What agreement is needed between the Treasury and the Reserve Bank with regard to the use of our balance sheet, and is it materially different to how we manage it now? We are currently working with the Treasury to finalise the institutional arrangements that will enable us to effectively use all of the described unconventional monetary policy tools, if they are ever required. This includes the arrangements for handling the balance sheet implications of unconventional tools. More fundamentally, we also need to ensure we can coordinate an appropriate mix of fiscal and monetary policy responses if so desired. • What additional policy responses might we need to consider to manage some of the consequences of low interest rates and market functioning? We could consider additional macroprudential tools and specific market interventions to ensure liquidity and credit flows. But we need to assess how best we communicate to all participating in the New Zealand economy as to the purpose of our actions, and our desired outcomes. New Zealanders have become used to the terminology associated with our current monetary policy activities. A low OCR is understood for its intent and implications on borrowing and lending rates and, in part, the level of the NZ dollar exchange rate. We need to outline how we could best translate activity in, for example, the interest rate swap market or asset purchases, into meaningful concepts for all. We need a meaningful ‘shadow’ OCR concept for ease of discussion. To ensure they operate effectively and efficiently, we also want to ensure market participants (e.g. banks and payments operators) can respond appropriately to the use of unconventional monetary policy tools. While we have done a lot of this preparatory work, we have more to do. These considerations are all well advanced, and we continue to speak with relevant decision makers, market participants, and technical experts over time. Any deployment of unconventional monetary policy tools will depend on the prevailing economic conditions, the functioning of the financial system, and the efficiency of the various monetary policy channels. This leads us to currently favour a baseline decision set for the purposes of cyclical demand management, assuming it is needed and superior to alternative policy responses, of: • • • • • • Lowering the OCR; Using forward guidance; Using mildly negative interest rates if more stimulus was needed; Considering the use of interest rate swaps to reduce interest rates for New Zealanders, Considering asset purchases (e.g., government bonds) for further impact; and Utilising a combination of all of the above, as needed. We could also introduce term lending activities if the above combined actions proved insufficient and if retail banks are not passing on the very low rates to customers. Foreign asset purchases could also be useful if a specific economic shock was from offshore and resulted in an overvalued NZ dollar. The underlying principle is that we would choose the most appropriate tool or combination of tools, and policy coordination, for the situation at hand. For example, if an economic disturbance resulted in significant disruption to the functioning of the financial system, this would naturally alter the stylised ordering outlined above. Over reliance on one tool “Give a man a hammer and everything becomes a nail”. Just as for building, economic policy needs the right tools for the job and no one tool can do everything. All of the conventional and unconventional monetary policy interventions discussed will be more effective when coordinated with supporting whole-of-government intervention activities. Changes in government consumption and investment, the use of automatic stabilisers, welfare transfers, and varying tax rates all have cyclical as well as structural/permanent impacts on economic activity in a modern economy. This simple observation appears to be one of the most ignored factors globally in recent economic history. A government’s fiscal policies can deliver similar outcomes for short-term inflation and employment as to monetary policy. However, fiscal retrenchment occurring simultaneously with monetary expansion is akin to one foot on the brake, the other on the accelerator. At times this makes economic sense, but not all of the time. If a government’s fiscal credibility is low, then investors may be more comfortable with a government focusing purely on debt reduction and fiscal restraint. However, if a government’s debt is low, and there are significant long-term benefits to spending and/or investing, then a more expansionary fiscal stance can make sense. Here in New Zealand, for example, the Government recently opted to increase and bring forward its infrastructure investment. 16 This action has supported monetary policy in meeting its mandate, increasing activity and employment. The nature of the economic shock that authorities may be looking to mitigate will inform the choice of tools. A specific supply shock (where goods and services cannot be produced for Budget Policy Statement 2020, https://budget.govt.nz/budget/2020/bps/delivering-for-nzinfrastructure.htm some reason) may be better managed through fiscal support (both automatic stabilisers and/or targeted intervention), with monetary policy assisting rather than leading. New Zealand’s current drought conditions in regions of the North Island provide an example of a supply shock. If the drought remains relatively region-specific, and/or short-lived, then monetary policy would have a very limited stabilisation role. Any resulting loss of production may be short-term, and automatic fiscal stabilisers and/or targeted government transfers and spending would be more effective at mitigating any broader economic disruption. Meanwhile, monetary policy would remain focused on any longer-term impacts on incomes and wealth, and hence inflation and employment pressures. A similar set of considerations confronts policymakers globally at present with the spread of the Covid-19 virus. The eventual economic impact on global supply and demand will depend on the location, severity, and duration of the virus. The optimal mix of policy responses are driven by these same factors. The severity in terms of disruption to economic activity depends on how the virus is contained and controlled, how long this will persist, and the collective response of governments, officials, consumers, and investors to these events. The Reserve Bank’s Monetary Policy Committee will be picking through these supply and demand issues. We will need to account for international monetary and fiscal responses, financial market price changes (e.g., the exchange rate and yield curve), and domestic fiscal responses and intentions, to inform our response. We also remain in regular dialogue with the Treasury to assess how monetary and fiscal policy can be best coordinated. We need to be considered and realistic as to how effective any potential change in the level of the OCR will be in buffering the New Zealand economy from shocks such as a lack of rainfall and the onset of a virus. The Reserve Bank is also well practiced in its business continuity roles both for our own team and for our role in the economy. For example, ongoing business and consumer access to credit and liquidity through the banking system, and ongoing orderly access for New Zealand institutions to global financial markets, are a key focus of our mandate. We will ensure a stable payment and settlement system, so that money and cash can flow as usual under all circumstances. For us, these monetary policy and financial stability decisions are repeat processes as the duration and severity of events play out. We are in a sound starting position with inflation near our target mid-point, employment at its maximum sustainable level, already stimulatory monetary conditions, and a sound financial system. Conclusion Monetary policy mandated to maintain stability in the general level of prices and contribute to achieving maximum sustainable employment has proved a success both here and globally over recent decades. An outcome of the low inflation rates and other structural factors has been unprecedented low nominal interest rates. These circumstances have led to an increasing use of alternative monetary policy levers rather than just central banks’ official interest rates. The use of alternative – unconventional - monetary policy tools has proved successful in general at supporting positive inflation and employment over the post-GFC period across a wide range of economies. These tools have, however, necessitated new modes of operation and communication. They have also worked through different transmission mechanisms, thus providing varying degrees of effectiveness and some unanticipated outcomes. The unanticipated outcomes – such as markets functioning differently, asset prices being impacted, and government balance sheets being inflated and exposed to other risks – are understood. But, these outcomes can become more significant the longer interest rates remain so unprecedentedly low. The Reserve Bank of New Zealand has not, and still does not, need to use alternative monetary policy instruments to the OCR. But it is best to be prepared. This speech has outlined the key principles we would use to assess alternative tools available to Bank, and the operational preparations we would need. We are confident of our success in assessment and implementation, but we are also aware that these tools work best when supported by wider stabilisation policies and additional macroprudential considerations. In the event we ever had to use these unconventional tools, our goal would be to ensure a strong and sustained increase in economic activity, with inflation expectations remaining well-anchored on our target mid-point.
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Remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, delivered to a virtual roundtable, 28 May 2020.
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A Near Horizon Seizing the opportunities and managing the risks in the transition to net zero: The importance of climate-related financial disclosures Remarks delivered to a virtual roundtable On 28 May 2020 By Adrian Orr, Governor 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Talofa lava, tēnā koutou katoa, welcome everyone Thank you to the organisers – McGuinness Institute, Simpson Grierson, and the Climate Disclosure Standards Board – for gathering us all for this important discussion. Thank you also to Mr Mark Carney. I want to acknowledge your role in shifting the global financial system to a more sustainable perspective. You shook us awake with your ‘Breaking the Tragedy of the Horizons’1 speech in 2015. Now, only five years on from your speech, a common topic across central banks and financial regulators more broadly is how can we best assess and address climate risks. I also acknowledge the Climate Change Minister, James Shaw, and his personal commitment, financial expertise and leadership on this very important issue. Today I will speak briefly to three points: Why climate matters to New Zealand’s financial stability; The Reserve Bank’s climate strategy; and The impact of COVID-19 in terms of risks and current opportunities. Why climate matters - New Zealand’s Financial Stability We use the Māori legend of Tāne Māhuta to tell the story of the Reserve Bank (Te Pūtea Matua). Tāne Māhuta – god of the forest and birds – separated the earth mother (Papatūānuku) and sky father (Ranginui) so that the sun could shine in and life could flourish. Thereafter, Tāne Māhuta served as the kaitiaki (guardian) of the forest ecosystem – protecting against threats and enhancing the wellbeing of everyone within it. Hold on to that image of Tāne letting the sunshine in – I’ll get back to it. At the Reserve Bank, we are the kaitiaki of the financial system tasked to maintain and enhance financial stability. Assessing material risks to banks and insurers, and the financial system as an ecosystem, is our core business. We see financial stability being best maintained when all relevant risks are adequately identified, priced, and allocated to those best able to manage them2. Climate change and its associated risks provide a direct challenge to financial stability. The risks are material but extremely difficult to identify, price, allocate, and manage with accuracy. 1 https://www.bis.org/review/r151009a.pdf 2 https://www.rbnz.govt.nz/research-and-publications/speeches/2019/speech2019-07-11#fn7; https://www.rbnz.govt.nz/about-us/the-journey-of-te-putea-matua-our-tane-mahuta In the jargon, ‘market failure’ is rife. We simply do not know the true scope and scale of the environmental risks we take on during our daily economic activities. Likewise, many of the material costs of our economic decisions are ‘externalised’, that is, borne by others including future generations. There is no obvious market or price for selling climate risk, and hence no personal reward for managing it. And market participants often take a short-term, myopic, view in their decision making, pushing longer term problems to the never-never. What this means is that we will never have perfect information on the risks of climate change. However, firms’ disclosure on how they identify and manage climate change risks greatly assist to sharpen our focus. After all, it is what gets measured that generally gets managed. And it is far often better to imperfectly measure something than ignore it completely. What we already know is that climate change holds far-reaching implications for New Zealand’s financial system. These implications include physical impacts such as sea level rise and drought. For example, the National Institute of Water and Atmospheric Research (NIWA) estimates $12.5 billion of property is already exposed to extreme coastal flooding in New Zealand, and that each 10cm of sea level rise puts another $2.4 billion of assets at risk.3 Climate change also implies transition impacts - such as ‘flight shame’ or a shift to plantbased protein that will pose unique challenges for our highly concentrated export economy. Agriculture is already staring down the challenge of a triple whammy: emission pricing, changes in consumer demand, and more extreme weather. The Reserve Bank’s climate strategy Our climate strategy at the Reserve Bank has three avenues: incorporating the impact of climate change into our core functions; managing our direct impact on the climate; and leading through experience and collaboration. Firm disclosure of climate risks assists all three avenues. Disclosure will enable risk assessment and mitigation, and incentivise investment in emission reduction and adaptation. Disclosure does this by subtly changing the rules to the game—without changing the game. Firms’ behaviour will change by directing attention to climate-related risks – ‘you manage 3 Niwa (2019) Coastal Flooding Exposure under Future Sea-level Rise for New Zealand. Accessed at https://www.deepsouthchallenge.co.nz/projects/national-flood-risks-climate-change. A second study, of modelling flooding from rainfall and rivers, estimated that around 411,000 were currently exposed along with 20 airports and 3400km of electricity transmission lines. Niwa (2019). New Zealand Fluvial and Pluvial Flood Exposure. Accessed at https://www.deepsouthchallenge.co.nz/projects/national-floodrisks-climate-change what you measure’. While investors’ behaviour will change as they see both climate risks and opportunities. Even then leadership will still be needed. Our survey of New Zealand insurers and banks last year found broad concern that climate change exposed the financial system to significant risk. But, we disappointingly found scant evidence that the climate risk concerns are influencing daily business decisions. The lack of action may relate to the partial awareness. Only 60 percent of surveyed banks and one third of insurers disclose some climate-related information.4 This creates inconsistent information and comparability, leading to uninformed decisions. Hence, we support the mandatory disclosure of climate risk, especially one that is collaborative in approach with industry. There are important challenges to making disclosure effective in meeting New Zealand’s carbon reduction objectives - including standardised measures and climate scenarios, and sound data management and interpretation. We need to get this right. Recently we stepped up our supervisory engagement on the identification and management of climate risks amongst New Zealand financial institutions. We also lead the Council of Financial Regulators’ work on the climate challenge, including helping to develop a shared programme to train regulators in climate risk disclosure. We do so with haste because any delay in disclosing climate risk increases the likelihood of a disruptive step change to our economic prosperity and social cohesion. Disclosure plays a key role in ensuring a smooth transition to a low carbon emission future. We encourage those banks and insurers who don’t already disclose climate-related information to hurry up and do so. You need to support our collective objective of enhanced financial stability. We will keep going harder on climate. As a member of the Network for Greening the Financial System we are working with 66 central banks, supervisory agencies and international financial institutions to develop a coordinated response to climate. As part of this, we are looking at options for better managing our own balance sheet to mitigate climate change risk and promote climate change adaptation more broadly in New Zealand. The impact of COVID-19 Like climate change, COVID-19 highlights interdependencies between economic prosperity, environmental sustainability, and social inclusion. COVID-19 has done something climate 4 https://www.rbnz.govt.nz/financial-stability/financial-stability-report/fsr-may-2019/industry-survey- on-the-potential-impacts-of-climate-change change has struggled to do: engage everyone on Earth. We have all been disrupted. As the Economist newspaper noted last week: “Following the pandemic is like watching the climate crisis with your finger jammed on the fast-forward button.” Our current response to COVID-19 in New Zealand shows that when the risk is acute, we can act together in a powerful, effective response. This is motivating: with climate change the risk is also acute. The current economic regeneration challenge requires bringing forth opportunities to reduce carbon emissions and adapt. We need to ensure that whatever we rebuild, reshape or invest in now is sustainable, long term in its horizon, helps us build climate resilience, and benefits generations to come. The task is significant but, as has been said, ‘The best time to plant a tree is 20 years ago. The second best time is now’. Conclusion I’ll return to Tāne Māhuta and his efforts to let the sunshine in so life could flourish. Disclosure is a tool to let in the sunshine. Better information to make better decisions. The degree to which climate change remains a ‘tragedy of the horizons’ depends on our ability to make better decisions today. Thank you.
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Speech by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, at the 2020 KangaNews New Zealand Capital Markets Forum, Wellington, 20 August 2020.
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COVID-19 and the Reserve Bank’s Balance Sheet A speech delivered to 2020 KangaNews New Zealand Capital Markets Forum in Wellington On 20 August 2020 By Christian Hawkesby, Assistant Governor1 General Manager, Economics, Financial Markets and Banking Group Chair, Assets and Liabilities Committee With many thanks to support from Andrew Besuyen, Jamie Culling, Patrick O’Meara, Rebecca Palmer, and Sam Wynands, and input from Geoff Bascand, Michael Callaghan, Bevan Cook, Adrian Orr, Sandeep Parekh, Vanessa Rayner, and Mike Wolyncewicz. Ref #9122402 v2.12 Introduction E nga mana, e nga reo. E nga karanga maha o te wa. Tēnā koutou katoa. It is great to be able to participate in this conference that was originally scheduled for late February, albeit still remotely due to COVID-19 restrictions. The last time I spoke to a financial markets audience in person was in late-January at a conference in Sydney. I recall being struck at the time that I had never seen a conference organiser so happy to see me arrive at a venue. Turns out it was nothing personal. All the rest of the keynote speakers were part of a world tour and had got stuck in Hong Kong in self-isolation. Travelling from Wellington, I was the only one that had made it in person. In my mind, that was a moment when COVID-19 became something very real and tangible, spreading to our part of the globe. Of course, the world has changed remarkably since late January in response to this global health crisis. One of those ways is that the Reserve Bank’s balance sheet has increased from around $25 billion to $60 billion (Figure 1), and growing. Thousands Figure 1: Size of the RBNZ Balance Sheet NZDbn NZDbn Source: Reserve Bank of New Zealand. For a long time, the Reserve Bank has been seen primarily as an institution that makes announcements on interest rates every six weeks. However, periods like the Global Financial Crisis (GFC) and COVID-19 serve as stark reminders that we are ultimately a bank – the bank to the banking system and the bank to the Crown (the New Zealand Government). Ref #9122402 v2.12 In recent years, we have used the story of Tāne Mahuta to illustrate to the general public this broader perspective of the role of the Reserve Bank of New Zealand – Te Pūtea Matua –in the financial system.2 Just as Tāne Mahuta is part of the forest and the guardian – kaitiaki – of that forest, the Reserve Bank is both a part of the financial ecosystem and kaitiaki. Figure 2: Tāne Mahuta Last month, my colleague, Geoff Bascand, spoke about the Reserve Bank’s role as the regulator and supervisor of the financial system, the actions taken during COVID-19, and the agenda ahead.3 The branches and leaves and roots of Tāne Mahuta. Today, I would like to focus on how we have utilised our balance sheet flexibility to support the economy and financial system throughout COVID-19. That is, the roots, sap and vascular system of Tāne Mahuta. Specifically, I will: describe what the Reserve Bank’s balance sheet looks like; outline our approach to managing it before COVID-19; explain our actions taken through the crisis; and share some reflections on that experience and the way ahead. While I am also a member of our Monetary Policy Committee (MPC), I am speaking mostly as the chair of our Assets and Liabilities Committee (ALCO), responsible for the internal governance of our balance sheet. While the MPC sets monetary policy, our ALCO oversees its implementation and our activities in financial markets. Reserve Bank of New Zealand (2018): The Journey of Te Pūtea Matua: Our Tāne Mahuta. Northern hapu Te Roroa is the kaitiaki to Tāne Mahuta, the kauri tree in Waipoua Forest. Bascand (2020): Banking the economy in post-COVID Aotearoa. Ref #9122402 v2.12 There are two key messages that I want to leave you with today about our role as a central bank. First, our goal is not to maximise our profits or dividend from the activities on our balance sheet. We use our balance sheet to achieve our ultimate policy objectives of monetary and financial stability. In an environment where the Official Cash Rate (OCR) is nearing its lower bound, the size and composition of our balance sheet will inevitably become a more active tool, particularly for our monetary policy decisions. Equally, it is not our goal to minimise financial risk on our balance sheet. Rather, our approach is to manage risk within a clear risk appetite framework, across the dimensions of operational, legal, financial, and reputational risk. In environments like the GFC or COVID-19, central banks need to take financial risks to succeed in achieving their objectives for monetary and financial stability. But these risks need to be very well-understood, wellexplained, and managed on a no surprises basis. Balance Sheet Pre-COVID-19 To appreciate the fundamental changes that happened to our balance sheet during COVID-19, it is useful to first touch on what it looked like before the crisis. Like any bank, our liabilities include deposits and our assets are a combination of loans, bonds and other assets. Liabilities The Reserve Bank’s liabilities predominantly consist of three core parts, which line up with three key roles that the Reserve Bank plays in the financial system: the sole issuer of currency, the bank for the banking system, and banker to the Crown. i) Currency in circulation The Reserve Bank has the trusted position of being the sole supplier of legal tender New Zealand dollar banknotes and coins. Currency is a liability on our balance sheet because it acts as an IOU from the Reserve Bank to the holder. Banks that hold physical currency can return it in exchange for a deposit in their account at the Reserve Bank. This liability is the sum of the ‘physical cash’ on issue. Before COVID-19, currency in circulation was around $7 billion. ii) Settlement accounts As the bank to the banking system, we hold deposits from settlement banks. Settlement balances in these accounts are a liability as banks can draw on this cash to make inter-bank payments to each other through a trusted intermediary – the Reserve Bank. There are currently 13 settlement banks in New Zealand out of the 27 banks registered here.4 These deposits with us can be thought of as ‘electronic money’ rather than physical currency. These settlement accounts cannot be overdrawn. Before COVID-19, there was typically $7 billion-$8 billion in aggregate across these settlement accounts, to facilitate the smooth functioning of the money market and interbank payments. A list of registered banks can be found here: https://www.rbnz.govt.nz/regulation-andsupervision/banks/register Ref #9122402 v2.12 iii) Crown settlement account Lastly, we act as the banker for the New Zealand Government. Like a normal bank, the Government can deposit surplus funds in their bank account with us, their Crown Settlement Account (CSA). It creates a liability on our balance sheet as it is money the Government can draw on. When the Government receives taxes, or sells a bond or bill, it produces an inflow into its bank account. Conversely, payments of welfare benefits, interest on Government bonds or repaying the principal of a bond as it matures, produces outflows from the CSA. Before COVID-19, the CSA typically had a positive balance up to $6 billion to manage the Crown’s cash flows.There was an overdraft facility available up to $5 billion, which has primarily been used by the Crown under normal circumstances to help manage very short-term mismatches created by large Crown cash flows, such as around a bond maturity. Liquidity management and other assets Before COVID-19, the asset side of our balance sheet consisted of two main categories to achieve our policy objectives. i) Liquidity management and monetary policy implementation The first was liquidity management, where we were a net lender to actively influence conditions in money markets, to ensure that overnight interest rates in the market traded near the OCR set by the MPC. 5 In short, from 1999 the Reserve Bank operated a type of “corridor system” to implement monetary policy.6 Banks received the OCR on their settlement balances with us, up to a certain amount. If they held balances above this level, they received OCR less a penalty rate. Similarly, if banks found themselves with insufficient balances at the end of the day, they could borrow from us but at OCR plus a penalty rate. By ensuring it was costly for a bank to have insufficient cash and also offering a poor return if settlement balances were too high, it incentivised banks to manage their balances carefully. It also encouraged borrowing or lending in the inter-bank market. The main role for the Reserve Bank in this framework was to be a net lender into short-term money markets to ensure there was enough settlement balances in aggregate in the system so that banks could collectively operate within this corridor, where there wasn’t too little or too much liquidity. An important feature of the amount of aggregate settlement balances – electronic central bank money – is that, alongside physical currency, it is a closed system. That is, one bank can reduce its settlement balance by paying another bank, but this only shifts the balance within the system, it doesn’t reduce the amount of settlement balances in total. The only way that the amount of aggregate settlement balances can change is through payments to or from the Crown or the Reserve Bank, who are outside the system. Therefore, the main role of our domestic market operations team before COVID-19 was to forecast the Government’s cash flows in and out of the CSA and look to offset the impact of those flows with our Open Market Operations (OMOs) in money markets, injecting or withdrawing liquidity. The tools we used to inject liquidity were reverse repurchase agreements (reverse repos) and foreign exchange swaps (FX swaps). These feature as assets on our balance sheet. The tools we used For a detailed description of our approach, I would recommend Parekh (2016). Technically, the Reserve Bank moved from a “corridor” system to a “tiered remuneration” system between 2007-2020, which was a hybrid between a “corridor” and a “floor” system. Ref #9122402 v2.12 to withdraw liquidity were repurchase agreements (repos) and issuing Reserve Bank Bills. These feature as liabilities on our balance sheet. Before COVID-19, lending via FX swaps was the largest asset held by the Reserve Bank for liquidity management purposes, with around $7 billion outstanding. We also typically held around $3 billion of NZ Government Bonds on our balance sheet before COVID-19. These assets gave us the capability to withdraw liquidity via our repos. They were also available to lend to banks, thereby helping to avoid settlement failures if a bond became scarce in the secondary market. In addition, when a specific NZ Government Bond was within a year of maturity, we would typically start a repurchase programme to increase our holdings of that issue to help smooth out the impact of a large maturity on settlement balances. ii) Foreign reserve management Finally, we hold foreign currency assets, made up largely of liquid US, European and Japanese government bonds. Around 70 percent of these foreign assets are hedged against foreign exchange risk. These provide the capability to intervene in the foreign exchange market in response to disorderly conditions. Varying the size of our foreign exchange position also provide a tool to manage the level of the NZ dollar exchange rate if it was deemed exceptionally high or low, unjustified, consistent with MPC’s Remit and the timing was opportune.7 Before COVID-19, we typically held around $12 billion in foreign currency reserves. In summary, Figure 3 brings together how the Reserve Bank’s balance sheet was structured at the end of 2019 – back in the days where the OCR was our primary monetary policy tool and the balance sheet was smaller and less dynamic. Figure 3: Balance Sheet Pre-COVID-19 Dec-19 Assets (NZ$ million) Dec-19 NZ Government Bonds 3,760 Notes and coins in circulation 7,557 Foreign Reserve Management assets 12,383 Crown settlement account 3,048 Foreign Investment Assets using FX Swaps proceeds 7,302 Bank settlement accounts 7,493 Reverse repurchases Reserve Bank bills 1,225 Other assets Repurchase agreements - Other liabilities 2,524 Equity 2,752 Total 24,599 Total 24,599 Source: Reserve Bank of New Zealand Liabilities (NZ$ million) For a detailed explanation, see Eckhold and Hunt (2005). Ref #9122402 v2.12 Balance Sheet with COVID-19 Conditions in global economies and financial markets deteriorated dramatically through February and early March. On 16 March, after an extraordinary meeting the MPC decided to provide further monetary stimulus and cut the OCR by 75 basis points to 0.25 percent, and indicated that a Large Scale Asset Purchase (LSAP) programme of NZ Government Bonds would be the next tool deployed if required.8 It is hard to overstate the strain on global markets through this period. Unlike many past crises caused by a vulnerability within the financial system, this was foremost a health crisis. This made it particularly hard for financial markets to judge how quickly or how widely COVID-19 would spread, the policy response, and the combined impact on economies. Equity markets experienced some of the largest daily falls of all-time (Figure 4a). Credit spreads widened sharply and government bond yields were also extremely volatile (Figure 4b). In response, liquidity in many secondary markets dried up as intermediaries withdrew to limit their risk. Internationally, financial markets were becoming dysfunctional. Figure 4a: Largest daily falls of the S&P500 % Change -25% -20% -15% -10% -5% 0% 19-Oct-1987 28-Oct-1929 16-Mar-2020 29-Oct-1929 6-Nov-1929 12-Mar-2020 18-Oct-1937 15-Oct-2008 1-Dec-2008 GFC COVID-19 20-Jul-1933 -25% -20% -15% -10% -5% Source: Bloomberg and Reserve Bank of New Zealand Reserve Bank of New Zealand (2020e): OCR reduced to 0.25 percent for next 12 months. Ref #9122402 v2.12 0% Figure 4b: Equity and Bond Market Implied Volatility Index Index VIX Index MOVE Index (RHS) 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Source: Bloomberg and Reserve Bank of New Zealand Note: The VIX Index measures the expected volatility of the S&P 500. The MOVE Index measures the volatility of interest rates on US Treasury bonds. Asset side of our balance sheet To continue to achieve our policy objectives, these conditions led us to take a number of actions across New Zealand’s money markets, term lending market, government bond market, and corporate bond market that fundamentally transformed our balance sheet. NZ dollar money markets Our initial and primary concerns were around New Zealand’s money markets. The FX swap market had become extremely stressed. The global dash for US dollar liquidity had influenced our local money markets through its impact on the FX swap market. Pressure had begun to build in February, and by March the implied interest rates to borrow NZ dollars in the FX swap market were rising rapidly (Figure 5). Despite cutting the OCR to 0.25 percent, the implied NZ dollar interest rates had risen to nearly 2 percent to borrow for one week and had spiked to around 20 percent to borrow overnight. This was spilling over into the bank bill market and other indicators of short-term wholesale funding costs in New Zealand money markets. Ref #9122402 v2.12 Figure 5: New Zealand Money Market Rates 2.0 % % 2.0 1.5 1.5 1.0 1.0 0.5 0.5 0.0 0.0 -0.5 -0.5 1 week FX Swap Implied Rate OCR 90-day Bank Bill -1.0 Aug-19 -1.0 Sep-19 Oct-19 Nov-19 Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Source: Bloomberg and Reserve Bank of New Zealand. Given the crucial role that the FX swaps market played as our primary tool for managing NZ dollar liquidity, we started lending in scale into this market in an attempt to lower these implied borrowing rates, and then drained excess liquidity using other tools to offset the impact on settlement balances. However, this was only having a marginal effect in stabilising interest rates. As a result, on 20 March, we announced a decision to lend at a much larger scale and not drain the impact on settlement cash.9 This was a fundamental decision in our crisis response. It marked the end of a target for settlement balances and discarded the ‘corridor system’. The penalty rate on excess deposits in settlement accounts was removed, moving us to a so-called ‘floor system’. All settlement balances would be remunerated at the OCR. This gave us a much better chance to anchor short-term money market rates near the OCR. This decision resulted in a dramatic expansion of our balance sheet. Within a week, our lending in the FX swaps market in maturities from overnight to six months rose to $20 billion, contributing to the amount of settlement cash in the system quickly rising from $8 billion to over $30 billion. New Zealand dollar bank term funding Longer-term funding for banks remained a key consideration through this period. While we had confidence that the New Zealand banking system was well-funded for many months ahead, globally the primary issuance market had ground to a halt, creating uncertainty about when Reserve Bank of New Zealand (2020i): Reserve Bank announces new facility and removal of credit tiers. Ref #9122402 v2.12 this channel of funding would reopen. As a result, we launched a number of facilities to ensure that banks were confident they could access term funding to continuing supporting their retail, corporate, and business customers. On 20 March, we announced the Term Auction Facility (TAF), offering regular access to collateralised loans for 3, 6, and 12 month terms.10 On 30 March, we launched the Corporate Open Market Operation (COMO), designed to support the functioning of the corporate paper market. 11 On 2 April, we introduced the Term Lending Facility (TLF), to provide banks funding for up to three years based on lending to businesses under the Government’s Business Finance Guarantee Scheme (BFGS). The BFGS offered a partial Government guarantee on loans banks made to eligible small and medium-sized businesses. 12 While none of these facilities have been drawn on in significant size to date, they are an important part of stabilising market conditions by providing an assurance that we were willing to provide term funding options for the banking system to access. New Zealand Government Bonds Through this period, government bond markets were also becoming strained globally. A combination of factors were at play locally. Government borrowing requirements were increasing rapidly, as the Government announced a large fiscal package as a policy response to COVID-19. At the same time, many fund managers and global investors were looking to liquidate holdings of NZ Government Bonds as a precaution against client redemptions in other asset classes. Crucially, intermediaries such as bank dealers were also beginning to withdraw their services, to reduce their risk as volatility rose. Bid-offer spreads on government bonds are one measure of market liquidity (Figure 6).13 While these rose dramatically through this period, they understated the problem. In practice, holders of Government bonds could not find an intermediary to provide a bid, for even small parcels of NZ Government Bonds with only a few months left until maturity. The secondary market had become almost completely illiquid. Reserve Bank of New Zealand (2020i): Reserve Bank announces new facility and removal of credit tiers. Reserve Bank of New Zealand (2020h): Reserve Bank announces Corporate OMO and NZGB 2021 bond repurchase. Reserve Bank of New Zealand (2020c): Longer-term funding to support business lending. The bid-ask spread is a common measure of market liquidity. A bid is the yield at which a bond dealer is willing to buy a bond, whereas the ask or offer is the yield at which the dealer is willing to sell the bond. Wider bid-ask spreads make it more expensive to buy or sell bonds. Ref #9122402 v2.12 Figure 6: Bid-offer spreads on NZ Government Bonds bps bps LSAP Announcement NZGB 2-year NZGB 10-year 1-Jan-2020 1-Feb-2020 1-Mar-2020 1-Apr-2020 1-May-2020 1-Jun-2020 1-Jul-2020 1-Aug-2020 Source: Bloomberg and Reserve Bank of New Zealand. There were three main measures we took in response to assist market functioning. First, we increased our early repurchases of maturing government bonds. We already had a programme in place to repurchase early the NZ Government Bond due to mature on 15 June 2020. On 30 March, we extended this programme to also include the NZ Government Bond maturing on 15 May 2021, beyond a year to maturity.14 This provided an additional avenue for dealers to reduce their inventories, and freed up their ability to intermediate other flows in the market. We also announced our willingness to support liquidity in the secondary market for NZ Government Bonds,15 implementing a separate Bond Market Liquidity Support (BMLS) scheme. This involved us placing bids for NZ Government Bonds in the wholesale broker market in conventional sized parcels of $5 million to $20 million, where no other bids were being offered by market participants. This small-scale intervention was designed to provide the market with confidence there was as a bidder of last resort, and enable price transparency in a market that had become illiquid and opaque. On 25 March following an extraordinary meeting, the MPC decided that the Reserve Bank would undertake a LSAP programme of up to $30 billion of NZ Government Bonds, to Reserve Bank of New Zealand (2020h): Reserve Bank announces Corporate OMO and NZGB 2021 bond repurchase. Reserve Bank of New Zealand (2020j): The Reserve Bank is committed to ensuring smooth market functioning. Ref #9122402 v2.12 provide monetary stimulus by lowering interest rates across the yield curve.16 Operational decision-making around the implementation of purchases was delegated to staff in the Financial Markets Department. This allowed us to purchase larger amounts initially, both to keep yields low and to support market functioning by introducing a buyer in large scale across the yield curve. The size of this LSAP programme was increased at subsequent Monetary Policy Statements. By early August, our holdings of NZ Government Bonds had risen to over $20 billion. The combination of these actions helped restore market functioning and contributed to the yield curve of NZ Government Bonds becoming lower and flatter (Figure 7), consistent with the MPC’s immediate objective of softening the blow from COVID-19 on the New Zealand economy. Figure 7: New Zealand Government Bond yield curve % 2.5 % 2.5 3-Jan-20 20-Mar-20 2.0 2.0 5-Aug-20 0.0 0.0 0.5 0.5 1.0 1.0 1.5 1.5 Maturity Source: Bloomberg and Reserve Bank of New Zealand. New Zealand dollar corporate bonds Finally, despite our actions in other interest rate markets, by early April the NZ dollar corporate bond market was becoming increasingly dysfunctional. As had occurred earlier in the NZ Government Bond market, given heightened uncertainty and volatility, intermediaries were withdrawing from the secondary market, resulting in a lack of bids, a widening of spreads, and an absence of price transparency. We had a particular concern about the lack of liquidity in bonds issued by the NZ Local Government Funding Agency (LGFA), which was the largest and most liquid issuer of non-government bonds in normal times, and a key benchmark for other issuers in the NZ dollar corporate bond market. A Reserve Bank of New Zealand (2020k): Reserve Bank to begin Large Scale Asset Purchases. Ref #9122402 v2.12 continued absence of secondary market liquidity was creating a real risk that primary issuance in New Zealand’s debt capital market – a key channel of monetary policy – could be closed for a prolonged period. On 6 April, LGFA bonds were added to our BMLS scheme, and we began asking wholesale market intermediaries for offers to sell LGFA in conventional sized parcels of $5m to $20m. 17 On 7 April, following another extraordinary MPC meeting, LGFA bonds were also added to the LSAP programme, enabling purchases up to $3 billion. 18 In May this was reformulated as a cap of up to 30 percent of LGFA bonds on issue. These actions saw benefits across the NZ credit market, even to issuers not included in the BMLS or LSAP programmes. The corporate bond spreads of LGFA and other issuers narrowed (Figure 8a and 8b), secondary market liquidity returned to more normal conditions, and primary issuance has been undertaken by both the LGFA and some other non-government issuers. Figure 8a: LGFA and Kāinga Ora spreads to NZ Government Bonds 1.0 % LSAP Announcement % LGFA LSAP Announcement 0.9 0.9 2025 LGFA spread 2025 Kāinga Ora spread 0.8 1.0 0.8 0.7 0.7 0.6 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.2 0.2 0.1 0.1 0.0 1-Jan-2020 0.0 1-Feb-2020 1-Mar-2020 1-Apr-2020 1-May-2020 1-Jun-2020 1-Jul-2020 1-Aug-2020 Source: Bloomberg and Reserve Bank of New Zealand. Reserve Bank of New Zealand (2020f): Offer to purchase Local Government Funding Agency bonds. Reserve Bank of New Zealand (2020l): Reserve Bank to extend Large Scale Asset Purchases. Ref #9122402 v2.12 Figure 8b: Bank spreads to NZ Government Bonds 1.8 % LSAP Announcement % LGFA LSAP Announcement 1.8 2024 ANZ spread 2024 ASB spread 1.6 1.6 2023 BNZ spread 2024 Westpac spread 1.4 1.4 1.2 1.2 1.0 1.0 0.8 0.8 0.6 0.6 0.4 0.4 0.2 0.2 0.0 1-Jan-2020 0.0 1-Feb-2020 1-Mar-2020 1-Apr-2020 1-May-2020 1-Jun-2020 1-Jul-2020 1-Aug-2020 Source: Bloomberg and Reserve Bank of New Zealand. Liabilities The rapid expansion of assets on our balance sheet was matched by an equally fundamental change in the size and composition of our liabilities. Crown Settlement Account It was an unprecedented time for the management of Crown liquidity through the CSA. The largest immediate pressure was the Government’s Wage Subsidy scheme that has paid out over $13 billion to date. From the start of Alert Level 4 lockdown in March, this involved upfront payments of three months’ worth of subsidy covering around half of New Zealand’s labour force. At the end of March, we agreed with New Zealand Debt Management to temporarily increase the overdraft facility on the CSA from $5 billion to $10 billion for three months. This was designed to assist the Crown in managing significantly higher short-term uncertainty around fiscal flows and to afford the Crown more flexibility in its design and implementation of funding activity, as well as any associated NZ Government Bond issuance. The CSA went briefly into overdraft in mid-April. Since then the balance in the CSA has grown steadily as the Government has raised funds through its weekly bond and T-bill tender programmes and large syndications of new bond issues. It has also been assisted by better-than-forecast fiscal outcomes in the near-term. At the end of July the CSA balance had grown to $18 billion. Settlement balances Since COVID-19, the settlement balances of the banking system have increased from around $8 billion to between $20-30 billion (Figure 9). Ref #9122402 v2.12 Under the previous corridor system, Government cash flows had to be offset through our OMOs to maintain the target amount of aggregate settlement cash in the banking system. This has not been required since the shift to a floor system, where all settlement cash balances receive the OCR. Since then, we have only partially smoothed out the lumpiest government cash flows. Rather, our influence on the level of settlement cash has come through two main actions. Open Market Operations: Our initial liquidity injections in March to support the functioning of the FX swap market lifted the level of settlement cash considerably. Since then, we have let some of these maturities run off as conditions in NZ dollar money markets have returned to normal. LSAP: The purchases of bonds from banks in the LSAP programme are funded by increasing banks’ settlement accounts. With purchases of up to $100 billion authorised by the MPC announced in total through to June 2022, this will be an ongoing upward influence on settlement balances and our overall balance sheet.19 NZDbn NZDbn Other RBNZ Operations LSAP Cash Influence Settlement Cash Level -5 -5 -10 -10 -15 -15 -20 Jan-20 Thousands Thousands Figure 9: Settlement Cash Level and Reserve Bank Influences -20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20 Source: Reserve Bank of New Zealand Note: Other RBNZ Operations includes OMOs and the TAF. Currency in Circulation The final component of our balance sheet I’d like to touch on is currency in circulation, coming back to our core role as the monopoly provider of legal tender in New Zealand. Many retailers chose contactless payment methods as a preference during the height of COVID-19, to reduce the amount of physical contact required to make payments. Reserve Bank of New Zealand (2020d): Monetary Policy Statement August 2020. Ref #9122402 v2.12 However, in practice we have experienced the very opposite of a decline in cash. Physical currency in circulation rose by around $800 million over the month of March.20 Around a year’s worth of normal demand for $50 notes was put into circulation by banks in the days leading up to the start of Alert Level 4 lockdown on 25 March. As a result, annual growth in currency in circulation rose to 18 percent, from its more normal average closer to 5 percent (Figure 10). Figure 10: Rolling annual growth of currency in circulation % % -5 Dec-02 -5 Aug-04 Apr-06 Dec-07 Aug-09 Apr-11 Dec-12 Aug-14 Apr-16 Dec-17 Aug-19 Source: Reserve Bank of New Zealand. This increase in cash in circulation through COVID-19 is both consistent with international experience and our own recent engagement with New Zealanders on the Future of Cash.21 The key message of that consultation was that while as a society we are using cash less, we are not becoming cashless. Cash still plays an important role for many people, including as a store of value outside the banking system or in its role as a contingency back-up method of payment. For some, particularly those financially or digitally excluded, access to cash remains an essential component of engaging in society. Through COVID-19 we have worked with banks, security companies, and the New Zealand Defence Force to activate a number of emergency contingency measures to ensure that NZ dollar cash is ready and available in all regions of the country, and resilient to further disruptions in supply chains and distribution if the COVID-19 pandemic escalates. Reserve Bank of New Zealand (2020b): Financial Stability Report May 2020. Reserve Bank of New Zealand (2019a): The Future of Cash Use - Te Whakamahinga Moni Anamata; Reserve Bank of New Zealand (2019b): The Future of the Cash System - Te Pūnaha Moni Anamata. Ref #9122402 v2.12 We have also reiterated the message that cash is just one of a number of frequently touched surfaces – much like a debit or credit card, phone or watch – and reinforced the need for good hand hygiene regardless of the way payments are made or accepted.22 Balance sheet with COVID-19 Bringing the asset and liability sides of the balance sheet together, Figure 11 illustrates the evolution so far through 2020. Figure 12 provides a more detailed background by each new scheme, programme and facility launched since COVID-19, against our balance sheet at the beginning of the year. All this information is updated each month on our website.23 Figure 11: Balance Sheet with COVID-19 Thousands Assets Liabilities and Equity NZDbn NZDbn - Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 LSAP Early Bond Repurchases Other NZ Government Bonds LGFA Cash Lending Facilities Liquidity Management Foreign Reserves Other Assets Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Notes and coins in circulation Crown settlement account Bank settlement accounts Liquidity Management Other liablities Equity Source: Reserve Bank of New Zealand. Reserve Bank of New Zealand (2020a): Cash and other payments systems ready for COVID-19. Data for this chart and more detailed explanations are available here: https://www.rbnz.govt.nz/marketsand-payments/our-balance-sheet-at-work. Ref #9122402 v2.12 Figure 12: Balance Sheet with COVID-19 Programme/ Assets (NZ$ million) Dec-19 Jul-20 Max Purpose Liabilities (NZ$ Programme/ Dec-19 Jul-20 million) Purpose LSAPs Nominal bonds - 25,496 25,496 Notes and coins in circulation LSAPs - Index Linked Bonds - 1,086 1,086 Crown settlement account BMLS - Bank settlement accounts 7,493 23,927 28,737 Early Repurchases 2,946 2,946 Reserve Bank bills - 1,225 Other 3,512 3,333 3,512 LSAPs - 1,167 1,167 Other liabilities BMLS - TAF - 1,244 COMO - - - TLF - CSA overdraft - - - 9,854 18,668 - NZ Government Bonds 7,557 Payment System Equity 7,928 - 2,524 3,393 5,054 Revaluation gains/losses 2,752 3,157 3,157 Cash lending Reverse repurchases Liquidity management 7,302 and monetary policy implementation Foreign Reserve Management assets Foreign Reserves Other assets - Total 12,383 12,595 13,907 24,599 58,393 1,489 Total Source: Reserve Bank of New Zealand. Note: Max is the maximum value of the month end figures since Dec-19. Ref #9122402 v2.12 8,088 3,048 19,917 19,917 Liquidity 1,225 management and monetary Repurchase policy agreements implementation LGFA Foreign Investment Assets using FX Swaps proceeds Max 24,599 58,393 Reflections, next steps and conclusion While New Zealand’s financial markets have been functioning again, with the global COVID-19 pandemic ongoing it feels far too early to claim victory. However, I think it is worthwhile to make some initial observations, reflections, and comments on next steps from here. Risk Appetite Framework As outlined in the narrative of what we have done through COVID-19, our goal has not been to maximise our profits or dividends from the activities on our balance sheet. Rather, it is to achieve our ultimate policy objectives of monetary and financial stability. However, we still need to anchor our balance sheet decisions within a clear risk appetite framework, across four key dimensions: Legal risk: meeting our mandate, operating within our legal powers, and working with others where additional powers are sought. Operational risk: designing, implementing and executing our plans. Financial risk: taking on additional credit, interest rate or liquidity risk from the assets and liabilities on our balance sheet. Reputational risk: explaining to all our stakeholders what we do, why we have taken certain actions, and where we see the limits of our capabilities and responsibilities. As a central bank, we have a very low appetite for legal and operational risk. However, we do understand that in situations like the GFC or COVID-19, we need to have a high appetite to take financial risks in order to successfully achieve our policy objectives. Some of these new activities on our balance sheet – such as the TAF, COMO, TLF, BMLS and increased activity in FX swaps – have been taken on using our existing capital and frameworks for managing financial risk. For some other new activities – such as the LSAP – we have received an indemnity from the Crown to cover the additional credit and interest rate risk from these holdings on our balance sheet.24 Equally, we are also aware that we need to have some appetite to take reputational risk to achieve our end goals. Undertaking anything new or uncertain will always increase the need to explain our actions under a heightened degree of scrutiny. That said, delivering on our mandate while engaging successfully with all our stakeholders along the way should be reputation enhancing. Global developments and comparisons In New Zealand, we launched a range of schemes and programmes across our balance sheet, including the TAF, COMO, TLF, BMLS and LSAP. At the same time, central banks around the world have unleashed an alphabet soup of measures. As a small open economy integrated into global markets, we have undoubtedly benefited from the actions of other central banks to calm markets, especially the US Federal Reserve in its crucial role as the global reserve currency.25 It is easy to focus on the differences in actions taken by central banks in other countries, either in the timing or the exact design of those actions. Robertson (2020): Letter of Indemnity – August 2020. The Fed also provided international USD liquidity by offering USD swap lines to nine major central banks, including the RBNZ. See Federal Reserve (2020). Ref #9122402 v2.12 But talking to other central bankers overseas and listening to their stories, the similarities are far more striking. 26 Within a four to five week period through March and April, many central banks deployed a range of emergency and unconventional measures that resembled the actions taken over an 18 month period during the GFC. We have not been alone, with central bank balance sheets expanding in concert (Figure 13). Figure 13: Global central bank balance sheets as a percent of GDP % % European Central Bank US Federal Reserve Reserve Bank of Australia Bank of Canada Reserve Bank of New Zealand Bank of England 2006 2007 2008 2009 2011 2012 2013 2014 2015 2016 2018 2019 2020 Source: Source: Haver, Bloomberg and Reserve Bank of New Zealand. The experience of central banks in other countries also provides some insight into exit strategies, especially those countries that began large scale asset purchase programmes during the GFC. In many cases, central bank balance sheets have remained relatively large for a prolonged period. There have been some instances where the size of balance sheets have started to reduce when policymakers had sufficient confidence their policy objectives could be achieved with less support. That said, it is not necessarily the case that central bank balance sheets should revert to their former size. It will be a case of what is optimal in the future to enable central banks to fulfil their remits.27 Country specific approaches Each country needs to find its own unique approach to both expanding the balance sheet and its exit strategy. Beyond the specific economic outlook, the approach of each country will also be dependent on the particular size, depth and structure of its financial markets; the composition of its financial system; and its governance and institutional arrangements between the central bank and government. Debelle (2020); Hauser (2020); Kent (2020); Logan (2020). Reserve Bank of New Zealand (2019c): The remit for the Monetary Policy Committee. Ref #9122402 v2.12 For example, there are a number of specific features for New Zealand that have shaped our balance sheet response to COVID-19. The relative importance of the FX swap market made this a focal point of actions to restore the functioning of New Zealand’s money markets. The relatively small number of intermediaries, local investors and hedging tools in the NZ Government Bond market shaped the design of the LSAP programme. Regular and consistent purchases across the yield curve through a transparent tender process have been important to not only lower bond yields, but to restore market liquidity and confidence to intermediaries and investors. The relatively low normal amount of activity in New Zealand’s corporate bond market also shaped our limited inclusion of the LGFA as the only non-government bond issuer within the LSAP programme. In April, we judged that a programme that included a wide range of corporate issuers on scale could potentially do more harm than good, by removing scarce supply and distorting conditions when normal activity resumed as market calm was restored. Just as Tāne Mahuta is part of the forest and the guardian – kaitiaki – of that forest, the Reserve Bank is both a part of the financial ecosystem and kaitiaki. As such, our engagement with participants in New Zealand’s financial markets has been crucial for us to assess and design how we have used our balance sheet and designed new facilities. Ongoing dialogue with the heads of dealing rooms, treasurers, chief economists, corporate issuers, fund managers, market analysts, global investors, the New Zealand Financial Markets Association, and New Zealand Debt Management all added to our understanding of market conditions and the response needed to continue delivering our policy objectives. Much of this was done remotely throughout the lockdown, sometimes into the night and weekends, demonstrating the importance of building strong relationships with market participants before the crisis. Next steps Of course, the implications of COVID-19 are not over, either globally or here in New Zealand. At the August Monetary Policy Statement last week, the MPC kept the OCR at 0.25 percent and expanded the LSAP programme to up to $100 billion. The Committee agreed that a lower or negative OCR, a Funding for Lending Programme (FLP), purchases of foreign assets, and interest rate swaps all provided policy optionality, to be assessed against the Committee’s five principles for alternative monetary policy tools.28 That is, they all remain on the list of possible instruments that could shape our balance sheet into the future. In particular, the Committee expressed a preference for considering a package of a negative OCR and a Funding for Lending Programme (FLP), in addition to the LSAP programme. Staff were Reserve Bank of New Zealand (2020g): Principles for Using Unconventional Monetary Policy in New Zealand. Ref #9122402 v2.12 instructed to actively prepare advice on their design and deployment if deemed necessary, taking account of the operational readiness of the financial system. Once again, our goal will not be to use our balance sheet to maximise profit or minimise financial risk, but as a tool to achieve our policy objectives, within a clear risk appetite framework to assess and manage the legal, operational, financial and reputational risks of these tools. As before, our external engagement with financial market participants is going to be crucial to help us design a potential package of measures to be as effective as possible, to help us bring stakeholders along the way with us, and to maximise the chance of success. Not only that, we will collectively need to build on the story of Tāne Mahuta with the public of New Zealand, to explain what we are doing, why, and how it will ultimately contribute to the long-term prosperity of New Zealanders. Nō reira, Nau te rourou, naku te rourou, ka ora ai te iwi. With your contribution, and my contribution, the people will prosper. Tēnā koutou, tēnā koutou, tēnā tatou katoa. Ref #9122402 v2.12 References Bascand, G. (2020, July 31). Banking the economy in post-COVID Aotearoa. A speech delivered to banking industry representatives in Wellington. Retrieved from https://www.rbnz.govt.nz/research-and-publications/speeches/2020/speech2020-07-31 Debelle, G. (2020). ‘The Reserve Bank's Policy Actions and Balance Sheet’. Speech to the Economic Society of Australia, 30 June 2020. Eckhold, K. & Hunt, C. (2005). The Reserve Bank’s new foreign exchange intervention policy. Reserve Bank Bulletin, 68(1). Federal Reserve. (2020, March 19). Federal Reserve announces the establishment of temporary U.S. dollar liquidity arrangements with other central banks [Press Release]. Retrieved from https://www.federalreserve.gov/newsevents/pressreleases/monetary20200319b.htm Hauser, A. (2020). ‘Seven moments in Spring: Covid-19, financial markets and the Bank of England's operations’. Speech at a Bloomberg Webinar, 4 June 2020. Kent, C. (2020). ‘The Reserve Bank's Operations – Liquidity, Market Function and Funding’. Speech online to KangaNews, 27 July 2020. Logan, L. (2020). ‘The Federal Reserve’s Market Functioning Purchases: From Supporting to Sustaining’. Speech at a SIFMA Webinar, 15 July 2020. Parekh, S. (2016). How the Reserve Bank of New Zealand manages liquidity for monetary policy implementation. Reserve Bank Bulletin, 79(9). Reserve Bank of New Zealand. (2018). The Journey of Te Pūtea Matua: Our Tāne Mahuta. Retrieved from https://www.rbnz.govt.nz/about-us/the-journey-of-te-putea-matua-our-tanemahuta. Reserve Bank of New Zealand. (2019a). The Future of Cash Use - Te Whakamahinga Moni Anamata. Retrieved from https://www.rbnz.govt.nz/notes-and-coins/future-of-cash/issues-paper-thefuture-of-cash Reserve Bank of New Zealand. (2019b). The Future of the Cash System - Te Pūnaha Moni Anamata. Retrieved from https://www.rbnz.govt.nz/notes-and-coins/future-of-cash/the-future-of-thecash-system Reserve Bank of New Zealand. (2019c). The remit for the Monetary Policy Committee. Retrieved from https://www.rbnz.govt.nz//media/ReserveBank/Files/Monetary%20policy/About%20monetary%20policy/Remit-for-theMonetary-Policy-Committee-April-2019.pdf?la=en&revision=a5783e23-a90b-43d5-876975c448eef89b. Reserve Bank of New Zealand. (2020a, March 19). Cash and other payments systems ready for COVID-19 [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2020/03/cash-andother-payments-systems-ready-for-covid-19 Reserve Bank of New Zealand. (2020b). Financial Stability Report May 2020. Retrieved from https://www.rbnz.govt.nz/financial-stability/financial-stability-report/fsr-may-2020. Reserve Bank of New Zealand. (2020c, April 2). Longer-term funding to support business lending [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2020/04/longer-term-fundingto-support-business-lending. Ref #9122402 v2.12 Reserve Bank of New Zealand. (2020d). Monetary Policy Statement August 2020. Retrieved from https://www.rbnz.govt.nz/monetary-policy/monetary-policy-statement/mps-august-2020 Reserve Bank of New Zealand. (2020e, March 16). OCR reduced to 0.25 percent for next 12 months [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2020/03/ocr-reduced-to-025percent-for-next-12-months. Reserve Bank of New Zealand. (2020f, April 6). Offer to purchase Local Government Funding Agency bonds [Press release]. Retrieved from https://www.rbnz.govt.nz/markets-andpayments/domestic-markets/domestic-markets-media-releases/offer-to-purchase-localgovernment-funding-agency-bonds. Reserve Bank of New Zealand. (2020g). Principles for Using Unconventional Monetary Policy in New Zealand. Retrieved from https://www.rbnz.govt.nz//media/ReserveBank/Files/Monetary%20policy/ump/Unconventional-Monetary-PolicyPrinciples-and-Tools.pdf?revision=f3d7bbac-bbec-4a8f-a49d-66d5e17c43d4&la=en. Reserve Bank of New Zealand. (2020h, March 30). Reserve Bank announces Corporate OMO and NZGB 2021 bond repurchase [Press release]. Retrieved from https://www.rbnz.govt.nz/marketsand-payments/domestic-markets/domestic-markets-media-releases/reserve-bank-announcescorporate-omo-and-nzgb-2021-bond-repurchase. Reserve Bank of New Zealand. (2020i, March 20). Reserve Bank announces new facility and removal of credit tiers [Press release]. Retrieved from https://www.rbnz.govt.nz/markets-andpayments/domestic-markets/domestic-markets-media-releases/reserve-bank-announces-newfacility-and-removal-of-credit-tiers. Reserve Bank of New Zealand. (2020j, March 20). The Reserve Bank is committed to ensuring smooth market functioning [Press release]. Retrieved from https://www.rbnz.govt.nz/news/2020/03/the-reserve-bank-is-committed-to-ensuring-smoothmarket-functioning Reserve Bank of New Zealand. (2020k, March 23). Reserve Bank to begin Large Scale Asset Purchases [Press release]. Retrieved from https://www.rbnz.govt.nz/markets-and-payments/domesticmarkets/domestic-markets-media-releases/reserve-bank-to-begin-large-scale-asset-purchases23-march-2020. Reserve Bank of New Zealand. (2020l, April 7). Reserve Bank to extend Large Scale Asset Purchases [Press release]. Retrieved from https://www.rbnz.govt.nz/markets-and-payments/domesticmarkets/domestic-markets-media-releases/reserve-bank-to-extend-large-scale-assetpurchases. Reserve Bank of New Zealand. (2020m). Statement of Intent 1 July 2020 - 30 June 2023. Retrieved from https://www.rbnz.govt.nz/about-us/statements-of-intent/statement-of-intent-1-july2020-30-june-2023. Robertson, G. (2020). Letter of Indemnity – August 2020. Retrieved from https://www.rbnz.govt.nz//media/ReserveBank/Files/News/2020/Letter-of-Indemnity-from-the-Minister-of-Finance-9August-2020.pdf The Treasury. (2020). New Zealand Government Bond Tender Schedule – May 2020 [Press release]. Retrieved from https://debtmanagement.treasury.govt.nz/investor-resources/new-zealandgovernment-bond-tender-schedule-%E2%80%93-may-2020 Ref #9122402 v2.12
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Victoria University of Wellington School of Government, Wellington, 2 September 2020.
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Monetary Policy: Same Objectives Different Challenges Speech delivered to the Victoria University of Wellington School of Government On 2 September 2020 By Adrian Orr, Governor With special thanks to colleagues Omar Aziz, Cameron Haworth, and Joseph Weller Embargoed until 2 September – Time 12.30pm 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Tēnā koutou katoa, welcome everybody. Today I want to outline how the Reserve Bank of New Zealand – Te Pūtea Matua – is working to maximise the effectiveness of its actions in the face of the global COVID-19 pandemic. While we all hope the health implications of the virus will be as short-lived as possible, it is clear that the economic implications will be severe and long-lasting. It is during such unsettling times that public confidence in our financial system matters most. I want to assure people that the goals of the Bank remain the same, as set in legislation. Our purpose is to ensure public confidence in the financial system, and to minimise the economic vulnerability of New Zealand through a sound and dynamic monetary and financial system. I also want to assure people that the Bank’s core values – integrity, innovation, and inclusion – remain our bedrock and continue to assist greatly in managing ongoing changing economic times. To succeed we continue to exercise sound judgement and work collaboratively to be most effective. And, consistent with our value of innovation, the Bank’s activities, capability, and capacity continue to evolve with the circumstances. During these times of COVID-19 our values have ensured Te Pūtea Matua has been able to respond effectively to the many new – sometimes unprecedented – economic challenges. We have been able to, for example: Exercise decision making under extreme economic uncertainty, using a least regrets approach for the current context; Collaborate with the Government, our regulator colleagues, and our regulated institutions, to prioritise actions, coordinate and communicate policy decisions, and urgently implement agreed actions; Review our strategies and the tools available to implement monetary policy in the most effective and efficient manner, in full line of sight of any different risks that we may need to manage or mitigate; and Test our understanding of the interaction between our monetary policy goals – of low inflation and contributing to maximum sustainable employment – and our financial stability and efficiency goals. These goals remain mutually supportive. Since the beginning of this pandemic, and to the full extent of our mandate and capabilities, we have helped to cushion the initial economic blow delivered by the COVID-19 virus. Our initial actions have been focused on promoting cash flow and confidence in the financial system. We have also acted to maintain monetary and financial stability, and provide broad support to the Government, financial institutions, and the people of New Zealand. However, it is early days. The duration of this economic challenge will only be decided by the virus and its containment. Hence, we are now well in the groove of ensuring we maintain our policy effectiveness as the nature and scale of the economic challenge unfolds. As always: Our goal is to achieve our policy objectives subject to no undue risk. How we achieve our policy objectives – our strategies – will evolve appropriately with the economic circumstances. And, We continue to ensure that any necessary risks we must accept to achieve our goals are well identified, appropriate, and managed. People can remain confident in New Zealand’s financial system knowing that we are acting in their best long-term interests. Ahead, I will provide a sense of the operating environment the Bank has been confronted with in recent months and how our strategies are evolving to maximise our effectiveness. In the beginning… It is hard to think of a more complicated economic shock and starting point scenario for policymakers, including central banks, globally. The economic shock from COVID-19 continues to evolve and remains difficult to assess in scale, duration, and impact on demand and supply. Most challenging is the downside bias to the economic risks, given the scarring impact the uncertainty has on peoples’ willingness to spend, and on businesses’ preparedness to invest and employ. This impact on confidence may prove to be the longest lingering impact on the economy. Fortunately New Zealand entered the pandemic in a good economic position. This included a sound banking and financial system, high employment, stable inflation, strong terms of trade, and robust Government accounts. New Zealand is also well positioned with a strong backbone of primary production and processing, to both support us through lockdown and provide important foreign earnings. However, like all economies in the world, we also harbour vulnerabilities to the COVID-19 pandemic. These vulnerabilities include our reliance on services with face-to-face interaction such as hospitality, tourism, and education. We also have a high reliance on global demand and trade, including in some relatively low margin and/or low productivity industries where we are a price-taker. And there is a high level of indebtedness in some sectors – including primary production, commercial property, and household balance sheets – making them vulnerable to income cash-flow variability. The pandemic also arrived at a time of very low global inflation, and hence historically low nominal interest rates. This has meant that the traditional monetary policy reaction of reducing interest rates to offset a downturn in economic activity is limited. What we have economically endured since the onset of COVID-19 has been unsettling. Supply has been cut short by health-driven social restrictions, interrupting production and separating businesses from their domestic and global supply chains, and customers. The demand shock has been even harsher. Households have been unable to consume, partly due to lockdowns, but also due to increased caution. And businesses have been similarly constrained and concerned about their future. If sustained, these conditions could lend themselves to persistently low inflation and higher unemployment. Globally, and here in New Zealand, this is why fiscal authorities urgently responded to these challenges, providing business and household support in a variety of ways to shore up jobs, incomes, and confidence. It was also immediately clear to central banks globally that expansionary policies were urgent and necessary. The Reserve Bank’s Monetary Policy Committee agreed that in these circumstances a ‘least regrets’ policy response was necessary and meant we eased monetary conditions significantly. We agreed it was better to risk doing too much too soon, than too little, too late. This is especially so given that monetary policy is a repeat game, that is we can reassess our policy stance on a regular basis. At the end of the beginning… Globally, monetary and fiscal policy responses, and financial stability policies, are working collaboratively to provide economic support. The policies adopted across countries are also broadly similar, and generally include some combination of: ensuring credit and cash is cheap and accessible, increased government spending and investment, support for employers to retain their employees and access credit, and enhanced health and economic welfare support.1 The Reserve Bank’s monetary policy mandate stood us in good stead to assist to our maximum effect. We are first to admit that the front line economic support is fiscal policy. However, we have managed to provide significant assistance by continuing to focus on maintaining price stability and supporting maximum sustainable employment, and promoting financial stability. While our goals remain strongly relevant, we have had to develop and implement some new strategies and tools to ensure we are most effective. As already mentioned, the pandemic struck at a time of already historically low nominal interest rates. The implication being that – like many other central banks globally – Te Pūtea Matua was limited in its ability to reduce the Official Cash Rate (OCR) before reaching zero or some notional effective lower bound. Our values and team capabilities ensured we were prepared for such a situation and ready to innovate as issues evolved. We also collaborated with our international colleagues, learning from their experiences and vice versa. Fortunately for us, unlike many of our colleagues, we’ve had time to consider the pros and cons of alternative monetary instruments before having to immediately deploy them. We published some of this thinking earlier this year.2 Our responses to the COVID-19 induced economic shock have included: a significant reduction in the OCR; the introduction of large scale asset purchases (LSAPs); the provision of plentiful and cheap liquidity for the banking system; supporting the functioning of New Zealand’s debt markets; ensuring accessibility of cash; and facilitating a variety of Government and industry-led initiatives to allow the financial sector to remain customer-focused. All of these strategies directly support our monetary and financial stability objectives and are managed well within our risk appetite for ensuring ongoing success. We highlight the interaction of these policies in the following figure. 1 Policy Responses to COVID-19, International Monetary Fund, Accessed: 31 August 2020 https://www.imf.org/en/Topics/imf-and-covid19/Policy-Responses-to-COVID-19 2 RBNZ (2020). ‘Principles for Using Unconventional Monetary Policy in New Zealand’, https://www.rbnz.govt.nz/monetary-policy/unconventional-monetary-policy Figure 1: Mahi tahi: Working together to ensure cash-flow and confidence Source: Mahi Tahi: Working together to ensure cash-flow and confidence (PDF 318KB) While some of the strategies and tools the Bank has developed and/or implemented recently appear new, they are in fact used widely internationally and, in some cases, have been deployed before here in New Zealand.3 I will return to discussing these tools shortly. What is unique, however, is the impact these policy actions have on the outcomes we are trying to achieve. The impact on monetary conditions and overall economic activity will always depend on the context we are working in.4 The impact of monetary policy will ultimately depend on whether it inspires people and firms to change their investment and consumption intentions. This impact depends on the functioning of the transmission channels of our policy actions, and how our actions have been received through the layers of health, economic, and policy uncertainties. Monetary policy purposes and decisions are generally well signalled and understood these days, but it is the eventual effectiveness of our actions that remains a continuous ‘learning by doing’. What have we learnt so far in the times of COVID-19? The initial transmission of the OCR and Large Scale Asset Purchase (LSAP) programme decisions has been effective in terms of lowering interest rates across the board. Government bond yields are at least 50bps lower, and potentially more than 100bps lower, than they would 3 See RBNZ press release, ‘Reserve Bank announces new facilities’, 7 November 2008: https://www.rbnz.govt.nz/news/2008/11/reserve-bank-announces-new-facilities 4 About using Monetary Policy Tools: https://www.rbnz.govt.nz/monetary-policy/unconventionalmonetary-policy/alternative-monetary-policy-tools#fn3 have been without the LSAP programme.5 And our OCR cuts have had significantly higher pass-through to mortgage rates than usual.6 Figure 2: New Zealand government bond yields (left) and mortgage rates (right) However, it will take time to know how households and businesses can and will respond to this stimulus, and how inflation and unemployment will evolve. So far, in the wake of the initial wave of the pandemic, household spending and business investment has lagged behind incomes and earnings. But it is still too early to tell how, if at all, things are different this time. Will people’s reactions be more delayed or muted, or will the historically low interest rates and significant disruption facilitate a necessary investment recovery? It will most likely be a bit of both. The discussion highlights the limitation of monetary policy in promoting economic activity when confronted with a pandemic. We can create the environment to spend and invest, but we can’t force it to happen. The outcome instead depends on confidence amongst households and businesses. This also highlights why fiscal policy has been at the forefront to economic support globally – governments are able to directly spend and invest, and ensure resources are mobilised. The beginning of the end…succeeding sustainably I have already said that it is hard to think of a more complicated economic scenario for policymakers globally – the scale, duration, and relative impact on demand and supply from the COVID-19 pandemic. The health-driven nature of the economic challenge means there remains more downside risk to the economic outlook, prompted by uncertainty and caution. Likewise, I have highlighted that monetary and financial stability are necessary to economic success, but far from sufficient especially in times of pandemic. As appropriate, starring in the times of COVID-19 are health, fiscal, and regulatory policy responses. Globally, health outcomes are key to driving business and household confidence levels in the long-term. Monetary policy may not be the lead role, but it is playing an important support role. The Reserve Bank cannot just step aside and say ‘sorry, not our patient’. We have a clear mandate to provide our economy its best chance of thriving. COVID-19 and the Reserve Bank’s Balance Sheet, 20 August 2012, Speech by Christian Hawkesby https://www.rbnz.govt.nz/research-and-publications/speeches/2020/speech2020-08-20 6 Monetary Policy Statement August 2020: https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Monetary%20policy%20statements/2020/mpsaug2020.pdf?r evision=3ca8a4de-673e-41d5-bff6-408f0198ad09 The Monetary Policy Committee stepped up to this challenge as recently as our August Monetary Policy Statement, announcing an immediate easing in monetary conditions and outlining policy options ahead. The policy tools that we’ve used to date and the additional tools that we are considering using as a package in the near future are not new to central banking. The instruments include various forms of negative wholesale interest rates, further quantitative easing using large scale purchases of domestic and foreign assets, direct lending to banks, and forward guidance as to what needs to be done under certain conditions. However, we acknowledge that these tools are technical and unfamiliar to most New Zealanders. We recognise we have an ongoing communications challenge to ensure people remain confident in our intentions and actions. Table 1: Principles for using Monetary Policy7 Decisions the Monetary Policy Committee makes regarding the use of policy tools are in accordance with the Principles of Monetary Policy (Table 1). We are also consulting with relevant stakeholders on the implementation of any tools, to ensure our toolkit is best suited for the job in New Zealand. I am pleased with the collaboration we have received from the financial industry and look forward to our ongoing work. We are very aware of the challenges that we face, which are not new. For example: Is there some point at which the pursuit of low and stable inflation and maximum sustainable employment could prove detrimental to efficiency or financial stability? We must be aware of broader consequences of our policy actions. For example, persistently low nominal interest rates could lead to undue risk-taking by people as they seek higher nominal yields for their savings. Such activity can promote other financial vulnerabilities that need to be managed or mitigated. At this stage in the COVID-19 challenge, however, we strongly believe that the best contribution we can make to our monetary and financial stability mandates is ensuring we head off unnecessarily low inflation or deflation, and high and persistent unemployment. We will also remain vigilant of financial institutions to best ensure they do not promote undue risk taking. And we are continuously assessing our prudential policy settings to bolster the conduct and culture conducive to long-term financial stability. Consistently below target inflation has its own unique challenges that are best avoided. For example, persistently low inflation can further reduce inflation expectations – leading to even lower actual inflation in the future. At an extreme, a falling general level of prices can significantly hinder economic activity as people delay their spending in the belief that things 7 See Principles for Monetary Policy will forever be cheaper in the future. In addition, the real (inflation-adjusted) value of debt will also rise (as general prices fall) making repayment ever more difficult. Could low interest rates simply result in ever higher asset prices, benefiting their owners but widening the wealth divide? This is an issue that we have been thinking about a lot. We have talked to other central banks as well to further understand the distributional impacts across society. There is a perception that the Reserve Bank’s actions only benefit those with assets. That offers only a partial analysis of what we are dealing with. We acknowledge that lower interest rates inflate asset prices, which is a transmission mechanism that monetary policy works through. Higher house prices, for example, make people feel wealthier, more inclined to spend, which supports the economy. However, job security and a predictable household income has the most immediate and beneficial impact on economic wellbeing. Unemployment worsens economic wellbeing and underpins income inequality. Moreover, periods of unemployment are both more likely and persistent amongst people with lower skills or more transitory attachment to the labour force. These characteristics are most evident, for example, amongst youth, female, and Maori and Pasifika, demographic cohorts. The biggest contribution we can make right now to economic wellbeing is to improve New Zealanders’ job prospects through lower interest rates. Can our monetary tools – such as negative wholesale interest rates – reduce banks’ willingness to lend? We will only implement monetary policy in a way that succeeds in achieving our dual goals of monetary and financial stability. This is why we are discussing a package that can best achieve this outcome. Our package includes a combination of lower interest rates, direct lending to banks, and ongoing quantitative easing. We will not overly rely on a single tool that could lead to suboptimal outcomes. Moreover, New Zealand remains a great environment for banks to operate in – recording some of the highest profitability in the world, with some of the lowest risks for shareholders. Our banks are in a strong financial position, with capital and liquidity headroom, to support their customers. New Zealand’s financial institutions must use their risk models and capital allocation tools to be part of New Zealand’s economic success. Banks and financial intermediaries will need to make important decisions based on sound risk-judgement. This is why we have insisted our regulated entities operate in their customers’ best long-term interests. This is not simply saying ‘yes’ in the good times and ‘no’ in the tough times. Financial intermediaries – especially banks given their dominant role in New Zealand – need to clearly articulate their risk appetite and their culture. They must then operate consistently within their risk appetite over time. It is only then that customers can be sure of how they will be treated and why. Acting consistently and transparently through time is what we mean by banks acting ‘courageously’. Courage also involves banks having deliberate conversations with their stakeholders – the owners of the equity – that past expected risk-adjusted returns may not be achievable if they wish to be ‘sustainably successful’, that is, over the medium- to long-term. Even with all of this in place there will still be a need for prudential regulation. The differing time horizons people operate within (e.g., shareholders, bank management, and customers), the lopsided understanding of risks and rewards between banks and customers, and the system-critical nature of large banks – promoting a reliance on government insurance – all necessitate regulatory intervention. This is why we have required banks to hold capital in reserve well in excess of what they would hold if it was left purely to shareholders or management. We need financial institutions to be able to store capital reserves in the good times, so that they can both weather adverse economic events and deploy their capital in tougher times. The capital buffers of banks should now be used to support their customers. Our bank economic stress tests, discussed in our May Financial Stability Report, illustrated that banks are able to continue to lend and prosper through a broad range of adverse scenarios. Sound support given to customers today will help to ensure better customer and bank outcomes tomorrow. Banks need to make the appropriate risk-reward decisions that endure over time. This is being courageous. Keeping options open…managing in the ‘new norm’ It has been said that we are currently in a period of ‘radical uncertainty’.8 Everyone in society is confronted with uncertainty in some way, shape, or form. There is no precedent for the economic shock caused by COVID-19 in people’s living memory. We acknowledge that this pandemic shock could also reshape people’s beliefs and expectations.9 So how do we operate in such a situation? For us at the Reserve Bank, we have clear goals to achieve as mandated. To succeed in achieving these goals we rely on our values, culture, and capabilities. This enables us to continuously assess the beliefs and assumptions that underpin our strategies, and adapt our strategies as circumstances dictate. And it leads us to refine the ways in which we communicate to ensure we are clear and consistent.10 The Reserve Bank has a long history of succeeding in this manner, through promoting the long-term wellbeing of all New Zealanders. Our Statement of Intent outlines what we are doing, why we are doing it, and the benefits we expect. Our next near-term challenge is to outline our future monetary policy strategies and tools, and when we might use them. We are well prepared for this challenge. Meitaki. 8 Radical Uncertainty: Decision-making for an unknowable future, John Kay & Mervyn King, 2020 9 Scarring Body and Mind: The Long-term Belief Scarring Effects of COVID-19, J. Kozlowski, L. Veldkamp, V. Venkateswaran, Jackson Hole 2020, https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2020 10 Evidence continues to suggest that policy communication with the public matters significantly in shaping their beliefs and expectations, and in turn, macroeconomic outcomes. Communication and the Beliefs of Economic Agents, Candia, B., Coibion, O., Gorodnichenko, Y., Jackson Hole 2020, https://www.kansascityfed.org/publications/research/escp/symposiums/escp-2020
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Speech by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to banking industry representatives, Wellington, 31 July 2020.
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Banking the economy in post-COVID Aotearoa A speech delivered to banking industry representatives in Wellington On 31 July 2020 By Geoff Bascand, Deputy Governor and General Manager of Financial Stability 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Hihiritia te ra, e tiaho ano ai āpōpō – Harness the rays of the sun today, so that we may bring a brighter future tomorrow. Introduction1 The COVID-19 health crisis has posed significant challenges for the New Zealand economy and financial system and we expect it will take some time before we see a full recovery. The immediate operational challenges for the financial sector have been successfully overcome and the system has proved resilient so far, in part resulting from a stronger regulatory framework and favourable economic conditions over the past decade. As we gradually move past the challenges currently facing the banking sector, we expect issues such as alternative monetary policy, accelerating digitisation and new competitive challenges will shape the banking sector in the years to come. In the short-term, business failures and rising unemployment will increase credit losses and act as a drag on bank profitability. Low interest rates will reduce net interest margins (a key determinant of banks’ profits) and may accentuate growth in non-deposit-taking, non-bank lending institutions. While changing consumer preferences towards online banking and digitisation of payments – which have been accelerated by social distancing – may expose differences in banks’ technological capacity and cost structures. In the face of these challenges, the banking sector could choose to hunker down and seek to ride out the storm until the good times roll again. Or, the banking system could continue to step up and play a crucial part in supporting New Zealand’s economic recovery and maximise its potential competitive advantage of relationship lending and customer information. How the banking sector chooses to respond to this crisis will have a major influence on how the financial system evolves over the next decade. Maintaining institutional resilience while continuing to serve customers in an uncertain environment will demand expertise, courage and an unwavering belief that the people and businesses of Aotearoa will find a way to come out of these challenges. Ultimately for banks, maintaining the flow of credit to businesses and households will contribute to the stability of the banking system. Longer-term, lower leverage, greater internal investment and risk management, and increased competition portend lower expected returns for bank shareholders than they have historically enjoyed. Evolving structural changes in the financial sector pose less of an immediate threat than the pandemic crisis, but could prove more disruptive in the long-term unless the sector responds to meet customer, investor and 1 I am very grateful to Tom Bird for considerable assistance in the preparation of this speech, along with valuable comments from other Reserve Bank colleagues. regulator expectations. For New Zealand, with its bank-dominant financial system, a vibrant, innovative and sustainable banking sector is crucial to our collective wellbeing (Figure A). The COVID-19 crisis has reinforced the focus of the Reserve Bank – Te Pūtea Matua – on resilience in regulatory policy settings, including the imperative of strong capital and liquidity requirements. Our focus on risk management is also evolving so as to be attuned to changing structures and dynamics in the financial sector, including the implications of cyber risks, FinTech, climate risks, financial inclusion and the economy’s increasing reliance on payments system stability. These longer-term structural changes highlight the importance of a regulatory system and perimeter that can adapt to non-traditional financial entities, which is a key consideration of the Phase 2 review of the Reserve Bank Act. Figure A: Country-by-country bank assets to gross domestic product % % DNK NZL JPN KOR AUS SWE NOR GBR ESP PRT NLD ITA FRA GRC LUX FIN AUT ISL DEU CHL BEL TUR ISR POL SVK EST USA CZE SVN COL HUN IRL LVA LTU MEX Source: World Bank (2018). Resilience now and for the future To-date, New Zealand’s financial sector has proved resilient to the dual health and economic shocks, and indeed, supported the business and household sectors through strong business continuity arrangements, the accommodation of many customers through the restructuring of borrowing terms, and only a relatively modest tightening of lending standards. Looking ahead, ensuring the ongoing health of New Zealand’s financial institutions and provision of credit will be crucial to our economic recovery. A financial crisis and ‘credit crunch’ on top of an economic crisis would be hugely disruptive for New Zealanders’ wellbeing. The ability of financial institutions to absorb shocks, manage risk and continue lending in the face of shocks is foundational to our regulatory framework. Banks’ business continuity plans have stood up well so far to this unanticipated and severe event. Prior to COVID-19, no business plan had contemplated 100 percent of staff having to work remotely almost overnight. Plans were not perfect, and of course there are lessons to be learned, but overall people and technology responded well to support customers. Banks managed to reassign staff from back office to front office, across geographies, and transition from manual to digital channels very successfully. Staff had to adapt to working from home with kids’ television programmes in the background, while also balancing increasing work demands with home-schooling! New Zealand banks entered the crisis having built up strong capital and liquidity buffers in the prior decade (Figure B). Prudential standards introduced since the Global Financial Crisis of 2007/08 included liquidity requirements to ensure banks could support lending with stable funding bases. In the early stages of the crisis, liquidity positions were highly uncertain for a period of time, but buttressed by strong starting positions brought about by the Reserve Bank’s liquidity requirements, liquidity has been ample. Having a more stable funding profile allowed New Zealand’s banks breathing space to manage temporary disruptions when funding availability in wholesale markets deteriorated. Since February, no New Zealand bank has needed to issue term funding in these markets. As an additional measure to support the banking sector during the difficult period, the Reserve Bank made a number of liquidity facilities available that proved mostly precautionary, and itself transacted in a number of markets to shore up market functioning. Figure B: Measures of banking system soundness Mar-08 13.4 Mar-20 23.5 87.8 64.8 7.9 7.1 Tier 1 Capital Ratio (%) % of mortgages > 80% LVR Core Funding Ratio (%) Source: RBNZ Capital Adequacy Survey, RBNZ LVR Lending Positions Survey, RBNZ Liquidity Survey, registered banks’ Disclosure Statements. Likewise, capital metrics were strong going into this crisis, boosted by Basel III regulatory requirements, a number of years of favourable economic performance, and preparations for the impending implementation of the Reserve Bank’s Capital Review. The COVID-19 crisis has underscored the importance of banks having sound capital buffers; increased provisions for expected credit losses have, so far, been easily absorbed by existing capital buffers. Healthy capital buffers are necessary not only to ensure banks survive crises, but to ensure banks survive ‘well’ and are able to continue to lend to creditworthy borrowers throughout a downturn. The Reserve Bank remains committed to fully implementing the outcomes of the Capital Review. However, as we indicated this past March, this will be delayed one year and not occur until July 2021.2 We expect to communicate further on the implementation of the Capital Review by the end of the year. Looking ahead, the deterioration of asset quality will likely mean further loss provisioning will be needed. This could weaken banks’ capital positions. The Reserve Bank has initiated stress tests of banks to assess their resilience to a significant worsening in the economic outlook. Modelling suggests that under severe – but plausible – scenarios, banks are likely to maintain capital ratios above minimum requirements. However, there remains considerable uncertainty about the future trajectory of the pandemic, and how this will affect the New Zealand economy. Under severe enough scenarios, the viability of banks would come into question. Beyond the immediate COVID-induced economic stresses, low interest rates are likely to be an enduring challenge for the banking sector. The decline in interest rates is a long-term phenomenon, which can be largely attributed to a combination of proven monetary policy credibility, a negative global output gap, as well as the downward trend of real interest rates caused by global demographic changes and investment/saving forces. In the short-term, low interest rates can be beneficial to banks by reducing funding costs, increasing asset prices and lowering default risk. However, a prolonged period of low interest rates could pose significant challenges to banks’ business models and profitability. New Zealand banks operate rather ‘vanilla’ business models focussed on intermediating between borrowers and savers to generate the majority of their revenues. New Zealand banks are also heavily reliant on retail deposit funding. An extended period of low interest rates may cause the yield curve to flatten. This compresses banks’ net interest margin – the See RBNZ press release, ‘Financial system sound, and Reserve Bank providing additional support’, 16 March 2020: https://www.rbnz.govt.nz/news/2020/03/financial-system-sound-and-reserve-bankproviding-additional-support. margin between the cost of banks’ short-term funding and the interest that bank charges on long-term lending – which is the main driver of bank profitability. This, combined with an effective lower bound on nominal deposit rates, may weaken bank profitability. The consequences for lending institutions of very low interest rates are ones they need to anticipate and manage.3 They are also consequences that the Reserve Bank will pay close heed to. Specifically, when we make monetary policy decisions we consider the consequences for financial stability as part of the decision-making process, including any adverse consequences of, say, lower interest rates, alongside the benefits for financial stability that may result from a quicker or stronger economic recovery. Reserve Bank actions to support bank lending For New Zealand, the COVID-19 crisis will likely result in the sharpest one-off drop in (quarterly) economic activity in its statistical history. Early on in the pandemic, it became apparent the COVID-19-induced recession and lockdown would have a significant impact on New Zealand’s financial system. Many businesses and households were facing losses of income, global financial markets were beginning to seize and supply chains were becoming congested. Cash flow and confidence became key to New Zealand’s financial stability. To support the provision of credit to the real economy and keep the financial system stable the Reserve Bank worked alongside the Government and industry on a number of initiatives. We cut the Official Cash Rate and lowered longer-term interest rates through the Large Scale Asset Purchases programme.4 We also delayed a number of regulatory initiatives (including implementation of the Capital Review), imposed dividend restrictions on banks and insurers, facilitated loan deferrals with guidance on appropriate capital treatment,5 removed the loan-to-value restrictions, eased the core funding requirement and introduced a number of term lending facilities.6 We are continually reviewing whether these rule-settings Insurers are also impacted by falling interest rates. Whilst many insurers benefit, for some insurers with long-term guaranteed liabilities low interest rates in the short-term increase the value of liabilities, which has implications for insurer’s solvency. In the long-term, low interest rates reduce the insurer’s return on assets, which may require premiums to increase to compensate. In the past six months the Reserve Bank has had to apply prudential licence conditions to several insurers to boost capital buffers to mitigate the impacts of potential reductions in interest rates. 4 See RBNZ press release, ‘RBNZ to implement $30bn Large Scale Asset Purchase Programme of NZ Govt Bonds’: https://www.rbnz.govt.nz/news/2020/03/rbnz-to-implement-30bn-large-scale-assetpurchase-programme-of-nz-govt-bonds. 5 Ordinarily these loans would have been treated as non-performing with the consequence that more capital would have been needed. This would in turn limit a bank’s ability to extend loans and reduce credit availability. 6 The Reserve Bank reduced the minimum Core Funding Ratio (CFR) requirement in March 2020 to ensure that this requirement would not restrict the flow of credit to the economy. The Reserve Bank intends to provide guidance on when and how the CFR minimum requirement will be increased back to 75% in due course. Those institutions below the 75% minimum requirement will be provided with adequate time to increase their CFR back to minimum levels. remain appropriate, and expect to announce the future treatment of mortgage deferrals soon. Taken together – and without being too self-congratulatory – these initiatives have had a significant impact on supporting the short-term financial needs of households and businesses. This was important to limit failures of businesses with good long-term income prospects, and prevent mortgage defaults and foreclosures for borrowers facing temporary decreases in income. We of course would not have been able to announce any of these initiatives without the close working relationships with industry and the whole of government. We thank the industry for the open dialogue during this time and the numerous supervisory meetings held throughout lockdown. It is indeed times like these when strong relationships are called upon to facilitate the difficult, but necessary, discussions. Bank lending activity The banking industry faces many emerging challenges – not least, retaining its social licence to operate. Banks’ initial responses to the COVID-19-induced lockdown was strong. Banks stepped up and supported their customers with mortgage deferrals, liquidity facilities, and covenant relief. Today, $20.6b of residential mortgages is currently deferring principal and interest payments, and a further $18.3b of mortgages have moved to ‘interest only’.7 This represents 14 percent of the banking sector’s mortgage book (Figure C). But a key determinant of the success of New Zealand’s economic recovery to come will be the willingness of banks to lend to productive, job-rich sectors of the economy so that we can collectively take advantage of New Zealand’s enviable position of having eliminated community transmission. Now is the time for banks to prudently drawdown on their buffers to support their customers. Shareholders will have to be patient for longer-term payoffs, but this forward-thinking, long-term approach will stand bank customers, banks, shareholders, the financial system and Aotearoa in the best position. 7 The Reserve Bank has released new Bank Customer Lending metrics which provide more timely measures of the changes in lending to bank customers since the onset of COVID-19. Find out more at: https://www.rbnz.govt.nz/statistics/c65-bank-customer-lending-flows. Figure C: Bank customer lending flows $bn $bn Interest only Mortgage deferral 27-Mar 03-Apr 10-Apr 17-Apr 24-Apr 01-May 08-May 15-May 22-May 29-May 05-Jun 12-Jun 19-Jun 26-Jun 03-Jul 10-Jul 17-Jul 24-Jul Source: RBNZ Bank Customer Lending flows. Given banks are anticipating a deterioration of their loan portfolios, hunkering down and tightening lending standards may seem to them to be the optimal response to perceived increased risk. However, given banks dominant role in New Zealand’s financial system a synchronised lending contraction across the banking sector would risk a ‘credit crunch’ amplifying the economic downturn (Figure D). Therefore ultimately it is in banks’ own interest to maintain the flow of credit and contribute to the long-term stability of the banking system by preventing large scale borrower defaults and disorderly corrections in asset markets. Figure D: The New Zealand financial system $bn $bn Banking system assets Stock Debt market exchange capitalisation capitalisation Insurance sector assets Assets of managed funds Non-bank sector assets Source: Reserve Bank Balance Sheet Survey, Reserve Bank Non-bank deposit takers survey, Reserve Bank Managed funds (quarterly) survey. In the year-to-date, aggregate credit volumes have remained steady and have not shown any material month-to-month contractions or growth (other than consumer lending – mainly because the lockdown forced households to put away their credit cards!) (Figure E). However, banks have reported a material decline in businesses’ demand for credit over the first half of 2020 (Figure F). While demand for loans for working capital from small to medium businesses (SMEs), corporates and sheep and beef farmers has increased, demand for credit for capital expenditure has fallen significantly. Businesses’ investment intentions have also fallen sharply, with increased uncertainty around the strength of future demand. Some apparent weakening of demand for credit may also reflect perceptions by businesses that credit would not be available or that terms have tightened. Figure E: Annual credit growth (by sector) % % Housing Consumer Business Agriculture -5 -5 -10 -10 -15 -15 Source: Reserve Bank Balance Sheet survey. Figure F: Credit demand (observed change over past 6 months) % Mar-18 Sep-19 Sep-18 Mar-20 Mar-19 Jun-20 % More demand for credit -10 -10 -20 -20 -30 -40 Less demand for credit Residential mortgage loans Consumer loans -30 Commercial property loans SME business loans Corporate loans Agricultural loans Dairy loans -40 Source: Reserve Bank Credit Conditions survey. Indeed, banks have begun tightening several lending standards, particularly around serviceability assessments and interest rate margins (Figure G). Much of the tightening that has occurred to-date has been limited to more risky sectors. For some (such as commercial property, SMEs and dairy) this represents a continuation of trends that preceded COVID-19. However, banks have begun to apply more conservative standards to particular sectors exposed to the COVID-19 shock such as tourism, retail, accommodation, and construction. While some tightening is understandable and will reflect the general deterioration in the quality of applications, banks should not become overly cautious and should continue to focus on the long-term prospects of the applicants. Figure G: Lending standards (change over past 6 months) % Collateral requirements Repayment terms Interest markup Serviceability requirements Covenants Other factors % Tighter -10 -20 -30 -10 Easier Residential mortgage lending -20 Commercial SME business property lending lending Corporate lending Agricultural lending -30 Source: Reserve Bank Credit Conditions survey. Emerging risks and structural changes Resilience and its corollary, risk management, is not “once and dusted”. It is a dynamic process, one that must be continually tested, prepared for and built in the face of unexpected scenarios, and new and emerging risks. Today, new risks are emerging as industry structures, technology and environmental factors evolve. The pandemic is a reminder that periodic crises are a fact of life, but that the timing and nature of future crises are notoriously difficult to predict. Amongst the many significant challenges facing the financial system over the next decade are cyber risk, FinTech, climate risk, financial inclusion and the changing landscape for digital currencies and payments. These threats, and others, that may emerge point to the importance of strengthening the resilience of the financial system. Banks should continually strive to innovate in response to competition, changing customer expectations, technological innovations, and the drive for efficiency. Change is nothing new. Banking in New Zealand has continuously evolved over the past 180 years; from small banks serving local communities when mobility was by horse and cart, to extensive nationwide branch networks where thousands of transactions are processed every second. Over the past 30 years, technological advances have accelerated the use of electronic payments at the expense of physical branches, cheques and notes and coins (Figure H). While bank branch numbers have been falling for a decade, there has been an increased focus on engaging with customers digitally, and the COVID-19 lockdown would appear to be accelerating this trend. Figure H: Number of New Zealand bank branches & ATMs ATMs per 100,000 people Bank branches per 100,000 people Source: World Bank Global Findex Database (2017). The Reserve Bank wants to see an innovative, dynamic and customer-focused financial sector. With the digitisation of financial services, the financial system enjoys more opportunities to drive up productivity and these innovations serve the majority of customers well. New Zealanders are enthusiastic adopters and have embraced the opportunities presented by technology (Figure I) However, any reduction in the availability of cash and branch closures will impact certain pockets of society more than others. It is important that financial institutions maintain a strong focus on financial inclusion, finding ways to service and support those less able to access the electronic channels. Regional banking hubs currently being trialled are one way to provide banking services in small rural communities. Figure I: Measures of financial inclusion Used mobile phone to access account Credit card New Zealand OECD Debit card Made or received digital payment Paid bill online Deposit account % Source: World Bank Global Findex Database (2017). This drive towards digitisation could lead banks to aggressively pursue low-cost business models – a utility-type approach to banking. Or, banks could use their digital strategies to support increasing customisation, differentiated and customer-specific service offerings. Perhaps there will be a mix, with different service strategies for different customer groups or product lines. Corporate and business lending, by its very nature, is likely to require more relational banking activities, while mortgage lending has both commodity (utility) and relationship dimensions, and deposit taking can also reflect customer-loyalty. There are many niches in the financial sector, and different providers (including non-bank financial institutions) will seek to compete on the basis of their perceived business model advantages; however, increasing digitisation appears common to them all. As banks determine new business models, increased internal investment will be needed in technology, customer management and risk management. Managing customer, investor and regulator expectations in the face of persistent structural changes and an evolving risk environment will require strong organisational leadership and governance. Cyber Risk The flip side of digital strategies is that the financial system has increased exposure to cyber risk due to ever-evolving cyber threats. Cyber risk imposes costs, not only for financial institutions, but also for their customers and the financial system as a whole. We estimate the average cost of a cyber-incident to be around $104m for the banking sector and $38m for the insurance industry. To put this in perspective, it is the equivalent of 2-3 percent of annual profits for the banking and insurance sectors. This may not seem significant at first glance, but cyber risk is a typical tail risk. We estimate that there is a 5 percent chance in any given year that the cost of a cyber-incident could exceed $2b, which is equivalent to one-third of the banking industry’s annual profit. These costs include both direct costs from financial loss and indirect costs such as reputational damage and the opportunity cost from foregoing more productive investment. Therefore, there is a great deal of common interest between the Reserve Bank and industry to promote cyber resilience. As a first step, we have developed guidance on cyber resilience for all our regulated entities. Consultation for guidance was initially planned for March but will now be released for public consultation in October. The Reserve Bank is also working closely with other relevant government agencies such as the GCSB, CERT NZ and the FMA to promote information gathering and sharing regarding cyber resilience. FinTech The march of technological innovation is relentless, and disruptive technologies and innovative financial service providers will challenge banks’ business models at an everaccelerating pace. ‘FinTech’ is the buzz term that encompasses a broad range of technologies that enable households and businesses to manage their finances, and includes open banking, real-time payments and digital currencies. New Zealand has a long tradition of pioneering technology companies, and has a strong pipeline of promising FinTechs with revenue exceeding $1.1bn.8 FinTech present both risks and opportunities for banks, and broader monetary and financial stability, and cuts across a number of Reserve Bank functions. This is not academic, it is happening now. 8 Technology Investment Network (2019) TIN Report: Technology Industry Analysis (Report No. 15). ‘Open banking’ refers to a standardised framework for sharing bank customer data. Open banking reduces barriers to entry and eliminates banks’ monopoly over their customers’ data, making it easier for FinTech firms to innovate. The secure sharing of customer banking data has the potential to promote financial system soundness. By increasing competition, and unbundling banking services across a larger range of firms, it reduces the systemic importance of large banks. Greater sharing of customer data may also create opportunities for more personalised financial products and lower switching costs (which may promote market discipline). Open banking also presents risks, including making the banking sector more prone to cyber risk. The reality is that open banking is here – even if it appears slow to emerge for end-users. The Reserve Bank is already fielding an increasing number of engagement requests from FinTech organisations. Banks’ business models and products must become more customer centric or FinTechs will expand at the banking system’s expense. The Reserve Bank is not guardian of the status quo. Whilst FinTech disrupters could weaken bank profitability and create transitional risks, ultimately the Reserve Bank supports a dynamic financial system focused on improving outcomes for customers and financial system participants. Commercial banks start with the advantage of established customer relationships and a prevalence of accumulated data. Whether banks embrace the opportunity of open data, or resist innovation and are competed away by emerging FinTechs is up to them. The Reserve Bank’s Statement of Intent sets out our commitment to ensure the regulatory system facilitates financial sector innovation that benefits New Zealand. We recognise that there is more we can do, and will look to play a more active role to better understand the risks associated with FinTech developments, enable innovation in the financial services sector, and help harness opportunities for increasing financial inclusion and financial literacy. We believe the current regulatory system is sufficiently flexible to allow innovative approaches to flourish, but we will continue to work closely with our stakeholders to identify and remove any unnecessary barriers to new firms entering the system or obstructions for incumbent firms developing FinTech solutions. That said, the Reserve Bank has little appetite to lower regulatory standards for deposit-taking FinTechs alone. Minimum standards need to be applied to avoid risks to financial stability and the reputation of New Zealand’s financial system. Our guiding philosophy is: “same business, same risks, same rules”. Criticality of payment systems Payment and settlement systems (often referred to as financial market infrastructures or FMIs) play a key role in the operation of the financial system by providing the essential services needed to clear payments and financial market transactions. Payment systems can vary from the EFTPOS system, which transacts millions of small retail payments between consumers and businesses every day, through to interbank settlement systems, like ESAS, operated by the Reserve Bank, which handles, on average, $30b worth of transactions each day. FMIs are one of those critical infrastructures – like telecommunications networks, electricity grids and water pipes – which operate in the background and allow for our modern way of life. Nobody realises how well they work, until they don’t! The danger is that nobody invests in their renewal until it is too late. The banking system has a crucial role to play in supporting sector-wide infrastructural investment, as well as at the individual institution level to interface with FMIs. Rationing investment in this area is destined to escalate risks and challenges for the banking system. Many FMIs are systemically important due to the role they play in the financial system and their high degree of interconnectedness with the rest of the system. Disruption or failure of any one of these infrastructures could affect the financial system as a whole, and create major solvency and liquidity problems for market participants, as well as disruption for consumers and businesses, making it difficult or impossible to buy or sell goods and services. These systems can also act as the mechanism for transmitting contagion from the failure of a systemically important financial institution, such as a large bank. The new Financial Market Infrastructures (FMI) Bill will establish an enhanced regulatory regime for the supervision of FMIs by the existing regulator, being the Reserve Bank for payments systems and Financial Markets Authority jointly for settlement systems. The Act will provide the Bank and the FMA with broad information gathering powers, the ability to designate systems as being systemically important, and have enhanced oversight and enforcement powers. Finally, one long-term, almost existential issue for the banking system arises from the declining use of cash and the potential for digital currency to be issued by the central bank. While the Reserve Bank has no immediate plans to issue its own digital currency, it is an area of continuing innovation and exploration around the world, and one that we are beginning to consider its relevance for New Zealand. For now, the Reserve Bank is reviewing how best to support, steward, and facilitate access to physical cash and we will continue to engage with the banking sector in order to effectively meet customer demands. For example, we have recently created a new department – the Money and Cash Department – to think broadly about a future that serves the money and cash needs of New Zealanders. This includes smarter ways of cash distribution, as well as innovative solutions to emerging risks noted above. Financial Inclusion and Te Ao Māori Financial inclusion has become an increasingly important part of the Reserve Bank’s policy agenda in our capacity as a Council of Financial Regulator member and our own Te Ao Māori strategy. The Strategy helps to guide the bank in understanding the unique prospects of the Māori economy, how Māori businesses operate, and what lessons the Bank may learn in setting systemically-important policy with this view in mind. An important part of the Strategy is making clearer the unintended consequences of our policies on unique economies like the Māori economy. The COVID-19 pandemic has demonstrated the disproportionate impact of such economic downturns on both Māori and Pasifika communities. These compounding economic impacts have necessitated the Reserve Bank proactively reaching out to its regulated entities, Government and Māori partners to form a fuller view of the issues. The feedback has highlighted a role for banks in bolstering financial inclusion through greater access to capital to alleviate the financial stress of these unique economies. For example, finding innovative ways to manage the difficulty of securing lending against collectively-owned land could yield significant benefits. As with the needed credit response to the pandemic, there is opportunity to enhance both soundness and prosperity objectives, so that a more diverse spectrum of New Zealanders are being serviced by their banking sector while still prudently managing the risks at hand. Climate risk Climate change and the increased frequency of severe climate events will have a significant effect on New Zealand’s economy. The financial system’s exposure is primarily through the sectors that it lends to and insures. The financial sector will be affected by both the physical impacts of climate change (through damage to property and changing property values) and the transitional impacts caused by the shift to a lower-carbon economy, such as regulatory changes and changes in consumer and investor preferences. Both these physical and transition impacts pose serious risks to our financial system: credit availability to impacted sectors may be tightened, extreme weather events will likely reduce firms’ output which may affect their ability to repay debt, while changing collateral values may increase credit risk. The physical impacts of climate change will be substantial. For example, the National Institute of Water and Atmospheric Research (NIWA) estimates that $12.5b of property is already exposed to extreme coastal flooding in New Zealand, and that each 10cm of sea level rise puts a further $2.4b of assets at risk. Climate change also implies transition impacts – such as ‘flight shame’ or a shift to plant-based protein – that will pose unique challenges for our highly concentrated export economy. Agriculture is already staring down the challenge of a triple whammy of emission pricing, changes in consumer demand, and more extreme weather. At Te Pūtea Matua, we see climate risk as having far-reaching impacts on the economy, and therefore the financial stability that underpins our economy. Managing major and systemic risks to the economy, such as climate change, sits squarely within our core mandates. We are continuing to develop our own climate change strategy, and disclosure will form a critical component of this. Disclosure of climate risks will assist not only by encouraging the market to price risk efficiently, but incentivising risk assessment and mitigation, and ultimately, investment in emission reduction and adaptation. Industry has a critical role to play in assessing its own exposures, ensuring the appropriate allocation of financial resources through robust lending standards (and insurance underwriting policies), and providing the necessary finance for mitigation actions. Changing supervisory philosophy As risks to the financial system evolve, so too must regulation and the Reserve Bank’s supervisory philosophy. In New Zealand, regulation of financial institutions revolves around ‘three pillars’: self, market and regulatory discipline. While we continue to rely on all three pillars, the Reserve Bank plans to place more of an emphasis on regulatory discipline and verification than it has in the past, to better monitor risks to regulated entities and identify potential non-compliance with regulatory requirements. This has been enabled by our new Funding Agreement with the Government, which will allow us to substantially increase our supervisory resources, including increasing our Auckland footprint. Disclosure will remain an important part of our supervisory philosophy. During business-asusual times, transparent disclosure of banks’ financial information gives teeth to market discipline. During times of crisis, this demand for information becomes insatiable. Our Financial Strength Dashboard works alongside biannual disclosure statements as a source of easily consumable information for the public to better understand and compare banks’ businesses and risks. Over the past three months we have observed a substantial spike in use of the Dashboard. As promised two years ago, we will be reviewing the Dashboard starting later this year, partly to ensure it maintains a relevant picture of new emerging risks such as cyber and climate related-risks9. We are also making other changes to our disclosure framework. In future, banks will have to report all potential and actual regulatory breaches to the Reserve Bank, but a materiality threshold will apply to determine what gets disclosed to the market. The intent of the proposals is to enhance market discipline and reduce the focus on relatively minor breaches that may divert directors’ attention away from more important areas such as the banks’ overall strategic direction and management of key risks. The next couple of years represents an exciting time of change for the Reserve Bank. The Phase 2 review of the Reserve Bank Act involves a broad review of the Reserve Bank’s governance and accountability framework and its financial regulatory powers. What is proposed is two pieces of legislation, the ‘Reserve Bank Act’ and the ‘Deposit Takers Act’. The bill for the Reserve Bank Act, which has just been introduced to Parliament, will give effect to decisions on the Reserve Bank’s institutional form, objectives and governance. It is expected that the new governance board will be in place and operational in the second half of 2022. Our focus is now turning back to progressing the Deposit Takers Act with the Review Team and Treasury, taking on board the lessons we have learned during COVID. The Deposit Takers Act is expected to strengthen and unify our regulatory focus on all deposit-takers – including banks and non-bank deposit-takers – and should be sufficiently flexible to adapt to non-traditional FinTech entities. At the same time, maintaining a regulatory approach that is proportionate to financial stability risks is important. The final Phase 2 consultation paper was published just before lockdown and public consultation remains open until 23 October. I encourage you all to read what is proposed and provide feedback to help shape the Reserve Bank for the next 30 years. 9 My colleague Toby Fiennes will elaborate on our plans for enhanced Dashboard reporting in his forthcoming speech: “COVID-19, financial stability and transparency”, on 3 August, 2020. Conclusion The COVID-19 health and economic crisis is still running its course through the world. New Zealand has progressed further health-wise than many countries but our economic challenges remain severe. The banking system has provided resilience through the initial phase of the crisis, helping businesses and households to manage short-term financial stress and providing services in difficult circumstances. Banks now have a crucial role in supporting customers and the economic recovery through maintaining the availability of credit. Bank profitability will be challenged by increasing credit losses, but an unduly cautious approach to protect profitability is likely to worsen economic and financial stability. Notwithstanding the extraordinary nature of the pandemic, these risks confronting banks are familiar consequences of economic recessions. The potential for very low interest rates for a long period presents a new challenge in New Zealand. Other risks continue to emerge and will present further challenges for banking well beyond the duration of the current crisis. Cyber threats, climate risks, and new forms of competition will all disrupt the sector in various ways. Banking must keep evolving. Old business models either get revamped or replaced eventually. COVID-19 has accelerated the already strong trend towards digitisation and online banking, while traditional branch-banking is waning. The Reserve Bank expects banks to continue innovating in the interests of customers and their sustainable financial viability. Maintaining support and service for vulnerable customers will be confronting but imperative, as will the necessary investment in technology, data and risk management. Shareholders will have to be patient for longer-term payoffs. The Reserve Bank will continue to evolve its regulatory approach in line with emerging risks and structural changes in the banking and broader financial sector. The crisis has reinforced how vital (capital and liquidity) resilience is, but also how crucial it is to prepare for the unexpected and emerging risks. The future of banking is bright - provided we look to the future and start preparing for it now.
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Speech by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Insurance Council of New Zealand, Wellington, 14 September 2020.
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Promoting the Soundness and Efficiency of our Insurance Sector: Recommencing the IPSA and Solvency Standard Review A speech delivered to the Insurance Council of New Zealand in Wellington On 14 September 2020 By Geoff Bascand, Deputy Governor and General Manager of Financial Stability 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction1 Back in March, I was ready, speech in hand, to provide you all with an insurance update, particularly in relation to our plans for the review of the Insurance (Prudential Supervision) Act, or IPSA, that we started in 2017. As with many things, COVID-19 intervened. My pandemic insurance was I could always do it later! As I update this speech, different alert level requirements are in place. Again, just like many things I’m contemplating whether I might have to defer again, or do it differently – can one get insurance for multiple, repeated and arguably expected phenomena? To some degree, this story is a metaphor for the IPSA review. We have started and stopped it a couple of times, due to competing priorities for us and industry. We are now recommencing it. We are confident we can do so sustainably, even with pandemic risks surrounding us. The IPSA and associated Solvency Standard review, including our approach to the review and its timetable, are the main focus of my address today. I’ll also provide feedback on our view of the insurance sector’s handling of the pandemic so far, as well as an update on the Appointed Actuary Thematic Review, some comments on issues that were significant before COVID-19 and remain in play, and an update on our supervisory approach, including our Auckland presence. Before coming to the details of the IPSA Review, I want to remark on the importance of insurance and its place in our financial system. Our insurance markets Maintaining a sound and efficient insurance sector is important for New Zealand. Customers are used to being able to insure their homes and possessions and obtain life and disability insurance, and businesses utilise a range of insurance products to protect their assets and business interruption exposures. There are about 90 licensed insurers operating in New Zealand. The sector is highly diverse, ranging from large international companies to tiny specialised entities providing services to 1 I am grateful to James Painter for considerable assistance in the preparation of this speech, and other colleagues for helpful comments. particular employee or professional groups. The sector covers home and contents, motor vehicle, travel, life, health, disability, credit, income protection, business interruption, and other products or services. General insurance is the largest sector accounting for 63% of total premiums with life insurance representing 22% and health insurance 14%. The distribution of gross premium between classes of insurance and between insurers is shown in Table 1. Table 1 - Insurers by size and sector2 IPSA’s treatment of overseas insurers recognises that New Zealand is heavily reliant on foreign-based and foreign-owned life and general insurers. Foreign-owned insurers include insurers operating in New Zealand as locally incorporated subsidiaries of overseas parents and insurers operating as branches. Table 2 – Share of premium by country of incorporation of insurer3 2 Quarterly Insurer Survey and Insurer Return 3 Quarterly Insurer Survey and Insurer Return IPSA provides for some exemptions to insurers operating as branches, providing their home regulator has been approved as meeting IPSA equivalence. Table 2 shows the mix between locally incorporated insurers, which include subsidiaries of overseas insurers, and branches. Regulatory equivalence between overseas domiciled insurers and locally incorporated insurers is important because customers should be able to regard their insurance product as trustworthy wherever the insurer is based. Insurance isn’t very useful if it can’t be relied upon for pay-out when a claim is made, and our insurance market won’t be efficient or serve New Zealanders well if we have unequal treatment of domestic and foreign insurers. We want to see insurance remain available and affordable. Widely held property insurance helps manage the social and economic cost of natural hazard events for property owners and communities. It also lowers the potential fiscal costs for the government to facilitate recovery. Property insurance also has wider economic benefits by providing the confidence necessary for economic activity and investment, such as banks requiring evidence of insurance coverage to lend against properties. Similar benefits exist in other forms of insurance - such as life and disability insurance - that support the willingness of individuals and businesses to take risks and protect them from financial hardship. The Canterbury earthquakes revealed high levels of insurance penetration for home insurance in New Zealand. The interaction between private insurance and the Earthquake Commission has also led to some changes and others continue to be reviewed in relation to EQC and insurers. While there were low levels of non-insurance amongst homeowners, the risk of under-insurance was mitigated because most home insurance was provided on a total replacement basis. Industry experience in managing home insurance claims without a cap on the rebuilding cost led to a change to sum insured policies that cover a specified dollar amount for rebuilding cost. This development changes, to some degree, the allocation of risk between insurers, customers and the state. The risk of underestimating rebuilding costs and having a sum insured that is too low has transferred from the insurer to their customers and, in turn, creates potential for increased economic risks if a significant number of homes cannot be rebuilt because pay-outs do not cover the full rebuild costs. Life insurers in New Zealand have moved away from offering combined savings and insurance products and the market now primarily offers cover for pure risks, such as premature death, disability and sickness. In doing so, insurance provides families with financial security to preserve financial assets and businesses with financial security to protect key personnel and the interests of owners. A key difference between the life insurance sector and the non-life sector appears to be that the extent of insurance take-up, or insurance penetration, for life insurance is low by comparison with other OECD countries. Another key feature of New Zealand’s life insurance sector is the prevalence of relatively high upfront commission rates compared with overseas counterparts, whilst profitability appears to be at least as good as overseas experience. It’s worth reflecting on the context into which IPSA became law in September 2010 and subsequent developments. Background to IPSA and subsequent developments Why we regulate Going back to why IPSA was enacted, it was considered appropriate to bring New Zealand up-to-date with international standards for prudential regulation. The sector was not broken and there was a desire to avoid regulation that created a compliance mentality. New Zealand’s financial markets regulatory regime is based on the ‘twin peaks’ model with the Reserve Bank administering prudential regulation and the Financial Markets Authority administering conduct regulation. Market conduct regulation is about ensuring consumers are adequately informed and that market participants act with integrity, with a focus on product disclosure and the behaviour of financial services providers. (Amendments to the conduct legislation are currently before Parliament with a view to strengthening the regulation of conduct by financial institutions (Financial Markets (Conduct of Institutions) Amendment Bill). By contrast, prudential regulation is about institutional soundness, and promoting the maintenance of a sound and efficient financial system. The Reserve Bank’s philosophical approach to administering IPSA is based on the three pillars of self-discipline, market discipline and regulatory discipline. Self-discipline is closely linked with governance; hence our framework placing primary responsibility for an insurer’s business with its Board and senior management. Market discipline is the influence the market place has on insurers to operate their business prudently. Recognising that market participants have less information about the insurer than the insurer knows about itself and market discipline seeks to address that imbalance, to a degree, by ensuring the disclosure of some information. One example is the requirement for insurers to disclosure a financial strength rating to customers. The regulatory pillar essentially fills the gap between our risk appetite and the outcomes solely achieved through self-discipline and market-discipline. Our risk appetite is a proxy for the public’s risk appetite (informed by public consultation and parliamentary processes). It is lower than the risk appetite of individual insurers because it takes into account costs of failure not borne by insurers themselves but by other, external parties. Minimum requirements imposed under IPSA are therefore designed to be more conservative than an insurer’s management would choose in the absence of regulation. This does not mean that IPSA is intended to prevent all insurance failures. Whilst a sound and efficient insurance sector is systemically important, failure of a single company doesn’t usually have large spill-over consequences for the rest of the financial system. So we have a moderate tolerance for individual entity failure. We also differentiate supervisory intensity between insurers according to our judgements about the relative impact their failure would have, combined with risks of failure, which generally means focusing supervisory resource on the larger insurers. The key IPSA provisions (the regulatory pillar) cover capital strength, risk management, governance, fit and proper requirements for key personnel and that insurers are run prudently. Some provisions relate more directly to protecting policyholder interests, such as the requirement for life insurers to maintain statutory funds to protect long-term life insurance assets. We are also bolstering the regulatory pillar through more intensive supervision and enforcement, as discussed further below. It is important to emphasise that the role of prudential supervision and regulation has not been to dictate the commercial terms on which insurers should be providing insurance. For example, we have not sought to influence the trend towards risk-based pricing. Rather, our involvement has been to better understand what is going on, and to consider its impacts on soundness and efficiency. In its ongoing review of the Reserve Bank Act4, the Government has made an in-principle decision to change the current objective of that Act from ‘soundness and efficiency’ to ‘protecting and promoting financial stability’. The implications of any changes to the high-level policy objectives of the Reserve Bank Act will need to be 4 https://www.rbnz.govt.nz/news/2020/07/introduction-of-bill-marks-exciting-new-phase-for-te-putea-matua considered by the IPSA Review, along with other outcomes from the Reserve Bank Act Review. What is happening with the IPSA Review and why A policy paper outlining the resumption of the IPSA Review will be published in early October. It will provide an updated overview explaining objectives, topics to be covered and an indicative timetable. We’ll be staying in regular communication with our industry stakeholders as this work progresses, building on earlier consultation feedback. Alongside the IPSA Review document, we will also release a consultation paper on principles to guide the review of Solvency Standards. We recognise that you are dealing with a busy regulatory environment so it is important that we progress the IPSA review with a mind-set that focuses on improving prudential regulation, not re-inventing features of the framework that appear to be working well. The starting point is that we have a regime that is not broken, but has been significantly tested in its relatively short lifetime, and lessons can be learned and applied to improvements. Your feedback will be crucial to helping us shape the regime in an efficient and effective matter. The reasons for enacting IPSA have not changed, but what has changed is the experience on which further refinements can be considered. Since 2010, the Reserve Bank and insurers have gained considerable experience across the legislation, helping us to see what works well and what could be enhanced. There has been a high level of activity in relation to transfers of business between insurers, changes of control and insurers entering or exiting the market. The AMP/Resolution Life transaction is a notable example. IPSA powers have also been used in relation to solvency-level settings for some insurers, as well as in other areas such as risk management. The Canterbury earthquakes, which commenced just a few days before the enactment of IPSA, resulted in an intense period of supervisory activity and application of IPSA provisions. Some administrative features of IPSA have proved cumbersome to utilise and could be improved. Issues arising amongst some insurers in relation to matters such as capital management and the quality of risk management and governance sometimes revealed scope for improvements in the form of more specific definitions or guidance. More specific provisions and definitions and clearer guidance on some matters would reduce scope for outcomes to be quite so dependent on firm’s interpretation of sufficient selfdiscipline. Solvency margin settings is one area in which provisions might be made more specific. We intend to re-start the review of the solvency standards alongside the broader IPSA Review in October, applying the same regulatory pillar philosophy by evaluating prudential safety against risks. Solvency standards define the amount of capital an insurer is required to hold to protect against costs from unforeseen events. A criticism of the approach towards capital adequacy within the current solvency standards is that it represents something of an “all or nothing” solvency measure whereby a solvency ratio above 100% (or any alternative regulated figure) is taken to be adequate and a ratio of less than 100% is taken to be inadequate. Thought will be given to a more graduated approach where there is more than one level of capital requirement. Using such an approach, the different levels of capital requirement provide trigger points for intervention. The closer the trigger point is to the minimum capital requirement, the greater the level of supervisory intensity or intervention. Any buffer above the statutory minimum is currently at the discretion of the insurer, although the Reserve Bank can impose higher solvency margin licence conditions. Over the years, we have observed a declining trend in solvency margins that may be illustrative of a key difference in approach between insurers and the prudential regulator. Insurers must balance the need to maintain a sensible level of capital strength against the expectations of investors for a return on investment. Higher levels of capital make for a more resilient insurer but at the cost of lower return on equity. Prudential regulators tend to focus on low probability but high impact risks, or ‘tail end risks’, and a concern about the what-ifs in the event of extreme impacts. Of course, checks and balances exist within insurers, but without prudential oversight, competitive forces alone are not always compatible with adequately addressing tail end risks. In other words, the risk-appetite of equity-holders will not always be compatible with the risk-appetite of society. The outcome of this is that solvency buffers above the minimum are getting thinner which, by definition, means that the risks of insurers breaching minimum solvency requirements are increasing. The retention of capital, largely because of dividend payments being withheld, has seen a recent, but probably temporary, change in this overall trend. I’ll come to this again later. An over-arching consideration for the review of solvency standards will be an assessment of the impact that changes from the introduction of IFRS 17 will bring. IFRS 17 is the international financial reporting standard that, by 1 January 2023, will replace IFRS 4 on accounting for insurance contracts. This change represents a fundamental impact, because solvency standards are based on accepting financial values generated from the production of insurers’ financial statements. Provisions within IPSA distinguish between life insurers and non-life insurers by having separate solvency standards as well as the statutory fund requirements for life insurers. Some prudential requirements of some overseas jurisdictions are recognised under IPSA in the form of a limited range of exemptions. This only applies where overseas requirements have been assessed as meeting equivalence with IPSA and is restricted to provisions in relation to solvency, governance and some fit and proper matters. Some overseas insurers are active in New Zealand but below the threshold of activity that triggers a licensing requirement5. It is appropriate for the IPSA Review to re-visit the definition of ‘carrying on insurance business in New Zealand’ and to consider concerns such as the possibility that there is a growing non-licensed insurance sector. Similarly, the definitions of ‘carrying on insurance business in New Zealand’, or ‘contracts of insurance’ result in some arrangements appearing to the general public to be insurance provided by licensed insurers when they are not. For example, products that protect against non-completion of building work and defects are available as guarantees and insurance. As a broad generalisation, a guarantee provides an assurance that something will be fixed whilst insurance provides equivalent compensation for the loss, which might be through fixing it or by some other form of settlement. There will always be boundary issues with regulation but the IPSA Review provides an opportunity to reflect on whether the current boundary is in the best place. Other factors that will help to inform the IPSA review include recommendations from two external reviews of insurance regulation and supervision. These were an IMF Financial Sector Assessment Programme6 (‘FSAP’) in 2017 that assessed New Zealand compliance against international standards for prudential supervision of insurers, followed by an independent review of Reserve Bank Supervision of CBL in 20197. Other developments that 5 Significant factors that indicate an overseas entity is carrying on insurance business in New Zealand include (but is not limited to) having a physical place of business, staff or infrastructure in New Zealand or actively and directly advertising or soliciting business within New Zealand. 6 https://www.rbnz.govt.nz/news/2017/07/bulletin-article-reviews-outcomes-of-imfs-financial-sector-assessmentprogramme 7 https://www.rbnz.govt.nz/-/media/ReserveBank/Files/regulation-and-supervision/insurers/CBL-RBNZ-FinalReport.pdf provide material for consideration in the IPSA review include the FMA/RBNZ Thematic Review of Life Insurer Conduct and Culture, the Thematic Review of the Appointed Actuary regime, and the amendments in train to the conduct legislation. As it stands, our plan is to resume the IPSA review from October with: The release of an initial overview paper; Commencement of a consultation on the Solvency Standards at the same time; Subsequent consultation papers on various components of the review during 2021 to 2023. We welcome feedback through the formal processes associated with the consultation papers as well as being open to engagement and discussions on a continuous basis throughout the Review’s duration. Details will be covered in October’s paper. We envisage a staggered implementation of changes, ranging from operational changes that might be relatively easy to implement, through to legislative changes that require decisions from Parliament. This impacts on timeframe and our estimated completion date is 2024. The Solvency Standard is an example. It will need to be revised for IFRS 17 by end-2021, and is expected to be further revised to align with the IPSA changes by 2024. The ongoing impacts of COVID-19 on the sector As we reported in our May Financial Stability Report, there is considerable uncertainty as to how COVID-19 and the associated economic downturn will affect New Zealand insurers. Whilst death and disability claims do not currently pose a threat to the solvency of life insurers, COVID-19 could play out in a number of ways, including the possibility of further waves of infection. The initial economic responses to the pandemic created major disruptions to economic activity - particularly travel - and that has been reflected in travel insurance claims. Other key areas of impact or potential impact include credit insurance in relation to unemployment and impacts on investment portfolios. Overseas, there are also some questions about the scope of business interruption insurance and liability in relation to COVID-19 related claims and many will be watching closely to see if outcomes from ongoing court cases have implications for local insurers. Low interest rates have impacted some insurers adversely and this factor will continue to materialise in the next few years. Insurers adapted quickly to working under the lockdown environment and we sensed an almost routine response by insurers to the recent return to Level 3 in Auckland and Level 2 elsewhere. We’ve also noted the various ways in which insurers have sought to provide customer-focused responses to hardships arising from COVID-19. Our stance in relation to prudential risks to insurers from COVID-19 is that there are many unknowns still to play out in terms of flow-on impacts from what we have already experienced, as well as the potential for new outbreaks. This caution is also reflected in our stance on capital retention and dividend payments, which we regard as being imprudent under these conditions. We will update insurers on our stance on this at or before publication of the next Financial Stability Report in November. Appointed Actuary Review Appointed actuaries have a critical legislated role to measure and report on material risks and the role also entails providing impartial advice to an insurer’s board and senior management to assist with decision-making. Insurance is about known and unknown risks and strong, independently minded actuarial advice is crucial to managing risks. This was the backdrop to our recent Appointed Actuary Review8, so that we could better understand how the Appointed Actuary role works in practice for insurers, actuaries and the Reserve Bank, and to identify potential areas of improvement to make the role and regime more effective. We selected 15 insurers and their appointed actuaries for the review and published our findings and recommendations in June. The input and participation from industry stakeholders in this review was incredibly helpful, and we look forward to similar constructive engagement in the IPSA review I’d like to take this opportunity to again thank all those that participated. The review concluded that the regime and appointed actuary role are largely effective but that improvements should be made, including; the need for clarity and guidance around the Reserve Bank’s expectations of the appointed actuary role; limiting the risk that the impartiality of appointed actuaries could be adversely impacted by factors such as the 8 https://www.rbnz.govt.nz/-/media/ReserveBank/Files/News/2020/Appointed-Actuary-Thematic-Review.pdf influences of senior managers and reporting lines; and strengthening the Reserve Bank’s oversight role. We have used the findings to outline our expectations of the appointed actuary regime in a policy note which we will follow up with formal guidance. Other risks to the sector and the Reserve Bank’s planned response From a Reserve Bank perspective, the key themes within the insurance sector that existed before COVID-19 were risk-based pricing of property insurance, impacts from low interest rates, an overall trend of declining solvency ratios and findings from the joint FMA/Reserve Bank review into conduct and culture. Alongside these issues, the sector, like other sectors, faces increasing cyber risks and climate change risks. Cyber risks take on increasing importance when business models are continually digitised with customer platforms and data management central to business performance. We will issue cyber guidance for the banking sector in the fourth quarter that will be relevant for insurers also. Like many central banks, the Reserve Bank has a strong interest in climate change. Climate change poses significant risks to New Zealand’s economy and financial system – and therefore financial stability. The medium-to long-term risks to financial institutions from climate change remain relevant through and well beyond the current crisis. As the Bank of England’s Executive Director of Insurance Supervision Anna Sweeney said at Moody’s Insurance Summit last week9: “Climate risk remains a real and credible threat to the integrity and soundness of the global insurance industry which, without significant action now, will only get more pronounced in the future”. That is why the Reserve Bank has developed a climate strategy and is collaborating internationally on climate. We are proud members of the Sustainable Insurance Forum (SIF) and the Network for Greening the Financial System (NGFS) and we are leveraging our involvement in these global forums to step up our understanding and supervision of climaterelated risks. For example, last month we drew on resources from the NGFS and the SIF train our supervisors in climate risks. Insurers can anticipate being asked about climate 9 https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/paving-the-way-forward-managing-climate-risk- in-the-insurance-sector-speech-by-annasweeney.pdf?la=en&hash=35D74A884840C7D5C7BB58B2C79224E512A003FC change risks, governance and strategy in upcoming discussions with their supervisor. We will keep intensifying our supervision of climate-related risks. In this world of heightened risk there are corresponding stakeholder expectations of confidence in our regulatory approach. As we implement recommendations from the 2017 IMF Financial Sector Assessment Programme, the independent review of Reserve Bank Supervision of CBL, and continue to seek improvements in insurer conduct and culture, we are making changes to strengthen our resourcing and supervisory approach. The key developments you can expect to see from this will be more intense supervision, particularly in relation to verifying information received from insurers, and concluding enquiries more efficiently. We will be supported with more resources to be able to achieve these outcomes. As previously indicated, we are increasing our supervisory presence on the ground in Auckland. This is making good progress with the appointment of a Senior Manager Supervision, and from 2021 we plan to be supervising some insurers from Auckland. The implementation of an Auckland presence and increasing supervisory and enforcement resources are part of the ongoing development of our regulatory approach. We will retain a risk-based approach that includes our split of insurers into the Portfolio group, consisting of insurers whose failure would have a relatively small impact on the sector, and the Designated group, consisting of insurers whose failure would result in greater impacts and more intense supervision. What we mean by more intense supervision is that we will seek to resolve supervisory concerns more effectively and decisively by obtaining the information we need when we need it, verifying the integrity of the information provided and arriving at a timely decision and resolution. Increased resources will also enable us to cover more ground and ensure that key topics, such as cyber risk and climate change are appropriately covered. We will keep you informed of these developments and of the changes they bring about to our interactions with you. Conclusion Insurance is an important financial service to many households – providing valuable protection against risks to housing and other assets, and against income loss in a number of forms. It supports credit markets, reducing risks to bank and no-bank lenders, and it helps avoid significant financial distress. The Canterbury earthquake, the COVID-19 pandemic, and historically low interest rates have challenged various parts of the sector in extraordinary ways. The insurance sector has been prudentially regulated in New Zealand since 2010 and it is timely to review the efficacy of regulatory settings. We look forward to your continued input on this important process, so together we can continue to ensure the best outcomes for New Zealanders.
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Speech (written with Ms Amber Wadsworth) by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to The Royal Numismatic Society of New Zealand, Annual Conference, Wellington, 19 October 2020.
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Working together to be ‘on the money’ A speech delivered to The Royal Numismatic Society of New Zealand, Annual Conference, Wellington 19 October 2020 By Christian Hawkesby, Assistant Governor1 General Manager, Economics, Financial Markets and Banking Group Written with Amber Wadsworth 1 Many thanks to Kirsten Ashley, Peter Dench, Graeme Denny, Mark Fahey, Kevin Graham, Naomi Mitchell, Peter Northcote, Adrian Orr, James Sergeant and Ian Woolford for their contributions and input. Introduction E nga mana, e nga reo. E nga karanga maha o te wa. Tēnā koutou katoa. It is real pleasure to speak today at the Royal Numismatic Society of New Zealand. I want to first acknowledge your global expertise in coins – and also bank notes and medals – including their history, value and knowledge of how they reflect our society. I would also like to thank the Society for all the assistance it has provided the Reserve Bank over the years, including with the development of our Brighter Money banknotes, the design and release of our circulating commemorative coins, as well as with our Museum and Education Centre. We are keen for this partnership to continue. As a young child, I spent a lot of time being looked after by grandparents in Christchurch. To keep me occupied, my grandmother would set me up at the kitchen table with a jar of coins for the milk collection. I would spend hours inspecting them and figuring out how many different ways to count the stacks of different denominations (and to be honest, hoping I would get to keep a few). While this didn’t develop into the level of coin expertise of the Numismatic Society, it may have eventually sparked an interest in money, finance, and ultimately central banking. A lot has changed in the way we make payments since those times. Leaving coins in a glass bottle beside the letter box was eventually replaced by using plastic milk tokens. After a while, many people switched to using debit or credit cards to buy milk at the supermarket. Now we can use remote payments to buy milk online and have it delivered. Buying milk is just one example. The way we make payments will continue to evolve, and this will vary significantly for different parts of our society too. Today, I would like to focus on the future of cash and money in New Zealand, and the Reserve Bank’s agenda ahead. Specifically, I will: describe the evolution of money and payments in New Zealand; outline the decline in cash use and access, and how it affects those who need it; explain how we aim to ensure the cash system remains fit for purpose; identify some trends in central bank digital currency; and provide a holistic view on the way forward. There are four key messages I want to leave with you today: 1. Cash is being used less as a means of payment and access to cash is declining. However, cash provides important benefits to many people, including legal tender money, social and financial inclusion, peer-to-peer payments, backup payments, privacy and autonomy. To preserve the benefits of cash for all who need them, the Reserve Bank is taking on the role of steward of the cash system. We encourage every banking sector participant to consider their role supporting their customers and their access to cash. 2. Recognising the Reserve Bank’s role and responsibilities – as issuer and steward of New Zealand’s money and operator of key payments systems – we are building our analytical, policy and governance capability to support this strategic leadership. In the years ahead, some of the biggest questions facing central banks could well be around the future of money itself. 3. Our immediate priority is to work with the banking and service industries to ensure that the cash system continues to be fit for purpose. This will include reshaping vaulting arrangements, banknote standards, and building towards a sustainable future. Ultimately, it could, for example, involve a more transformational utility solution. 4. Looking forward, we remain open minded about how the technology of money and payments will continue to evolve. Central banks around the world, including us, are researching retail central bank digital currencies (CBDC). Although we have no imminent plans to issue a CBDC, we are well-connected and considering these developments very closely. To issue currency that meets the needs of the public, we must take a new and holistic approach. We acknowledge there is much work to be done. We do not yet have all the answers, nor do we expect to find them alone. However, by working together with New Zealand we want to be ‘on the money’ now and in the future. A brief history of money in New Zealand2 Before I begin, let me give you a brief history of money in New Zealand. The way we pay in New Zealand is continuously evolving. In the earliest days of our country, trade and commerce was facilitated within economic systems based on tikanga. Gift giving and communal living were central to Māori social structure and long distances meant that trade was often limited to smaller items of value such as pounamu.3 Transactions were typically either on the basis of giving or bartering where goods or services are exchanged for the promise of other or future goods and services. The arrival of early European whalers and sealers expanded New Zealand’s bartering economy, trading European food and clothing in exchange for local wood, water and knowledge. Europeans also brought tokenised money in the form of foreign coins made of gold and silver. Eventually, this concept of money replaced the bartering system due to its convenience. Fundamentally, ‘money’ provides three important features: a uniform unit of account (we can write our prices in it and compare one to another) a store of value (we can build up our savings in it and trust they will hold their value) a medium of exchange (we can make payments with money as the intermediary) By the 1840s, after the signing of the Treaty of Waitangi, there was a steady increase of European settlement in New Zealand. It was then that the first commercial bank in New Zealand, the Union Bank of Australia, was established and it issued the first bank notes in New Zealand out of a shed in Petone. 2 This section draws heavily from Reserve Bank of New Zealand (2018) “The Journey of Te Pūtea Matua: Our Tāne Mahuta”. 3 Greenstone sourced from the West Coast on the south island. Other commercial banks followed including Bank of New Zealand, Bank of New South Wales, National Bank of New Zealand, Colonial Bank of New Zealand, Commercial Bank of Australia, Bank of Aotearoa, Bank of Otago, Commercial Bank of New Zealand, and Bank of Auckland. Maori did not issue currency of their own. However, the Bank of Aotearoa issued several one pound notes at the request of Tāwhiao Tukaroto Matutaera Potatau Te Wherowhero, the second Māori King. These were not circulated. Eventually pressure mounted for the formation of a New Zealand central bank. In 1934, the Reserve Bank of New Zealand was established with the sole right to issue notes and coins in New Zealand, and we issued our first banknotes and coins just six months later. Central bank issued notes and coins remain the only form legal tender money accessible to the public. Legal tender money represents a claim on the central bank and can always be redeemed for face value at the Reserve Bank. It also represents a legally valid form of payment which, for example, can be used to settle debts and obligations. However, traders and retailers have discretion to select what form of payment they will accept for goods and services prior to the transaction.4 Through time, the Reserve Bank’s functions expanded from issuing fiat money5 to the public in the form of bank notes and coins, to taking actions to ensure fiat money remains a stable unit of account, store of value, and medium of exchange. Our monetary and financial stability mandates as well as our currency mandate are legislated in the Reserve Bank Act (1989) and aim to promote the prosperity and well-being of New Zealanders, and to contribute to a sustainable and productive economy. For example, inflation targeting aims to ensure the general rise in prices is low and stable, meaning that we can easily predict how much we will be able to buy with a dollar. Likewise, the Reserve Bank provides accounts to commercial banks and issues electronic money to banks to facilitate the smooth settlement of payments in New Zealand, ensuring the fiat money remains a useful medium of exchange. The role of cash in society Today, the vast majority of New Zealand’s money balances are digitally represented and bank notes make up just seven to nine percent of liquid money. Few people use cash for their everyday transactions. However, some people, such as tourists and those who are financially, digitally or socially excluded do heavily rely on cash.6 Our 2019 public cash use survey indicated that six percent of New Zealanders rely on cash for their everyday needs (Figure 1). Despite the decline in its transactional use, cash in circulation continues to increase. This is likely due to its usefulness to some as a store of value. 4 There is no legal obligation in New Zealand for shops and merchants to accept cash as a means of payment for transactions at the point of sale. See also McBride (2015). 5 Legal tender money issued by the central bank and backed by the government rather than any physical commodity. 6 People who don’t have access to the banking system, or with challenges that prevent them accessing it. Among, for example, people with disabilities, senior citizens, people with low socio-economic status, and people living rurally with limited internet services. In addition, cash provides key public benefits including legal tender money (that represents a claim on the government), instant ‘in-person’ settlement, emergency offline backup payments, and privacy and autonomy in savings and payments. These benefits of cash have so far been not well replicated by electronic money in commercial banks. Figure 1: New Zealanders’ use of cash ‘over the last seven days’ is declining Share of survey respondents 50% 40% 30% 20% 10% 0% No response More than 20 11 - 20 7 – 10 3–6 1-2 Not at all Never use cash -10% Change Source: Reserve Bank (2019b). Cash and COVID-19 COVID-19 has also highlighted the important role that cash plays in times of economic uncertainty. During the weeks leading up to the March 25 pandemic lockdown, New Zealanders demanded an unprecedented amount of cash, with $800m of bank notes issued in March alone (compared to $150m in March 2019). These bank notes have not yet returned to the banking system, meaning they are likely still being held by the public. Since then, cash in circulation has continued to increase, growing by about 15 percent year on year during the second quarter of 2020. Many other countries have also experienced increased demand for bank notes during the pandemic, as a store of value and a back up method of payment (Figure 2).7 It is not unusual for cash holdings to increase during periods of uncertainty. In the lead up to the year 2000 wide-spread uncertainty of potential computing failures (the so-called “Y2K bug”) resulted in a sharp increase in cash in circulation (quarterly). Similarly, economic uncertainty during the financial crisis over 2008 - 2009 resulted in a rise in cash in circulation (Figure 2). Smaller increases in cash holdings can also be seen with regional events such as the 2011 Canterbury earthquakes. 7 See also Auer et. al. (2020). Figure 2: Cash in circulation continues to increase Quarterly year-on-year percentage growth 25% 20% 15% 10% 5% 0% -5% -10% -15% Australia Canada NZ Norway Sweden Q2/2020 Q4/2018 Q2/2017 Q4/2015 Q2/2014 Q4/2012 Q2/2011 Q4/2009 Q2/2008 Q4/2006 Q2/2005 Q4/2003 Q2/2002 Q4/2000 Q2/1999 -20% UK Notes: Grey lines denotes (in order) the year 2000 (Y2K) period, great financial crisis (GFC) period and the COVID-19 pandemic. Source: Haver Analytics. Public access to cash is decreasing At the same time, it is getting harder to get hold of cash. Access to cash8 reduced by around 2 percent over 2018 – 2019. A cash system incurs high fixed costs and depends on a high number of users to keep the per transaction cost of providing cash services low. As the use of cash falls, the per transaction cost increases, causing some cash providers to reduce their services or to introduce or raise fees. This in turn further reduces the number of people who use cash while also increasing the costs to those who rely on it. In contrast, some debit and credit card schemes generate profitable returns for commercial banks and might present a more favourable service offering for banks compared to cash services. Reduced access to cash has been particularly felt by regional New Zealand as bank-owned ATMs and branches have become more concentrated in urban centres and cash services have been pulled out of regional areas. This is particularly evident in rural communities on the West Coast of the South Island where there is only one bank ATM located between Wanaka and Hokitika – a distance of 418 kilometres. These rural communities are now more likely to be serviced by independent cash providers which charge fees and are generally located inside retailer premises (with limited hours). Moreover, unreliable internet, fees for card transactions, and occasional isolation due to natural disasters can create additional barriers to these communities ability to transact. 8 Defined by access to five major commercial banks’ cash sites. A site comprises all ATM’s and branches at one location. On the East Cape of the North Island, communities are also facing challenges. Reduced cash services and low internet coverage make it difficult for people living in these remote areas to make and receive either cash or electronic payments, or to give koha. Professional cash transport services can be prohibitively priced for businesses in these remote areas. As a result, some small businesses have to travel lengthy distances to the nearest town with a bank branch or street facing ATM to deposit their cash takings or acquire change. Cross-border payments are also becoming more difficult for some. Many people sending money to and from the Pacific islands tend to rely on cash to initiate and complete their remittance transactions. However, fewer commercial banks are willing to provide cash and banking services to businesses that transfer money to and within the Pacific.9 The future of cash – te moni anamata Given these forces, and the eventual need to replace our aging bank vaulting facilities, the Reserve Bank established the future of cash initiative in 2017. The initiative recognised that despite the importance of the cash system, no agency in New Zealand was responsible for it as a whole. The Reserve Bank has historically been responsible for issuing bank notes and coins on demand. This meant, issuing cash to banks, collecting unfit cash, and processing, storing or destroying the cash that is returned to us. The remainder of the cash system, i.e. the banks’ distribution of cash to the public and the transportation of cash to and from retailers (Figure 3) has been held together by a set of informal arrangements and commercial incentives. Figure 3: The supply of cash to the New Zealand public Source: Reserve Bank of New Zealand. In 2018, as a first step towards addressing the gaps in our legislation regarding cash, the Reserve Bank Act’s purpose statement was amended to focus on prosperity and well-being, and a requirement to issue bank notes and coins to meet the needs of the public was added (Figure 4). Building upon this mandate, the Reserve Bank last year published two papers inviting feedback from the public on the role of cash. The public policy case on cash was set out in 9 We have been working with the Ministry of Foreign Affairs and Trade, the Department of Internal Affairs, the Reserve Bank of Australia, South Pacific Central Banks and international financial agencies to address the challenges facing providers of these services domestically and in the Pacific region. The Future of Cash Use issues paper and was followed by a series of korero moni (cash conversations) held with diverse communities and representatives across New Zealand. Feedback through this process revealed to us that we needed to go a step further than simply issuing currency to meet the needs of the public. That, to lead the future of cash, we must also ensure that the cash system remains fit for purpose in the face of falling transactional cash use and the emergence of new innovations in money. We then published a range of possible responses to ensure a fit-for-purpose cash system in The Future of the Cash System consultation paper and proposed new cash and money provisions in the recently introduced Reserve Bank Act Bill. One of these provisions introduced the role of the Reserve Bank as the steward of cash and the cash system. Stewardship is defined as “the act of taking care of or managing something.” 10 For us this means ensuring that New Zealand has a cash system where people can easily withdraw, deposit and pay with cash when they need to, and the cash system remains efficient and resilient to sudden shocks and a declining transactional use of cash. In February this year, the Minister of Finance affirmed the unique benefits of cash and supported our proposal for the Reserve Bank to take an active stewardship role in the provision and supply of cash. We have now moved from issuing currency that meets the needs of the public, to holistic stewardship of the cash system. Figure 4: Future of Cash initiative Source: Reserve Bank of New Zealand. 10 Oxford University Press. Stewardship of cash through COVID-19 Our response to cash demand during the pandemic is an example of stewardship in action. As the scale and significance of the global pandemic first emerged, we identified that the distribution of bank notes and coins in New Zealand could be affected by an outbreak of COVID-19 or transport restrictions either in our Wellington operations or anywhere in the cash system where people handle and transport money. As a result, we worked with industry to organise a back-up network of vaults throughout New Zealand where cash could be stored and issues; preparation which proved to be vital in ensuring the supply of cash to the public. This ongoing experience has highlighted the importance of these ‘distributed’ vaults, as well as how important it is to collaborate with the banking sector and cash industry. Our COVID-19 experience also revealed the need to encourage retailers, particularly of essential services, to adopt practical and balanced cash practices that do not make it more difficult to access and use cash for those who need to. We acknowledge the efforts of banks to assist many customers in the move to digital payments during COVID-19, as well as the New Zealand Bankers’ Association coordinated effort for the upcoming trial of regional banking hubs. However, we have also witnessed some banks fast-tracking planned reductions in cash services during the lockdown. These included reducing operating hours and cash access points; changes which have made it harder for individuals and retailers to transact in cash. Since September 2019, the largest four commercial banks have collectively reduced their number of bank branches by 6 percent and reduced the operating days or hours of 271 remaining branches. We are sympathetic to the complaints from those who are struggling to adjust to changes to cash services from their bank. Strategy, capability and governance Going forward, our role as steward of cash requires us to build a strategy for the future of currency in New Zealand. To do this, we recently raised the profile of our Future of Cash initiative and created a new department called Money and Cash - Tari Moni Whai Take.11 Te reo Māori version of the name sums up its purpose nicely, “the department bringing money that’s fit for purpose”. This department is now responsible not only for the production and distribution of bank notes and coins, but also evaluating the broader policy issues associated with the future of money in New Zealand. Accompanying this, we are planning to establish a new governor-level Payments and Currencies Committee, responsible for strategic, policy and oversight decisions for our roles as an issuer of currency, operator of payments and settlement systems, and steward of the cash system. The Reserve Bank is continuing to engage with the public and industry, including on systemlevel information and resilience needs. We are also formalising and embedding the distributed vaulting arrangements deployed during COVID-19. Alongside this, we will be 11 Reserve Bank of New Zealand (2020). working with industry to develop standards for banknote processing machines to ensure the authenticity and quality of our notes. However, it has become clear that the cash system as it stands will not be sustainable in a world where cash is used less and less. This requires a broader response with either a series of changes to the cash system or a transformational redesign of the entire system. To make this decision we will undertake a holistic and strategic review of the cash system. The objective of the review will be to ensure that the physical and business arrangements for cash distribution are efficient, resilient, lower carbon and set up to meet the public’s needs now and into the future. The review will also take into account the public benefits and the increasing costs and efficiency challenges of providing cash One option to ensure that cash is available for the long-term might be concentrating cash services in a single provider. For example, the end-to-end cash infrastructure could be provided by an industry monopoly model. Alternatively, a private-public-partnership as seen in some parts of the water, transport and electricity industries could be used. Such a model would recognise the public case for cash. Trends in digital money As steward of currency, we must also look to the future of money and remain open to emerging payment methods. Payments are predominantly digital (Figure 5). Consumers are increasingly drawn to convenient methods of payments including contactless cards and mobile wallets. Meanwhile banks, big tech and fintech firms are innovating with new types of payment instruments and methods. Some firms and consortiums are proposing new ways of paying that rely on cryptoassets or so called ‘stablecoins’12 and distributed ledger technology. COVID-19 also accelerated existing trends towards contactless and remote payments. During the lockdown some retailers requested either contactless ‘in-person’ payment methods or remote payments via internet orders. Cash was notably discouraged by many despite having similar viral transmission risks as other common objects such as plastic cards, handrails and door knobs.13 New Zealand was not alone in experiencing these trends. We are currently undertaking a public survey and wider research supporting analysis to determine how much our payment behaviours have changed during COVID-19 and whether this will be lasting. 12 Crypto-assets are generally tokens that rely on cryptographic methods and non-traditional payment infrastructure to be transacted and stored. Stablecoins is an industry term that refers to the issuer’s intention to stabilise the value of a crypto-asset relative to a certain asset(s) such as a fiat currency. The name stablecoin does not confirm its stability. 13 Auer, Cornelli and Frost (2020). Figure 5: Payments becoming increasingly digital Selected countries Cash in circulation (% GDP) JP EA SG US AU SE CA UK NZ NK Value of card payments (% GDP) Notes: Arrows denote 2007 – 2018 changes. Source: CPMI Red Books, Reserve Bank of New Zealand, Norges Bank. The Reserve Bank recognises the potential for transformative innovation in financial services (“fintech”) to increase efficiency and financial inclusion.14 At the same time, innovations may create new risks that need to be managed or mitigated appropriately.15 Some of those risks include money-like proposals that sit outside of the regulated sector and are not reliably denominated in New Zealand dollars. Such innovations could pose challenges to our ability to set monetary policy. Central Bank Digital Currencies (CBDCs) Among these trends, central banks around the world are exploring the benefits of and potential for retail CBDCs that are issued to the public (Figure 6).16 CBDCs present a range of high-level benefits and challenges as previously described in our 2018 research.17 In particular, CBDCs provide a digital form of legal tender money to the public and represent a claim on the central bank. In contrast, electronic deposits held in commercial banks are a claim on a commercial bank and although they might be low risk, they are not completely risk free and could be lost if the commercial bank failed. In 2019, the Bank of International Settlements (BIS) established an innovation hub with partner central banks which proposes to look at, among other innovations, central bank digital currencies.18 14 Robbers (2019). 15 Bascand (2020). 16 Boar, Holden and Wadsworth (2020). 17 Bascand (2018), Wadsworth (2018b). 18 Bank for International Settlements (2020). In addition, the BIS together with a group of central banks recently agreed to three principles when considering CBDCs. 19 1. CBDCs should do no harm i.e. they should not hinder a central bank’s ability to meet its monetary and financial stability objectives. 2. CBDCs should co-exist with cash and robust privately-issued money such as deposits in bank accounts, and 3. CBDCs should be innovative and efficient. Ultimately, the catalysts for researching CBDC depend on local needs. Central banks in economies with declining use of, and access to, cash are considering whether a CBDC could deliver an additional form of legal tender. For example, in Sweden, the Riksbank is considering an e-krona as a digital complement to cash given the decline of cash in circulation.20 Conversely, central banks in economies with a heavily reliance on cash are investigating the potential for CBDC’s as a stepping stone to help the unbanked population move into the formal banking sector.21 A CBDC could improve financial inclusion, particularly if it is established with a government-led digital identity scheme. For example, the Central Bank of the Bahamas has launched a CBDC pilot called “Project Sand Dollar” with the goal of increasing financial inclusion across the islands in the Bahamas, where many people rely on cash but face difficulties accessing bank branches.22 Further, in the case that a foreign-issued or privately-issued currency became prevalent, a CBDC could enable a central bank to retain monetary sovereignty and price stability. To be clear, we have no immediate plans to launch a CBDC in New Zealand. We are, however, following developments very carefully, and are among the 80 percent of central banks that are actively researching CBDCs (Figure 6). 19 Bank of Canada et. al (2020). 20 Riksbank (2018). 21 Cash is beneficial for financial inclusion in the immediate term and by providing an alternative means of payment, but long term financial inclusion requires creating pathways to electronic means of payments. This includes, addressing challenges such as digital identity, access to online platforms, and education. See also Committee on Payments and Market Infrastructures and World Bank (2020). 22 Central Bank of the Bahamas (2019). Figure 6: Central banks are engaging in CBDC work Share of central bank respondents Central banks also engaged in development/pilot arrangements Central banks also engaged in experiments/proof of concept Total central banks researching CBDCs 0% 20% 40% 60% 80% 100% Source: Boar, Holden and Wadsworth (2020). Taking an active and holistic view To conclude, as the way we access and spend our money continues to evolve, the Reserve Bank must take a proactive and holistic approach to the future of money. This requires future-proofing the cash system and giving more attention to the interaction of physical and electronic money. In doing so, we are supporting the prosperity and wellbeing of New Zealanders. As steward of currency we must build a cash strategy that is economically viable, resilient and supports inclusion. To do this, we will continue to build on the relationships we have established with the banking and cash industry while also building out our own capabilities. We have seen the cash industry work together through COVID-19 to support the public’s access to cash and this is something we want to encourage further. Cash is a crucial form of money for our country and we encourage every banking sector participant to consider their role in preserving the benefits of cash. We are also monitoring the ever-changing technology of digital money and payments with respect to our stewardship role, and desire to support innovation and efficiency. To support all of this, at the Reserve Bank we are deepening our policy and analytical capacity, and putting in place the governance structures required to provide the strategic leadership that will be needed. There are several points through history where central banks have faced defining challenges. In the 1990s it was inflation targeting. By the mid-to-late 2000s it was financial stability. In the 2020s, the biggest question facing central banks could well be the future of money itself. We acknowledge there is much work to be done. We do not yet have all the answers, nor do we expect to find them alone. But, by working together, we plan to be ‘on the money’ now and in the future. Nō reira, Nau te rourou, naku te rourou, ka ora ai te iwi. With your contribution, and my contribution, the people will prosper. Tēnā koutou, tēnā koutou, tēnā tatou katoa. References Auer, R, Cornelli, G, and Frost J (2020) “Covid-19, cash and the future of payments”, Bank for International Settlements Bulletin, No 3, April. Auer, R, Frost, J, Lammer, T, Rice, T, Wadsworth, A (2020) “Inclusive payments for the post-pandemic world”, SUERF Policy Note, Issue No 193, September. Bank for International Settlements (2020) “BIS Innovation Hub” https://www.bis.org/topic/fintech/hub.htm accessed 7 October. Bank of Canada, European Central Bank, Bank of Japan, Sveriges Riksbank, Swiss National Bank, Bank of England, Board of Governors Federal Reserve System, and Bank for International Settlements (2020) “Central bank digital currencies: foundational principals and core features”, Report no 1. Bascand, G (2018) “In search of gold: exploring central bank digital currency”, A speech delivered to The Point Conference, hosted by Payments New Zealand in Auckland, 26 June. Bascand, G (2020) “Banking the economy in post-COVID Aotearoa”, A speech delivered to banking industry representatives in Wellington, 31 July. Boar, C, Holden, H and Wadsworth, A (2020) “Impending arrival: a sequel to the survey on central bank digital currency”, Bank for International Settlements Papers, No 107, January. Central Bank of the Bahamas (2019), “Project Sand Dollar: a Bahamas payments system modernisation initiative”, December. Committee on Payments and Market Infrastructures and World Bank (2020) “Payment aspects of financial inclusion in the fintech era”, April. McBride, N (2015) “Payments and the concept of legal tender”, Reserve Bank of New Zealand Bulletin, Vol 78. No. 6. Oxford University Press. http://www.oed.com/viewdictionaryentry/Entry/7179;jsessionid=61494FA30F6628009908C8 00D2210718 (accessed 2 October, 2020). Reserve Bank of New Zealand (2018) “The Journey of Te Pūtea Matua: Our Tāne Mahuta. Northern hapu Te Roroa is the kaitiaki to Tāne Mahuta, the kauri tree in Waipoua Forest”. Reserve Bank of New Zealand (2019a) “The future of cash use - Te Whakamahinga Moni Anamata”, Issues Paper, June. Reserve Bank of New Zealand (2019b) “Cash use in New Zealand - public survey 2019 high level findings”, October. Reserve Bank of New Zealand (2019c) “The future of the cash system - Te Pūnaha Moni Anamata”, Consultation Paper, October. Reserve Bank of New Zealand (2020) “Leadership appointments in Reserve Bank’s Money Group”, Media Release, 7 July. Riksbank (2018) “The Riksbank’s e-krona project”, Report 2, October. Robbers, S (2019) “The Fintech opportunity in personal finance”, A speech delivered at the Singapore FinTech Festival in Singapore, 13 November. Wadsworth, A (2018a) “What is digital currency?” Reserve Bank of New Zealand Bulletin, April 2018, Vol 81, No 3. Wadsworth, A, (2018b) "The pros and cons of issuing a central bank digital currency", Reserve Bank of New Zealand Bulletin, June 2018, Vol. 81, No. 7.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the 2020 Pacific Ocean, Pacific Climate Change Conference, 28 October 2020.
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Progressing Climate Action by Driving Transformational Change A speech delivered to the 2020 Pacific Ocean, Pacific Climate Change Conference On 28 October 2020 By Adrian Orr, Governor With special thanks to colleague Susan Livengood 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Introduction Kia orana tatou katoatoa, talofa lava. Thank you to the organisers – the Government of Samoa, Victoria University of Wellington, the National University of Samoa, and the Secretariat of the Pacific Regional Environment Programme – for the opportunity to contribute to the conversation on how to progress climate action for the people of the Pacific. Today I’ve been asked: How do we make transformational change to manage climate risks in the Pacific? This is an important, difficult, and urgent question. To promote transformational change, the issue that needs addressing must be convincingly important, imminent, and personal. Our recent history – and lack of collective action – has highlighted how difficult it is to ignite this sense of urgency for climate change transformation. Climate change transformation will involve developing and implementing renewable energy strategies, ‘greening’ the financial system, and managing economic and social adaptation. A full suite of plans and activities is necessary for such a significant task. But they also need to be viewed as real and tangible – not abstract and intellectual. Transformational change needs to be motivated through engaging both minds and hearts in individuals, institutions, and broad society. Each of these levels interweaves, and builds on and supports each other. As Pacific Islanders we have lived with constant change. Throughout, however, we have continued to honour others and retained our deep integration with nature. Now, against a backdrop of environmental threats, the world needs our way of being, our ‘mōmō’, more than ever. Individual transformation My personal story of transformation begins here in the Pacific. Nooroa, my granddad, left the beautiful island of Atiu in the Southern Cook Islands and came to Aotearoa New Zealand in the 1930s. When he left Atiu the average temperature would have been around 24oC. It must have been a shock to settle in Taupō, in the interior of the North Island of New Zealand, where the average temperature was just over 10oC. Yet Nooroa prospered. In the cold pumice soils of Taupō he grew everything – potatoes, broad beans, pip fruit, and even an avocado tree. He demonstrated how to plant, conserve, and preserve. He ingrained in me the type of change Māori know as te iho – a change that seeps into your bones. I have remained inspired by the notion of kaitiakitanga – or guardianship – from Polynesian culture. I know, however, that this notion is common across cultures. It is now critical that we use our guardian mind-set more than ever given that the world of the 1930s no longer exists. Compared to Nooroa’s world, the average temperature has increased 1 degree, the sea is rising and extreme weather events such as storms are expected to increase in intensity and frequency.1 Auckland experienced its longest dry spell of 47 days this year, well above the average length of 10 days.2 At our home in coastal Bay of Plenty, we continue gardening, but the crops have changed. Sustainability in 2020 also means adapting the garden to protect our home. We’ve been planting Pīngao, a grass to help bind the sand and build the dunes. This is to help protect our home – for now – from the 21cm of global sea level rise projected by 2040 if emissions remain high.3 As people of the Pacific know as well as anyone, climate change is lapping, and increasingly crashing, at our doors. Institutional transformation Shifting now to institutional change, I’m going to share where we’re going at Te Pūtea Matua, the Reserve Bank of New Zealand. As New Zealand’s central bank, we are the kaitiaki of the financial system tasked to maintain and enhance financial stability. We act collectively to promote the prosperity and well-being of all New Zealanders. We do this in large part by promoting a sound and dynamic monetary and financial system – a necessary platform for a sustainable and productive economy. One of our core activities is assessing material risks to banks and insurers, and the financial system as an ecosystem. Climate change is a key risk to global financial stability.4 New Zealand being a small, island nation with an agricultural-based economy means we will be impacted differently than others. And thus, we must keep our preparations in tune with our environment and resources for our economy to prosper. MFE (2020) National Climate Change Risk Assessment New Zealand Snapshot Our Atmosphere and Climate 2020 summary https://www.mfe.govt.nz/node/27249 Against an average of 10 days for 1960–2019. MFE (2020) National Climate Change Risk Assessment New Zealand Snapshot Reserve Bank and Climate Change And here is the challenge: climate change and its associated risks provide a direct challenge to financial stability, however the risks are material but extremely difficult to identify, price, allocate, and manage with accuracy. We will never have perfect information on the risks of climate change, but we do know that climate change holds far-reaching implications for New Zealand’s financial system. The environment and the economy are interdependent. The New Zealand Treasury estimated that the 2007/08 and 2012/13 droughts jointly reduced GDP in New Zealand by around $4.8 billion. 5 The National Institute of Water and Atmospheric Research (NIWA) estimates $12.5 billion of property is already exposed to extreme coastal flooding in New Zealand, and that each 10cm of sea level rise puts another $2.4 billion of assets at risk.6 And the frequency and severity of floods and droughts – like Northland in New Zealand experienced this year – will increase with climate change. As well as physical risks such as these, there are also adaptation risks associated with the shift to a climate resilient economy – such as the impacts of ‘flight shame’ or the accelerated pricing of greenhouse gas emissions. These risks can intensify and snowball. It is not hard to imagine agriculture facing a triple whammy: a pummelling by drought, a consumer shift towards plant-based protein, and regulations to ensure transition to a low carbon future. We have moved to incorporate climate change as a key priority in our activities.7 Our strategy has three components: incorporating climate change into our core functions; managing our direct impact on the climate; and leading through experience and collaboration. We are getting our own house in order.8 This month we reported our verified carbon footprint for the first time in our annual report. This covers our direct emissions.9 We are now working on an emissions reduction plan, including reviewing our reserves portfolio. We are also building our climate expertise and awareness through training and development for all staff, and building our technical expertise. In particular, we are stepping up our supervision of climate-related risks for banks and insurers. We have recently completed D. Frame, S. Rosier, T. Carey-Smith, L. Harrington, S. Dean, I.Noy (2018), Estimating financial costs of climate change in New Zealand, New Zealand Climate Change Research Institute, and NIWA Niwa (2019) Coastal Flooding Exposure under Future Sea-level Rise for New Zealand. Accessed at https://www.deepsouthchallenge.co.nz/projects/national-flood-risks-climate-change. A second study, of modelling flooding from rainfall and rivers, estimated that around 411,000 were currently exposed along with 20 airports and 3400km of electricity transmission lines. Niwa (2019). New Zealand Fluvial and Pluvial Flood Exposure. Accessed at https://www.deepsouthchallenge.co.nz/projects/national-floodrisks-climate-change Reserve Bank Climate Change Strategy Working together to strengthen resilience, develop culture, and support economic recovery, a speech delivered by Assistant Governor Simone Robbers to the 16th Financial Markets Law Conference on 22 Oct 2020 Reserve Bank Annual Report 2019 – 2020 (see page 28) training our supervisors in climate-related risks and are integrating climate risks into our supervision frameworks. Societal transformation At a societal level, change can be incremental or driven by a shock. For example, right now, the COVID-19 pandemic is a shock causing global change. From a financial perspective, COVID-19 has again highlighted why we need to guard against systemic risk.10 The inescapable nature of the current global health crisis has parallels for what climate change may have in store for us. We need to think about the challenges and opportunities that lie ahead. We have opportunities for a more sustainable economic recovery form the ravages of COVID-19 by rebuilding our economies in a more environmentally sustainable manner. To build a more sustainable economy globally we are going to need all hands on the pump. Public and private sector knowledge and capital must be mobilised together. No one party can afford to tackle the challenge alone. The UN Environment Programme estimates, for example, that global greenhouse gas emissions must be cut by 7.6% a year from now until 2030 to meet a 1.5°C temperature goal.11 The International Energy Agency estimates that such action will require US$3.5 trillion per annum until 2050 for energy sector investments alone.12 Collaboration and co-investment is necessary. After all, we live in a world with a global glut of savings and massive infrastructure deficits. We need to connect capital and opportunities. Work is already underway in our Pacific region – but it will take ongoing collective effort from the public and private sector, and through appropriate incentive structures. For example, in 2017 Fiji issued a sovereign green bond.13 In 2019 the Asian Development Bank launched in Fiji an Action Plan for Healthy Oceans. Their plan is to finance ocean health and marine projects up to $5 billion from 2019 to 2024 for Asia and the Pacific, including co-financing from partners.14 And, the New Zealand Super Fund is one of 18 founding members of the Pacific Banking the Economy in Post-COVID Aotearoa, a speech delivered by Deputy Governor Geoff Bascand to banking industry representatives in Wellington on 31 July 2020 UN Environment Programme https://www.unenvironment.org/news-and-stories/press-release/cut-globalemissions-76-percent-every-year-next-decade-meet-15degc Grantham Research Institute on Climate Change and the Environment, Climate change and the just transition A guide for investor action https://www.unpri.org/download?ac=9452 The Role of Ocean Finance in Transitioning to a Blue Economy in Asia and the Pacific https://development.asia/explainer/role-ocean-finance-transitioning-blue-economy-asia-and-pacific ADB Launches $5 Billion Healthy Oceans Action Plan https://www.adb.org/news/adb-launches-5-billionhealthy-oceans-action-plan Islands Investment Forum (PIIF) actively sharing expertise on how to integrate climate change into investment strategies. Regulatory policy is another tool to drive transformational change. At the Reserve Bank we are playing our part in contributing to New Zealand’s climate response. For example, we are contributing to the Sustainable Finance Forum, submitted on the Zero Carbon Act15 and are contributing to the development of New Zealand’s first National Adaptation Plan. We also support the proposal for mandatory disclosure of climate-related financial risks.16 More good quality, comparable information being disclosed by the firms we regulate is critical to climate change management. And we are taking every opportunity to highlight the risks to financial stability from climate change and the need for an effective response. For example, our bi-annual Financial Stability Reports17 have highlighted the systemic risks from climate change and this focus will continue. In the last month we highlighted climate risks amongst audiences such as the NZ Australia Chartered Accountants, the New Zealand Bankers’ Association, and the G30.18 Our collaborative climate change work is also expanding with the New Zealand Council of Financial Regulators, as well as internationally as a member of the Sustainable Insurance Forum (SIF), and the Network for Greening the Financial System (NGFS). And we are leveraging our contribution to these global fora to step up our understanding and supervision of climate-related risks. For example, last month we drew on resources from the NGFS and SIF in training our supervisors in climate risk. Last year we collaborated with the NGFS at the South Pacific Governors’ Annual Meeting in Sydney. Conclusion You asked for my thoughts on transformational change. This means doing things differently as individuals, institutions, and society. Climate change is a risk that requires a collective response. Grounding a response in our collective knowledge, data and expertise will strengthen its effectiveness. The consideration of climate change needs to be a ‘must do’ not a ‘nice to have’, and we need to take every opportunity to succeed, such as in our current response to the COVID-19 virus-led economic challenge. Kei te whanakē, tangata rite. Reserve Bank: Submission on the Climate Change Response (Zero Carbon) Amendment Bill Reserve Bank: Submission on the Climate-Related Financial Disclosures Discussion Document Reserve Bank Financial Stability Reports A Near Horizon: Seizing the opportunities and managing the risks in the transition to net zero: The importance of climate-related financial disclosures, remarks delivered by Governor Adrian Orr to a virtual roundtable in May 2020 “We are all of one race, we must adapt” Meitaki.
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Text of the Sir Leslie Melville Lecture by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, Canberra, 2 December 2020.
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Monetary Policy Challenges for a Small Open Economy during COVID-19 Sir Leslie Melville Lecture: A speech delivered to Australia National University in Canberra, Australia On 2 December, 2020 By Adrian Orr, Governor I would like to thank Omar Aziz, Oliver Bates, Isaac Heron and Lewis Kerr Introduction Tēnā koutou katoa, welcome everybody. Thank you for the privilege and opportunity to deliver this year’s Sir Leslie Melville lecture. Joining today via video conference provides the appropriate backdrop to the theme of my speech – implementing monetary policy during the COVID-19 pandemic. Today I will outline the focus Te Pūtea Matua, the Reserve Bank of New Zealand, maintained throughout our response to the pandemic crisis. Our legislative mandate and operational independence put us in good stead to act swiftly and with confidence to provide effective assistance in buffering the economic impact of the virus here in New Zealand. The team at the Reserve Bank remained focused on maintaining low and stable consumer price inflation, contributing to maximum sustainable employment, and promoting a sound and efficient financial system. I also outline how the Reserve Bank’s monetary and financial policies provided significant mutual support for the Government’s fiscal initiatives. The support was direct through lower interest rates and financial regulatory efforts, and indirect via our market operations. Not all has been plain sailing of course, and I am immensely proud of our team as to how they responded to rapid change with innovation and commitment. New Zealand, like most OECD countries, commenced the pandemic response with nominal interest rates near an effective lower bound. To be successful in our recent work we were tasked with both building and operating new means of implementing monetary policy. Our goals remained the same, our tools evolved. In hindsight, the development of new monetary policy tools was simple, not easy. It is the communication challenges with our stakeholders and broader public that remains work in progress. As is the case internationally, central bankers must continually explain what they can and can’t do – that is, where the limitations of monetary policy rest. I will conclude by outlining the work we have ahead of us on communication and research, so as to best ensure that the Reserve Bank of New Zealand remains effective and well understood. Current Economic Environment The recent news of the efficacy of several trial vaccines aside, the global economic recovery from the COVID-19 induced recession continues to be highly variable. To date, in New Zealand, the impact of the pandemic has been less dramatic than some of the extreme scenarios we envisaged as recently as April 2020. However, we still faced a historically large loss in output and employment during the year, with very uneven effects across industries, employment, and demographic and regional groups (Figure 1). Page 2 of 17 Figure 1: GDP and Employment Growth Source: Stats NZ. Following the initial containment of the virus and the lifting of social restrictions in New Zealand there has been a rebound in domestic spending underway. Considerable economic uncertainty remains, however, with business investment lagging and significant segments of economic activity stagnant. Until the scientific and distribution solutions for the vaccines are resolved and implemented, we continue to operate in an environment of uncertainty. It is still assumed by policy makers internationally that the economic impact of the COVID-19 pandemic will be long and variable. As such, we need to retain a medium-term focus on our efforts, beyond the immediate bounce back in spending that monetary and fiscal policy have provided. Outlined in our most recent Monetary Policy Statement is our view that economic risks are still skewed to the downside.1 This of course does not rule out upside scenarios; it is more a statement of relative risks. What we are observing internationally, and here in New Zealand, is a scarring on the economy from the impact of COVID-19. Pervasive uncertainty has dramatically reduced businesses’ preparedness to invest and employ. And, we observe unemployment rising at the same time as increased skill shortages. Redeploying labour is not a straightforward activity. The impact of the pandemic on peoples’ confidence may prove to be the longest lingering impact on the economy.2 Similar to international experience, in New Zealand domestic social restrictions have eased with the containment of COVID-19. However, international borders remain tightly controlled (Figures 2, 3).3 4 1 Monetary Policy Statement November 2020 2 Ibid. 3 Industry, Age and Unemployment Risk During a Pandemic Recession, Graham, J., Özbilgin, M., RBNZ Analytical Note, 2020 (Forthcoming) 4 Monetary Policy Statement November 2020 Page 3 of 17 Figure 2: Cross-country Lockdown Comparisons Figure 3 The implications of closed international borders have meant that service export industries, such as tourism, will operate well below capacity for a prolonged period. This is despite what we are witnessing in New Zealand at present, with Kiwis enjoying ‘staycations’ as a substitute for international travel; relaxing in our own backyard (Figure 4).5 Demand for New Zealand’s education and tourism services is being significantly suppressed by fewer international arrivals. Prior to the COVID-19 outbreak, international tourism and education accounted for around 6 percent of nominal GDP. Receipts from these and other services fell 40 percent in the June quarter 2020, and are only being partially offset by increased local spending. This spending weakness will affect incomes in the wider economy for years to come. An early taste of this will occur in early 2021, when the seasonal influx of international tourists fails to show up at our doorstep. 5 Monetary Policy Statement November 2020 Page 4 of 17 Figure 4: Current vs. historic net flows in/out of NZ While there are significant areas of economic stagnation amongst economies globally, many sectors have proved more resilient than expected at the outset of the pandemic. New Zealand economic activity has benefitted from commodity prices and export volumes for our exports of goods holding up. Internationally people have continued to demand New Zealand’s soft commodities (Figure 5). Asset prices globally have also risen, assisted by low interest rates and pockets of significant outperformance in the technology-driven sectors. Figure 5: Commodity Indices & Prices Source: ANZ, Global Dairy Trade Domestic consumer spending has recovered for many goods and services, consistent with patterns internationally (Figure 6).6 Underpinning the rebound in domestic spending patterns have been significantly lower interest rates and increased government welfare payments and wage subsidies. We have also witnessed significant workplace innovation, with many businesses proving adaptable to working from home. Finally, asset prices have also been on the rise – in equity and residential property markets especially. In New Zealand, equity in home ownership is a key component of overall household wealth. Rising house prices have increased our perception of wealth and heartened our expenditure. 6 Monetary Policy Statement November 2020 Page 5 of 17 Figure 6: Electronic card spending 2020 The rebound in economic activity from the depths of our recent social-lockdown is pleasing to see. New Zealand entered the pandemic in a sound economic position, so we should not be overly surprised. However, downside economic risks will remain as long as the spread of the virus persists. The virus remains rampant globally, and especially so at present in Europe and the United States – key trading partners. The sustainability of the global economic recovery remains in question. Our Policy Response to COVID-19 Early in 2020, the Reserve Bank’s Monetary Policy Committee (MPC), when confronted with the COVID-19 facts, was quick to significantly ease monetary conditions i.e., lower interest rates. It was very clear that the virus posed a significant negative economic shock. The Committee’s “least regrets” approach to policy meant it was better to risk doing too much too soon, than too little too late when it came to easing policy. The scale and duration of the COVID-19 economic shock was unprecedented and unknown. We were not alone in this action. Globally, monetary and financial stability policy responses, and fiscal expansion policies, were quickly put to work collaboratively to provide economic support. Across the OECD countries the adopted policies were all broadly similar, including some combination of: ensuring credit and cash is appropriately affordable and accessible, increased government spending and investment, support for employers to retain their employees and access credit, and enhanced health and economic welfare support. All countries designed their policy responses for their local conditions, commencing with the tools that were most operationally ready to deploy. While the front-line economic response to the COVID-19 pandemic is fiscal policy, the Reserve Bank of New Zealand provided significant assistance by ensuring interest rates were reduced to a level consistent with maintaining low and stable inflation, and contributing to maximum sustainable employment. Consistent with our dual monetary policy mandate and our financial stability mandate, we acted to support economic and financial activity. Our actions included: Instigating a significant reduction in retail interest rates; Ensuring there was ample liquidity for the banking system; Page 6 of 17 Supporting the functioning of New Zealand’s foreign exchange and debt markets; Bolstering community access to cash; and Facilitating a variety of Government and industry-led initiatives to allow the financial sector to remain customer-focused. On the latter, the Reserve Bank worked with the Government and financial sector to implement a mortgage deferral scheme, business financing schemes, and a reprioritisation of our regulatory work to ensure banks were able to use their capital to support their customers (Figure 7). Figure 7: Mahi Tahi: Working together to ensure cash-flow and confidence Source: Mahi Tahi: Working together to ensure cash-flow and confidence (PDF 318KB) Our actions assisted the New Zealand economy to remain on track to experience low and stable consumer price inflation, a lower unemployment rate than otherwise, a New Zealand dollar exchange lower than otherwise, and ongoing financial stability. Our debt and foreign exchange markets also performed robustly and our financial system remains sound. Same challenge, new tools Again, as in many OECD countries, at the outset of the COVID-19 pandemic New Zealand’s nominal interest rates were approaching an effective lower bound. Globally, as inflation and inflation expectations have declined, so have nominal interest rates. We were forward looking enough during 2019 to initiate thinking on what alternative monetary policy tools are available for us if we could no longer rely purely on the Official Cash Rate (OCR) to deliver our policy goals.7 Our work assessed the merits of various tools for achieving our monetary policy goals against principles of effectiveness, efficiency, operational capability, 7 See: About Alternative Monetary Policy Tools, RBNZ, https://www.rbnz.govt.nz/monetary- policy/alternative-monetary-policy/alternative-monetary-policy-tools#fn1 Page 7 of 17 and government balance sheet stability.8 What we didn’t realise at the time is how quickly we would need to use this playbook. And, as in many other OECD countries, we ended up with two jobs to do simultaneously: building and operating new monetary policy tools to achieve our desired monetary conditions. This multi-tasking has proved more of a communication challenge than an engineering one. We were quick to lower the OCR to 0.25 per cent and commit publicly that it would remain at this level for at least a year. However, we also committed our local banks to ensuring they would be operationally ready to manage negative wholesale interest rates by the end of this period. We wanted to provide some immediate certainty to the public about the path of the OCR while also creating future policy optionality – the right but not the obligation to implement a negative OCR if future conditions necessitated this. We remain true to these commitments. We subsequently implemented a Large Scale Asset Purchase (LSAP) programme aimed at lowering and flattening the New Zealand wholesale interest rate curve. The purpose of this was to drive retail interest rates lower, to be consistent with our dual monetary policy mandate. This action has proved effective (Figure 8). Figure 8: Change in New Zealand interest rates (change since beginning of 2020) Source: Bloomberg, interest.co.nz, RBNZ Note: Data for business loans reflects the change in the average interest rate on outstanding business loans. Other rates are based on advertised and market rates We have more recently moved to supplement the LSAP programme with a Funding for Lending Programme (FLP). The FLP is designed to provide domestic banks with an additional source of wholesale funding at interest rates commensurate with achieving our monetary policy mandate. Lower bank funding costs should embed the retail borrowing and lending costs we need to be successful. Our communication challenge remains ongoing despite the successful implementation of these new monetary policy tools. We share this challenge with other central banks.9 The impact of the LSAP and FLP on the government’s balance sheet differ to that of moving the OCR up and down to implement monetary policy. It is this difference that can blur the 8 For an overview, see: Navigating at Low Altitude: Monetary Policy with Very Low Interest Rates, Speech by Adrian Orr, Governor RBNZ, March 2020, https://www.rbnz.govt.nz/research-andpublications/speeches/2020/speech2020-03-10 9 What has central bank independence ever done for us?, Haldane, A., Bank of England Speech, November Page 8 of 17 distinction between monetary and fiscal policy in the public’s mind – or in the parlance – monetary financing of fiscal spending versus monetary policy quantitative easing. Our LSAP – or quantitative easing – is the Reserve Bank purchasing government bonds in the secondary market to reduce market interest rates. We will always be limited by how much of this we can achieve through our monetary policy remit. We must, by law, aim to keep annual consumer price inflation between 1-3 percent and support maximum sustainable employment. The Government, meanwhile, continues to finance its spending through the issue of fixed term interest bearing government bonds. Monetary financing, by contrast, occurs when government spending is financed by a central bank being instructed to issue irredeemable fiat non-interest bearing liabilities to the Government. This activity sits outside of the Reserve Bank’s mandate and is unrelated to the Bank’s inflation and employment remit. Our new tools remain purely for the purpose of ensuring interest rates in New Zealand are consistent with achieving our mandate. The LSAP and FLP instruments – like the OCR – can be altered to achieve our legislated purpose. Their design and implementation remain at the call of the Monetary Policy Committee. Many other central banks have taken similar approaches in dealing with impact of COVID-19, albeit starting from a different market structure. For instance, the Reserve Bank of Australia and Reserve Bank of New Zealand have now both entered large-scale asset purchases and funding for lending programmes.10 We have also both provided significant liquidity to the financial markets to ensure orderly functioning. And we have both reduced the OCR to a rate near zero, with forward signalling data dependent.11 Another common theme in New Zealand, the UK, Australia, Canada and the United States has been the pros and cons of using negative official interest rates (e.g., a negative OCR) relative to other monetary instruments. We focused on being operationally ready to implement a negative OCR if necessary. Its actual use will always depend on the economic context at the time, and its relative efficacy. Selecting the appropriate policy mix The past few months have shown remarkable adaptability and resilience by policymakers internationally, and in New Zealand. As is appropriate, starring in the times of COVID-19 have been health, fiscal, and regulatory policy responses. When economic confidence is low, governments are able to directly spend and invest, and ensure that economic resources are mobilised and redeployed. In New Zealand, the Government has supported households and businesses directly by helping people maintain access to credit and cash flow – through business credit schemes and income support – and assisting ongoing employment via wage subsidies (Figures 9, 10).12 Our research suggests that the Government’s wage subsidy scheme significantly improved job retention by approximately 2.5% of the total labour force.13 The scheme also most 10 Monetary Policy in 2020, Debelle, G., Speech to the Australian Business Economists Webinar, November 2020, https://www.rba.gov.au/speeches/2020/sp-dg-2020-11-24.html 11 Ibid. 12 Financial Stability Report (FSR), RBNZ, November 2020 13 Industry, Age and Unemployment Risk During a Pandemic Recession, Graham, J., Özbilgin, M., RBNZ Analytical Note, 2020 (Forthcoming) Page 9 of 17 benefited those in the service sectors which is heavily dependent on female and younger workers, some of the most vulnerable to economic downturns.14 Figure 9 Figure 10 Employment and Labour market Connectedness Overall, to date, the New Zealand labour market has proved relatively resilient to the COVID19 economic shock. This positive outcome can be explained by both the Government’s fiscal measures and other factors such as:15 Labour shortage existed prior to the COVID-19 outbreak; Domestic spending resumed rapidly after social restrictions were eased, suggesting that a critical mass of New Zealanders were sound financially; and Businesses favoured reducing the paid hours worked, rather than reducing the numbers employed, due to the temporary nature of the lockdowns (Figure 11).16 The easing in monetary conditions also had a significant role to play in retaining jobs. When setting monetary conditions, the Monetary Policy Committee was kept aware of the Government’s fiscal policies’ purposes and desired impacts. We were thus able to calibrate our response appropriately. Coordination worked well. The most recent New Zealand data shows annual consumer price inflation currently at 1.4% (compared to our 1-3% target range) and the unemployment rate is at 5.3% (above our estimate consistent with maximum sustainable employment).17 We estimate that in the absence of our recent monetary policy actions, unemployment would be higher still (nearer 6.0%), inflation expectations would have continued to decline, and the New Zealand dollar trade-weighted exchange rate would have risen by around 7%.18 In other words, monetary policy has been effective to date in supporting both inflation and employment as intended – at least at the aggregate level. 14 Ibid. 15 Drawing on internal RBNZ analysis, T. Bohm, 2020 16 Internal RBNZ analysis, 2020 17 Monetary Policy Statement November 2020 18 Internal RBNZ analysis, 2020 Page 10 of 17 Figure 11: Employment rate and hours worked Source: RBNZ Managing the dual mandate – inflation and employment To date, there has been no need to consider any trade-off between meeting our employment and inflation targets. Both employment and inflation have been below our target remit, necessitating an easing in monetary conditions. However, we have had to remain humble in our ability to both assess and influence the level of employment in the face of the COVID-19 economic shock. The COVID-19 economic impact has seen economic output across sectors of the economy, and employment, vary considerably (Figure 12).19 We are seeing some sectors of the economy experience labour and specific skill shortages, while other sectors are experiencing layoffs and surplus labour. It is unlikely these supply and demand issues are going to be resolved quickly – as not all people are alike and labour mobility is constrained. People live in their communities. As a result, we are likely to see longer-term unemployment become embedded side-by-side with labour shortages at the national level. Figure 12: Employment by Industry - change since March quarter 2020 Preliminary research also indicates that downturns in employment last a lot longer than downturns in output. Even if economic activity picks up over 2021, unemployment will remain 19 Monetary Policy Statement November 2020 Page 11 of 17 elevated for quite some time.20 And certain demographic and ethnic groups are more likely to experience the lingering negative effects of the current recession than others. This effect occurs due to location, skills training, experience in the labour market, and broader roles in society such as caring for dependents. For example, we already observe that: The pandemic shock has disproportionately affected the service sector in many economies, with New Zealand as no exception. It is the service sector that employs most youth. Younger workers are also likely to have lower wages and less savings (Figure 13).21 And their labour market separation rates (redundancy or leaving the workforce) are considerably higher than those of older people.22 23 There is a greater impact on female than male unemployment during economic downturns (Figure 14).24 And, Maori and Pasifika are much more negatively exposed to labour market fluctuations than Europeans (Figure 15).25 26 Figure 13: COVID-19 Employment Impact by Age (change March quarter 2020 to September quarter 2020) Figure 14: COVID-19 Employment Impact by Sex (change March quarter 2020 to September quarter 2020) 20 COVID-19 and the Labour Market: What can history tell us, Markham, S., Özbilgin, M., Robinson, F. RBNZ Discussion Paper, 2020 (Forthcoming) 21 Monetary Policy Statement November 2020 22 The job-separation rate is the probability of an employed person losing their job in a given quarter. These rates have been adjusted to account for flows in and out of the labour force. 23 Industry, Age and Unemployment Risk During a Pandemic Recession, Graham, J., Özbilgin, M., RBNZ Discussion Paper, 2020 (Forthcoming) 24 Monetary Policy Statement November 2020 25 COVID-19 and the Labour Market: What can history tell us, Markham, S., Özbilgin, M., Robinson, F. RBNZ Discussion Paper, 2020 (Forthcoming) 26 Maori and Pasifika bear a disproportionate impact of labour market fluctuations relative to their population share. Source: RBNZ estimates based on Ministry of Social Development (MSD) and Stats NZ data. Population shares are indicative only and are based on a total response output approach. Page 12 of 17 Figure 15: Increase in Jobseeker/COVID-19 Income Relief Payment numbers February to October 2020 vs. Indicative Share of Working-age Population The economic impact of the COVID-19 is also geographically uneven. In New Zealand, less populated regions have been more exposed to labour market fluctuations than the large regions, in large part due to industry concentration.27 There is also evidence that this geographical variation can have a ‘contagion’ effect, whereby unemployment in one region may spill-over to other regions.28 29 For instance, in New Zealand there is a strong link between two neighbouring – densely populated – regions, Auckland and Waikato. Jobs created or lost in one region leads to the same in the other region due to connectedness.30 What this work confirms is that the concept of “maximum sustainable employment” is complex and context dependent. This is why we rely on a suite of measures to understand whether we are at or near our optimal monetary policy setting. This complex relationship between output and employment underpins why many central banks are now adjusting their policy decision-making to remain ‘lower for longer’.31 Central bankers are increasingly wanting to stare employment in the whites of the eye before making their decision. It is also why we believe it is better to do all we can to avoid lower inflation and higher unemployment in the first instance, consistent with our Monetary Policy Committee’s ‘least regrets’ strategy. The Reserve Bank’s dual mandate – of price stability and maximum sustainable employment – has ensured we remain cognisant of the impacts of our activities, and that our dual mandate 27 COVID-19 and the Labour Market: What can history tell us, Markham, S., Özbilgin, M., Robinson, F. RBNZ Discussion Paper, 2020 (Forthcoming) 28 Regional Labour Market Spillovers, Haworth, C., RBNZ Analytical Note, 2020 29 Changes in employment levels in one region can affect other regions, though the impact varies around the country e.g. changes in unemployment in the North Island may affect the rest of the country more than changes in unemployment in the South Island. 30 Regional Labour Market Spillovers, Haworth, C., RBNZ Analytical Note, 2020 31 New Economic Challenges and the Fed’s Monetary Policy Review, Jerome H. Powell, Speech delivered to economic policy symposium, Jackson Hole, Wyoming (August 2020). See: https://www.federalreserve.gov/newsevents/speech/powell20200827a.htm Page 13 of 17 is proving welfare enhancing.32 Furthermore, Bank of England research shows that easier monetary policy after the Global Financial Crisis in 2009 had significant welfare benefits, making the majority of households better off.33 Monetary Policy needs Friends Monetary policy is a blunt tool and best used for the specific purposes outlined by our remit. There will always be trade-offs when implementing policy, and these must be understood and managed appropriately with the right tools. The Monetary Policy Committee has acted decisively to ensure we head off unnecessarily low inflation or deflation, and unnecessarily high and persistent unemployment resulting from the COVID-19 economic shock. Our remit has appropriately necessitated low nominal interest rates. Consistently below-target inflation creates significant challenges that are best avoided. Persistent low inflation can reduce inflation expectations and lead to a deflationary spiral. At an extreme, a falling general level of prices will significantly hinder economic activity, as people delay their spending in the belief that things will forever be cheaper in the future. The real (inflation-adjusted) value of debt will also rise, making debt servicing and repayment ever more difficult. However, while low real interest rates are good for investment and employment, they can prompt undue financial risk-taking by people seeking higher nominal yields for their savings. Taking on more risk (perhaps unwittingly) for more returns can promote financial vulnerabilities. As a full service central bank – that is undertaking financial policy in addition to monetary policy – we are very cognisant of the financial stability risks that can arise. We have highlighted the actual and potential risk-taking issues in Financial Stability Reports over many years. We have also discussed the importance of financial literacy, financial institutions’ conduct and culture, the benefits of collaborative fiscal support, and the importance of a deep and broad capital market to promote financial soundness. There is a broad base of work to be done in New Zealand in this area. Impact on house prices A case in point is the challenge New Zealand has with house prices. We recently received a letter from the Minister of Finance seeking our views on ways the Government and the Reserve Bank of New Zealand can work together to address the issue of rising house prices.34 The letter outlines, amongst other things, the role that low interest rates have had on household investment decisions, leading to increased housing activity and house prices. We will respond to the letter with careful consideration, outlining the trade-offs that exist and what we can do to assist. The Monetary Policy Committee takes asset prices (household wealth) into consideration when assessing its policy decisions. The ‘consumption’ of housing is also captured in the 32 Economic welfare and a dual mandate for monetary policy in a small open economy, Jacob, P., Özbilgin, M., 2020 (Work in progress) 33 Philip Bunn, Andrew G Haldane & Alice Pugh, “Has monetary policy made you happier?”, Staff Working Paper No. 880 (July 2020). 34 Hon. Grant Robertson, Letter to RBNZ Governor, 24 November 2020 https://www.beehive.govt.nz/sites/default/files/2020-11/Letter%20to%20RBNZ%20Governor.pdf Page 14 of 17 Consumer Price Index, including rents, rates, construction costs, and housing transaction costs.35 And, we acknowledge that lower real interest rates make residential mortgages more affordable, tempting increased housing purchases and building. However, there are many other factors impacting on house prices outside of the Monetary Policy Committee’s influence. A historic undersupply of housing and restrictions on land supply are two widely acknowledged issues. More recently, with the impact of COVID-19, employment prospects have also tended to remain more positive for the traditional homeowning age group, compared to youth. And, Kiwis who were living overseas returned home in the early stages of the COVID-19 pandemic, and fewer have left since, hence more housing demand.36 Access to affordable housing is an important issue for New Zealand’s economic wellbeing, and we are pleased to be requested to assist the Government’s thinking on this issue. Distributional impact of monetary policy The impact of monetary policy decisions on wealth and income equality is another important topic for considering overall economic wellbeing. As Janet Yellen recently noted, despite the fact that the tools of monetary policy are generally not well-suited to achieve distributional objectives, it is nevertheless important that policymakers understand and monitor the effects of macroeconomic developments on different groups within society.37 Here at the Bank we have undertaken an assessment of the international literature on the distributional impacts of monetary policy on wealth and income. Our work highlights that it is unclear whether looser monetary conditions (i.e., lower real interest rates) increase or decrease income and wealth inequality, on net. In theory, lower interest rates are capable of both, and empirical studies on this issue are inconclusive. There are four broad means by which monetary policy can have wealth and income distribution impacts (Figure 16).38 35 Items directly reflecting the housing market account for just under 20% of New Zealand’s current CPI basket, up from around 15% three years ago. These items reflect rent and building costs. Other housingrelated items, such as rates and household appliances, account for about a further 10% of consumers’ typical spending basket. 36 Monetary Policy Statement November 2020 37 Macroeconomic Research After the Crisis, Remarks by Janet L. Yellen at the 60 th annual economic conference sponsored by the Federal Reserve of Boston, October 14, 2016, https://www.federalreserve.gov/newsevents/speech/files/yellen20161014a.pdf 38 Distributional Impact of Monetary Policy, Leong, J., RBNZ 2020 (Work in progress) Page 15 of 17 Figure 16: Transmission Channels of Distributional Impacts in the Empirical Literature The direct wealth channels include: - Savings redistribution: lower interest payments on debt make net borrowers better off and net savers worse off. Since lower income households are more likely to be net borrowers, looser monetary policy is likely to decrease wealth inequality. - Portfolio composition: lower real interest rates increase asset prices, including house prices. The overall impact of looser monetary policy on wealth inequality depends on the composition and distribution of assets across the wealth distribution. In New Zealand, home ownership is more broadly distributed across net worth quintiles than are financial assets.39 The indirect income channels include: - Earnings variation channel: the earnings of lower income households’ are determined mostly by: (a) whether they are employed, and if so, (b) the hours they work per week. In contrast, higher income earners are mainly affected by the rate of their hourly wages. This means that expansionary monetary policy tends to benefit lower income households most through lower unemployment. - Income composition channel: By lowering unemployment, lower interest rates tend to support the incomes of wage earners’ more than of those who rely mainly on business profits and capital income. Again this would tend to reduce income inequality, especially for middle income earners whose main form of income are wages. Empirical studies globally looking at the overall net effects of looser monetary policy on wealth and income inequality have produced mixed results. While the necessary data is limited for New Zealand, we intend to push forward on this work in our research agenda. Of course, none of these observations are reasons for a government to be unconcerned, or for policy makers to not carefully analyse the data. Issues arising from 39 “The composition of assets varies over the net worth distribution…[r]eal estate is a higher proportion of assets of low and middle net worth households. The wealthiest twenty percent of households hold mostly financial assets, although this will include real property that is held in businesses and trusts” Reference: Pg. 11, Tax Working Group, Information Release, Distributional Analysis, September 2018, https://taxworkinggroup.govt.nz/sites/default/files/2018-09/twg-bg-distributional-analysis.pdf Page 16 of 17 wealth and income inequality need to be understood and, if necessary, managed with the appropriate interventions. Conclusion Today we have traversed a lot of issues. The economic environment, the roles of monetary and fiscal policy, the challenges of building and operating new monetary tools, and the perennial concerns related to excessive financial risk taking, and income and wealth inequality. We have been reminded that with low global inflation and hence low neutral interest rates, our new monetary policy tools will become increasingly mainstream. And that these new tools do not mean we have new targets or policy objectives. Price stability and contributing to maximum employment remain the targets for monetary policy. We have also been reminded that fiscal and monetary policy coordination remains critical to economic wellbeing. In New Zealand our institutional relationships are strong, providing complementarity of fiscal and monetary actions. This collaboration has been supported – not deterred – by clarity around the Reserve Bank’s purpose and operational independence. Work must be done to ensure that the operational aspects of our new monetary tools do not interfere with this clarity. Finally, we have highlighted how important it is to have clarity and collaboration on fiscal, monetary and financial policy when considering equity and distributional aspects within an economy. Monetary policy decisions appropriately target aggregate measures – inflation and maximum sustainable employment – while being attuned to equity considerations of our policy actions. However, we do not have the tools to manage any desired equity implications of our actions. There are additional decision-makers and tools for such tasks. That said, these are complex and ambiguous issues, and at the Reserve Bank a lot of work is ongoing to understand the transmission mechanisms for, and the wider implications of, monetary policy, particularly in relation to the new suite of tools I have just mentioned. Thank you for listening and for the privilege of delivering this speech. Page 17 of 17
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Opening statement by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Finance and Expenditure Committee (FEC), 10 February 2021.
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Finance and Expenditure Committee (FEC) 2019 - 20 Financial Review of the Reserve Bank of New Zealand Governor’s opening statement Date: 10 February 2021 Tēnā koutou katoa, welcome all. It is a privilege to be here with you today – alongside the rest of the Bank’s Senior Leadership Team – to report on the Reserve Bank of New Zealand’s achievements, challenges, and opportunities on what has been an extraordinary and unprecedented year. Like many organisations and businesses, we, at Te Pūtea Matua, have had to change our way of working, refocus our priorities, and take necessary actions to continue to support cashflow and confidence among New Zealanders during the tough times. The experience of the past year has brought forward new challenges, risks, and opportunities for us. While our priorities in the recent (2019-20) financial year have been focused significantly on supporting New Zealand’s economic recovery from the COVID-19 pandemic, we have also continued our work on a wide range of initiatives, including: Working with The Treasury to have the new Reserve Bank of New Zealand Bill introduced to Parliament; Agreeing to a new Funding Agreement with the Minister of Finance; Working closely with our fellow Council of Financial Regulators (CoFR) members to manage and co-ordinate regulatory work; Launching a new payment settlement system; Progressing our Te Ao Māori strategy; and Managing climate risks to our financial system, among others. At the end of June last year – New Zealand looked and felt quite different to what it does some eight months later. We’d just entered Level 1 – activity was starting to pick up, sporting events and larger gatherings were going ahead and we were all finding our ‘new normal’. But - there was so much uncertainty about how the global pandemic would continue to unfold, and what responses would be needed. While we’ve got more information to work from now, and global policy responses are clearer, we still continue to learn and adapt. We are committed to responding to challenges and progressing initiatives that will ensure we remain an active, relevant cornerstone of New Zealand’s economy and society. Page 2 of 9 I thank my Board, my colleagues and our people for their dedication, hard work, flexibility, and assistance. Let me take you through some of the initiatives we have worked on in the past year: Responding to the COVID-19 pandemic Early in 2020, when the COVID-19 pandemic began unfolding, we acted quickly and in tandem with the Government to keep our financial system stable, and cushion the economic blow to households and businesses from this unprecedented event. Since then, we have delivered a broad range of activities to ensure cash-flow in the economy and ensure that the financial sector is well positioned to meet the needs of New Zealanders, including: Easing monetary conditions by keeping interest rates low to build confidence and enable cheaper lending for businesses and households. Our Official Cash Rate is has been at 0.25% since March 2020; Developing and deploying a full set of alternative monetary policy tools – which includes the Large Scale Assets Purchases (LSAP) programme and the Funding for Lending program – to support inflation and employment; Reprioritising the regulatory reform landscape so financial service participants can focus on supporting customers’ needs; and Helping the Government roll out the mortgage payment deferrals and business finance guarantee schemes. All of these actions are driven by our mandate, focused on supporting the economy to achieve our mandate of price stability and maximum sustainable employment. Having entered the pandemic with a low level of pre-existing debt and a strong economic position at that time, we were well placed to respond to the crisis. New Zealand is now in a privileged position of having successfully contained the virus and with many parts of the economy back up and running. But the economic shock from the COVID-19 pandemic continues to evolve. Although recovery is now underway, it will be a lengthy and difficult process but we are well prepared for this challenge and we stand ready to provide stability and support. Page 3 of 9 You will hear more from us about this when we discuss our next Monetary Policy Statement, due for release on the 24th of February. On this note, I would like to recognise the Monetary Policy Committee members, whose collective decisions have been instrumental in our COVID-19 response. Payments Systems Replacement One of the major projects that we have delivered in the 2019/20 financial year was a new payment settlement system. In February 2020, we went live with a new futureproofed payment settlement platform, launching two separate systems – ESAS 2.0 and NZClear 2.0 – replacing a 20-year-old inter-bank settlement system and central securities depository. This is an integral part of our commitment to enhance our payments systems’ resilience and establish a more modern and secure platform for future development. With New Zealand being a highly financially digitised economy, these two new systems are critical infrastructure to our financial system, allowing every New Zealander and major institutions to go about their daily lives settling their financial obligations with integrity and confidence. The project was the most complex technology switch that our Payments and Settlements group had ever undertaken. The scope was unprecedented as we simultaneously replaced both the country’s Real Time Gross Settlement (RTGS) and Central Security Depository (CSD) systems which is unheard of for a modern economy. No material issues arose during the go-live. In fact - weeks after the launch, COVID hit putting enormous pressure on the economy and our markets, but we had confidence in the integrity of our newly-launched system, knowing that we had prepared our members, our staff, all our processes and technology well to handle unprecedented volumes with ease. Transformation and change Looking to the future now, and we are navigating through a period of change and transformation at the Bank as we await the enactment of the new Reserve Bank of New Zealand Act – the legislation that underpins our purpose and how we operate. Page 4 of 9 Since 2018, we have been jointly working with The Treasury to see the new Reserve Bank of New Zealand Bill introduced to Parliament in July last year. We are incredibly excited with the foundational opportunity we have through the new legislation to fully modernise and empower New Zealand’s central bank. The implementation of the new Reserve Bank Act will enable us to be fit for purpose and to undertake the considerable transformation that will allow us to continue to effectively and consistently deliver on our mandate. Other major legislative changes are also underway which will strengthen our prudential regulation and supervisory powers: The Deposit Takers Act will modernise, strengthen, and unify our regulatory framework for all deposit-takers; The review of the Insurance (Prudential Supervision) Act (IPSA). Last year we have launched a dual consultation on the scope of the IPSA and associated Insurer Solvency Standards; The Financial Markets Infrastructure Bill will establish a new regulatory regime for FMIs that will be jointly administered by the Bank and the Financial Markets Authority. Our funding Part of our transformation is ensuring that we have the adequate resources to meet our increasing responsibilities and the expectations of New Zealanders. In the financial year 2019/20, we agreed a new funding agreement for the period 1 July 2020 to 30 June 2025 with the Minister of Finance. Prior to this new funding agreement, we are pleased to report that we completed the previous five-year funding agreement on target despite the challenges we’ve encountered over that period, including the relocation to temporary office premises due to asbestos remediation work, review of the Reserve Bank Act, and the reform of major systems. Additionally, in 2019/20, COVID-19 created an extraordinary high demand for banknotes resulting in the Bank exceeding the net operating expenses specified under the funding agreement. The excess cost is expected to largely reverse at some stage as we expect the bulk of the growth in banknote volumes issued to be repatriated. Page 5 of 9 Our new funding agreement accounts for additional investment to ensure we operate as a Great Team, Best Central Bank. The increase in funding means we are able to address the critical risks to delivering our mandate, respond to areas of past underinvestment, and establish a long-term model to promote the wellbeing of New Zealand. We are committed to managing our resources effectively and measuring our delivery on the priorities we’ve set. Diversity and Inclusion As Aotearoa New Zealand’s central bank, we need to ensure that we drive economic wellbeing for all New Zealanders. In our capacity as a Council of Financial Regulator member and with our own Te Ao Māori strategy, we are harnessing diversity and financial inclusion, and collaborating to better understand the economy. In particular, we continue to embed our Te Ao Māori strategy across our work at the Bank and with our stakeholders. Most recently, we have released Te Ōhanga Māori, a report on the Māori economy, in partnership with Business and Economic Research Ltd (BERL). Understanding how the Māori culture and how Māori businesses operate, gives us a richer insight into their important contribution to and impacts on the New Zealand economy. This research will form the basis of ongoing engagement over the coming years as we look to better understand the perspective of the Māori economy. Internationally, we have initiated a series of virtual global discussion with our central bank colleagues in Canada, the United States, and Australia on building a collective, foundational understanding on indigenous histories and economics. Work is also underway to translate the key metrics of our Financial Strength Dashboard into Te Reo Māori. Internally, we have a Diversity and Inclusion Working Group, in charge of a work programme to increase awareness of diversity and inclusion and further improve gender and ethnic diversity at the Bank over time. Last year, for the first time, we joined the Tupu Tai Pasifika Public Sector Internship Programme, offering a paid 11-week summer internship to Pasifika tertiary students and recent graduates. Page 6 of 9 Housing, LVRs and the Reserve Bank’s role While we are proud of what we have accomplished in the past financial year, there is more to do and we are still doing the hard yards to ensure the wellbeing of all New Zealanders. We recognise that housing affordability is an important issue for New Zealand – as a nation, but also for many people on a personal level. At the height of the COVID-19 pandemic, one of the levers we have used to help maintain credit flows and to support the mortgage deferral scheme was to remove loan-to-value ratio (LVR) restrictions. LVR restrictions are used to put a limit into banks’ mortgage lending to borrowers that are highly-leveraged. We removed LVR restrictions so as they didn’t impede COVID-19 responses and policies to promote cashflow and confidence in the system. Since then, the domestic economy has seen a strong recovery, the housing market has proved resilient, and high-LVR lending has been increasing. We are concerned about the risk of sharp correction in the housing market and the harm this could do. If continued, this could lead to emerging risks to financial stability. And so in December last year, we launched a public consultation proposing to reinstate LVR restrictions. Yesterday we announced our decision to put in place firmer LVR restrictions to reduce the risks to financial stability caused by higher-risk mortgage lending. From 1 March 2021, LVR restrictions will be reinstated at the same level they were set at prior to the onset of COVID-19, with a further tightening of restrictions taking effect on 1 May 2021. We’ve also made it clear we expect banks to respect the tighter investor restrictions immediately with all new loan approvals, to ensure that their mortgage lending is consistent with our policy decision. While a broader set of policy measures is needed to address long-term imbalances in the housing market, the Reserve Bank is acting on its mandate to control financial stability risks resulting from excessive high risk borrowing. As you are aware, last year, we received a letter from the Minister of Finance seeking our views on ways we can work together to address rising house prices. We have since provided detailed feedback on the comments raised by the Minister in his letter. Page 7 of 9 This is an important topic for all New Zealanders and we remain committed to engaging with the Minister to utilise the unique role of the Reserve Bank in relation to the complex and multifaceted drivers of housing market. This is a collective challenge. Solutions to any identified problem of high house prices or housing affordability require the involvement of many government portfolios and agencies, as well as non-government participants. Data Breach A significant challenge that we continue to respond to is the malicious attack of a third party file system used by the Bank. The Bank was not the target of the attack – other Accellion FTA users around the world have also been affected. We had no warning to avoid the attack which began in mid-December. Accellion failed to notify us for five days that an attack was occurring against its customers, and that a patch was available that would have prevented this breach. If we were notified at the appropriate time, we could have patched the system and avoided the breach. Our own analysis has identified shortcomings in our processes once the system was breached. The impact this had is part of the review underway. While we will continue to be as transparent as possible, we need to be mindful not to jeopardise the criminal and forensic investigations and reviews underway. We’ve have had teams working, at times around the clock, to respond to this breach. We have completed our assessment of the files illegally downloaded during the breach and we are notifying organisations involved. External legal advisers are also providing assurance checks and advice on any personal information which was included in the downloaded files. We are working closely with the organisations affected. As part of this support, we have engaged IDCare - a specialist national identity and cyber support service providing counselling and advice to people and organisations. This support will be provided at no cost to them. Page 8 of 9 We can’t undo the breach, but we can make sure that anyone affected gets the support and help they need. Conclusion While some of our work at the Bank has been tested through these tough times, I want to say that I am proud of what everyone at the Bank – our Board, our leadership team, our Monetary Policy Committee and our people – have delivered for the benefit of all New Zealanders. The challenges we have experienced have reinforced the importance of identifying and managing risks, working collectively and collaboratively, and adapting to necessary changes. I am confident that we have a strong and capable team at the Bank committed to taking a long-term and sustainable approach to economic recovery and resilience. We stand ready to do everything that we can to be better kaitakiti of New Zealand’s financial system. Thank you. Page 9 of 9
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the 2021 New Zealand Economics Forum, University of Waikato, 4 March 2021.
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Some Policy Lessons from a Year of COVID-19 A speech delivered to the 2021 New Zealand Economics Forum University of Waikato On 4 March, 2021 Adrian Orr, Governor With special thanks to my Reserve Bank colleague Karsten Chipeniuk, and many others who provided wise copy and comment. Introduction Tēnā koutou katoa, welcome everybody. Thank you for the opportunity to speak today on an important and live topic ‘The policy lessons from a year of living with COVID-19’. In the beginning… From late-2019 citizens of the world have watched the COVID-19 virus evolve into a global pandemic. We observed global decision makers face what seemed an incalculable dilemma: whether to implement measures to contain the spread of the virus - potentially sacrificing lifestyles and livelihoods - or to endure the health consequences of allowing the virus to spread. This policy dilemma was quickly, and unfortunately, resolved by compounding hospitalisations, threatening the sustainability of health care systems. Policy inaction was not an option and social mobility has been dramatically curtailed as a result. In Aotearoa, New Zealand, we have now been living in this constrained world for a year. The level of social restrictions has fluctuated with our COVID Alert Levels – as we have seen in the events of this week – between the extremes of being one of the most mobility-constrained societies on the planet to one of the most free (Figures 1 and 2). As citizens, our economic fortune has been closely linked to these actions. Figure 1: Cross-Country Lockdown Comparisons Source: Corona Virus Government Response Tracker from Oxford University (Hale et al., 2020) Figure 2: International Arrivals At the Reserve Bank of New Zealand, Te Pūtea Matua, we were also watching this global health crisis evolve and brew into a pending economic crunch. However, we were also in the midst of preparing a broader range of monetary policy and financial stability tools to bolster the resilience of New Zealand’s financial system. This is our kaitiaki (guardian) role.1 Our work agenda followed largely from lessons learnt from the Global Financial Crisis a decade earlier. Our efforts included increasing banks’ liquidity, capital buffers, and risk management awareness and ownership. We were also developing additional monetary policy tools to be used if the Official Cash Rate (OCR) reached a lower nominal bound. And, we were finalising the implementation of a superior payment and settlement system for New Zealand, while also formalising a more co-ordinated regulatory relationship between colleagues through the Council of Financial Regulators. 2 3 4 An urgent, collaborative response Our preparedness efforts proved timely given the arrival of COVID-19. Te Pūtea Matua was in a sound position to support cash-flow and confidence in the economy and continue to meet our core mandates in the face of the COVID-induced economic shock. These mandates are maintaining low and stable consumer price inflation while contributing to maximum sustainable employment, promoting and maintaining a sound and efficient financial system, meeting the 1 The Journey of Te Pūtea Matua: Our Tāne Mahuta 2 Reserve Bank Statement of Intent 2019 – 2022 3 Reserve Bank Statement of Intent 2020 – 2023 4 Council of Financial Regulators cash needs of the public, and providing robust payment and settlement services for New Zealand’s financial institutions. 5 Of course we were far from alone in the preparation for, and provision of, economic support in the face of shocks. At best we have played an important support role. New Zealand’s broader economic policy settings provided scope and optionality for economic policymakers. A low level of government debt, favourable terms of trade, and solid economic momentum at the commencement of the pandemic put Aotearoa in good stead to weather the initial economic brunt. Likewise, the rapid development and mobilisation of a suite of fiscal support measures significantly bolstered the balance sheets of households and businesses. I am very proud that Te Pūtea Matua has been able to assist in the whole of government effort to develop, implement, and support this wide range of policy responses. We delivered a broad range of actions, including: Easing monetary conditions, including through the deployment of additional monetary policy tools to lower interest rates; 6 Introducing a range of liquidity facilities to support the smooth functioning of New Zealand’s financial markets and to allow banks to swap their assets for cash in order to keep lending; Ensuring public access to cash was maintained during the social restrictions; Assisting the Government design and implement the mortgage payment deferral scheme and the business finance guarantee scheme; and Reprioritising our regulatory reform priorities – in coordination with COFR – to enable financial institutions to focus on the urgent tasks at hand. And throughout this period, we worked very closely with industry, with two-way flows of information proving extremely important in shaping policy responses, understanding operational resilience, business dynamics, and credit and liquidity risks. These initiatives continue to develop and advance as we speak. Working together – mahi tahi – (Figure 3)7 proved to be a critical catchphrase and one that we will continuously foster. ‘Mahi tahi’ acknowledges that no one individual, enterprise, or policy institution can succeed alone. 5 Reserve Bank Annual Report 2020 6 Tools to support the economy 7 Mahi Tahi: Working together to ensure cash-flow and confidence Figure 3: Working Together: Mahi-Tahi Diagram Source: RBNZ. Released in March 2020 Being prepared beats guessing The ability of New Zealand to sustain the current economic momentum remains in large part at the will of the COVID-19 virus in the short-term, and our confidence and adaptability in the longer-term. Our recent Monetary Policy Statement (MPS)8 outlines that New Zealand has been in the relatively fortunate position of having dealt swiftly with the initial COVID wave. This health outcome, combined with the economic policy response, has seen domestic activity pick up. However, we continue to emphasise that the current pick up is sector and event specific, and that we will not be ‘resuming business as previous’ in its entirety any time soon. The initiation of global vaccination programmes is positive for both future health and economic activity. However, there remains a significant period before widespread immunity is achieved. In the meantime, economic uncertainty will remain heightened and international mobility restrictions will continue. Confidence and investment will be needed to sustain economic performance. For this reason we have retained a stimulatory monetary stance. 8 Reserve Bank February 2021 Monetary Policy Statement Given this elevated uncertainty, at the Bank we are still operating with scenarios in mind rather than predictions. Our recent Briefing to the Incoming Minister outlined some of the challenges confronting society globally and in Aotearoa, and their impact on Te Pūtea Matua policy considerations. We summarised the challenges under the long-term headings of Prosperity, Sustainability, Cohesion, and Inclusion. These headings reinforce a long-term horizon and the inter-related forces that will determine our success. 9 For example, New Zealanders have all weathered the economic implications of the pandemic differently based on a wide range of drivers, e.g. demographics, location, sector of economy, connectedness to the labour force, and individual’s reliance on wages or profits. Aggregate economic statistics mask a myriad of distributional implications for health and economic outcomes. This is a topic I will return to with regard to housing and house prices. The pandemic also occurred during a secular decline in nominal and real (inflation-adjusted) interest rates (Figure 4). Lower real interest rates reflect lower expected future GDP growth rates and higher savings. Lower nominal interest rates reflect the addition of declining inflation expectations. The extremely low level of nominal interest rates has led central banks – including us – to develop additional monetary policy tools which remain effective but relatively untested.10 Figure 4: 10-year Government Bond yields in selected countries Source: Haver Analytics 9 Reserve Bank Briefing to the Incoming Minister 2020 10 Monetary Policy: Same Objectives, Different Challenges, Speech by Adrian Orr, Governor RBNZ, September 2020 The pace and magnitude of the pandemic-induced economic shock also necessitated unprecedented coordination between policy agencies, and between Government and the private sector. ‘Outsourcing’ policy implementation – such as mortgage deferral or wage subsidies - has proved necessary. Of significant interest to central banks globally was how timely and effective fiscal policy could prove to be in support of demand management? ‘Quite timely and very effective’ was the answer across many countries – with a ‘very timely and effective’ answer here in New Zealand. In recent months we have seen significant fiscal and monetary policy collaboration in both demand-side management and ensuring financial markets remain liquid and functioning. Along with this collaboration, the Reserve Bank has been actively ensuring that people understand the similarities and differences between ‘quantitative easing’ (our Large Scale Asset Programme)11 and direct financing of debt. While there appears to only be subtle operational differences between the two concepts, there are significant institutional differences. The Government’s debt issuance – or bond programme – is purely a fiscal policy decision, based on the Government’s spending and investment intentions. Under the Bank’s LSAP programme, the quantum and timing of our government bond purchases were decisions made by our operationally independent Monetary Policy Committee (MPC), with our purchase solely from the secondary market. The MPC’s aims were to lower interest rates across the New Zealand dollar yield curve so as to meet their inflation and employment remit. MPC’s decision making processes and the Bank’s LSAP operations ensure that monetary policy and the Government’s debt management policy are independent. A Crown indemnity insulates the Bank’s balance sheet from the financial risks associated with LSAPs in the absence of a significant increase in Bank capital. This provides the MPC sufficient capacity and optionality to discharge its duties consistent with the Reserve Bank Act and MPC remit. 12 Another interesting twist to the pandemic is the role of our currency and payment systems. Technology transformation is permanent and we are in the midst of re-thinking the role of cash in society and how we deliver transactional capability to New Zealanders. 11 See Large-Scale asset purchases 12 Letter from the Reserve Bank to the Minister of Finance – 6 August 2020 Our recent work has highlighted the ongoing important role that cash plays with regard to financial inclusion and social cohesion. We are a ‘less cash’ not ‘cashless’ society.13 Cash use continued to change with the arrival of COVID-19, so we are capturing the lessons and will need to adapt quickly. Expect to hear more from us on this topic shortly. Monetary policy with relative benefits As already mentioned, the Bank acted on a number of fronts to cushion the impact of the COVID-19 economic shock and promote cash-flow and confidence. Our main action was to significantly ease monetary conditions by lowering the OCR to a record 0.25 per cent and progressively implementing alternative monetary instruments - such as the Large-Scale Asset Purchase (LSAP) and Funding for Lending Programmes (FLP) still operating. While the operational backgrounds differ for these tools, they all act to lower the interest rates faced by households and businesses so as to incentivise spending and investment and keep the NZ dollar exchange rate lower than otherwise. These actions aimed to head off unnecessarily low inflation or deflation and unnecessarily high and persistent unemployment resulting from the COVID-19 economic shock. Monetary policy remains a blunt tool, however, with its relative impacts on individuals varying significantly. The impact of monetary policy decisions on wealth and income equality is an important topic for considering overall economic wellbeing. As Janet Yellen recently noted, despite the fact that the tools of monetary policy are generally not well-suited to achieve distributional objectives, it is nevertheless important that policymakers understand and monitor the effects of macroeconomic developments on different groups within society.14 Our current assessment of the international literature on the distributional impacts of monetary policy suggests it is unclear, on net, whether lower real interest rates increase or decrease income and wealth inequality.15 The net results are an empirical rather than theoretical outcome and appear country and time specific. There are several channels through which lower interest rates can impact on the return on capital (profits) and the return on labour (wages). Our work is ongoing as to which channels are more important and under what circumstances. 13 The Future of Cash – Te Moni Anamata 14 Macroeconomic Research After the Crisis, Remarks by Janet L. Yellen at the 60 th annual economic conference sponsored by the Federal Reserve of Boston, October 14, 2016, https://www.federalreserve.gov/newsevents/speech/files/yellen20161014a.pdf 15 Distributional Impact of Monetary Policy, Leong, J., RBNZ 2020 (Work in progress) The house as a home and an asset What is clear for one monetary policy transmission channel, however, is that lower interest rates assist in inflating asset prices, with the subsequent ‘wealth effect’ supporting spending by the owners of these assets. This ‘wealth effect’ directly benefits the owners of the assets, but it only indirectly impacts others in the economy through the subsequent increase in economic activity and jobs. The impact of low nominal interest rates and significant fiscal stimulus on asset prices is very evident over recent years. Global equity market prices have risen to historic highs both in market capitalisation terms and relative to companies’ underlying earnings (Figure 5). House prices have also risen in general across many of our trading partners and here in New Zealand, especially relative to household incomes. Given that adequate housing is a basic economic need, affordable housing and sustainable house prices will always be in the front line of economic policy importance. The Reserve Bank must have a clear understanding of the impacts its policy decisions have on the housing market both directly and indirectly – that is both our monetary and financial stability policies. Figure 5: Asset prices in New Zealand and around the world Source: Bloomberg, REINZ Before talking directly to the impact of the Bank’s policies, I briefly allude to the many factors – including the level of interest rates – that impact on both housing affordability and house prices (Figure 6). Recent studies have identified housing supply as the most significant determinant of house prices in New Zealand, with responsive housing supply essential for ensuring positive and sustainable housing outcomes.16 Likewise, housing demand factors can influence house prices, but increasing or suppressing housing demand generally only has a temporary impact on house prices and affordability.17 Ensuring house prices are sustainable, thus requires coordination and consistency across many government policies and agencies and non-government participants. Table 1 provides a simple snapshot of the many policy levers that can influence the demand, supply, and ultimately price of houses and housing affordability. Figure 6: Factors affecting house prices and housing costs (or affordability) Source: Adapted from the Productivity Commission’s Inquiry into Housing Affordability (2012). 16 See, for example, the Productivity Commission’s 2012 Inquiry into housing affordability in New Zealand, and Eaqub, Howden-Chapman and Johnson (2018), A Stocktake of New Zealand’s Housing. 17 Ministry of Business, Innovation & Employment. Briefing for the Incoming Minister of Housing and Urban Development (2017). Table 1: Existing housing policy levers Supply Tax policy Fiscal transfers Social housing Land availability / housing plans Building standards (including materials) Infrastructure building Immigration (for example, hiring foreign builders) Education (for example, training programmes) Demand Tax policy Fiscal transfers Overseas investment restrictions Rental standards Immigration Capital market development Kiwisaver policy Monetary policy Financial policy Monetary policy and housing The Bank’s Monetary Policy Committee (MPC) takes into account the impact of house prices on its inflation and employment remit targets in a number of ways. Housing demand affects the demand for housing-related goods and services, such as property construction, rents, and property maintenance. These components account for around one quarter of the Consumer Price Index weight – the target index for the Committee’s Remit. The level of interest rates also influences asset values, including house prices, and the decision to own or rent a house. In particular, house price variations influence households’ spending decisions, and eventually economic growth, inflation, and employment. This ‘wealth effect’ is especially strong in New Zealand given that equity ownership in housing represents more than two-thirds of New Zealand households’ total wealth.18 And, higher house prices relative to the costs of house building will also encourage increased building activity. These factors add up to a complex relationship between monetary policy, housing affordability, and house prices. For example, the current low interest rates are simultaneously contributing to both a rise in house prices while also improving housing affordability. The latter occurs through the lift in employment and household incomes and the lower debt-servicing costs of mortgage borrowers. Financial stability policy and housing Asset (including house) price volatility poses risks to New Zealand’s financial system soundness. This is why, for example, retail banks actively manage their lending. They need to 18 RBNZ estimate: Household balance sheet ($m) – C22. Estimate includes housing, land, and rental properties. ensure their balance sheets (and economic returns) are not unnecessarily vulnerable to variations in both house prices and households’ ability to service their mortgages. These risks to financial system stability become particularly acute when many mortgage borrowers are highly indebted - relative to either their incomes and/or home values. The risk of borrowers defaulting on their loans is further exacerbated when banks provide a large amount of credit to higher-risk borrowers, in particular housing investors. It is easier to enter and exit ownership of an investment property as you are not the occupant. Bank balance sheets overly exposed to higher-risk investment property loans is a recipe to amplify house price volatility. The recent rapid rise in higher-risk house lending – in particular high-LVR investor lending – is largely why the Reserve Bank recently reinstated more stringent Loan-to-Value Restrictions (LVR).19 The Reserve Bank also has a number of other financial (prudential) tools which we are continuously reviewing to assist us to maintain financial stability. These include shining a light on financial risks (mostly via the twice-yearly Financial Stability Report); imposing capital and liquidity requirements on banks; stress testing banks’ balance sheets; and supervising banks as to how they manage their financial exposures. Even then, when it comes to economic equality, our financial stability (macro-prudential) tools have significantly different relative impacts over time. For example, higher prudential requirements generally imply higher deposit requirements, lower credit ceilings, and/or higher interest costs for the mortgage borrower. While these factors can suppress house prices over the short to medium term, they can disadvantage lower income and lower wealth households more immediately. The relative benefits and costs of our financial stability actions vary over time horizons. 19 Media Release, February 2021: Financial stability strengthened by firmer LVR restrictions New policy goals and consideration In line with its recently announced housing policy objectives, the Government issued a direction to require the Reserve Bank’s financial stability policy to have regard to “support[ing] more sustainable house prices, including by dampening investor demand for existing housing stock which would improve affordability for first-home buyers”.20 We welcomed the direction as it makes specific how our financial stability policies and actions can assist the Government’s housing policy objectives, while operating consistently with our financial stability mandate. We are mandated to promote a sound and efficient financial system, under section 68 of the Reserve Bank Act.21 The Government’s direction is also in line with our recent advice to them in which we detailed the many influences on house prices, including the actions of the Reserve Bank.22 We will be considering our financial stability policy settings via our prudential tools – like loanto-value ratios, bank stress testing, and capital requirements – against particular types of mortgage lending. This is done with a view to moderating housing demand, particularly from investors, to best ensure house price sustainability. We also welcome the Minister’s request for more information and analysis on debt-to-income ratios and interest-only mortgages, and will respond in due course. Importantly, the Monetary Policy Committee’s remit targets remain unchanged. We remain focussed on maintaining low and stable consumer price inflation and contributing to maximum sustainable employment, as recently outlined in our Monetary Policy Statement. The Bank will be required to outline, amongst other things, the impact of its decisions on the Government’s housing objectives. This MPC Remit adjustment sits well with our long-standing commitment to transparency about our policy actions and approaches. 20 The Government’s policy objectives for the housing market includes: Ensure every New Zealander has a safe, warm, and dry and affordable home to call their own – whether they are renters or owners. In the short to medium-term, support more sustainable house prices by dampening investor demand for existing housing stock, which will allow additional opportunities for first-home buyers. Create a housing and urban land market that credibly responds to population growth and changing housing preferences, that is competitive and affordable for renters and homeowners, and is wellplanned and well-regulated. 21 Media Release, February 2021: RBNZ supports focus on housing 22 Media Release, December 2020: Reserve Bank’s response to Minister of Finance The Government’s direction creates important work for the Bank, both on our own and in collaboration with other government and non-government organisation. The multifaceted nature of the housing market necessitates a multipronged response. For starters, the Bank (and our colleagues and stakeholders) will need to develop a collective understanding of what ‘sustainable house prices’ means, and how ‘having regard to’ fits within our broader financial stability mandate (section 68 of our legislation). We will also discuss the effectiveness and efficiency of our current financial stability tools at influencing actual house prices toward ‘sustainable’ levels, and of course managing the public’s expectations of our time horizons. This work and understanding necessitates us viewing the housing market from both an ‘occupiers’ and an ‘investors’ perspective. The occupier’s decision largely comes down to whether to rent or buy a house. To assess a sustainable house price, we need to understand how buying a house (and hence servicing a mortgage) stacks up against paying rent over the long-term. Buying implies you will own the house at the end of the mortgage period, hence it is a form of compulsory savings in a single asset. In a purely financial sense, this decision would depend on expected rental costs versus mortgage costs, plus expected capital gains in the house versus other forms of investing/saving. Of course there are also a broad range of additional considerations, including the availability of housing in the location of choice or need, and factors associated with the sense of long-term belonging to a community. From an ‘investors’ perspective, we need to understand how decisions to build new homes or buying existing ones fit into an efficient investment portfolio. There is a wide universe of asset classes readily available to savers/investors, with a range of expected risk and return characteristics. And, there are limits to ‘how much is too much’ of any one asset class, including residential property. This means we should be able to financially-explain what an ‘optimal’ allocation of savings/investment to residential investment property would be. The drivers of residential property investment can then be explained by factors influencing expected risk and return such as, for example, the ability to leverage (a 20% deposit on a house implies 5:1 leverage), tax (dis)advantages of competing investments, and/or myopic investment behaviours leading to under- over-investment. I view the recent section 68b - financial policy - directive from the Government as a significant display of confidence in the Bank’s capabilities and operational independence and transparency. It places a high level of trust in the Reserve Bank to apply our analysis and tools to support a specific objective – sustainable house prices - while remaining within our legislated mandate. The directive is also provided with a clear understanding that we are only one of the many stakeholders that influence the demand for, supply and price of houses. Conclusion I have covered a lot of ground today with a necessary light touch. The economic environment, the roles of monetary and fiscal policy, the challenges of building and operating new monetary tools, the perennial concerns related to excessive financial risk taking, and issues of income and wealth inequality. We have been reminded that with low global inflation, and hence low neutral interest rates, our new monetary policy tools will become increasingly mainstream. We have also been reminded that fiscal and monetary policy coordination remains critical to economic wellbeing. In New Zealand our institutional relationships are strong, providing complementarity of fiscal and monetary actions. This collaboration has been supported – not deterred – by clarity around the Reserve Bank’s purpose and operational independence. Our ability to engage and communicate in a manner which all New Zealanders can understand remains key to our ongoing success. And, we have much to learn and communicate ahead. I encourage your interest and participation in our work. I hope you can at least feel my desire to lead a modern Central Bank that has the vision of operating as a ‘Great Team at the Best Central Bank’.23 As I said at the beginning, ‘mahi tahi’ means working collectively and collaboratively, so ensure we remain effective, relevant, and a cornerstone of New Zealand’s economy and society. Thank you for your attention today. Meitaki ma’ata. 23 Reserve Bank Vision and Values
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Panel remarks by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, to the Institute of Directors New Zealand Leadership Conference, Tāmaki Makaurau, 6 May 2021.
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The Future is Māori Panel remarks delivered to the Institute of Directors New Zealand Leadership Conference in Tāmaki Makaurau On 6 May, 2021 By Christian Hawkesby, Assistant Governor and General Manager, Economics, Financial Markets and Banking Group Written with Evelyn Truong 1 1 With thanks to Naomi Mitchell, Ngarangi Haerewa, Emily Laws, Adrian Orr, Ngarimu Parata, Gael Price, Adam Richardson, Juliet Tainui-Hernandez and Tania Te Rangingangana Simpson for their input and ongoing work in this area. 2 The Terrace, PO Box 2498, Wellington 6140, New Zealand Telephone 64 4 472 2029 Online at www.rbnz.govt.nz Mihimihi (greeting) E nga mana, e nga reo. E nga karanga maha o te wa. Tihei mauri ora! (To all authorities, all voices, to the many chiefs gathered here. Behold the breath of life! ) No Rangiora ahau Ko Waimakariri te awa Ko Aoraki te maunga Kei Te Whanganui-a-Tara ahau e noho ana Kei Te Pūtea Matua ahau e mahi ana Ko Christian Hawkesby tōku ingoa Tena koutou katoa (Hello, my name is Christian Hawkesby: my home town is Rangiora; my river is the Waimakariri; my mountain is Aoraki/Mt Cook; I reside in Wellington; and I work at the Reserve Bank of New Zealand.) E te rangatira, Kirsten Patterson (KP) Karanga mai Mihi mai Whakatau mai Tena koutou katoa (Thank you to the leadership of the Institute of Directors who have called us here; who have welcomed us here; who have looked after us here. Thank you very much). Whakatakinga (introduction) As a member of the Institute of Directors, I was delighted to see the important topic of Te Ōhanga Maori (the Maori Economy) on the agenda for this conference. It will shape the role of directors in the years to come. Today I want to talk about why an understanding of Te Ao Māori (the Māori world) needs to be a core competency of all New Zealand directors. I’ll do this in two ways: • First, I want describe my own journey into Te Ao Māori. I’ll highlight some of the ongoing work at Te Pūtea Matua – The Reserve Bank, and reflect on how we, as Pākeha, as Māori, as tauiwi, can improve our understanding of the Māori economy. • Second, I want to look beyond the Māori economy that exists today, and talk about how Te Ao Māori is shaping the future of Aotearoa New Zealand. When I reflect on my learning about Te Ao Māori to date, I’m reminded of how Māori describe our emergence into the world of light. Ka puta te ira tangata ki te whaiao, ki te ao mārama. The phrase can refer both the first emergence of ngā Atua (the gods) into the light of day, and also to the dissemination of knowledge, when Tāne (or Tāwhaki, according to some iwi) returned from his trip to the highest of the heavens. It describes a progression, first ki te whaiao – to the glimmer of dawn, or a moment of recognition, and only then ki te ao mārama, into the full light of day. I feel as though my understanding of Te Ōhanga Māori is somewhere along that progression. I’ve seen the glimmer, and recognised its significance, but I know I have a long way to go. It’s a progression I am passionate about forging, and I’m fortunate 2 There’s a Māori proverb that says “Kaore te kumara e korero mo tōna ake reka” – “The kumara does not speak of its own sweetness” however there’s a caveat to this proverb “Engari ia ka whakanuia te taiao nāna i whakatō te māngaro” – “however it does acknowledge the environment that nurtured its inner sweetness”. to be working alongside many others on this path. At Te Pūtea Matua, we are working hard to gather new information to shed light on Te Ōhanga Māori, in the hope that we’ll eventually emerge ki te ao mārama. Tihei mauri ora! Ki te whaiao Since joining in 2019, I’ve been privileged to be a part of the journey of Te Pūtea Matua to learn about and embrace Te Ao Māori (the Māori world). Early last year, I gave a speech at the Raising Māori Investment Capability Conference (Hawkesby 2020), where I described the three core elements of our Te Ao Māori Strategy (Figure 1): • Te reo me ngā tikanga – Culture – our effort to raise our collective knowledge and understanding of Māori language and culture • Whanaungatanga – Engagement – our efforts to strengthen the ties between the Reserve Bank and Māori people, Iwi, Māori business, and the Māori world • Kaitiakitanga – Policy – recognition of our responsibility as a policy maker and as guardian of the financial system Through this framework, we are working to gradually strengthen our understanding of and interactions with Te Ao Māori. Figure 1. Our Te Ao Māori approach Source: Reserve Bank of New Zealand But why is it so important that we at the Reserve Bank learn from and embrace Te Ao Māori in our day to day work? We are the central bank for all of Aotearoa. Māori people are our people. As kaitiaki (guardians) of the financial system, we have a responsibility to ensure that Māori have fair and equal access to the financial services they need – something our system has not always delivered. But it’s not just about creating better outcomes for Māori. Māori language, history, and culture shape our identity as a country. Our economy has unique opportunities and challenges that set us apart from the rest of the world. We need to understand and acknowledge these complexities to be better policy makers for all of Aotearoa. We know we still have a long way to go. Luckily, we’re not alone in our efforts to become a more diverse, inclusive, and representative central bank. Like us, the global central banking community is opening up to the importance of indigenous economies, and this means we’ve been able to learn from and share our learnings with international colleagues through the Central Bank Network for Indigenous Inclusion (Reserve Bank 2021). Our mahi - Tikanga We aren’t experts by a long way, but we are making good progress on integrating tikanga and Te Reo Māori into the daily life at Te Pūtea Matua. To grow our understanding, in partnership with the northern iwi of Te Roroa, we tell our story through the narrative of Tāne Mahuta. Just as Tāne stands firm as kaitiaki of the ngahere (forest), so too must we strive to stand firm as kaitiaki of the financial system (Reserve Bank 2018). Our kaupapa (agenda) is to maintain trust in our organisation so that Tāne will not wilt and lose mana. Our offices in Auckland and Wellington have been designed to reflect elements of our Tāne Mahuta narrative, such as the forest, sky, and earth. Each day as we walk through the security gates to enter our Wellington offices, Tāne Māhuta looks back at us as a reminder of our responsibility (figure 2). Figure 2: Tāne Mahuta in the Reserve Bank Lobby in Wellington Source: Reserve Bank of New Zealand Our mahi - Kaitiakitanga One of our responsibilities as kaitiaki of the financial system is to remove barriers to allow the Māori economy to thrive. Our Te Moni Anamata - Future of Cash work programme (Reserve Bank of New Zealand, n.d.) considers the barriers that may emerge from a contracting cash system. It explores how access to physical currency supports financial inclusion for our kaumatua (elders), enables koha (customary gifting), and helps support Māori economies to thrive independently on ancestral lands, which may be further from our main population centres and have less access to digital payments. Looking forward, the next big challenge we face is understanding the factors that limit Māori access to capital. A recent survey (BDO 2020) found that funding and access to capital were two of the greatest challenges faced by Māori businesses. We want to learn more about how factors like collective land ownership, lower home ownership, and systematic bias might be affecting the rates at which Māori businesses access debt and other forms of financing. You can read more about this in our Financial Stability Report (Reserve Bank 2021), published yesterday. We want to find ways to remove those barriers, so that te māra o Tāne (Tāne’s garden, our financial system) can flourish. Our mahi – Whanaugatanga We recognise that iwi are already working tirelessly to address the challenges Māori face in the financial world. Just last month we published a review of Māori financial services institutions and arrangements (Mcleod and Lam, 2021). We discovered a broad range of innovative solutions to increase financial inclusions, literacy, and security for Māori. Initiatives such as collective marae insurance, and shared equity housing initiatives are helping more and more Māori find success in the financial world. So while we work to remove barriers, we know we need to do so in open dialogue with Māori, to ensure that we are providing a system that serves all of our communities. Te Ōhanga Māori in Data While we continue to grow our understanding of Te Ao Māori through the lens of Te Reo me ngā tikanga, we are also working to build a more detailed view of the Māori economy through data. In aid of this, we recently commissioned Berl to produce a report that measures the Māori economy, Te Ōhanga Māori 2018, the Māori Economy Report (Berl 2020). We commissioned the report because we think it’s important to shine a light on this vital part of our economy, not just as a resource for ourselves, but also for local and central government, iwi, community groups, and for you as directors. We recognise that there are a lot of important collective decisions that need to be made, and we’re proud to be part of the conversation. The Berl report gives a fact based grounding for our understanding and decision making. It updates a similar report produced by Berl in 2013, and compliments other recent Māori economy research such as the Te Matapaeroa report from Te Puni Kōkiri (2020). The report shows that Te Ōhanga Māori has grown in value from $42.6b in 2013, to $68.7b in 2018. But more important are the themes of vibrancy, variety, and growth that challenge historical stereotypes. Māori collectives and businesses are supporting the wellbeing of their people through a broad range of channels, including; • Community engagement, participation, and contribution • Whānau and family caring • Paid employment • Unpaid voluntary work • Trust and business enterprise activities. The Māori economy extends far beyond the scale of Treaty settlements and far beyond the traditional industries of Fishing, Forestry, Farming, and Tourism. Māori business is becoming increasingly diversified and dynamic, with high numbers of skilled Māori moving into entrepreneurship and employing considerable numbers of people. The employment base is expanding too. Between 2013 and 2018, the Māori population grew by 30 percent, and the number of Māori in employment grew by a massive 47 percent. More and more Māori are joining the labour force each year and, at least prior to the disruption of COVID-19, they were finding successful employment at the highest rate in almost a decade (Stats NZ 2018). The Māori population is expected to continue to grow. Māori are young, and they’re growing their families faster than the average for Aotearoa. Currently, Māori represent 17 percent of the population. By 2038, that share is projected to grow to nearly 20 percent (Stats NZ 2017). All of these trends are described in great detail in Berl’s report. The authors have gone to great lengths to provide a detailed analysis of the data we have available, to help shape these emerging narratives about Te Ōhanga Māori. For those who haven’t already, I strongly recommend that everyone in this room takes some time to explore some of their insights. The themes which emerge add up to a view that the future of the New Zealand economy is Māori. Ki te Ao Mārama When I say that the future is Māori, I’m not just talking about Māori people, Māori businesses, or Māori jobs. Perhaps one of the most powerful ways in which Māori will shape the future of Aotearoa New Zealand is through Māori values. For generations, Māori economic relationships have been guided by core principles like manaakitanga (respect and generosity), kaitiakitanga (guardianship), and whanaungatanga (relationships). While I don’t claim to be an expert on these values, it is easy to see how these guiding principles have led to some common themes in the Māori approach to the economy: • Firstly, Māori businesses aim to support collective rather than individual wellbeing. This means success is often measured across dimensions other than profit. • Secondly, that collectivism extends to future generations, meaning Māori have an emphasis on kaitiakitanga and take a long-term, intergenerational view of decision making. • Thirdly, our responsibilities to Papatūānuku are deeply ingrained in Māori thinking, meaning environmental sustainability and respect stand at the foreground of business decisions. In the past, some observers might have described a ‘tension’ between these values and a firm’s drive to generate profit, implying that these values can hold firms back from recognising their economic potential. But if that were ever true, it certainly does not describe the future of the New Zealand economic landscape as I see it standing here today. Indeed, the Productivity Commission (2020) recently produced a fascinating report which notes how Māori businesses can leverage their unique identity and values to strengthen their value proposition. It would seem that mainstream social values are becoming increasingly Māori. We see this in government, with the introduction of the Wellbeing and Living Standards framework (The Treasury 2019). We see it in business, with the rise of socially driven enterprise, and the large number of traditional firms actively targeting their impact on climate change. We see the same trends reflected in investment choices. Whereas sustainable and impact investing were once niche strategies, incorporating ESG (Environmental, Social, and Governance) factors into investment decisions is now standard practice. Firms which can effectively generate a virtuous circle of economic prosperity, environmental sustainability, financial inclusion, and cultural diversity are being rewarded for their efforts. In many ways, it seems the Pākeha world is catching up with Te Ao Māori, and this is a trend I expect to continue. We only need to look to our rangatahi (youth), and the fierce enthusiasm with which they approach kaupapa like climate change, racial inequality, and social justice, to see that Māori values are shaping our future. As our schools, iwi, and community groups continue to promote and develop proficiency in Te Reo Māori and tikanga Māori, they will further accelerate this process. Our mokopuna (grandchildren) will know and accept te tirohanga Māori ki te ao (the Māori worldview) as an integral part of life in Aotearoa. And to them I say kia kaha (keep it up). The future of the New Zealand economy is Māori, and it’s bright. As directors, these are the values of your future employees, customers, shareholders, stakeholders, and business partners. Which leads us to the natural conclusion that an understanding of Te Ao Māori must be a core competency for all New Zealand directors. Not only because Māori deserve to have their values represented, not only because it’s our obligation under the Treaty of Waitangi, but because the Māori world view is an increasingly integral aspect of the New Zealand society that we all serve. That is why I am delighted that the Maori Economy is a prominent part of this Institute of Directors Leadership Conference, as we take these first steps of information, awareness and understanding together. Whakakapinga (conclusion) Mā te rongo ka mōhio, mā te mōhio ka mārama, mā te mārama ka mātau, mā te mātau ka ora. (Through information comes awareness, through awareness comes understanding, through understanding comes knowledge, through knowledge comes life and wellbeing) Nō reira Tēnā koutou, tēnā koutou, tēnā tatou katoa. Tihei mauri ora! (Greetings to you all. Thank you.) Kuputaka (Glossary) Aotearoa New Zealand Iwi The largest social units in Māori society. The Māori-language word iwi means "people" or "nation", and is often translated as "tribe", or "a confederation of tribes". Kaitiaki A term used for the concept of guardianship, for the sky, the sea, and the land. A kaitiaki is a guardian, and the process and practices of protecting and looking after the environment are referred to as kaitiakitanga. Kaupapa Values, principles and plans Kia kaha Keep it up, be strong, you can do it Mana Mana is often referred to as status; a person with mana had a presence. While mana was inherited, individuals could also acquire, increase or lose it through their actions. Manaakitanga Generosity, respect, and hospitality. Actions which grow and support others’ mana. Mokopuna Grandchildren and future generations Ngahere Forest Pākeha People of New Zealand European descent Papatūānuku The earth. In Māori mythology, all living things descend from Papatūānuku, the earth, the mother, and Ranginui, the sky, the father. Rangatahi The younger generation, youth Taonga A treasured possession in Māori culture. Due to the lack of a direct translation to English and the significance of its use in the Treaty of Waitangi, the word has been widely adopted into New Zealand English as a loanword. Tauiwi People of non-Māori descent Te Ao Māori The Māori world. This is a holistic term which captures Māori people, places, values, ideas, culture, beliefs, and world view. Te mara a Tāne Tāne’s garden. All that which Tāne oversees. At Te Pūtea Mātua, we use this narrative to help describe and understand our role within the financial system. Te moni anamata The Future of Cash. Te tirohanga Māori ki te Ao The Māori worldview Te Pūtea Matua The Reserve Bank of New Zealand Tikanga Māori customary traditions and practices that guide correct behaviour Whānau Extended family group Whanaungatanga Realtionships and a sense of connection. At Te Pūtea Matua, our committment to whanaungatanga is about developing strong partnerships with stakeholders, and recognising that our uniqure role in the economy creates a responsibility to all New Zealanders Rarangi pukapuka (Bibliography) Berl (2020) Te Ōhanga Māori 2018 BDO (2020) Māori business survey report Hawkesby (2020) Kaitiakitanga: Te Ao Māori o Te Pūtea Matua - Guardianship: The Māori World View of the Reserve Bank. Speech delivered to the Raising Māori Investment Capability Conference 2020 in Tauranga, New Zealand McLeod, R. and V. Lam (2021) An overview of Māori financial services institutions and arrangements, Reserve Bank of New Zealand Discussion Paper 2021-03 New Zealand Productivity Commission (2020) New Zealand firms: Reaching for the frontier, draft report. Reserve Bank of New Zealand (n.d.) The Future of Cash - Te Moni Anamata. Retreived 27 April 2021 Reserve Bank of New Zealand (2018) The Journey of Te Pūtea Matua: our Tāne Mahuta. Retrieved on 30 April 2021 Reserve bank of New Zealand (2021) Te Pūtea Matua becomes inaugural member of new, international Central Bank Network for Indigenous Inclusion. Stats NZ (2017) National ethnic population projections: 2013: 2013 (base)-2038 (update) Stats NZ (2018) Māori unemployment rate at nine-year low, but twice New Zealand rate. Te Puni Kōkiri (2020) Te Matapaeroa 2019 - looking toward the horizon The Treasury (2019) Our living standards framework. Retrieved 30 April 2021.
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Mindful Money Awards, Auckland, 29 June 2021.
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Adrian Orr: Working as one, towards our ultimate purpose Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Mindful Money Awards, Auckland, 29 June 2021. * * * This time last year, Aotearoa New Zealand had just moved into the third week of Alert Level one, following 11 weeks of unprecedented social and physical restrictions, similar to what some parts of the worlds are still enforcing. Our relative freedoms remind us of the mahi (work) we have done as a nation to contain COVID-19. However, the fact that I am addressing you today virtually highlights the ongoing virus risks prevalent. Firstly, I do acknowledge that economic activity in New Zealand is returning to its pre-COVID-19 levels which has been supported by our ability to keep COVID-19 contained, along with significant monetary1 and fiscal stimulus. The global economic outlook has continued to improve, with ongoing fiscal and monetary stimulus underpinning the recovery. New Zealand’s commodity export prices have benefited from this rise in global demand. However, divergences in economic activity, both within and between countries, remain significant. The sustainability of the global economic recovery remains dependent on the containment of COVID-19.2 At Te Pūtea Matua, the Reserve Bank of New Zealand, we are kaitiaki (guardians) of New Zealand’s financial ecosystem. Under the Reserve Bank Act we are required to provide a Statement of Intent (SOI) to the Minister of Finance before the start of each financial year. The SOI sets out the objectives for the next three years and the budget for the first year of that period.3 Our latest Statement of Intent,4 5released today, sets out our strategic priorities for the next three years and outlines how we will continue our role as kaitiaki of New Zealand’s financial ecosystem. We perform our kaitaiki role through our purpose: Toitū te Ōhanga, Toitū te Oranga – meaning, we enable economic wellbeing and prosperity for all New Zealanders. We deliver our purpose through our mandates: maintaining low and stable consumer price inflation while contributing to maximum sustainable employment - ensuring that our currency retains its store of value and supporting the ability of all New Zealanders to participate in the economy. promoting and maintaining a sound and efficient financial system - where all participants of the financial ecosystem are well-governed, well-capitalised and promote public confidence. meeting the cash needs of the public - the money we print and circulate ensures New Zealanders have a means of exchange, a store of value, and is hard to replicate. providing robust payment and settlement services for New Zealand’s financial institutions - enabling New Zealanders to make safe and efficient payments and to complete day-to-day transactions. We approach this mandate in a holistic manner. This means we look at the full range of challenges and opportunities available to us. We see progressing initiatives such as Te Ōhanga Maori, Climate Risk, and South Pacific Remittances as key to our purpose and vision. While Great Team, Best Central Bank remains our vision, we seek to deepen our understanding of its meaning and relevance through the concept of Matangirua ki Matangireia – working in unison, to fulfil our ultimate purpose. At Te Pūtea Matua, being a Great Team means being ‘fit for purpose’ – cost effective, risk aware, 1/5 BIS central bankers' speeches and working collectively in a sustainable way. It also means being unified by our purpose – everyone knowing what to do and moving in sync in the same direction. In Te Ao Māori this concept can be described as ‘Matangirua’ (when every function on a sailing vessel is in use and all are in sync – ‘full steam ahead’). Being the Best Central Bank means scaling new heights, striving to achieve our ultimate purpose – in effect ‘reaching for the sky’. In Te Ao Māori this concept might be described as ‘Matangireia,’ the place to which Tāne ascended so as to bring back the three baskets of knowledge. We have also refreshed our values and reconceptualised these through a Te Ao Māori lens: Wānanga/Innovation: stemming from knowledge gained through our diverse perspectives; Tauira/Integrity: sustained through self-reflection and modelling our shared principles; Taura/Inclusion: binding our individual strengths together enabling our resilience and collective success. We recently updated our brand, as seen throughout our Statement of Intent, to better reflect our purpose and the work we do on behalf of all New Zealanders. This signals our commitment to being relevant, open and inclusive as your central bank. These changes will support our transformation as we implement the new Reserve Bank of New Zealand6 Act due for Royal Assent later this year. I will now touch on three areas where we are holistically delivering our mandate, in our Te Ao Māori, Climate Risk and South Pacific Remittances initiatives. All of these areas directly impact maximum sustainable employment, financial stability and access to money and cash. Te Ao Māori Te Pūtea Matua, the Reserve Bank of New Zealand, has a unique position. We are not limited to how we respond to Treaty obligations, nor are we under obligation to follow how other parts of the state sector respond to theirs. However, we acknowledge that as a state sector entity that serves all New Zealanders, we must recognise a special relationship with Māori and the long-term nature of the Māori economic eco-system. We recognise Te Ōhanga Maori, the Māori economy as having a long-term presence. A recent report we commissioned, Te Ōhanga Māori 2018, the Māori Economy Report, shows that Te Ōhanga Māori has grown in value from $42.6b in 2013, to $68.7b in 2018.7 Māori are an increasing proportion of the New Zealand workforce, and we recognise the criticality of Māori as key partners in the long term sustainability and stability of the New Zealand economy. I would emphasise that Te Ōhanga Māori is not a separate, distinct and clearly identifiable segment of the Aotearoa economy. It is a closely connected component of numerous pieces of the jigsaw puzzle that together make up the economy of Aotearoa. As kaitiaki of the financial ecosystem we must recognise and respond to this important part of the economy. Te Ohanga Maori is key to our legislative objectives and our strategic goals. It is closely linked with our sustainable employment and financial stability mandates by its nature, size and enduring presence. As Assistant Governor Christian Hawkesby recently explained in a speech on Te Waka Hourua, our Te Ao Māori strategy8 we are focusing our workplan appropriately. Others are also recognising the importance of Te Ōhanga Maori. A recent survey found that funding and access to capital were two of the greatest challenges faced by Māori businesses. This was supported by the Productivity Commission’s report ‘New Zealand firms: Reaching for 2/5 BIS central bankers' speeches the frontier’.9 We want to learn more about how factors like collective land ownership and lower home ownership, and systematic bias might be affecting the rates at which Māori businesses access debt and other forms of financing. In response, we have launched a work programme to better understand Māori access to capital in the New Zealand economy, primarily with a focus on bank lending to small and medium-sized Māori enterprises. The work programme will collect both quantitative and qualitative data through interviews with these Māori enterprises, iwi, pan-tribal groups and public and private sector groups. This data will form an initial report discussing policy options with our public and private sector peers. The final report will be released in 2022. It is critical for the financial ecosystem of Aotearoa that we take opportunities to build our understanding of our history, and Māori culture, for example through developing deeper understanding of Te Ōhanga Maori. Through this work we can better understand our country and ensure we are meeting our purpose of economic prosperity and wellbeing for all New Zealanders. Climate Risk Ināia tonu nei – the time is now10 – were the words of the Climate Change Commission in its recent advice to the Government. At Te Pūtea Matua we recognise that promoting and maintaining a sound financial system includes a global effort to understand and address the implications of climate risk for the economy. Starting now to get on the path to a low emission, climate-resilient economy as part of the global effort will help reduce the risks to the stability of the financial system and macroeconomy.11 Our climate change strategy has three components: incorporating climate change into our core functions including the supervision of financial institutions; managing our direct impact on the climate; and leading through experience and collaboration.12 We are contributing to the leadership group of the Sustainable Finance Forum, the Climate Change Commission’s work and the development of New Zealand’s first National Adaptation Plan led by the Ministry for the Environment. We are also working alongside our Council of Financial Regulators agencies on the development of mandatory climate-related financial reporting. Last year we collaborated with the Financial Markets Authority to upskill supervisors on climate risks and climate-related financial disclosures. We will continue this collaborative approach to training, including other agencies where appropriate. We also recognise that sustainability is critical for our long-term future and are considering how we can incorporate sustainability objectives into our balance sheet operations. However we are mindful that any changes to our balance sheet need to be aligned with our ability to effectively and efficiently execute our existing policy objectives. We are a proud member of the Network for Greening the Financial System (NGFS) which brings together 90 central banks and supervisors to share best practice on climate change. The NGFS recently examined a range of options for central banks to consider when adapting their monetary policy operational frameworks to reflect climate-related risks.13 Although it will take time and effort, Te Pūtea Matua is committed to implementing our mandate with regard for climate risks. During my time at the New Zealand Superannuation Fund we signed the Paris Pledge for Action, affirming our commitment to a safe and stable climate where temperature rise is limited to under 2 degrees Celsius and launched a climate change strategy to ensure the fund was more resilient 3/5 BIS central bankers' speeches to climate risks.14 In 2017 we exited or reducing holdings in 300 firms as part of our carbon transition. We believed that climate change represented a material risk which was not being properly priced by the markets. The Fund also increased its focus on environmental, social and governance factors which are now integrated into all aspects of the Fund’s investment activities. In the broader industry, organisations such as Mindful Money empower individuals to understand where their money is invested through KiwiSaver or Investment funds.15 I would encourage you to examine your portfolios and see how you can incorporate climate risk into the way you invest and allocate your capital. Working in unison we can make a larger impact than anyone could alone. South Pacific remittances As kaitiaki we recognise the need to promote strong regional economies as these support our financial stability mandate. We believe that it is our duty to act as a responsible regional citizen particularly in today’s economic environment. In a recent article16 I outlined that the scale and complexity of the challenges facing Pacific Island countries are significant, including climate change and the severe economic impacts of COVID19. With international travel and trade disrupted by the pandemic, we know that Pacific Island countries are facing tough times. At the latest census, Pacific people made up 8.1% of population of Aotearoa.17 I am personally proud to be of Cook Islands descent. We know that Pacific people living in New Zealand send money home, or remittances, to support their family members. Pacific Island countries are some of the most remittance-reliant jurisdictions in the world. World Bank data shows that in 2020 remittance as a share of Tonga’s GDP was close to 40%, nearly 19% for Samoa and just over 7% for Fiji, with New Zealand being one of the main sources of these funds.18 We recognise the economic importance of Pacific people in New Zealand being able to send money back to their home countries through remittances and maintaining financial corridors and services into the South Pacific countries continues to be of importance. In 2019 we established the Pacific Remittances Project with support from the Ministry of Foreign Affairs and Trade to address challenges facing remittance services domestically and in the Pacific region. We are working with other agencies in New Zealand, Australia, the Pacific and internationally, such as the Asian Development Bank and International Monetary Fund to make remittances more accessible, safe and cost effective. Along with the Reserve Banks of Australia, Fiji, Papua New Guinea, Samoa, the Solomon Islands, Timor Leste, Tonga, Vanuatu and other partners we are developing a regional ‘Know Your Customer’ facility. This will help remitters and other businesses to meet their compliance needs. Ultimately we hope that it will enable access to financial services for sectors of the Pacific region that are in danger of being financially isolated.19 In doing so we hope to maintain financial corridors and services to enable Pacific countries’ recovery and growth which in turn supports the financial stability and prosperity of our regional economy. Conclusion Te Pūtea Matua is kaitiaki for Aotearoa’s financial ecosystem. We have a clear purpose, vision and values which support us in delivering kaitiakitanga for all New Zealanders. This includes 4/5 BIS central bankers' speeches delivering our mandates holistically with our workstreams on Te Ao Māori, Climate Risk and South Pacific Remittances. We’re incredibly proud of our Statement of Intent published today, and the mahi that is underway to help us achieve our ambitious, but incredibly important, workplans. As I’ve explained today – this work is critical to us continuing to be the central bank for all New Zealanders, now, and for generations to come. I’d encourage you to take a closer look at our Statement of Intent, and see where you can contribute. Embrace the concept of Matangirua ki Matangireia in your endeavours to promote a more inclusive and climate-friendly financial ecosystem. Working in unison, we fulfil our ultimate purpose. Meitaki ma’ata Tēnā koutou, tēnā koutou, tēnā koutou katoa 1 Monetary Policy: Same Objectives Different Challenges 2 Monetary Policy Statement May 2021 3 Statements of Intent 4 RBNZ Statement of Intent 2021–2024 5 RBNZ Statement of Intent 2021–2024 6 Reserve Bank Bill 7 Te Ōhanga Māori 2018 8 Hawkesby (2021): The Future is Māori 9 New Zealand firms: Reaching for the frontier 10 Climate Change Commission (2021): Ināia tonu nei: a low emissions future for Aotearoa 11 Reserve Bank responds to call for Climate Change consultation 12 Our approach to climate change 13 Network for Greening the Financial System (2021): Adapting central bank operations to a hotter world: Reviewing some options 14 Climate Change, NZ Super Fund 15 About Mindful Money 16 Reserve Bank of New Zealand Governor Adrian Orr says New Zealand banks need to show courage by supporting banking services and remittances to the South Pacific, Interest.co.nz 17 Statistics New Zealand 18 Migration and Remittances Data, The World Bank 19 The FinTech in Personal Finance, a speech delivered by Assistant Governor Simone Robbers at the Singapore FinTech Festival on 13 November 2019. 5/5 BIS central bankers' speeches
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Speech notes by Mr Christian Hawkesby, Assistant Governor and General Manager of Economics, Financial Markets, and Banking of the Reserve Bank of New Zealand, finalised 15 September 2021.
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A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) By Christian Hawkesby, Assistant Governor Written with Ashley Dunstan and Ngarimu Parata Text finalised 15 September Introduction For a long time it has become common for followers of monetary policy to categorise central banks as ‘hawks’ or ‘doves’, and for their decisions to be seen as ‘hawkish’ for signalling higher interest rates or ‘dovish’ for signalling lower interest rates. In Aotearoa, New Zealand, our equivalent bird life are the kahu (the harrier hawk) and the kererū (the wood pigeon). But when it comes to making monetary policy decisions under uncertainty, it may be that the kōtuku (white heron) provides a much more fitting metaphor. In Māori culture, there are two whakataukī (proverbs) involving the kōtuku that capture how its behaviour must change depending on the environment, outlook, risks and uncertainties: • “Tapuwae kōtuku” refers to taking “considered steps”. • “He kōtuku rerenga tahi” is loosely translated as “a white heron’s flight is seen but once”, and can also be interpreted more generally as a call that “once ready, open your wings and commit to flight”. In this speech, I would like to: • Outline the types of uncertainties that we face when navigating monetary policy decisions. • Introduce a risk management approach to bring together these uncertainties into our decision making. • Illustrate how we applied this “least regrets” approach over the past 18 months in response to the threat to our mandate from COVID-19. • Reflect on what we have learnt about the economy over the past 18 months during COVID-19, and how this influenced the outlook for monetary policy published in the August Monetary Policy Statement (MPS). • Return to the kahu (harrier hawk), kererū (dove) and kōtuku (white heron) to relate this all back into a metaphor for our least regrets approach, and how this helps us navigate uncertainty. However, first, let’s start at the beginning, with the Bank’s purpose and mandate, which ultimately guides all our monetary policy decisions. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Purpose, Mandate and Monetary Framework Our purpose at Te Pūtea Matua is to enable prosperity and wellbeing for all New Zealanders: Toitū te Ōhanga, Toitū te Oranga. Monetary policy contributes to this purpose by providing stability in the general level of prices and supporting maximum sustainable employment. This dual mandate is captured as the operational objective set out in the Remit of our Monetary Policy Committee.1 Our main monetary policy tool is the Official Cash Rate (OCR). The seven members of the Monetary Policy Committee (MPC) decide where to set the OCR. More generally, as banker to the banking system and Crown, we have the ability to influence the current and expected level of interest rates in the economy, in pursuit of achieving our mandate. Given the many months that it takes for changes in interest rates to impact economic activity, employment and inflation pressures, we are forced to continually look into the future. For the past 30 years now, the Bank has practiced what is commonly called “forecast targeting” when making monetary policy decisions.2 Applying this approach, we develop economic projections to assist our current monetary policy decisions, and provide a clear sense of the likely direction, magnitude, and timing of future decisions. The Monetary Policy Statements that we publish quarterly use these economic projections to explain our policy decisions and to reinforce our commitment to achieving our targets. Typically, the projections we publish will show that we are taking actions now to give us confidence that we will achieve our mandate in 18 to 24 months’ time, when the full effects of our actions work through the economy. The Role of Uncertainty in Monetary Policy We are very aware that there is uncertainty around any projection for the economy – the outlook could turn out to be better or worse than our forecast. Former Chairman of the US Federal Reserve, Alan Greenspan, summed it up nicely when he said, “uncertainty is not just a pervasive feature of the monetary policy landscape; it’s the defining characteristic of the landscape”.3 The uncertainties faced when setting monetary policy are typically placed in three different categories4: • The starting point for the economy: The first challenge is gaining an understanding of the current state of the economy. Economic data measuring the overall state of the economy are sometimes subject to significant revisions and often released with a long delay. Furthermore, many of the variables that guide our policy decisions are not measured with precision. For example, we assess the level of maximum sustainable employment based on a wide range of imperfect indicators. The MPC’s Remit is available here: https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Monetary%20policy/About%20monetary%20policy/ Remit-for-Monetary-Policy-Committee-Order-Feb-2021.pdf?revision=de3ef331-3ad9-4c12-9793-e35868c353a4. The Remit was updated on 1 March 2021 to require the Committee to assess the effects of its monetary policy decisions on the government’s policy to support more sustainable house prices. See Kendall and Ratcliffe (2019). Greenspan (2004). See Conway (2000). A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) • The structure of the economy: The way economies behave, including how the economy responds to our policy decisions, are the result of thousands of complex decisions by individuals, households, businesses, financial institutions and government agencies. Even where the structure of economic relationships is widely accepted, there is uncertainty about the speed and strength of these relationships. The structure of an economy can also change through time. • Future events: Finally, the outlook for the economy is always subject to news and events. That is a key reason why we update our projections every 3 months. It is just a reality that unexpected developments will occur that force us to reassess the outlook. The outset of COVID-19 or the timing of the Global Financial Crisis (GFC) are more extreme example of this. However, in practice, many different shocks will hit the economy over time, from floods or droughts to international events or changes in technology. There are a couple of main ways that we incorporate an appreciation of uncertainty into our longstanding “forecast targeting” approach. The first is to emphasise that our projections are a communication device and decision-making tool, rather than a crystal ball. Our projections provide us with an opportunity to explain the underlying assumptions we are making about the economy, and how the outlook might change under different assumptions. This approach is intended to provide the public and financial markets with a more complete guide to how we are likely to react in the future. This helps them to more accurately gauge the monetary policy outlook as new information comes to light, whether good or bad news. Second, our published projections typically assume that we will move interest rates on a smoothed path. This reflects the fact that the economic outlook and the required path of interest rates are uncertain, and a smoothed path for interest rates can provide more time to assess our assumptions about the economy before taking policy actions. In other words, our central projections are designed to deliver small considered steps – tapuwae kōtuku. Risk Management and a Least Regrets approach When it comes to lessons from the academic literature, there are no hard and fast rules about how to make monetary policy decisions that are robust to periods of heightened or extreme uncertainty. The earliest theoretical research suggested taking small steps was most appropriate, but subsequent research has found a range of circumstances where it is appropriate to make large and rapid changes in the policy stance, highlighting that the answer depends on the specific circumstances.5 While the academic literature is mixed, there is, however, a long tradition among central banks globally of applying a risk management approach to monetary policy decisions under uncertainty.6 Although most of the time actions will be based on the central bank’s view of the most likely outcome for the economy, a common feature of these risk management approaches is that policy will occasionally be set to mitigate the risk of a very bad outcome for the economy that threatens the central bank’s ability to achieve its mandate. In a seminal paper, Brainard (1967) found that heightened uncertainty dictates changing policy in small steps. Subsequent research includes Ferrati et al (2019), who show that the appropriate response to uncertainty about the relationship between inflation and unemployment will vary depending on model assumptions. Also see Kay and King (2020) for an extensive discussion of decision-making under irresolvable uncertainty. In addition to the speech by Greenspan referred to in footnote 3, the role of risk management in monetary policy decision-making has been set out in speeches by the Federal Reserve (Evans (2019)), the Bank of Canada (Poloz (2020), and Reserve Bank of Australia (Stevens (2009)). A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Indeed, research of the decisions made by the US Federal Reserve show traits of this type of risk management approach in around 25 percent of cases between 1987 and 2008.7 In the same spirit of these risk management approaches used by central banks globally, in recent years our Monetary Policy Committee at Te Pūtea Matua has developed a language around its “least regrets”, to complement the signals from our published central projections. This least regrets approach is a way to test that our policy stance provides a high degree of confidence that our mandate of low and stable inflation and maximum sustainable employment will be achieved across a range of possible scenarios for the economy, particularly during periods of rapid change in the economic outlook and heightened uncertainties. It involves identifying the most likely ways that the economy could evolve differently than in our central view, and what our mandate implies about our “regret” if these risks eventuate. The language of least regrets – the mirror of maximising our chances of success – conveys our humility about being able to accurately predict the future. It’s important to emphasise our least regrets approach is not designed to be applied in a rigid or formulaic way. Rather, it is where the science of macroeconomics meets the art of policy decision making. Applying a Least Regrets through our COVID response To bring this to life, I would now like to turn to how we have applied this approach over the past 18 months in response to the threat from COVID-19 to our ability to achieve our mandate. The COVID-19 virus, and the response by governments to manage the health impacts, were an unprecedented shock to the starting point for the global and domestic economy. Along with other forecasters, through the first phase of the crisis, we faced substantial uncertainty about the impact on the New Zealand economy. However, our judgement was that the size of the starting point shock was significant, and the risks were skewed towards a further material deterioration in the economy, presenting a significant threat to our employment and inflation mandates. We published scenarios for the economy that involved unemployment reaching between 8 and 12 percent, and an extended period of inflation below 1 percent (figure 1). Figure 1 Scenarios for the unemployment rate and inflation from May 2020 MPS Unemployment Inflation Source: Stats NZ, RBNZ estimates. This statistic is based on Evans (2015), who review the minutes of the meetings of the Federal Open Market Committee for evidence that the Committee appealed to uncertainty to justify positioning the funds rate at a different level than implied by the staff forecasts alone. 31 out of 128 minutes included an appeal to uncertainty, while 14 out of 128 minute cited insurance against adverse outcomes being an important consideration in the stance of policy. Along with Caggiano et al (2017), the paper also provides formal empirical evidence that the Fed sometimes takes risk management considerations into account in its policy decisions. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Our fear was that the need to shut down the economy to avoid a health crisis could create a deep and prolonged recession. There was a risk that the downturn in the economy could create a vicious circle, where weakening household and business finances and declining asset prices hampered any recovery. And although we had confidence in the resilience of our banking system, the impact could have been worsened if financial institutions became overly cautious and restricted access to credit to households and businesses. As a result, there was a significant threat to maximum sustainable employment if these fears materialised. A protracted downturn in the labour market could have resulted in permanent labour market scarring where unemployed workers find it difficult to re-enter the labour market once the economy recovers.8 Furthermore, after around a decade of CPI inflation being below the 2 percent mid-point of our target range, we were also concerned that inflation expectations could become unanchored below our target. In an environment of already low interest rates, the looming threat of deflation had the potential to seriously reduce our ability to stimulate the economy in order to achieve our employment and inflation mandate. In response to these factors, during the early phase of COVID-19 the MPC decided that “a least regret approach is needed, delivering stimulus sooner rather than later, and thus minimising the risk that the stimulus delivered turns out not to be enough”. During the early phase of COVID-19 the Monetary Policy Committee decided that “a least regret approach is needed, delivering stimulus sooner rather than later, and thus minimising the risk that the stimulus delivered turns out not to be enough”. This strategy involved rapidly cutting the OCR by 75 basis points to 0.25 percent in March 2020, committing to keep it at that level for at least 12 months, and launching an alphabet soup of schemes and facilities designed to keep interest rates low and the financial system functioning.9 As we progressed further through 2020 and into early 2021, we had a considerable amount of monetary stimulus in place to support our objectives, and the immediate economic impact of the virus was less severe than we had feared. Nevertheless, we continued to judge the risks to the economy were biased to the downside. In particular, we faced uncertainty about the extent of the global economic recovery following the emergence of COVID-19. It was also unclear how the domestic economy would cope with the expiry of Wage Subsidy support, and the absence of international tourists through the traditional peak summer period. See IMF (2020). See Hawkesby (2020). A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) In response to these developments, by February 2021 the Committee reformulated its least regret by agreeing that “it would not change the stance of monetary policy until it had confidence that it is sustainably achieving the consumer price inflation and employment objectives”. By February 2021 the Committee reformulated its least regret by agreeing that “it would not change the stance of monetary policy until it had confidence that it is sustainably achieving the consumer price inflation and employment objectives”. A Least Regrets approach 18 months through Covid-19 Fast forward to the current period, and we are now able to draw from almost 18 months of experience about how COVID-19 affects the New Zealand economy, and the lessons we have learnt about its impacts on both the demand and supply side of the economy. On the demand side, the early discovery of vaccines against COVID-19 has supported a strongerthan-expected recovery in the global economy (figure 2). Figure 2 Economic recoveries in selected trading partners (as at February 2020, level of expenditure GDP indexed to 2019Q4, seasonally adjusted) Source: Haver Analytics, Stats NZ. More generally, demand for our goods exports has fared much better than during previous global downturns. The impact of COVID-19 has seen a shift in global demand away from services such as travel and tourism towards goods, including the dairy, meat and seafood exported by New Zealand. We have also benefited from a robust recovery in the Chinese economy, our largest trading partner. Equally important, has been the resilience of demand within New Zealand’s closed borders. Initial health measures were able to largely contain the virus, with most households and businesses able to return to more normal activities in a space of time that was shorter than feared. Together, monetary and government spending policies have supported a strong recovery in spending. The government’s Wage Subsidy Scheme is a policy that has been particularly effective in supporting the wider recovery. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) By supporting business income, it has allowed many businesses to maintain staff levels and has provided confidence in job security. As a result, at a national level household incomes were largely maintained through COVID-19 lockdown periods. This has provided a financial buffer that has helped to stimulate spending when households have emerged from lockdowns. Business investment has also picked up as the economy has recovered. The recovery phase has also seen house prices grow rapidly from already elevated levels. This is partly explained by the stronger than expected domestic economy and associated improvement in job security. Looking ahead, we see the level of house prices as unsustainable relative to their fundamental drivers, and have tightened our macro-prudential settings to limit risks to financial stability.10 While the demand side of the economy has been more resilient than expected when COVID-19 arrived, the disruption to the supply side of the economy has also been more prolonged than anticipated. It has been much harder and more expensive to source finished and intermediate goods from overseas and within New Zealand. There have been significant disruptions to supply chains, particularly related to the shipping industry. COVID-19 has also made it more difficult for firms to source labour. The highly uneven impacts across sectors – with the tourism and customer-focussed sectors hardest hit – have made it harder to match employers and employees. International evidence has also illustrated a hesitancy of some to return to the workforce after periods of lockdown, especially in customer facing roles. Along with reduced access to migrant workers, these developments are likely to have reduced the level of maximum sustainable employment.11 All of these factors limit the productive capacity of the economy. Given the emergence of more transmissible variants of COVID-19, disruptions to the movement of goods and people globally looks more likely to continue over the medium term, even once a significant proportion of the global population is vaccinated. In response to these lessons on the impact of COVID-19 on both the demand and supply side of the economy, in the latest Monetary Policy Statement we noted that we had more confidence that employment was already at its maximum sustainable level (Figure 3) and that pressures on capacity would feed through into more persistent inflation pressures over the medium-term (Figure 4). See https://www.rbnz.govt.nz/news/2021/08/house-prices-above-sustainable-levels See the Special Topic “The recovery in New Zealand’s labour market” contained in the August MPS. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Figure 3 Indicators of Maximum Sustainable Employment (MSE) Source: Stats NZ, MBIE, ANZ, NZIER, RBNZ estimates. Figure 4 Measures of core inflation Source: StatsNZ, RBNZ estimates. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) In response, the Committee agreed that their “least regrets policy stance is to further reduce the level of monetary stimulus so as to anchor inflation expectations and continue to contribute to maximum sustainable employment.” In August 2021, the Committee agreed that their “least regrets policy stance is to further reduce the level of monetary stimulus so as to anchor inflation expectations and continue to contribute to maximum sustainable employment”. This formulation of our least regrets signalled a return to being guided by our central projections and how these evolve with new information (Figure 5), aided by: • a better understanding of the starting point of the economy, • more balanced risks to the outlook, and • the threat of consumer price deflation having abated. Finally, the Committee also noted that whether or not a monetary policy response would be required in response to future health related lockdowns would depend on whether there was a more enduring impact on inflation and employment. This will involve continuing to deepen our understanding of the persistent impacts on both demand and supply. We are in a good position to navigate the period ahead, with the labour market operating at maximum sustainable employment, inflation expectations well-anchored at our target, and financial markets functioning well. Annex 1 outlines how the Committee’s least regrets evolved through time in relation to its assessment of the economic environment. Figure 5 Official Cash Rate projections Source: RBNZ estimates. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Summary: The hawk, dove, and white heron (he kōtuku) Finally, lets return to the kahu (harrier hawk), kererū (dove) and kōtuku (white heron) to relate this all back into a metaphor for our least regrets approach, and how this helps us navigate uncertainty. For a long time, followers of monetary policy have developed a shorthand to categorise central banks and central bankers as either ‘hawks’ or ‘doves’. The origins of these terms can be traced back to descriptions used to capture the attitudes of leaders to war, with a hawk more inclined to go to war, and a dove more inclined to seek peace. In the midst of the Vietnam War, these terms found their way into monetary policy and were used in the minutes of a US Federal Reserve meeting in May 1966.12 In this context, a hawk was determined to bring inflation down by having interest rates higher than otherwise, and a dove more inclined to tolerate bouts of higher inflation with a preference to keep interest rates lower than otherwise. As time has passed and inflation has remained relatively low and stable for past 25 years, this original definition has evolved into a shorthand used by market participants where any decision by a central bank that results in interest rates higher than expected is “hawkish” and any decision where interest rates are lower than expected is “dovish”. In Māori culture, the hawk (kahu) and the dove (kereru or native wood pigeon) both have prominent roles. The kahu represents strength and dominance as the most powerful bird in the environment. The kererū represents eternal life, and was once traditionally offered as a sacrifice to Papatuanuku (the earth mother) to promote life and growth in the forest of Tane Mahuta. For these reasons, the feathers of both the kahu and kererū are highly regarded and prominent on the Korowai (cloak) of Māori chiefs. See Financial times (2014). What’s with the doves and hawks? – YouTube A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) However, when it comes to our approach to making monetary policy decisions under uncertainty, it may be that another bird – that is also sought after on the cloaks of chiefs – provides a more fitting metaphor: the kōtuku (white heron) that adorns our $2 coin. A key feature of our least regrets approach is responding to the environment, risks and uncertainties, including: • the starting point of the economy, • the balance of risks, and • threats to achieving our mandate. It requires an approach that is adaptable, sometimes moving with caution in slow, small steps, and other times moving with confidence, quickly in large steps to remain successful. In Māori culture, there are two whakataukī (proverbs) involving the kōtuku that capture this trait of responding to the environment around you. The saying “he kōtuku rerenga tahi” loosely translates to “a white heron’s flight is seen but once”. This whakataukī expresses an idea that “once ready, open your wings and commit to flight”. Applying this to the protocols of a marae (meeting house), it is used as a reminder that when it is your opportunity to speak, you may only get one chance, so you must take your chance and be bold. In the world of setting monetary policy, this proverb translates to those times when: • the outlook for the economy has been subject to large and uncertain changes, • the risks are heavily skewed in one direction, and • there is a material threat of not achieving your mandate. In that situation, the path of least regret is to move quickly and take large steps to provide more confidence that policy settings will be appropriate if the risks to the outlook eventuate. As described above, this approach is consistent with our actions (and other central banks globally) through the early stages of COVID-19. By contrast, the saying “tapuwae kōtuku” signifies a different mode of operation. It translates roughly to “considered steps”, and is an expression often used to describe the way to walk as a visitor onto a marae. The idea is to take small considered steps as you assess the environment around you. You are walking in the right direction, but slowly in case your assessment changes quickly (are your hosts friends or foes?). Powhiri, welcome ceremony in front of Te Whare Rūnanga at the Waitangi Treaty grounds A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) In the world of setting monetary policy, this translates to having confidence in the outlook for the economy, and inching in the right direction based on how the economy is likely to evolve. This is consistent with the observation that when there is a typical amount of uncertainty, and the risks are evenly balanced, then central banks globally tend to follow a smoothed path and keep their policy rate unchanged or move in 25 basis point increments. There is another reason that the kōtuku is prominent in Māori culture. In traditional Māori oral history, around 1000 years ago Kupe is said to have journeyed from Hawaiki, the ancestral homeland of Māori, to become the first person to navigate the dangers and challenges of Te Moana-nui-a-Kiwa (the Pacific Ocean) and discover Aotearoa, New Zealand. The kōtuku is associated with Kupe in artwork capturing the significance of his journey. At Te Pūtea Matua, it is the role of the Monetary Policy Committee to navigate the right settings for monetary policy to achieve our mandate for low and stable inflation and contributing to maximum sustainable employment. This is our best contribution to the ultimate purpose of the Reserve Bank, which is to enable prosperity and wellbeing of all New Zealanders: Toitū te Ōhanga, Toitū te Oranga. Along the way, we need to steer our way through uncertainties and threats to our mandate from the evolving economic environment. Our least regrets approach is one tool to navigate these judgements. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) References Bannister, G, Finger, H, Yosuke, K, Siddharth, K & Loukoianova, E (2020) ‘ Addressing the Pandemic’s medium-term fallout in Australia and New Zealand’, IMF Working Paper, 2020/272. Brainard, W (1967) ‘Uncertainty and the effectiveness of policy’, American Economic Review, 57(2), pp 411-25. Caggiano, E Castelnuovo and G Nodari (2018) ‘Risk management-driven policy rate gap’, Economics Letters, 171, pp 235-238. Conway, P (2000) ‘Monetary policy in an uncertain world’, Reserve Bank of New Zealand Bulletin, 63:3, pp 5-15. Evans, C, Gourio, F, Fisher, J., & Krane, S (2015) ‘Risk management for monetary policy near the zero lower bound’ Brookings Papers on Economic Activity, Spring 2015, pp. 141-219. Evans, C (2019) ‘On risk management in monetary policy’, Federal reserve Bank of Chicago speech. Ferrero G, Pietrunti, M & Tiseno, A (2019) ‘Benefits of gradualism or costs of inaction? Monetary policy in times of uncertainty’, Bank of Italy Temi di discussione, 1205. Greenspan, A (2004) ‘Risk and uncertainty in monetary policy’, Federal Reserve Board speech. Hawkesby, C (2020) ‘COVID-19 and the Reserve Bank’s Balance Sheet’, Reserve Bank of New Zealand speech, delivered on 20 August. Kaminska, I (2014) ‘What’s with the doves and hawks’, Video published by the Financial Times, available at http://www.ft.com/video/62d5bfc4-3b89-39ca-97bf-c19d6fe097fc Kay, J and King, M (2020) ‘Radical Uncertainty: Decision-making beyond the numbers’. Poloz, S (2020) ‘ Dealing with exreme uncertainty’, Bank of Canada speech. Ratcliffe, J and Kendall, R (2019) ‘Monetary policy strategy in New Zealand’, Reserve Bank of New Zealand Bulletin, 82:3. Stevens, G (2009) ‘The conduct of monetary policy in crisis and recovery’, Reserve Bank of Australia speech. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Annex 1: Summary of least regrets monetary policy since the arrival of COVID-19 Source of uncertainty Immediate postCOVID period March-May 2020 Initial recovery from COVID February 2021 Most recent August 2021 Starting point uncertainty Uncertainty so heightened that central projections were replaced with alternative scenarios. Health measures more effective in containing COVID-19 than initially feared. Although a robust recovery in spending is underway, there is ongoing uncertainty about the impacts of COVID-19 on the supply side of the economy. Several published downside scenarios highlighted a material risk of a severe economic correction. Although risks to the outlook were becoming less skewed, it was unclear how the economy would cope with expiry of Wage Subsidy support and the absence of international tourists. Downside risks of a severe contraction have declined as evidence has accumulated that demand in the economy is more resilient to COVID-19 than we had feared. A prolonged downturn could still present a threat to inflation and employment objectives. Increased confidence that robust demand and supply constraints will feed through into more persistent inflation pressures, and that employment is at its maximum sustainable level. Maintain stimulus until confident that inflation and employment objectives will be sustainably achieved. Reduce monetary policy stimulus to reduce the risk that inflation expectations become unanchored. Bias of risks to the outlook Our ability to stimulate the economy could have been constrained by the Effective Lower Bound. Risks to achieving our mandate Significant threat to employment mandate if risks to the economy materialised. A decade of below-target inflation increased risk of expectations becoming deanchored on the downside. Least regrets Deliver stimulus sooner rather than later, thus minimising the risk that stimulus delivered turns out not to be enough. Considerable monetary and fiscal stimulus supporting the economy. A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku) Risks assessed as evenly balanced.
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Remarks by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to Financial Services Council (FSC) Regenerations, online, 7 December 2021.
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Geoff Bascand: Reflections of a central banker Remarks by Mr Geoff Bascand, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to Financial Services Council (FSC) Regenerations, online, 7 December 2021. * * * Thank you for the opportunity to speak with you today. The growth in our relationship with the Financial Services Council (FSC) has been enjoyable, fruitful, and indicative of our maturing engagement approach with the financial sector. We have played our part, but I am also very appreciative of how constructive and proactive Richard Klipin, Rob Flanagan and the FSC have been in fostering it as well. Macroeconomic and financial volatility I came into the RBNZ in 2013 – after having observed and interacted with it from close proximity in other related analytical and policy domains during my time at Stats NZ and Treasury prior to that. This was a time in the aftermath of the GFC when central banks were reflecting on monetary and financial stability policies and how to avoid another financial crisis in the future. Domestically, our housing market was surging, with loose lending standards seeing greater than 20% of all outstanding mortgages with LVRs over 80%. The RBNZ became a fast follower of the emerging practice of macro–prudential policies. The role and interaction of monetary and macro-prudential policies has been a feature of the past decade and looms just as large today as it did in 2013. Using interest rates to lean against excessive borrowing is undesirable when inflation is low, as it was then, and so the macro-prudential policies we use to mitigate boom & bust cycles in the economy provide additional freedom for monetary policy to do its role whilst containing risks from excessive leverage. While it is challenging getting macro-prudential policies understood and indeed calibrating them in terms of costs and benefits,1 I am a strong believer they redress the inherent tendency of banks to be pro-cyclical, underestimating credit risks when asset prices are rising. I expect macro-prudential policies to remain an important policy tool in years to come, though how much they are applied in a temporary manner or via permanent standards will be a topic for future policymakers. Debt-to-Income restrictions to my mind are an important and probably better tool than LVRs, but perhaps a mix is best. Neither will fix the housing market, and nor should they be expected to. We can lean against house prices by increasing the cost and restricting the availability of credit, but we cannot alter the supply of land or buildings, and should not be held responsible for the housing market. Our job (and capability) is to limit financial stability risks and keep overall inflation under control. When in doubt, a bias towards prudence is probably a good thing. You might expect a conservative central banker to say that, but I think there is a good deal of evidence in favour of optimism bias amongst borrowers and lenders (or perhaps simply an expectation of being rescued if things go sour).2 There is a long tradition to this view, all the way back to Adam Smith: 'The over-weening conceit which the greater part of men have of their own abilities is an ancient evil remarked by the philosophers and moralists of all ages. Their absurd presumption in their own good fortune has been less taken notice of. It is, however, if possible, still more universal. There is no man living who, when in tolerable health and spirits, has not some share of it. The chance of gain is by every man more or less overvalued, and the chance of loss is by most men 1/6 BIS central bankers' speeches undervalued, and by scarce any man, who is in tolerable health and spirits, valued more than it is worth.' Adam Smith Low inflation was our monetary policy challenge for the 4 to 5 years prior to the COVID-19 pandemic, driven by high international savings, a greater than 70 percent fall in oil prices, the international flow of labour, digitisation, and global competition keeping downward pressures on prices. However, just when we thought we had things back to about an even keel in terms full employment and inflation at target at the end of 2019, the global pandemic came and knocked everything for six. Anticipating a very deep and prolonged recession, monetary and fiscal policies went into emergency over-drive. Fortunately, the combination of these policies, health restrictions and sound private sector balance sheets avoided an economic crash and supported a fairly quick and strong recovery.3 What do I take from these experiences of economic trends, cycles, and shocks? Firstly, smooth sailing is rare: the economy at equilibrium (sailing on calms seas with neutral policy settings) is as much the outlier in the distribution of economic circumstances as is the rare instability we wished we were prepared for. The New Zealand economy is a small boat on a turbulent global sea.4 Secondly, the single most important thing we as central bankers can do is to ensure the economy and in particular the financial system (the oil that keeps the boat’s engine running) is highly seaworthy at all times. This means building resilience, maintaining private sector and public-policy buffers that can be drawn on when required, and having enough policy flexibility to be able to exercise a variety of tools and settings when needed. Our review and decision to lift banks’ regulatory capital requirements was a major step forward in this respect. One of my more pleasurable responsibilities has been as a member of the East Asia-Pacific (EMEAP) Deputy Governors six-monthly meetings. It is always enlightening and humbling comparing and contrasting central banking policy approaches in the international context. These discussions regularly remind me that we are in the mainstream of countries looking to lift their bank capital levels in order to provide adequate resilience. The pandemic has been a further pertinent reminder to all of the benefits of higher capital.5 Regulatory approach The international context leads me to my next topic. New Zealand is a net importer of capital and reliant on strong credit standing (though less critically so than in the past).6 We welcome international financial institutions and open capital markets for the innovation, networks and lower cost of capital they bring. Of course, there can be attendant volatility or fickleness so we need good international relations and we value our participation in international fora. Our close working relationship with APRA is especially important (and the broader Trans-Tasman Banking Council), given the dominance of Australian banks, as are the wider Basel, BIS, IOSCO, NGFS and EMEAP communities. The IMF Financial Sector Assessment Program (FSAP) review of our regulatory framework in 2016–17 endorsed a number of key features and competencies in our regime, while at the same time setting the bar higher in terms of the international benchmark for regulatory discipline (more intensive supervision and enforcement, greater operational independence in macro prudential policy, and more standard and higher regulatory requirements for crisis management and FMIs). We accepted the challenge and (aided by increased funding) have been actively strengthening our regulatory pillar, whilst maintaining continued attention to the market and self-discipline 2/6 BIS central bankers' speeches pillars.7 The development of the Bank Financial Strength Dashboard has been an excellent initiative, and I look forward to the counterpart for the insurance sector that is in development. I am a data junkie and it has been tremendously enjoyable working with our Data and Stats team to enhance understanding and reporting on the economy and financial sector. We have doubled supervisory capacity, placed much of it closer to regulated entities in Auckland, and increased the weight on positive assurance and verification; less ‘tell us everything’s ok’, and more ‘show us’. We’ve also seen the FMIs legislation developed and enacted; we established an Enforcement Department and are building our enforcement framework; and our banking and non-bank deposit taking prudential framework and resolution regime is being overhauled via the Deposit Takers Bill, out for consultation at present. As we bring these new frameworks and expectations to life, the culture and behaviours of how we work together will be more important than ever. Intensifying our scrutiny of entities’ risk and compliance potentially could drive more adversarial positions between the Bank and financial institutions. Perhaps more than anything else, I am proud that we have, in fact, forged stronger industry relationships over the past few years. The Relationship Charter was an excellent initiative forged from our supervisors and has underpinned our active engagement and mutual relationship behaviours, initially with banks and increasingly with insurers. CBL’s demise was another defining episode in our regulatory approach. Failures in market discipline, self-discipline and regulatory discipline were all evident.8 For our part, the corporate failure marks a threshold change in supervisory attitude: we have learnt and determined to act more quickly and proactively on suspicion of inadequate risk management, having the confidence to act and demand prudence before a crisis unfolds. Governance and institutional arrangements CBL provides a tidy segue to my next theme – the importance of strong governance and institutional arrangements. As most who know me, I have always been a market-oriented economist. Unfortunately, there are many instances where market and self-discipline forces have been found wanting on their own. Our review of banks’ attestation processes revealed significant weaknesses in board governance processes, with directors signing to the veracity of financial and risk compliance on the basis of no awareness of issues, rather than pro-active review and positive confirmation vouching for their integrity. The continued identification of historical compliance issues (e.g. via the Liquidity Review, Conduct and Culture reviews) testifies to the ongoing need for firms to intensify positive assurance processes and lift investment in systems, processes and compliance. The planned Governance Thematic review we are conducting with the FMA in 2022 will add further light and focus on expectations and practices for board governance. When I joined the Bank, I was part of a new internal Governors Committee, the first step into collective decision-making for monetary policy. Subsequently, the Government introduced legislation mandating a statutory Monetary Policy Committee, from April 2018. This has proved an excellent development, consolidating collective decision-making and strengthening further transparency and integrity of policy deliberations. The Committee has worked well, appropriately testing the Bank’s analysis and advice and making consensual decisions in the uncertain times. The interaction between monetary policy and financial stability analysis and decision-making has been increasingly close, partly driven by economic forces (low interest rates, rising house prices and high household borrowing), and by the evolving practice of the financial policy committee 3/6 BIS central bankers' speeches directly advising MPC of its financial stability assessment. Looking ahead, the Bank faces significant governance changes with the Board (comprising 4-8 non-exec directors plus the Governor) accountable for all non-monetary decisions. It will take great discipline and skill to make this unique model (for a central bank) work and maintain the Bank’s operational independence, reputation, and effective coordination of decision-making across the MPC, the Board and the Bank’s policy (e.g. financial stability) committees. My first speech when I joined the Bank was on communication – with the tagline “I’m just a soul whose intentions are good, Oh Lord, please don’t let me be misunderstood” (courtesy of The Animals). I must say, somewhat immodestly, that looking back on it, it was rather prescient, or perhaps timeless. As Yogi Berra was reported to have said “It’s like déjà vu all over again.” For example, I touched on the special challenges of communicating LVR policies and noted that [the] extension in regulatory and supervisory responsibilities will demand new channels, new audiences and new messages.” Communicating the objectives of macro prudential and unconventional monetary policies hasn’t gotten any easier, but we have been broadening our channels, our audiences, and our story-telling narratives, and will keep doing so. Looking ahead I have already touched on some important continuity challenges in the years ahead. I want to mention a few more. Central bankers – especially their financial stability representatives – are paid to think about future trends and market dynamics and worry about what might go wrong, preparing mitigation plans accordingly. Cyber risks and climate risks require deeper understanding and are appropriately receiving increased focus. While risk management is the day-to-day activity of financial institutions, understanding how these risks can cumulate at the system level or be under-priced due to implicit government guarantees is appropriately a focus for the central bank. Without further analysis, we don’t know how serious these risks are to system stability. Important as it is to keep alert to new or emerging risks, as these two are, at the same time we need to maintain our constant watch around market, credit, liquidity, or operational risks that will inevitably raise their head in the years ahead. For the Reserve Bank, oversight of climate and cyber risks needs to be an ’and’, not an ’or’. Efficiency and innovation An enduring challenge for a regulator is the tension between promoting efficient, dynamic markets that generate innovation and customer benefits with the uncertain consequences for stability, resilience, and disruption or adjustment costs. The costs of regulatory compliance play into this equation as well. Proportionate regulation is the goal; but as a prudential regulator I would put more weight on being proportionate to risk than to size. I acknowledge the weight of our endeavour in recent years has been to strengthen resilience and compliance. There is still work to do to complete this ’uplift’. Implementation of the Deposit Taker’s Bill and its new prudential standards framework will keep the banking and NBDT sector occupied for a number of years yet. The focus will shift somewhat to enhancing and completing the resolution framework, including the major task of implementing deposit insurance (compensation). Across our COFR partners, seeing through the Conduct of Financial Institutions Bill (COFI) and the Credit Contracts and Consumer Finance Act (CCCFA) into the way the financial sector works will absorb considerable effort. Closer COFR relationships have been a big step forward 4/6 BIS central bankers' speeches but there are more steps on the ladder to achieve joint prioritisation and integrated policy and supervisory approaches. The strengthened cooperation amongst regulatory agencies, now embedded via legislation in the formalisation of the Council of Financial Regulators (COFR), should help maintain a balanced focus on efficiency, customer outcomes, and financial stability. We have strived to support efficiency through informed, trustworthy markets, regulations that allow overseas entities to compete, levelling the playing field in bank capital, etc. Overall, I think the next ten years will see a greater concentration on efficiency, industry dynamics, technological innovation and how financial institutions meet customer needs. These competitive and regulatory tensions lie very close to the surface in the insurance sector with its role in supporting households and businesses in managing financial risks arising from a wide variety of adverse events. The pandemic has reminded us of the crucial role life and health insurers are expected to play in supporting household welfare and confidence. However, significant adjustment issues lie ahead for the insured and insurers as the industry adjusts pricing for seismic and climate risk in various locations. Thorough policy analysis will be important to avoid simply shifting risk to the Crown, either directly or through residual liability from under-insured households. Changes in the future of money and payments represent an extraordinary challenge to central banking. Central bank digital currencies are more than a simple technology change. If conducted at the retail level, they have the potential to radically impact the banking system in ways that are not yet sufficiently analysed or understood. This will be a huge focus for the central banking community in coming years. Other changes in the payments and financial market infrastructures, e.g. open banking and cross-border payment arrangements, have the potential to change customer behaviour and market dynamics. Industry dynamics are likely to see significant structural change over time. Our banking system, in particular, remains heavily concentrated, and the dominance of banks in the NZ financial system is stark when compared with other advanced economies. The expansion of NBFIs elsewhere is posing a significant challenge to central banks in the US and Europe, and NZ will need to find the right ’touch’ to take advantage and manage the risks from these developments. Concluding remarks As I have highlighted, potential or emerging risks abound. The nature of financial innovation, NZ’s inherent vulnerability to shocks – economic or physical – and the incentive biases that mean private sector financial institutions never fully internalise risks, mean that central bankers must continually look forward, understanding and mitigating potential vulnerabilities and building resilience to the shocks that will at some time eventuate. Most probably, the next shock will be something different again, one none of us have predicted, which is why we conduct our annual stress tests, and place the emphasis we do on strong balance sheets. While our work is never done, we can take pride in the steps taken. I am confident our financial stability approach has strengthened, the foundations are more solid, and most of all our broader sector and industry engagement stand us in good stead to keep learning from one another. Lastly, I want to thank my team and colleagues for the shared endeavour, the wisdom I have gained from them, and the fun we have had together. 1 See our macro-prudential framework 5/6 BIS central bankers' speeches 2 Kahneman, Daniel (2011). Thinking, Fast and Slow. Farrar, Straus and Giroux. ISBN 97-1-4299-6935-2.David de Meza and Clive Southey, “The Borrower's Curse: Optimism, Finance and Entrepreneurship”, The Economic JournalVol. 106, No. 435 (Mar., 1996); Adam Smith, wealth of Nations, Book 1, Chapter X, p88. 3 The contribution of strong balance sheets to New Zealand’s economic resilience and recovery from the pandemic 4 Supporting sustainable economic growth through financial stability policy 5 I note that APRA has just released its final capital review decisions in Australia, setting total capital requirements at 18.25 percent for major banks from 2026, compared with our requirements of 18 percent from 2028. 6 Though I note we have made great progress in reducing our foreign liabilities. 7 Toby Fiennes New Zealand’s evolving approach to prudential supervisionGeoff Bascand Renewing the RBNZ's approach to financial stability 8 Trowbridge-Scholtens report 6/6 BIS central bankers' speeches
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Opening remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, before the Finance and Expenditure select committee for the RBNZ's 2020/21 annual review, 15 December 2021.
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Adrian Orr: Finance and Expenditure Committee 2020/21 - Reserve Bank of New Zealand Annual Review Opening remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, before the Finance and Expenditure select committee for the RBNZ’s 2020/21 annual review, 15 December 2021. * * * Tēnā koutou katoa, welcome all. It is a privilege to be here with you today, alongside the rest of the Reserve Bank of New Zealand’s Leadership Team, to report on the activities and achievements for Te Pūtea Matua over the past financial year. I am very proud of all we’ve achieved and continue to achieve together. We have worked with government, other regulators, and financial institutions, to implement and co-ordinate a range of monetary and financial policy settings so as to continue to best meet our legislated mandates. Delivering our monetary policy mandate Early in 2020, when the COVID-19 pandemic began unfolding, we acted quickly to ease monetary conditions so as to cushion the economic blow, and continue to meet our price stability and employment mandate. We undertook these actions in full line of sight of other fiscal initiatives aimed at providing cash flow and confidence in the economy. We eased monetary conditions by reducing the Official Cash Rate (OCR) to 0.25% in March 2020, where it remained until October 2021. We also developed and implemented additional monetary policy tools so as to further lower interest rates across the board. These actions, amongst broader government initiatives, meant that while the economy fell into its worst economic decline on record, it was able to rebound quickly, with consumer price inflation remaining low but positive and unemployment rising only modestly. Subsequently, despite rolling lockdowns and changes in alert levels, New Zealand’s underlying economic strength has remained, supported by generally strong household and business balance sheets, government spending and investment, and strong export returns for our key goods. The monetary policy actions we under took through the pandemic, combined with government support for businesses and jobs, have proved highly effective in preventing deflation, unnecessarily high unemployment, and financial stability concerns more generally. As the COVID-19 health situation evolved, so too has been our economic policy responses. Employment is now above its maximum sustainable level, with a broad range of measures of labour market tightness at or near record levels. For example, unemployment was 3.4 percent in the September 2021 quarter, one of the lowest rates in the OECD. We have also seen consumer price inflation rise and expect it to move temporarily above 5 percent in the near term. Much of this price pressure reflects the global economic impacts of COVID-19. We currently operate in a world of higher oil and energy prices, and the impact of global supply bottlenecks. The ‘supply capability’ of the global economy is impaired. 1/5 BIS central bankers' speeches In addition, underlying these global price spikes are increasing domestic demand pressures, which can drive more generalised price rises and inflation. In response to the rising inflation risks, in October this year the OCR was lifted to 0.50% and then to 0.75% in November. We are one of the first central banks that have had the economic confidence to commence returning interest rates to more normal levels. The Monetary Policy Committee expects to further remove monetary stimulus over time. It is our expectation that the OCR would eventually need to be raised above its neutral rate, conditional on the economy evolving as expected. The Committee also expects to gradually unwind the additional monetary policy tools that were introduced last year. The Committee stopped purchasing assets under the Large Scale Asset Purchasing (LSAP) programme in July. We intend to manage our LSAP bond holdings down in a way that maintains the smooth functioning of financial markets. More details on how bond holdings will be reduced will be provided early next year. I note that the level of government bonds on issue is a Government fiscal decision. The Committee’s decision to purchase Government bonds as a means to lower interest rates is a monetary policy decision. On this note, I would like to recognise the Monetary Policy Committee members, and the operational support of the Reserve Bank teams. These tools and decisions have been instrumental in our COVID-19 response. Financial stability As outlined in our November Financial Stability Report, the financial system remains resilient and is well-placed to support the economic recovery and the challenges of COVID-19. Strong balance sheets for households, businesses, financial institutions, and the government going into the pandemic contributed towards maintaining a sound financial system, and yielding a faster economic recovery than following previous deep recessions. However, strong demand for housing has pushed house prices above their sustainable level, increasing the chance of a correction. Recent buyers are borrowing more relative to their income, and are now vulnerable to higher mortgage rates or a fall in house prices. One of the persistent drivers of higher house prices, and asset values more generally, has been the persistent downward trend in global interest rates, as consumer price inflation has been anchored. This downward trend in global interest rates has been extended further due to the significant negative economic impact of COVID-19. In New Zealand, the low global interest rate environment coincided with very low rates of house building relative to population growth in the past decade, leading to a significant supply-demand mismatch and accentuated house price growth. The collaborative work we are undertaking with other government agencies highlights that the lack of access to space to build has been a major driver of rising house prices over recent years. However, house building is now happening at scale that should significantly rebalance the demand-supply mismatch. We have also taken action to manage the financial stability concerns associated with the rapid rise in house prices. We recently further tightened Loan-to-value ratio (LVR) restrictions, which are our main tool used to address housing risks. We are also consulting on the merits of implementing debt servicing restrictions to lean against these risks. It is important we are prepared to implement them if required. And, we expect banks to remain cautious about high 2/5 BIS central bankers' speeches debt-to-income loans given the risks of rising interest rates and the economic outlook. Our latest stress tests also show the importance of our work to strengthen resilience in the banking sector, especially the benefits of continuing to build capital buffers. Capital requirements for banks will progressively increase from 1 July 2022 and it is encouraging to see them rising ahead of our timeline. Consistent with our financial stability mandate, we recently published a climate change report outlining the actions we are taking to help climate-related risks be appropriately understood and managed. Our latest stress tests also considered the impacts of increased frequency of droughts and other weather events on banks and insurers, including impacts on profitability and capital. We are undertaking further analysis of the impacts of climate change to understand the extent of these risks. While central bankers have the responsibility to play a critical role, we recognise it is primarily the Government’s role to lead emission reduction and adaptation as part of a collective response. The future of money and cash We are currently consulting on issues key to the future of how New Zealanders pay and save. This is driven by our stewardship mandate for cash and ensuring we have a money system that supports the prosperity and wellbeing of all New Zealanders. Central bank money – typically cash but also the electronic settlement accounts we operate with large institutions – provides an anchor of value for people to trust and go about their business. Our cash also provides a one-for-one exchange for the private (commercial bank) money sitting in our personal accounts. We want to hear peoples’ views on the use of cash and digital currencies, and how we can ensure the cash system meets the future needs of all New Zealanders. Transforming Te Pūtea Matua We are undergoing a period of change at Te Pūtea Matua, as signalled in our Funding Agreement signed by the Minister back in 2020. When we met with you for our last annual review, we were in the thick of responding to a significant cyber-breach, after a malicious attack on one of our systems. I am glad to report that we have effectively responded to the breach. But lessons have been learned, and guided by findings from an independent KPMG report, we continue to roll out and embed our multi-year programme to implement system and process improvements. We remain in regular contact with the Office of the Privacy Commissioner about our progress. Significant change is also under way to modernise the legislative foundations of Te Pūtea Matua. The Reserve Bank of New Zealand Act 2021 has now passed into law and will come into force in July 2022. The Act will modernise how we operate and are governed, with far reaching implications for our operating model. We have also just released for consultation the draft legislation for the proposed Deposit Takers Act. This is a significant step towards strengthening the regulatory framework for all institutions that take deposits. I encourage all stakeholders to share their views on the proposals. We have made continued progress on investing in people, capability and capacity – including 3/5 BIS central bankers' speeches security – so that we can sustain a central bank that is fit for the future. We have a significant programme of work underway related to the Bank’s pending legislative change, improving our digital resilience, raising our prudential supervision capacity and capability, meeting the stewardship needs of cash and payment and settlement systems, and meeting the formal expectations of our key stakeholders. We are currently undergoing changes to our operating structure, with a view to bolstering our talent, capabilities and leadership, in particular the roles of technology, data and information, and strategy and risk management. We are also confronting investment decisions related to our physical locations, and how we deliver our services in general, such as cash stewardship. We continue to build our Auckland presence – where the bulk of our regulatory interface occurs. Our Auckland office is ably led by an Assistant Governor. We have also undertaken important changes to enhance our supervisory capabilities, including launching a new Enforcement Department to promote compliance in regulated sectors. This is an important step as we focus on embedding a more intensive supervisory approach on the firms we regulate. Our drive is to be cost effective and fit for purpose in all we do. In doing so we continue to work with a range of stakeholders, in particular through the Council of Financial Regulators (CoFR), on issues related to financial stability and inclusion. We have collaborative priority work streams to progress in areas such as conduct and governance, financial inclusion, climate change adaptation, digital innovation, and regulatory effectiveness and coordination. We are also actively collaborating in work on housing related matters with The Treasury and The Housing and Urban Development Authority. Our Te Ao Māori strategy remains a key strategic priority for Te Pūtea Matua. We have continued to ensure that the Te Ao Māori perspective is interwoven throughout our work at the Reserve Bank and with our stakeholders. A good example of this is our refreshed vision and values and updated brand, to better reflect our purpose and the work we do with our partners on behalf of all New Zealanders. Another example is our work programme on identifying any unnecessary constraints on access to capital for Māori enterprises. Finally, we also maintain our focus on enabling and ensuring diversity and inclusion in our team. In line with international benchmarks we set a target of achieving a 40/40/20 gender balance (i.e. at least 40 percent women in our workforce), which we achieved in 2020/21. Alongside this we have also continued to build our partnerships with Māori and Pacific Graduate Programmes. We have a long way to go, but we are committed and organised. Conclusion At Te Pūtea Matua, being a Great Team means being fit for purpose, cost effective, risk aware, and working collectively in a sustainable way. It also means being unified by our purpose – everyone knowing what to do and moving in sync in the same direction. I would like to thank our Board, my colleagues and our people for their dedication, hard work, flexibility, and assistance. It is through your commitment, effort and determination that we have continued to live our purpose in supporting all New Zealanders, especially during this difficult year. We are looking forward to the future. Meitaki ma’ata 4/5 BIS central bankers' speeches Tēnā koutou, tēnā koutou, tēnā koutou katoa 5/5 BIS central bankers' speeches
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Angel Association New Zealand Summit, Wellington, 8 February 2022.
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The Future of Money demands innovation A speech prepared for delivery to the Angel Association New Zealand Summit Wellington, 8 February 2022 By Adrian Orr, Governor [EMBARGOED UNTIL 3.15PM, TUESDAY, 8 FEBRUARY 2022] Introduction Tēnā koutou, tēnā koutou, tēnā koutou katoa… Today I am here to talk about the future of money, particularly the need and opportunities for innovation in the ways in which Kiwis pay and save.1 Money underpins everything we do in an economy. And supporting public trust and confidence in money – both central bank money and private forms of money created by financial institutions – is core to our role as a central bank. It is key to our economic and financial stability objectives and – by extension – to Aotearoa’s prosperity and wellbeing. At the Reserve Bank we use the legend of Tāne Māhuta to tell the story of our role. Te toto, the sap of Tāne Māhuta, represents money, cash and foreign reserves. It is the lifeblood of Tāne Māhuta and supporting the health of Te toto is critical to our role as Kaitiaki of New Zealand’s financial system, and in supporting a thriving economy and inclusive society.2 In this speech today I am going to talk about the way Te Pūtea Matua, the Reserve Bank is thinking about our role in the money and cash system and our work programme in this area.3 But first it is important for me to provide some context about why we are taking this renewed focus on money and cash issues. The first piece of context should be obvious to all. Money is evolving in an increasingly digital global economy. Day-to-day use of physical cash is continuing to decline. COVID-19 has reinforced this trend. But, we also know that cash remains a vital tool for many New Zealanders, and we want to ensure its continuing availability and acceptability. At the same time, New Zealanders have demonstrated a clear preference for digital ways to pay that are convenient, efficient and secure. New forms of money, leveraging advanced technologies, have also emerged. Their success is in no small part because that many are asking fundamental questions about what money is and what it should do. We can no longer take conventional forms money for granted. For some, the so-called ‘cryptocurrencies’ offer a way to opt out of the existing financial system altogether, while others are drawn to the promise of another gold rush. Other new forms of money also promise further innovation - for example peer-to-peer payments, micropayments, programmability, and low cost cross-border payments - than existing digital products provided through the existing banking system. However, the rush to withdraw cash during Level 4 lockdown in 2020 showed that cold, hard cash still provides security and certainty for many New Zealanders. Against this context, there is a historic opportunity for us to shape how money can better serve a sustainable and productive economy for all New Zealanders, both by considering how we can ____________ I would like to acknowledge with thanks principal author Jean-Christopher Somers, the wider Money and Cash policy team and department, and other reviewers and contributers from Te Pūtea Matua. https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Speeches/2019/Speech-The-view-from-Tane-Mahuta.pdf See: https://www.rbnz.govt.nz/notes-and-coins/future-of-money make use of digital technology to modernise central bank money, and how we can ensure cash remains an option for those who need it. To do this, we need courageous conversations with New Zealanders now about how we can innovate to preserve the current system's benefits and to address its shortcomings. There is an immense opportunity for central banks, financial institutions, fintech organisations and other innovators to harness technological advances to deliver better and cheaper services to customers. Those that don’t keep up risk being left behind. I want to draw your attention to our recent and ongoing public consultations on the Future of Money, building on the Future of Cash consultations that began in 2019. These consultations explore the stewardship role we are taking on for money and cash. They also discuss the potential opportunities and challenges associated with issuing a central bank digital currency in New Zealand. The third and current consultation, released in late November 2021, discusses issues affecting the cash system and options to address them. You can find the links to these consultations on our website.4 We welcome your feedback on all of these subjects. This speech draws and expands upon the material of the issues paper. I will discuss stewardship, central bank digital currencies and cash in more detail shorly. But, first, I want to revisit the role of central bank money and why it matters. The Public Role of Central Bank Money Our monetary system is made up by both central bank and private money. Currently private money exists only in digital forms, while central bank money used by the public is in physical bank notes and coins. While central bank money might take more widely used digital forms in the future, this does not change its essence. The following “Money Taxonomy” graphic illustrates these different types of money. Central bank money performs two critical roles to support public confidence in the money of the future. That is, first, central bank money provides a safe and trusted value anchor for the monetary and financial system and, secondly, it provides a fair and equal way to pay for all that supports inclusion. These two unique attributes are central to understanding why central bank money matters so much and why we at Te Pūtea Matua are investing so much effort in understanding and addressing these issues. Maintaining a healthy monetary system is at the core of what it means to be a central bank, and providing and stabilising money, both public and private, is central to this. The Reserve Bank’s reason for being can be traced back to the need for a public monopoly over the production of banknotes and coins when the Reserve Bank was created in 1934. Today, banknotes and coins remain the only form of central bank money that the public can access directly – although we have long used electronic central bank money in the accounts we transact with, and settle transactions between, major banks. Central bank money has always ____________ The links to the documents can be found here: https://www.rbnz.govt.nz/notes-and-coins/future-of-money coexisted with private money. Private money is currently far more significant in volume, transacted through bank accounts which are already digital. Central bank money continues to play a crucial role. It supports public trust and confidence in private money through the promise of one-for-one convertibility. Central bank money brings some distinct advantages to this partnership: it is liquid, stable, uniform and backed by the state. It is all that and more because it is created in the public interest. That promise of one-for-one exchange is further underpinned by ensuring that private banks are managed prudently, through our regulation and supervision of them, for example. To demonstrate the role that central bank money provides in supporting trust and confidence in other forms of money, we only need to look back a year to the period leading up to New Zealand’s first encounter with the COVID-19 driven Alert Level 4 in early 2020. I remember that time vividly because of the huge sense of uncertainty that existed about what the future would hold. Many people sought to insulate themselves from that uncertainty by withdrawing cash from their bank accounts. In the weeks leading up to the nationwide lock down in March 2020, about $800 million of cash was issued from the Reserve Bank, more than five times the $150 million issued in March 2019.5 The need for such certainty, which is associated with central bank money, is deep-rooted and always manifest in times of particular uncertainty. It is clear that the ability to withdraw money held in bank accounts one-for-one for cash supports trust and confidence in the banking and broader monetary systems. Central bank money serves other critical public policy objectives. It is public money issued by a public institution accountable to Parliament and New Zealanders. Full control of central bank money enables New Zealand to conduct monetary policy – including inflation and employment rates - independently, rather than having interest rates set by external actors, for example. The ability to implement monetary policy is a critical part of our macroecnomic framework, allowing us to manage through the economic cycle in pursuit of our dual objectives of low and stable inflation and maximum sustainable employment. If another currency gained widespread use in New Zealand, our ability to meet our monetary policy mandate in the best interests of New Zealanders would be eroded. If that were to happen, it could be said that New Zealand had lost monetary sovereignty. To understand the challenges associated with a loss of monetary sovereignty, we only need to look at the countries at the periphery of the European Union during the Great Financial Crisis. Today, I fear that those countries experimenting with adopting crypto-assets, such as Bitcoin, as legal tender might soon find themselves in an even worse situation. Bitcoin has no institution at its core that is charged with stepping in to secure the public interest in the event of a crisis. In contrast, the value of central bank money lies in its institutional legitimacy, where qualities such as transparency and accountability are paramount, and the state's legitimacy that provides fiscal backing through taxation. These are in turn supported by a myriad of things ranging from prudent monetary and fiscal policymaking to counterfeit prevention. This is why central bank money succeeds where previous forms of fiat money issued by unaccountable sovereigns have failed. Our money is issued in the public interest. We should never take such legitimacy for granted. We need to work hard to maintain that legitimacy into the future, in part by responding to the needs of the public, and their preferred way of transacting, be that in physical central bank money (banknotes and coins) or digital central bank money. ____________ See Cash and payments data update: COVID-19 special https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Notes%20and%20coins/future-of-cash/cash-and-payments-dataupdate-COVID-19-special.pdf?revision=9eac7a8d-cc97-454f-a9ff-2190311d055f&la=en As an example, our consultations have confirmed the priority attached by many to the privacy and autonomy provided by cash. We are committed to keeping cash available as long as people need it but also to ensuring that any digital version of cash is designed with privacy considerations at its core. We will do this in line with our independent role as the steward of the money and cash system. Nor can we neglect financial and social inclusion, and the fair distribution of the costs of the money and cash system. A key motivation for CBDC is to improve access to digital financial services for those who are unable or unwilling to rely on private digital money through banks. This complements the Bank’s broader work programme on inclusion (see the Box below)6. ____________ Financial Stability Report for November 2021 - Reserve Bank of New Zealand (rbnz.govt.nz) Inclusion and fairness will be central to the collective legitimacy that public money must draw from. The same can be said about environmental sustainability and Te Tiriti o Waitangi obligations7 and partnerships. He waka eke noa – we are all in this together. All the more reasons why we must work harder to realise the benefits of a publicly-provided currency for the prosperity and well-being of New Zealanders and for a sustainable, innovative and productive economy. Reserve Bank's Stewardship of Money and Cash In line with this broader perspective and enabled by updates to our legislation, we have refreshed our approach to the money and cash system, and have been seeking feedback through public consultation. We have concluded that the concept of stewardship' or 'kaitiakitanga' best describes our responsibilities for money and cash. The Reserve Bank's proposed objectives for stewardship are to ensure that, now and in the future: 1. Central bank money is a trusted and stable value anchor for the money and cash system. 2. Central bank money is available as a fair and equal way to pay and save. We are taking a forward-looking, system-wide approach to advancing these objectives, including monitoring, reviewing, reporting on, analysing and supporting change to the money and cash system. What this means in practice is that we will, first, develop a strategic view of the role central bank money plays in the financial system and beyond, considering how wider initiatives impact central bank money and the key objectives I’ve just set out. This is so that we do not lose sight of our statutory economic and financial stability objectives. It also means we are conscious of the interconnections and flow-on consequences of changes to New Zealanders' well-being. Secondly, we want to take a coordinated and strategic approach to working with other agencies and stakeholders to promote the best possible outcomes across the systems. For instance, we are taking a close interest in work being led by the Ministry of Business, Innovation and Employment on a consumer data rights regulatory regime.8 Similarly, we are interested in work being led by the Department of Internal Affairs on a Digital Identity Trust Framework. We see an important role for government, through initiatives like these to support financial innovation that benefits New Zealanders.9 We are also conscious of the role we play in achieving other policy objectives outside a narrow central banking lens. We are thinking carefully, for example about how to mitigate new risks that digital innovation can create in terms of anti-money laundering and counter terrorism funding, as well as better managing existing risks related to cash. Thirdly, stewardship will be inclusive and respect Te Tiriti o Waitangi. This means that we will take care to consider the trade-offs between different groups, including intergenerational ones, and ____________ For the Bank’s work to instil a Te Ao Māori perspective, see Te Ao Māori: an evolving and responsible strategy - Reserve Bank of New Zealand (rbnz.govt.nz) Consumer data right | Ministry of Business, Innovation & Employment https://www.mbie.govt.nz/business-and-employment/business/competition-regulation-and-policy/consumerdata-right/ Digital Identity Programme, the Department of Internal Affairs https://www.digital.govt.nz/digital-government/programmes-and-projects/digital-identity-programme/ think about how we can increase inclusion and well-being. This is consistent with our broader effort to support financial inclusion as we outlined in the latest Financial Stability Report.10 For example, we know that access to cash is particularly important for some of our most vulnerable communities and we are thinking about how their needs for cash can be better met by improving the cash system. We also thinking about how a central bank digital currency could support wider financial inclusion and well-being efforts, to reach those digital natives who are excluded for other reasons or for whom existing product offerings do not meet their needs. We will also challenge ourselves to ensure Te Tiriti is honoured in our work, including by applying a Te Ao Māori lens proactively in our work. This will complement our other areas of focus, including addressing barriers to capital faced by Māori.11 Digital innovation and the potential for a central bank digital currency As alluded to earlier, some significant changes in the monetary landscape globally are being driven by private sector players from outside the conventional financial system and its regulatory perimeter. While the most visible trend has been the proliferation of the crypto-assets, including so-called ‘stablecoins’, other developments such as the decentralised finance or ‘DeFi’ model have equally profound and potentially more long-lasting impacts. The Reserve Bank is supportive of private innovation provided risks are managed, including risks to financial stability and monetary sovereignty.12 We also work with other regulators to address a wider range of risks such as market integrity, money laundering, as well as risks for the holders of these assets. We also recognise the potential for enhanced competition from innovation that brings benefits to customers in financial services. However, many – and not just central bankers – have observed that while the technology underpinning new forms of money may be new, the economic substance may be as old as money itself, and the potential gains could well be lost in the effort to reinvent the monetary wheel. For example, so-called stablecoins have sought to replicate the convertibility to central bank money that underpins the existing system of private money. Some do so without the attendant safeguards – prudential regulation and supervision - for the same risks. Others purport to do away with the risks altogether by essentially foregoing the useful credit creating role of private (bank) money, and the benefits of - and for - the banking system. 'Global' stablecoins issued by large technology companies are a particular concern, given their considerable existing market power globally. These can pose additional systemic risks and cause anti-competitive and other undersirable outcomes if such schemes also came to monopolise the issue of private money, or challenge our monetary sovereignty. Another key risk is that new forms of money have the potential to fragment the money and cash system itself. Imagine having a ‘choice’ of 6000 different currencies just to buy a bottle of milk from your local dairy, which might prefer to a different currency than the one you chose. Imagine needing to hold a range of currencies, some with very uncertain values, in order to purchase necessities. Imagine having to find out how much your money is worth relative to other forms of ____________ https://www.rbnz.govt.nz/financial-stability/financial-stability-report/fsr-nov-2021/reserve-bank-initiatives-to-support-financial-inclusion See fn5 for referene The Reserve Bank is part of the Council of Financial Regulators. A priority of the Council’s work is to ensure the New Zealand regulatory system facilitates innovation that improves outcomes for customers and participants of the financial system Digital and innovation | Kaunihera Kaiwhakarite Ahumoni - Council of Financial Regulators (cofr.govt.nz) money all the time so you can work out how much you are actually getting paid or what the real value of something is. What we know from history is that systems that require people to transact in multiple currencies of different value, quality and risk are very inefficient, and can scarcely be described as having equity, fairness and the public interest at heart. However, the opportunities presented by some new technologies to do things better and stimulate innovation and efficiency for the benefit of everyone are clear. It is my view that we have a positive responsibility to innovate in pursuit of economic wellbeing and prosperity for all New Zealanders. I encourage innovators to consider how they can better serve the needs of those left behind or excluded by existing digital platforms, as well as those who have no problem accessing existing digital products. Therefore, we are also consulting on the case for a central bank digital currency, alongside our proposed approach to stewardship. Just to be clear, our agenda is neither to replace cash nor to crowd out private innovation that enhances public welfare. Instead, we are concerned about preserving the access to safe and trusted central bank money that reinforces its value anchor role, given the declining use and availability of physical cash to do this. We are also thinking about how to modernise the cash system so that New Zealanders can continue to have that choice to use a publicly provided way to pay and save. A choice that is fair and equal for all New Zealanders, supports financial and social inclusion, and enables further innovation. Moreover, a CBDC should provide an open, public, platform to support further innovation in the financial and banking sector that traditionally has had high barriers to entry. A digital form of public money should incentivise healthy competition, and enhance value-add by privately provided services. Low cost cross-border payments is an obvious area where a CBDC could drive improvements and benefits, but there are a range of other opportunities, from integration with all manner of financial capability building tools, to the ability to programme money so that it executes transactions automatically, to the ability to make digital payments offline or without an intermediary. Graph 1: CBDC design principles We are conscious of the challenges potentially posed by a CBDC. A CBDC is likely to affect the banking sector’s current business model. By how much would depend both on the design of the CBDC and how the public used it. A CBDC must be, by design, operationally resilient to outages and cyber security risks and comply with all relevant legislation and regulation. A CBDC should act as a catalyst for innovation and competition in a wider money and payment ecosystem that supports, rather than crowds out private innovation. Privacy and autonomy will be a central design feature for any CBDC we develop. Privacy and autonomy promote trust in money, which is a core role central bank money provider in the wider monetary system. We believe that a CBDC can be designed in such a way that privacy and autonomy can exist alongside design features that make it hard for central bank money to be used for nefarious or illegal purposes to target, influence and coerce. A CBDC will need to meet AML requirements while balancing the important value that the public places on their privacy.13 The ____________ The Reserve Bank supervises banks, non-bank deposit takers and life insurers to ensure they meet obligations designed to help deter and detect money laundering and terrorist financing. Anti-money laundering and countering financing of terrorism - Reserve Bank of New Zealand (rbnz.govt.nz) emphasis we place on privacy reflects the fact that the CBDC design will be driven by public, rather than commercial, interest. In addition to design choices driving innovation – directly and indirectly – design choices can influence the challenges that innovation could bring to current providers of private money. For example, the Reserve Bank has choices about how to respond to ensure the ongoing smooth operation of the market as a whole. In contrast, other sources of risk and disruption such as stablecoins, do not come with the same, or as robust, mitigation tools on hand. That is to say, a CBDC would not be the only competition the existing financial sector will face in the future. It’s also clear that the existing financial sector has no ‘right’ to generate profits from deposits, in the same way the Reserve Bank has no ‘right’ to retain cash users in perpetuity. Choice and competition are critical underpinnings of a vibrant, stable and resilient financial system. There are CBDC design complexities that give rise to a wide range of policy choices and accompanying trade-offs. There are operational complexities and risks such as cyber security risks. Some of these challenges are more novel to central banks, as central banks seek to preserve the public benefits of central bank money in a digital world. How to deliver privacy and autonomy while addressing regulatory requirements around AML is one. Others, such as cyber security risks, are less unique to central banks but no less challenging. We are taking a multi-stage approach to our work on a CBDC. A CBDC would take many years to design and implement. And we need to get the process right to ensure ongoing public confidence in central bank money. Our recent issues paper was about surfacing the issues and our proposed approach to assessing these – future consultation will get down to specifics of design and implementation assuming the case continues to be assessed positively. Eighty-six per cent of central banks are exploring CBDCs and many countries have already undertaken operational tests, developed proof of concepts, or run trials.14 Private players have also developed sophisticated products for differing interests. Falling behind is also not an option for us and for that reason we will soon be commencing proof-of-concept design and testing for a CBDC as part of our assessment of the case for a CBDC in New Zealand. The technology exists now to implement a CBDC, but it needs to be well designed and thought through, user-friendly, bulletproof to cyber and operational risk, with privacy and other controls that ensure and promote widespread trust and use. Cash system issues I want to emphasize again that the Reserve Bank is not proposing to remove physical cash from our economy. Cash is central bank money that is a safe and trusted value anchor. Cash plays a critical role in supporting financial and social inclusion. Cash allows people to engage in the economy without having to rely entirely on banking services for all their day-to-day activities, without the need to be able to access a computer or smartphone, and with the safety and security of knowing that the cash you have is worth what it says it is. It provides choice, supports competition with other forms of money, offers a back-up for users of other means of payments, and allows all users a degree of autonomy and privacy. ____________ Bank for International Settlement BIS Innovation Hub work on central bank digital currency (CBDC) Although cash is used less in percentage terms (from 30% in 2007 for households payments to 13% in 2019), the amount of cash in the hands of the public has been growing at an average of 3.7% per year since 1995.15 Graph 2: Cash in the hands of the public Cash in the hands of the public, 2017 prices, $ per person 1995 to 2021 1,400 $ per person 1,200 1,000 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 avg $ per person, 2017 prices We know that New Zealanders consider cash to be important and they support its ongoing availability. We at Te Pūtea Matua are committed to ensuring cash remains available for as long as people need it. However, our earlier work has identified some challenges facing the cash system. An innovative approach is needed to support a more efficient and resilient cash system. Graph 3: The Current Cash System ____________ Based on Household Economic Survey 2007-2019 See Appendix 5 of the Cash System Redesign consultation paper https://www.rbnz.govt.nz/notes-and-coins/future-ofmoney/cash-system The Reserve Bank recognises that the issues concerning the future of cash are complex and interconnected, and the changes required are potentially far reaching. We are currently consultating on issues facing the cash system and options to address these, with feedback closing on 7 March 2022.16 Conclusion To conclude, the money and cash system in New Zealand and globally is at a turning point. Digital innovation is here and it will disrupt. We need to preserve what works in our current system and embrace changes that will benefit all New Zealanders. We have choices to shape what the future will look like for generations of New Zealanders to come. At Te Putea Matua, we want to see a future where our central bank money, whether cash or in a future digital form, is available and convenient to access, regardless of who you are, where you are, or what kinds of phone you use or don’t use. We want to see a future where Kiwis have a range of choices in the ways they pay and save, and can feel secure and content whether they choose to put their money in an account, or hold it in their hands, or save it on their smart devices. We want to see a future where responsible financial innovation thrives in New Zealand, enhances the welfare and prosperity of New Zealanders, and helps to bridge divides in our financial and social systems, rather than create new chasms between haves and have-nots. We want to see a future where innovation in money enhances our global connections, facilitating trade and commerce, and allowing people to send money to loved ones overseas with the ease of paying for groceries in a local supermarket, and at a similar cost. We want to see a future where our money, public or private, remains trusted by all New Zealanders, and serves our needs as a nation. These are no small challenges, but in many ways, our relevance as a central bank depends on stepping up to meet them. I invite you to join me to meet these challenges. It’s our money, and it’s our future. ____________ https://www.rbnz.govt.nz/notes-and-coins/future-of-money/cash-system
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Waikato University NZ Economics Forum, Hamilton, 25 February 2022.
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Tackling Inflation During a Pandemic Speech delivered to the Waikato University NZ Economics Forum Adrian Orr, Governor 25 February 2022 I would like to acknowledge with thanks principal author Mac McKenna and the wider Economics and Research departments, and other reviewers and contributors from Te Pūtea Matua Ref #X303207 v1.17 Introduction Tēnā koutou, tēnā koutou, tēnā koutou katoa. Central banks around the world are currently being confronted by a challenge we have not experienced for some time: high and sustained inflationary pressure. While the inflationary challenge is a familiar one, the environment within which we are tackling it is unique and uncertain. In this speech I will touch on the context for the Monetary Policy Committee’s decision this week, and the key monetary policy challenges facing the Reserve Bank of New Zealand – Te Pūtea Matua – ahead. Monetary policy during a pandemic The COVID-19 pandemic presented a unique setting for many central banks globally. We must meet our low and stable inflation mandates in the context of a large and evolving health shock to the global economy. In early 2020 there were a number of unique factors that confronted economic policy makers globally. The economic outlook – and hence optimal policy responses – became dependent on the scale and severity of the COVID-19 virus. This scale and severity in turn depended on: How individuals, households, governments and central banks would react to the pandemic environment; The pace at which a vaccine would be developed and its effectiveness; The speed at which a vaccine could be rolled out internationally; and How the virus would evolve over time. Epidemiologists struggled to model and predict the path of the virus. But this path, and the predictions of epidemiologists, have played a considerable role in how governments and central banks have developed the appropriate economic policy responses. From the outset of this health shock, the Reserve Bank’s Monetary Policy Committee was convinced that a search for economic certainty was near-futile. Instead, we needed to provide as much monetary policy certainty as possible within an uncertain economic environment. This is why we adopted a ‘least regrets’ framework for deciding on our actions, and continue to do so today.1 By this, I mean ensuring our decisions avoid the worst policy mistakes while maximising our ability to meet our objectives over the medium term. In early-2020 the risks to the global economic outlook were heavily skewed in a downward direction. Governments deliberately restricted economic and social activity to control the spread of COVID-19, and people acted to protect their personal health first and foremost. New Zealand faced a material threat of experiencing a prolonged period of below-target consumer price inflation, and employment levels well below any estimate of a maximum sustainable level. ____________ Christian Hawkesby (2021, 21 September). Speech: A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku). Retrieved from: https://www.rbnz.govt.nz/research-and-publications/speeches/2021/speech2021-09-21 The situation the Committee needed to most avoid in early 2020 was one where inflation, economic activity and employment became persistently depressed. We were particularly concerned about the scarring impact on New Zealand’s economic capability driven by a collapse in business investment and high unemployment becoming unnecessarily persistent. Our path of least regrets was to move quickly to ease monetary conditions significantly and take steps to bolster cash flow and confidence to ride the initial wave of uncertainty.2 The Reserve Bank entered this period of the COVID-19 pandemic with nominal interest rates near an effective lower bound – the point at which further Official Cash Rate (OCR) reductions become ineffective in bringing forward expenditure. This was the case globally, following a long period of low and stable consumer price inflation. This meant that the Committee, like many of our peer central banks, needed to supplement reductions in our preferred OCR policy tool with other forms of monetary easing that would further lower longer-term interest rates and generate aggregate demand.3 Fortunately for us, we had been preparing for the use of alternative monetary policy tools in the lead up to this unanticipated event.4 Figure 1 - COVID-19 additional spending/foregone revenue by country (to October 2021) % GDP Source: IMF Database of Fiscal Policy Responses to COVID-19 (to October 2021) ____________ Reserve Bank of New Zealand (2020, 30 March). Media release: Mahi Tahi: Working Together to Ensure Cash-flow and Confidence. Retrieved from: https://www.rbnz.govt.nz/news/2020/03/mahi-tahi-working-together-to-ensure-cash-flow-and-confidence Adrian Orr (2020, 10 March). Speech: Navigating at Low Altitude: Monetary Policy with Very Low Interest Rates. Retrieved from: https://www.rbnz.govt.nz/research-andpublications/speeches/2020/speech2020-03-10 Sarah Drought, Roger Perry and Adam Richardson (2018). Aspects of implementing unconventional monetary policy in New Zealand. Retrieved from: https://www.rbnz.govt.nz/research-and-publications/reserve-bank-bulletin/2018/rbb2018-81-04 We responded to the COVID-19 shock by lowering the OCR by 75 basis points5 to its lowest practical level (at the time) and implemented additional monetary policy tools – including the Large Scale Asset Purchase Programme (LSAP)6 and the Funding for Lending programme (FLP)7. Our monetary stimulus was, over time, accompanied by significant government spending and investment (fiscal stimulus) to support people and businesses, equivalent to around 20 percent of GDP.8 The Government’s fiscal response was one of the highest levels of direct fiscal support across advanced economies outside of the United States (see figure 1)9. The combined health and economic policy response of New Zealand has, to date, been ranked as one of the most effective across a wide range of countries. For example, a hybrid index of economic and health measures (see figure 2) by economist David Skilling places New Zealand near the top-end of success in responding to the pandemic, with the caveat being the pandemic is not over yet.10 Figure 2 – Landfall Strategy COVID-19 Performance Index Index Note: The index is an equally weighted index of (1) the average level of Covid restrictions stringency (over the full Covid period) taken from the Blavatnik School at Oxford; (2) the cumulative excess deaths per capita over the Covid period (a calculation from the Economist); and (3) cumulative GDP performance since Q1 2020 (compared to full year GDP in 2019). Source: Landfall Strategy. ____________ Reserve Bank of New Zealand (2020, 16 March). Media release: OCR reduced to 0.25 percent for next 12 months. Retrieved from: https://www.rbnz.govt.nz/news/2020/03/ocrreduced-to-025-percent-for-next-12-months Reserve Bank of New Zealand (2020, 23 March). Media release: Reserve Bank to begin Large Scale Asset Purchases. Retrieved from: https://www.rbnz.govt.nz/markets-andpayments/domestic-markets/domestic-markets-media-releases/reserve-bank-to-begin-large-scale-asset-purchases-23-march-2020 Reserve Bank of New Zealand (2020, 11 November). Monetary Policy Statement November 2020. Retrieved from: https://www.rbnz.govt.nz/monetary-policy/monetary-policystatement/mps-november-2020 New Zealand Government (2020, 14 May). Budget 2020. Retrieved from: https://www.beehive.govt.nz/feature/budget-2020-rebuilding-together IMF Fiscal Monitor of Country Fiscal measures in Response to the COVID-19 Pandemic. Skilling, David (2022, 11 February). The superpower of successful countries. Retrieved from: https://www.landfallstrategy.com/commentary/2022/2/11/the-superpower-of-successfulcountries Taking the foot off the accelerator The Reserve Bank’s monetary policy response will always be based on what we believe is best to achieve our mandate of low and stable inflation, and contributing to maximum sustainable employment. We set our policy based on: information we have at hand and our best assessment of how the economy works; and how we expect the economy to evolve over time, including in response to unanticipated future events or shocks. We are also aware that monetary policy can only provide a temporary buffer to an economic shock, by bringing forward household spending and business investment through the lowering of interest rates. We generally cannot influence real variables in the long run. As more information has become available and we have had time to observe how the economy has responded to the economic shock, our outlook and therefore our optimal policy response has changed. The economy has remained remarkably resilient in the face of such high uncertainty and restrictions. This doesn’t mean there are not issues or challenges that need addressing, but they are not the same issues or challenges we previously feared. While we managed to avoid the worst-case scenario of embedded deflation and unemployment, we now face a more traditional challenge of constraining consumer price inflation, albeit in the unique context of the COVID-19 pandemic. Employment is above a broad range of estimates of its maximum sustainable level and consumer price inflation is uncomfortably high. This is occurring at a time when the global economy is still adjusting to an evolving health situation, as the COVID-19 virus moves from its pandemic to endemic status, and New Zealand is experiencing its first widespread and significant virus outbreak. Global inflationary pressures To a significant extent, the recent increase in New Zealand’s consumer price inflation has been driven by global disruptions that have caused sharp price increases for critical commodities and a broad range of imported goods and services. In the decade prior to the pandemic, imported consumer price inflation into New Zealand was either negative or close to zero. These deflationary or disinflationary ‘tradables’ price pressures – which makes up 40 percent of New Zealand’s CPI basket - acted as an anchor on total headline inflation. Domestically driven consumer price inflation (non-tradables) averaged more than 2 percent per annum over recent years (see figure 3). Downward pressure on prices from global competition and technological progress has, at least for now, abated. This results from the pandemic-induced shifts in demand patterns (from services to goods), ongoing supply disruptions (such as to semiconductors and shipping lines) and reduced mobility of goods, services and labour. Figure 3 – New Zealand CPI, tradables and non-tradables inflation % 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 Headline % Non-tradables % Tradables % Source: Statistics NZ Monetary policy authorities globally can no longer rely on declining price pressures for internationally tradable goods and services. Central Banks globally are now grappling with high imported prices that have proved persistent. New Zealand’s monetary policy has no direct influence on these imported global prices, other than indirectly – and even then unreliably – via the level of the New Zealand dollar exchange rate. The global nature of the economic shock has meant a relatively stable period for exchange rates – which are usually more volatile during periods of economic uncertainty and disruption. Our trading partners experienced the health and economic shock simultaneously, leaving very little relative work for exchange rates to do. Towards the end of 2021 the New Zealand dollar did weaken as interest rate differentials between countries closed. The New Zealand dollar – measured against a basket of our closest trading partners (TWI) – is now around 7 percent lower than its pandemic peak. The most notable driver of recent inflation pressures, from a tradables perspective, is rising oil prices. New Zealand petrol prices increased 30 percent in 2021. Higher oil prices have resulted from robust global demand, restrained oil supply during the early stages of the pandemic as global economic uncertainty increased, and more recently geopolitical tensions in Eastern Europe. Higher fuel prices are pervasive within the economy, as they are a significant input cost for many firms. Price pressures arising from tradables inflation is also becoming more broad-based. Globally, the recent significant government and monetary stimulus helped avoid the prolonged negative impacts on demand from the COVID-19 pandemic. Now, this demand is struggling to be met with sufficient global supply due to continued COVID-19 outbreaks and various health related restrictions and disruptions. The degree of inflationary pressure experienced across economies has, to some extent, depended on the different starting points and experiences heading into the pandemic. Most of our advanced economy trading partners have experienced a long period of very subdued (often below target) consumer price inflation and persistently high unemployment (see figure 4 and table 1). Until recently, the central banks of Japan, the United States, Euro-area, Australia and (less so) New Zealand were all increasingly concerned about undershooting their inflation mandates. Figure 4 – Headline Consumer Price Inflation (CPI) across selected economies % Change YoY -1 United Kingdom Canada United States Euro Area New Zealand Australia Source: Federal Reserve Bank of St. Louis, Economic Data (FRED) The pandemic has tipped this concern on its head. Central banks are now signalling and undertaking policy tightening. These policy responses vary across countries based on their starting point measures of inflation and policymakers’ own assessment of inflationary risks. Table 1 – comparisons of central bank starting points (2019 – 2021) Country CPI (2019 y/y %) CPI (2021 y/y %) Unemployment % Unemployment % New Zealand 1.9 5.9 4.1 3.2 Australia 1.8 3.5 5.0 4.2 United States 2.3 7.0 3.6 3.9 United Kingdom 1.3 5.4 3.8 4.1 Euro Area11 1.3 5.0 7.5 7.0 Sources: Statistics New Zealand, Australian Bureau of Statistics, U.S. Bureau of Labor Statistics, Office for National Statistics (UK), Statistics Canada and Eurostat. ____________ Euro area uses HICP instead of CPI (harmonised index of consumer prices). Domestic inflationary pressures While global factors do account for much of the recent high inflation, domestic factors are now also playing a large role. This is an important reason why the Committee has responded by acting to reduce the level of monetary stimulus over recent months, and expects to continue to do so until convinced inflation is confidently contained, and employment levels are sustainable. The Committee’s policy challenge is no longer the prospect of a prolonged economic shock requiring extraordinary levels of monetary and fiscal stimulus. Our challenge is now to ensure the economic recovery includes low and stable consumer price inflation. The Committee, using our tried and trusted monetary policy approach, is acting to ensure inflation heads back to within our 1-3 percent per annum target range. We will do so without causing undue volatility in interest rates, the exchange rate or output. This is our business-as-usual monetary policy. Our ‘path of least regrets’ has now become one where we must ensure that consumer price inflation and inflation expectations do not rise persistently above our target level. Anything less from the Committee risks spiralling long-term economic costs and reduced wellbeing for New Zealanders. Our response within a global monetary policy context To highlight the Committee’s commitment to our low Remit, it is useful to compare our actions globally. Amongst many of our central bank peers, we were one of the first to begin removing monetary stimulus and start the tightening cycle (see table 2). Table 2 - Central bank snapshot United States Inflation Target Unemployment (%) Output Gap CPI Preferred inflation measure Policy Rate Averages 3.9 3.3 7.0 4.9 0-0.25 2% United Kingdom 2% 4.1 -0.4 4.8 4.8 0.5 Australia 2-3% 4.2 3.5 2.6 0.1 Euro Area Symmetrical -0.6 5.0 5.0 -0.5 3.2 1.6 5.9 3.2 1.0 2% New Zealand 2% Sources: Statistics New Zealand, Australian Bureau of Statistics, U.S. Bureau of Labor Statistics, Office for National Statistics (UK), Statistics Canada, Eurostat, RBNZ, RBA, BoE, ECB, Federal Reserve. Note: Output gap projections are based on IMF 2022 estimates, except for New Zealand’s, which is based on the Reserve Bank’s current projection. CPI, preferred inflation measure and unemployment rate data are either the final quarter or month of 2021, depending on the statistical frequency of the jurisdiction. Euro area uses HICP instead of CPI (harmonised index of consumer prices). To be explicit, the Committee ceased quantitative easing in July 2021 by ending the purchase of Government Bonds, and over the remainder of 2021 we raised the OCR by 25 basis points twice, and signalled it will return to more “neutral” levels by late 2022. We have now raised the OCR by a further 25 basis points, signalled we will sell down our LSAP holdings over the coming years, and steepened our OCR outlook further. Financial market pricing for future interest rate levels have been very responsive to our signalling (see figure 5). Market pricing of future central bank policy rates continue to indicate that New Zealand is expected to tighten policy sooner than many other comparable economies. By getting on top of inflation pressures quickly, by raising interest rates sooner, we aim to prevent the need for even higher rates in the future. In other words, we are taking our foot off the accelerator now to minimise having to use the brakes harder in future. Figure 5 - Central bank policy rate projections (1-year forward 1-month overnight-indexed swap rates) % 3.0 2.5 2.0 1.5 1.0 0.5 0.0 -0.5 01/2020 07/2020 United States 01/2021 Australia Canada 07/2021 United Kingdom 01/2022 New Zealand Note: these rates represent where market participants expect central bank policy rates to be in one year. Source: Bloomberg. Other considerations I now wish to return to some of the more unique backdrop issues that the Monetary Policy Committee, and the broader Reserve Bank, are negotiating. Fiscal support As I have mentioned, government fiscal support – both globally and in New Zealand – has played an incredibly important role in managing economically through the COVID-19 pandemic. The level of fiscal support in response to the pandemic has been considerably larger than in recent shocks – both in scale and timeliness. Governments acted quickly to buffer household and business balance sheets during the strictest periods of social and economic restrictions. In New Zealand, fiscal support for bolstering aggregate demand was welcomed by the Committee, given the size and pace of the economic shock, the ongoing environment of low nominal interest rates, and some of the specific supply-side effects of the health management actions. The bulk of the fiscal impulse created by the government’s response to the COVID-19 pandemic is now behind us (see figure 6). Treasury’s current outlook suggests that fiscal policy is expected to be less stimulatory on aggregate over coming years and, as such, add less to the economy’s aggregate demand. The Committee’s ongoing challenge is to ensure that inflation remains low and stable while government fiscal policy goes about its future business. As just proven, fiscal policy can play an important role in stabilising the economy, particularly in an environment of low interest rates, or when, as with COVID-19, there are major disruptions to the ability of the economy to produce goods and services. But, in normal times, monetary policy will remain the most effective tool to stabilise the economy due to the ease and frequency with which it can adjust, its operational independence, and the potentially significant economic costs of dynamically adjusting government spending, taxes and transfers. Figure 6 – Stance of fiscal policy over time % nominal potential GDP 8% Forecasts 6% 4% 2% 0% -2% -4% -6% -8% 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 Total Fiscal Impulse Fiscal Balance Source: The Treasury, HYEFU 2021 At its simplest, the way we think about fiscal policy is through its impact on both supply and demand in the economy. Higher government spending (all else equal) will add to price pressures. However, ‘all else’ is never equal and not all Government spending or actions have the same impact on the economy. For example, direct government spending and/or higher welfare transfers to households will have an immediate impact on aggregate demand. By contrast, investment in infrastructure or education can lift both aggregate demand (using resources) and improve the supply capacity (productivity) of the economy. In addition, households and businesses will change their spending behaviours based on government activities and policies. Labour regulations, border settings, COVID-19 restrictions and various investment rules all have a material impact on the capacity of the economy and inflation. We will continue to observe fiscal decisions and actions and ensure their potential impacts are incorporated in our monetary policy decision making. There is no simple rule of thumb. Asset price volatility Of particular focus, given the recent easing in global monetary conditions, has been its role in driving up asset prices. In New Zealand this has been most evident – and certainly most discussed – in residential house prices. At the end of last year I outlined some of the Reserve Bank’s current thinking about housing.12 Like high consumer price inflation, the rapid rise in asset price inflation has been a global phenomenon. However, the increase in New Zealand house prices has been considerable and has taken the level of house prices above its sustainable level.13 Figure 7 - International asset prices Source: S&P, Australian Bureau of Statistics, REINZ, OECD, Haver Analytics. Note: Share prices are capital indices. House prices for OECD members serve as a proxy for world prices. Our research shows that it is the persistent decline in global nominal interest rates that have most affected asset prices, whereas changes in New Zealand’s OCR relative to this global neutral level have significantly less effect.14 Recent global research suggests that shifting preferences for the consumption of housing – as a result of people having to “stay at home” – have also contributed significantly to rising house prices.15 New Zealand’s monetary policy does not determine the level of global interest rates. The longterm decline in nominal interest rates have been driven by low and stable global inflation, and ____________ Orr, Adrian (2021). Housing Matters. Retrieved from: https://www.rbnz.govt.nz/research-and-publications/speeches/2021/speech2021-11-02 Brunton, Matthew (2021). Measures for assessing the sustainability of house prices in New Zealand. Retrieved from: https://www.rbnz.govt.nz/research-and-publications/analyticalnotes/2021/an2021-08 Brunton, Matthew (2021). Measures for assessing the sustainability of house prices in New Zealand. Retrieved from: https://www.rbnz.govt.nz/research-and-publications/analyticalnotes/2021/an2021-08 William Gambler, James Graham and Anirudh Yadav (2021). Stuck at Home: Housing Demand During the COVID-19 Pandemic. Retrieved from: https://cama.crawford.anu.edu.au/publication/cama-working-paper-series/19682/stuck-home-housing-demand-during-covid-19-pandemic various structural factors such as demographics and productivity that affect future real growth and the balance between savings and investment. A key reason why lower global interest rates have had such a significant impact on house prices in New Zealand has been the lack of supply of new housing. Land-use restrictions and other constraints on building have restrained the supply of land and housing. It is important to note that this trend has recently turned. Building consents are at record levels, at a time when population growth in 2021 was just 0.5%16 (its lowest level since 1988), mortgage interest rates are rising, and there is tighter access to credit. We are now confronted with thinking about how asset prices will react to rising interest rates and how homeowners might react to falling balance sheet wealth. We recognise monetary policy has distributional impacts, including through the housing market. Our research17 has shown that monetary policy easing and tightening can affect the distribution of wealth and income through several channels. Our monetary policy mandate recognises the limitations monetary policy has in influencing these distributional issues. Instead it recognises that the best impact monetary policy can have on economic wellbeing for all is through maintaining low and stable consumer price inflation and doing so in a manner that contributes to maximum sustainable employment.18 However, Te Pūtea Matua is a full service central bank and we have responsibilities for both monetary policy and financial stability. Our purpose for responding to any unsustainable asset price movement is to ensure broad financial stability is maintained. We aim to ensure that both borrowers and lenders are able to manage their financial risks through good times and bad, and that any specific issues to the otherwise do not lead to general financial instability. To manage some of the cyclical drivers of financial instability we have increasingly deployed a range of ‘macroprudential’ tools. Since the onset of the pandemic we have removed and then reinstated one of our key prudential settings. We first removed loan-to-value restrictions (LVRs) at the onset of the pandemic to ensure our monetary policy easing was most effective in promoting cash flow and confidence, enabling banks to use their credit allocation skills most effectively (i.e. lending to those who were willing and able to borrow and invest). By early-2021 we were in a much more certain position regarding the economic response to the pandemic. This provided us the confidence to re-introduce LVR restrictions to head off undue leverage and borrowing risks associated with investing in housing.19 We subsequently tightened LVRs further20 and are also consulting on the introduction of debt to income (DTI) limits.21 ____________ Stats NZ National Population Estimates: At 31 December 2021. Retrieved from: https://www.stats.govt.nz/information-releases/national-population-estimates-at-31-december2021-infoshare-tables Leong, Jinny (2021). An overview of the distributional effects of monetary policy. Retrieved from: https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Analytical%20notes/2021/AN2021-05.pdf?revision=3ac08032-2b9a-4787-9cb2-fc7b8217eb77 Reserve Bank of New Zealand (2021, 1 March). Monetary Policy Committee Remit. Retrieved from: https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/monetarypolicy-framework Reserve Bank of New Zealand (2020, 8 December). Media release: Reserve Bank proposes reinstating LVR restrictions. Retrieved from: https://www.rbnz.govt.nz/news/2020/12/reserve-bank-proposes-reinstating-lvr-restrictions Reserve Bank of New Zealand (2021, 23 September). Media release: Reserve Bank tightens LVR restrictions. Retrieved from: https://www.rbnz.govt.nz/news/2021/09/reserve-banktightens-lvr-restrictions Reserve Bank of New Zealand (2021, 23 November). Consultation: Debt serviceability restrictions. Retrieved from: https://www.rbnz.govt.nz/regulation-andsupervision/banks/consultations-and-policy-initiatives/active-policy-development/debt-serviceability-restrictions Our ongoing research and discussion about housing sustainability and stability is consistent with the recent ‘please explain’ and ‘please act’ additions to the Committee’s Monetary Policy Remit and Reserve Bank’s financial stability legislation respectively.22 New tools, same outcomes Another challenge the Committee – and broader Bank and fiscal authorities – have faced is the design, implementation, assessment and explanation of additional monetary policy tools. On the explanation front, a significant challenge has been the singling out of the new tools as the cause of house price inflation. However, correlation is not causation, and there is much more to a modern monetary system than meets the eye.23 The additional monetary policy tools we utilised over recent quarters do nothing more than assist to lower interest rates in the economy, across the yield curve. It is then up to financial institutions and individuals to decide how to utilise the lower interest rate environment. Our Large Scale Asset Purchase (LSAP) programme affects long-term interest rates through the exchange with retail banks of new cash reserves (settlement accounts at the Reserve Bank) for their holdings of Government bonds. In doing this we reduce long-term interest rates by creating additional demand for Government bonds. The level of Government bonds on offer however is determined solely by the fiscal authorities – not the Reserve Bank. Likewise, the amount of bonds the Committee chooses to buy or sell remains the exclusive decision of the Committee – not the fiscal authorities. Monetary and fiscal policy remain operationally independent and for good reason. Review and improve The Reserve Bank is continually considering how we can improve the implementation and formulation of monetary policy. While our monetary policy remit sets our current objectives for monetary policy, the new RBNZ legislation requires the Reserve Bank to review the framework for monetary policy every five years. This follows monetary policy framework reviews in recent years by the Federal Reserve, European Central Bank and the Bank of Canada. The purpose of these regular (5-yearly) reviews is to ensure we are an accountable and transparent central bank, the monetary policy framework remains fit for purpose, and the Monetary Policy Committee is well placed to achieve our objectives. This will be an opportunity to consider how the Reserve Bank balances our inflation and employment objectives, and what weight, if any, should be put on secondary considerations such as distributional impacts and housing. Our review process – which is now underway – has two parts: a backward looking review and assessment of monetary policy performance over the last five years, which will consider how monetary policy performed during the pandemic period; and, the formulation of ‘remit advice’ for the Minister of Finance on whether we believe there are any changes required to the remit when it must next be renewed. ____________ https://www.rbnz.govt.nz/news/2021/02/rbnz-supports-focus-on-housing Bank of England (2014). Quarterly Bulletin: Money creation in the modern economy. Retrieved from: https://www.bankofengland.co.uk/-/media/boe/files/quarterlybulletin/2014/money-creation-in-the-modern-economy.pdf We are legally expected to deliver our advice no later than November 2023. This review and remit advice process will involve public consultation. The first round of consultation, in the middle of this calendar year, will take stock of the structural changes that have affected the context for monetary policy, and reflect on the lessons from the operation of monetary policy in recent history. The feedback from this consultation will be used to inform the scope of options for changes to the remit, which will be part of the second round of consultation later in the year. I encourage you to take part in this review process. Concluding remarks Today I have outlined how Te Pūtea Matua is thinking about the current inflation challenge. Despite the unique global economic shock, the operation and response of monetary policy is relatively conventional. We are committed and confident we will return inflation back towards more acceptable levels, through the use of our conventional monetary policy tools. I have also made clear how we are continually assessing the impact our decisions have on the wider economy – such as asset markets – and we are mindful of those impacts, within the constraints of our mandate. We also look forward to beginning a public consultation process on what changes, if any, should be made to the monetary policy remit to ensure it is fit for purpose moving forward. We are conscious of the challenges facing monetary policy, and the role we can play as a central bank of a small open economy. “Kua takoto te Manuka, hikina, amohia”. The leaves of the Manuka tree – the challenge - has been laid down, take it up, embrace it. ENDS
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Panel remarks by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, delivered to the Central Bank of Ireland, 27 April 2022.
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New Zealand’s Experience with Macroprudential Policy Panel remarks delivered to the Central Bank of Ireland On 27 April 2022 Delivered by Christian Hawkesby, Deputy Governor and General Manager Financial Stability Prepared with Graeme Cokayne Ref #X457566 v1.8 Introduction Kia ora koutou katoa and thank you for inviting me to be a part of this panel on an important topic. For me, it is a great opportunity to listen and learn from the experiences of the other the panel members with macroprudential policy in their countries. In return, I was planning to share our experience in New Zealand. In particular: the issues that motivated the introduction of macroprudential tools; the actions we have taken to adjust their settings through time; the lessons we have learned from their use along the way; and the next steps we are planning to take in this space. By way of background, it is useful to first outline where macroprudential policy sits within the role of the Reserve Bank of New Zealand - Te Pūtea Matua (RBNZ). The purpose of the RBNZ is set out in our Statement of Intent for 2021-2024 and is described by the Māori phrase Toitū te Ōhanga, toitū te Oranga. This is usually translated as ‘enabling the prosperity and wellbeing of all New Zealanders’. We do this by promoting a sound and dynamic monetary and financial system. Within this overall statement of purpose we have four key policy objectives set out in our enabling legislation. The first is monetary policy, where we target low and stable inflation, and support maximum sustainable employment. The second objective is promoting a sound and efficient financial system. The third and fourth policy objectives are meeting the public’s cash needs and overseeing an effective payments system. By international comparison, we are a full-service central bank (Table 1). Table 1: Central Bank Functions and Responsibilities Monetary Policy Liquidity Management FX Intervention Prudential Policy Bank & Insurance Supervision New Zealand ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ Australia ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ Japan ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ South Korea ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ Norway ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ United Kingdom ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ Eurozone ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ United States ⚫ ⚫ ⚫ ⚫ ⚫ ⚫ Country Leader of Last Resort Central bank functions and responsibilities key: ⚫ Full ⚫ Shared or partial ⚫ None or minor Source: Adapted from Aldridge and Wood (2014), Monetary policy decision-making and accountability structures: some crosscountry comparisons. Reserve Bank Bulletin, 77 To achieve these policy objectives, we have different tools that broadly fall into three categories. First are monetary policy tools, which in New Zealand are the Official Cash Rate (OCR) and other instruments across our balance sheet. These are largely aimed at managing demand in the economy through influencing interest rates across the yield curve, and ultimately for households and businesses. Secondly, we have micro-prudential tools such as capital requirements, liquidity requirements, and regulations on governance and disclosure. These are mainly aimed at promoting the stability of individual financial institutions, and thereby supporting the resilience of the financial system. This is supplemented by prudential supervision and enforcement to ensure that banks are operating consistently with these prudential settings. Finally, we have macroprudential tools, which are designed to address wider systemic risks to the financial system as a whole that may not be adequately managed through microprudential regulation and supervision. In New Zealand, this has primarily involved loan-tovalue ratio (LVR) restrictions in the mortgage market (which in Ireland would be called LTV restrictions). It has also involved sectoral capital requirements and – in future – the countercyclical capital buffer. The Motivation for Macroprudential Tools In New Zealand, we first introduced macroprudential tools back in 2013. The motivation at the time was that we felt that the low level of interest rates required to achieve our monetary policy mandate was creating risks to financial stability that we needed to manage. Introducing macroprudential tools, therefore, gave us an “extra degree of freedom,” especially in an environment where the financial cycle and business cycle were out of sync. In particular, in 2013 our official interest rate was still near a record low level at the time, as consumer price inflation pressures were weak in the aftermath of the Global Financial Crisis (GFC). However, with easy monetary conditions, house prices rose sharply, especially in our largest city, Auckland (Figure 1). In this period, house prices in Auckland reached nine times the average income. We felt we needed extra tools to manage this growth, especially as we had observed from other countries through the GFC how unsustainable asset prices could have material consequences for the stability of the financial system down the track. The use of macroprudential tools was also gaining acceptance around the world at the time, though actual experience was somewhat limited. In May 2013 we entered into a Memorandum of Understanding with the Minister of Finance, under which the RBNZ initiates any macroprudential policy action, but only after consultation with the Treasury and Minister1. In practical terms, this meant that adjustments to ____________ See ‘Memorandum of Understanding Between the Minister of Finance and the Governor of the Reserve Bank of New Zealand’. Memorandum of Understanding between the Minister of Finance and the Governor of the Reserve Bank of New Zealand - Reserve Bank of New Zealand (rbnz.govt.nz) macroprudential settings could be undertaken by the RBNZ but major alterations (such as the introduction of new tools) requires consultation. Initially, the macroprudential tools that we introduced were LVR restrictions on residential mortgages and core funding ratios for banks. While we introduced core funding ratios, we have only rarely adjusted them, so I will focus here largely on our experience of LVRs. Figure 1: House Price Growth in New Zealand The first shaded area is the tightening phase, the second is the easing phase, and the final is the COVID19 phase. Our Experience of Macro Prudential Tools Our experience of managing macro prudential tools since 2013 has broadly involved four phases. All decisions since in 2013 can be found in the Annex. Initial Settings (2013-2015) When we first introduced LVR restrictions, our main concerns were that rising house prices, particularly in Auckland, but also Christchurch, would lead to vulnerabilities in the financial system. Our analysis suggested that the main causes of the rising house prices were housing supply shortages and easy credit. We saw that banks were competing strongly for borrowers with low deposits and so by tightening lending criteria we felt that we could slow the rapid expansion of credit that was fuelling the house price growth. We were actively seeking to influence house prices. The RBNZ governor at the time stated that "[t]he LVR restrictions are designed to help slow the rate of housing-related credit growth and house price inflation, thereby reducing the risk of a substantial downward correction in house prices that would damage the financial sector and the broader economy… In the current situation, where escalating house prices are presenting a threat to financial stability but not yet to general inflation, macroprudential policy offers the most appropriate response."2 The initial settings of the LVR restrictions in October 2013 were that banks could not issue more than 10 per cent of loans to borrowers looking to borrow more than 80 per cent of the value of the house. This so-called speed limit of 10 percent allowed banks to continue to allocate credit to some borrowers with LVRs above 80 per cent as they saw appropriate, mitigating to some extent concerns about what restrictions meant for allocative efficiency. While the initial impetus for imposing LVRs was primarily due to concerns about the housing market in Auckland, we felt that imposing LVR restrictions solely on Auckland could create issues around their administration and the possibility of shifting housing pressures outside of wherever the boundary was drawn. Therefore, we initially put in place national rather than Auckland-specific restrictions. Tightening Phase (2015-2016) Nonetheless, by November 2015, we did institute a tighter policy for Auckland compared with the rest of the country. At the same time, in Auckland, we imposed different regulations for owner-occupiers and investors (which in Ireland would be called ’buy-to-let buyers’). The objectives of the amended policy were to "…more directly target investor activity in the Auckland region, where house prices relative to incomes and rent are far more elevated than elsewhere in New Zealand. The objective of this policy is to promote financial stability by reducing the rate of increase in Auckland house prices, and to improve the resilience of the banking system to a potential downturn in the Auckland housing market"3. The split between owner-occupiers and investors was then extended to the rest of the country in October 2016, and has been maintained since, while the regional differentiation has been removed. Our policy has been to have tighter regulations on investors than owneroccupiers reflecting the greater risk from that type of borrowing.4 Easing Phase (2017-2019) By late 2017, the general economic outlook internationally was fairly stable and the nearterm financial stability risks appeared to be easing so it was seen as a good time to ease some of the restrictions on LVRs in order to remove some of the potential for inefficiency in the mortgage market.5 At the time we said “[d]omestically, LVR policies have been in place since 2013 to address financial stability risks arising from rapid house price inflation and increasing household debt. These policies have helped improve banking system resilience by substantially reducing the share of high-LVR loans. Over the past six months, pressures in the housing market have continued to moderate due to the tightening of LVR restrictions in October 2016, a more ____________ 2 See RBNZ press release: Limits for high-LVR mortgage lending. 20 August, 2013 rbnz.govt.nz/news/2013/08/limits-for-high-lvr-mortgage-lending 3 See RBNZ press release: Reserve Bank announces new LVR restrictions on Auckland housing. 13 May 2015 rbnz.govt.nz/news/2015/05/news-release-for-fsr-may-2015 4 In addition, we introduced a new class of loans for residential investors under our capital adequacy framework, with a higher risk-weight compared with owneroccupiers. As a result, banks now need to hold more capital for investor loans, reflecting their greater risk. 5 See RBNZ press release: Reserve Bank to ease LVR restrictions. 29 November 2017 rbnz.govt.nz/news/2017/11/reserve-bank-to-ease-lvr-restrictions general firming of bank lending standards and an increase in mortgage interest rates in early 2017”6. COVID-19 Period (2020-2021) Finally, in the face of the extreme uncertainty posed by the start of the COVID-19 pandemic in early 2020, we both loosened monetary policy significantly and removed restrictions on LVRs, in order to support the economy and financial system through this unprecedented period. A key reason for removing the LVR restrictions was to eliminate a potential barrier to putting in place a mortgage deferral scheme implemented in response to the pandemic, while a general concern for supporting credit flow provided an additional impetus. We decided that the policy that we would least regret through this period was to remove restrictions and have to put them back on later; rather than the alternative of keeping conditions too tight and exacerbating a contraction in the financial system and economy. As the Deputy Governor at the time said, “[g]iven the current uncertainty around the economic outlook, the Reserve Bank considers that it is unlikely that banks will weaken lending standards to high risk borrowers. The more likely risk is that banks are overly cautious with lending to credit-worthy borrowers”7. As it turned out, the New Zealand economy was much more resilient to the impact of COVID19 than had been feared. Economic activity bounced back relatively quickly, as did house prices supported by resilient demand, low interest rates and an historic lack of supply.8 Having announced in April 2020 that we would be removing LVR restrictions for a year, by December 2020 we produced a consultation document foreshadowing an earlier reintroduction of LVRs. LVR restrictions were reintroduced in March 2021 and tightened further for investors in May 2021, and then owner-occupiers in November 2021. Lessons Learnt from Our Experience So that is a brief history of our experience of using macro-prudential tools over a period of a little less than a decade. A key general point that I would like to leave you with is that making decisions about macroprudential settings has not been straightforward or easy in any sense. We have reviewed our LVR settings on average every six months over this period. Compared to setting monetary policy every six weeks for the past 30 years, macroprudential policy in New Zealand is still in its infancy; we are still learning; and still finding our rhythm of following a consistent, repeatable process backed by clear and transparent communication. However, there are three high-level lessons that I do think are worth sharing. ____________ 6 See RBNZ press release: Reserve Bank to ease LVR restrictions. rbnz.govt.nz/news/2017/11/reserve-bank-to-ease-lvr-restrictions 7 See RBNZ press release: Reserve Bank removes LVR restrictions for 12 months. rbnz.govt.nz/news/2020/04/reserve-bank-removes-lvr-restrictions-for-12-months 8 Orr, Adrian (2021) Housing matters: A speech to the Property Council of New Zealand. Social Licence To earn our social licence to operate, policymakers need to ensure that the public understands and supports why our policy tools are being used. This has been an ongoing work in progress. Unlike other prudential policies like capital and liquidity regulation of financial institutions, LVR restrictions are highly visible to the public and directly impact the ability of households to access credit. In the case of macroprudential tools, for example, the argument is often made that borrower-based restrictions affect first-time buyers disproportionately, and can keep people out of the housing market. For the policies to be accepted, therefore, a high degree of public transparency and accountability is needed. Equally, for banks responsible for implementing macroprudential policies, they need to buyin to the broader benefits to financial stability, and the importance of investing in their systems and compliance capability. From the start of our use of macroprudential policy tools, social acceptance has been important for us. This included our Memorandum of Understanding with the Minister of Finance, which ensured that we were in agreement on what tools we could use and how we could use them. Our dialogue with the government has continued, including the direction that we received in February 2021 from the Ministry of Finance under section 68B of the Reserve Bank Act indicating that when setting financial policies we have regard to the government’s policy “to support more sustainable house prices, including by dampening investor demand for existing housing stock which would improve affordability for first-home buyers”.9 Further, at each stage of our macroprudential policy settings, any major changes have involved public consultation where we considered the views of industry as well as the public more generally. Managing House Prices vs Building Resilience When we first introduced LVR restrictions, we thought that they should be used as a temporary measure when the housing market was overheated that could then be eased or removed as the housing market cooled. What we have come to understand is that the effect of LVR restrictions on house price cycles are quite modest. Tightening LVRs beyond a certain point can inhibit house price growth, but once loosened they have a fairly minimal effect.10 By contrast, monetary policy, through changing the level of interest rates for all borrowers, has a far greater effect on house prices than LVR restrictions. Even then, there any many other supply-side factors that have a considerable influence house prices, outside the control of the central bank. ____________ See RBNZ information release (11 March 2021). The minister of Finance’s Section 68B direction and accompanying correspondence. rbnz.govt.nz/research-and- publications/information-releases/2021/ir-2021-01 10 Reserve Bank of New Zealand (2018) Loan-to-value restrictions and house prices, DP2018/05. Therefore, rather than a tool to actively manage asset prices, we have found the major benefit from LVR restrictions to be their more permanent role of building resilience into the financial system, better preparing the economy and financial systems to the potential fallout from a sharp reversal in the housing market. Specifically, LVR restrictions reduce the chance of borrowers going into negative equity following a large correction in the house prices, and therefore also reduce the loss given default for banks if borrowers fail to maintain their mortgage payments. As such, we find that it is the effect of LVR policy on the stock of mortgages that matters more than its effect on the flow of new mortgages. In New Zealand, the stock of high-LVR lending has declined markedly since we first imposed LVR restrictions and is currently near historic lows (Figure 2). It has declined from nearly 17% of all lending in 2014 to around 7% at the end of 2021. The system-wide loss given default has therefore declined leading to a more stable, resilient financial system. This has been the main benefit from having macroprudential policy options. Figure 2: The Stock of High LVR Mortgages in New Zealand The Need for a Complete Set of Tools While it has been beneficial for us to add macroprudential tools to our policy suite, it has also become apparent that we need a full set of tools to better manage risks. Debt to income has been increasing in New Zealand over the past 35 years, with only a modest dip following the GFC (Figure 3). Therefore, households are still vulnerable to falls in income affecting their ability to service their debt. As mentioned earlier, LVR restrictions help us manage the loss given default in a period of widespread default on mortgage lending. Including a debt to income measure in our toolkit would help with reducing the probability of default. Therefore, these two policy tools deal with different sources of risk: LVRs with the risk to banks from a fall in house prices, and DTIs with the risk to households from a fall in income. We see reducing the probability of default and loss given default as two complementary policies in creating a more resilient financial system. As with LVR restrictions, we see DTI measures as policies aimed at reducing through-the-cycle risks. And indeed DTIs might well be better at managing such risks, as income tends to vary much less through the financial cycle than the value of houses. Figure 3: Household debt-to-income ratios Among other policy measures,11 we have also looked at implementing floors or buffers on banks’ test interest rates, to ensure that borrower households are better equipped to deal with fluctuations in interest rates and, hence, less likely to default on their mortgages. With all of these tools in place, LVRs, DTIs, interest rate floors, and enhanced prudential buffers, we would have a number of different ways of enhancing the resilience of the New Zealand financial system to deal with different challenges as they appear. ____________ 11 On the prudential side, we are increasing the prudential buffers that banks are required to maintain. These prudential buffers will include a countercyclical capital buffer (CCyB). Our approach to administering the CCyB is somewhat different to other countries, as we do not intend to be as active as other countries in adjusting it, as it will be fully incorporated in the capital requirements. This is consistent with our understanding that macroprudential policy tends to be less effective in managing the top and bottom of cycles but rather as through-the-cycle policy to add to overall resiliency. Next Steps Looking ahead, there are two main next steps on our macroprudential agenda. Consulting on Additional Tools to Complete the Suite We are currently consulting with banks and the general public on adding debt–to-income (DTI) tools to our framework. Some banks have expressed their preference for a floor on test interest rates instead of a DTI. They have argued that an interest rate floor would be much easier for them to administer and it could, in the end, achieve similar results. While we have taken on their argument, a DTI continues to be our preferred option. We feel that a DTI produces a better control on the probability of default as a complement to the reduction in loss given default provided by existing LVR restrictions. By contrast, test interest rates are only one input into banks’ serviceability assessments, and there is a risk that a test rate floor could be offset by adjustments to other elements of banks’ calculations. However, an interim test rate floor could be put in place in the short term if necessary to address financial stability risks. We are currently looking for banks to be operationally ready to introduce a debt servicing tool by mid-2023, if they are required12. Enhancing our Framework and Communications For monetary policy, so-called ‘neutral interest rates’ provide a sense for whether the current settings for interest rates are expansionary or contractionary. In a world where macroprudential tools have turned out to be a more permanent feature of the landscape than we initially expected, we think that it is important to consider and explain the neutral macroprudential settings. That way we will not only be able to express whether we think current macroprudential settings are expansionary or contractionary at any time, but also provide a clearer path ahead into the long-term to their neutral settings. Again, to use the analogy with monetary policy, much like how we publish a projection for the Official Cash Rate (OCR), we should aspire to be able to publish a projection of our macroprudential settings, and to explain how these will assist us achieve our mandate for a stable and efficient financial system. With potentially more macroprudential tools available as part of a full suite, we will also need to consider and explain how they combine in total to a neutral long-term setting to support financial stability through the cycle. All of these considerations are part of the building blocks we need to put macroprudential policy on an equal analytical footing with monetary policy, and to find the rhythm of following a consistent, repeatable process backed by clear and transparent communication. ____________ Reserve Bank Summary of Submissions: Debt Serviceability Restrictions: https://www.rbnz.govt.nz/-/media/ReserveBank/Files/Publications/Policydevelopment/Banks/Debt-serviceability-restrictions/DSR-consultation-summary-of-submissions.pdf Conclusion So to sum up the New Zealand experience, we have evolved and developed our thinking on macroprudential policy tools. Our experience has informed us that macroprudential tools are an important part of delivering on our responsibility for the stability of the financial system as a whole, alongside other prudential settings. We have shifted our LVR restrictions through time, applying different setting for regions and types of borrowers, and adjusted our settings in response to the changing threats to financial stability. Over time we have evolved our thinking from considering LVR restrictions on mortgage lending to be a temporary tool for managing ups and downs in the financial cycle to seeing them to be a more permanent device to maintain the resilience of the financial system. We have also come to see that it is important to have a fuller suite of macroprudential tools, which help manage both the risks to the financial system from a fall in house prices and the risks to households being unable to service their debt. Aligning with our Memorandum of Understanding with the Minister of Finance on macroprudential policy, in designing debt serviceability restrictions we will have regard to avoiding negative impacts, as much as possible, on first-home buyers. We have more work ahead of us to continually enhance our frameworks, processes and communication, focused on our ultimate purpose of contributing to the prosperity and wellbeing of the New Zealand people. Thank you very much for asking me to speak here today. Annex 1. Table 2: History of LVR Settings All NonAKL October November October January January Owner Occupier AKL Owner Occupier Investor Speed Limit Threshold Speed Limit Threshold Speed Limit Threshold Speed Limit Threshold Speed Limit Threshold Speed Limit No restriction No restriction Threshold No restriction No restriction Speed Limit Threshold Speed Limit Threshold Speed Limit Threshold 2020 April 2021 March 2021 May November Red = Tightening, Yellow = Steady, Green = Easing AKL Investor
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Speech (virtual) by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Central Banking Global Summer Meetings 2022, 13 June 2022.
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Why we embraced Te Ao Māori Speech delivered to the Central Banking Global Summer Meetings 2022 Adrian Orr, Governor Written with Emily Laws On 13 June 2022 Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Tēnā koutou katoa E ngā hau e whā, tēnā koutou (I acknowledge those from all four winds) Ko Tongariro te Maunga Ko Taupo te Moana Ko Atiu te motu Kei Te Whanganui-A-Tara ahau e noho ana Kei Te Pūtea Matua au e mahi ana Ko Adrian ahau No reira tena koutou, tena koutou, tena koutou katoa Firstly, I want to thank Kate Minter and the team at Central Banking for inviting me here to speak. It is a privilege to be asked to speak on how the Reserve Bank of New Zealand embraces our indigenous history and heritage, and applies a Te Ao Māori – or Māori world view – in what we do. We are recent adopters of this approach, so I must be humble in our experience and results so far. I will be using some Te Reo Māori, or Māori language - one of three official languages of New Zealand – in my talk today. I will explain this as I go, starting with the Māori name for our country – Aotearoa. This means land of the long white cloud. The name for the Reserve Bank of New Zealand is Te Pūtea Matua. Pūtea meaning money, while Matua means primary source. In a Te Ao Māori sense, we see ourselves as the kaitiaki of our financial system. Kaitiaki in short means guardian, but it also means so much more and carries with it the long-term stewardship central to our role. Our kaitiaki role is underpinned by our founding legislation, the Reserve Bank of New Zealand Act 20211. ____________ Reserve Bank of New Zealand Act 2021 https://www.legislation.govt.nz/act/public/2021/0031/latest/LMS286978.html Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Our core legislative functions include: maintaining low and stable consumer price inflation while contributing to maximum sustainable employment. promoting and maintaining a sound and efficient financial system. meeting the cash needs of the public. providing robust payment and settlement services for New Zealand’s financial institutions. The inclusion of a Te Ao Māori view encourages us to think holistically and long-term, as we go about our legislative tasks. Most importantly, we increasingly look to focus on long-term, holistic, and sustainable outcomes when setting and implementing our strategies. A longer-term focus is one that sees prolonged economic prosperity consistent with environmental sustainability, social cohesion and cultural inclusion. As part of broader Government policy, the Minister of Finance also writes a Letter of Expectations to us each year. In 2022, the Minister outlined that our Te Ao Māori strategy aligns with an expectation that we embody a collaborative approach in the Māori-Crown relationship2. Brief history - navigators, settlers, and what came after… In order to best understand why and how we are embracing Te Ao Māori in our work it is important to be aware of the history of Aotearoa. The general tale will sound familiar to many in the audience. Polynesians – to later be known collectively as Māori - were the first people to permanently settle in Aotearoa. The period of settlement, from about 1325-1400AD, correlates with oral tradition and the number of generations since. The next wave of immigration was a long time later and came in fits and starts. ____________ Letter of Expectations 2020 https://www.rbnz.govt.nz/hub/publications/corporate-publications/letters-of-expectation/letter-of-expectations-2020 Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Initial contact with European explorers was brief. A Dutchman named Abel Tasman is credited as the first European explorer to reach New Zealand in 1642. It would be another 127 years before the next recorded European foray into Aotearoa and encounter with Māori. The British explorer James Cook arrived in 1769, with the French hot on his tail. At that point, suffice to say, Māori isolation was over and contact grew rapidly over the next 60 years. Initially there was a relatively easy relationship between early European visitors and Māori. The British were tentative about their settling at first, seeing formal colonisation as unnecessary and expensive, especially as their Empire was stretched. Then things changed comparatively quickly for a variety of reasons. Tensions grew between the recently arrived European settlers, and between Māori and Europeans. In part in response to these escalating tensions, and in part due to a formalising of the colonisation intent, the Treaty of Waitangi was signed in 1840 between the British government and about 540 Māori tribal leaders. There are two versions of the Treaty - one in Te Reo Māori, Te Tiriti o Waitangi - and the other in English. And, there are significant differences in meaning between the two versions. These differences have left us in Aotearoa almost 200 years on debating the implications. In Te Reo Māori, Te Tiriti o Waitangi can be seen as the founding document of New Zealand, and unique in the world as a way of setting out the relationship between an indigenous people and the colonisers. Soon after the Treaty of Waitangi was signed, colonisation proceeded on a substantial scale and, with it, a British-style economy and institutions evolved. The influx of settlers led to a demand for land, and from the 1840s Māori were under great pressure to sell their ancestral territories. The sale of Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE land was also the main means by which Maori could purchase the new goods and services arriving from afar. Wide scale loss of Māori land ensued, through sale, confiscation, Crown purchase and allocation by the Native Land Court. This loss of the land carried a monumental cultural impact that is felt to this day. There existed no concepts of property ownership prior to the arrival of the European. In losing land, Māori lost their homes, their ability to grow food and trade, and their connections to their tipuna (ancestors). For Māori, te taiao – the natural world – is paramount and inextricably linked to the wellbeing of people. I’m going to take licence and again skip forward to the present day – acknowledging that the history of our indigenous people and the impact of colonisation is far more significant than I could ever summarise in this short session. The present In 2022, Tangata Whenua –people of the Land – still face economic adversity relative to the population in general. In early 2021, Te Pūtea Matua in partnership with Business and Economic Research Ltd (BERL)3 produced Te Ōhanga Māori – the Māori Economy 2018 report. The report highlighted that Māori, who make up 17% of our population, earn less than 9% of our nation’s income. With lower incomes comes lower saving rates and hence financial wealth. Māori have also been over-represented in lower-wage employment, and experienced persistently higher unemployment than the general population. These outcomes are generations in the making. However, Māori are significantly contributing to New Zealand’s economic and cultural wellbeing, with this contribution on the rise. We are witnessing a renaissance of sorts. ____________ Berl (2020) Te Ōhanga Māori 2018 Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE The Māori economy is growing, becoming more diverse, and is increasingly recognised as an area of opportunity, in particular by reinvigorating long held connections to environmental sustainability and social cohesion. Aotearoa is slowly embracing the richness our diverse cultures bring. This is why we, as New Zealand’s central bank, talk about these issues. Our legislative task is to enable economic wellbeing and prosperity for all New Zealanders: Toitū te Ōhanga, Toitū te Oranga. Focusing on the Long Game I might have sounded a little gloomy so far – I do not apologise for that because to move forward we must understand and acknowledge our past and present. Our challenges aren’t unique. I also want to acknowledge your own challenges, and those of the indigenous people of your countries. Our vision At Te Pūtea Matua we are actively looking to harness the knowledge of both our post-colonial society and Te Ao Māori to establish and maintain a long-term vision in all we do. An important start for our work is to honour Te Tiriti o Waitangi - the Treaty of Waitangi - in the English and reo Māori versions. We aim to reflect the Treaty principles of partnership, protection, and participation within the core tenants of our strategy. We seek to implement our legislated purpose through the concept of Matangirua ki Matangireia – working in unison, to fulfil our ultimate purpose. At Te Pūtea Matua, we strive to be a great team working to be the best central bank we can. This implies working together so as to be fit for purpose, cost effective, and risk aware. Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE We describe this ‘great and best’ aspiration in a Te Ao Māori context as Matangirua ki Matangireia: Matangirua – when every function on an ocean vessel is in full use and all onboard are in sync. Matangireia – the place to ascend to so as to access knowledge. Our values We have also refreshed our values through a reconceptualisation through Te Ao Māori. Our values are: Wānanga (Innovation): stemming from knowledge gained through our diverse perspectives; Tauira (Integrity): sustained through self-reflection and modelling our shared principles; and Taura(Inclusion): binding our individual strengths together enabling our resilience and collective success. Our story And we utilise a Te Ao Māori framework to describe the purpose and interconnectedness of our work. To do this we have adopted the legend of Tāne Māhuta4. In Māori mythology, Tāne Māhuta is the god of the forest and birds. Māori oral traditions tell us that Tāne Māhuta dug his shoulders into Papatūānuku (mother earth) and used his legs to push against Ranginui (father sky) so as to separate them and let light into the world. With that light, Tāne Māhuta the kaitiaki of the forest and birds, enabled life to thrive. The Reserve Bank is akin to the being Tāne Mahuta of New Zealand’s financial landscape. ____________ The Journey of Te Pūtea Matua: Our Tāne Māhuta Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Our roots are our legislation, outlining our purpose and giving us strength (legality and operational rights) and well-being (resourcing). The money we print and circulate for New Zealand is the sap that flows through Te Pūtea Matua, ensuring New Zealanders have a means of exchange, a store of value, and a unit of account they can trust. Our monetary policy actions – keeping consumer price inflation low and stable – are to ensure that our currency retains its store of value. Our complex payment and settlement system is our trunk. This system allows the money to flow to the branches of Te Pūtea Matua, which are the financial institutions that have chosen and are allowed to operate in Aotearoa. These financial institutions are so important that we need to establish rules and supervision to ensure they are of appropriate quality and robustness to remain grafted to Te Pūtea Matua. Some of the banks are so large that, should they fail, they could bring our whole system down. For this reason we need to ensure the systemically important banks remain grafted on and can keep working even if the current owners are gone. These closely interrelated functions enable Te Pūtea Matua to protect, nurture and grow New Zealand’s wider financial ecosystem for the greater benefit of all New Zealanders. Being able to tell a story about our purpose and activities brings several advantages. Our own team is reminded of how all of our tasks are connected creating a supportive culture. We are able to relate the complex story of central banking and financial stability to a broader audience. We are reminded of our interconnectedness to the wider financial ecosystem of New Zealand, as well as other regulator colleagues. We are also made to think a lot harder about what makes Te Pūtea Matua unique – we are New Zealand’s central bank. Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Our Te Ao Māori strategy Our Te Ao Māori strategy is helping inform our policy programmes, broaden our external stakeholder engagement, and grow our internal cultural capabilities. We breathe life into our Te Ao Māori strategy through three key work programmes: policy, engagement, and culture. While we have made considerable progress in each work stream, we continue to be future-focussed. Our work streams reflect the forward looking nature of our challenge. Te reo me onā tikanga (Culture, People and Organisation) – our effort to raise our individual and collective knowledge and understanding of Māori language and culture. Whanaungatanga (Advocacy building) – our efforts to strengthen the ties between the Reserve Bank and Iwi, Māori, Māori business and organisations. Kaitiakitanga (Policy Impact) – recognition of our responsibility as a policy maker and as guardian of the financial system. Through this framework, we are working to gradually strengthen our understanding of, and interactions with, Te Ao Māori. Culture We are making progress on integrating Māori language and cultural values into daily life at Te Pūtea Matua. We ensure the use of Te Reo Māori is supported and enabled by providing learning opportunities for staff. We also created an online learning application (Haumi), to support our knowledge of tikanga and Te Reo Māori. We also offer training opportunities for all staff on Te Tiriti, have staff forums, and celebrate events and speakers important in a Te Ao Māori world view. We have made a bold start. Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE As an example of tangible steps towards contributing to the Māori language , we’ve established a glossary of Te Reo Māori financial terms. These terms are incorporated into our documentation. Partnering Over recent times many banking industry participants have adopted their own Te Ao Māori initiatives, and the sector is working towards a more collective response. Māori leaders from the banking sector established the first Māori Bankers Rōpū (group), known as Tāwhia, to share ideas and deepen the understanding of key issues for Māori within the banking sector. The Rōpū includes senior representatives from banks and the Reserve Bank. We are there as an observer and kaitiaki to the financial system. We’re proud to stand alongside leaders from the banking industry, to promote outcomes centred on Māori financial inclusion and wellbeing. Rōpū members have highlighted three key focus areas – bolstering access to capital, improving financial literacy for Māori, and raising Māori employment in the banking sector. Along with Indigenous partners, Te Pūtea Matua partnered with other Central Banks (the Bank of Canada, Reserve Bank of Australia, and the US Federal Reserve System) to form a voluntary network. Together we are fostering dialogue on indigenous economic and financial issues. This Central Bank Network for Indigenous Inclusion, formalised in January 2021, aims to share knowledge and best practices, promote engagement with Indigenous Peoples, and foster greater understanding and education about Indigenous economic issues and histories. Our first symposium was hosted in late 2021, with another planned for 2023. The Network serves as a community of practice, rather than trying to formulate policy positions. Other central banks are encouraged to join. Policy development We are tasked with improving economic prosperity for all New Zealanders, hence we must tackle the challenges faced by Māori. Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Our report (Te Ōhanga Māori - Māori Economy Report 2018) showed how integral the Māori economy is to New Zealand’s economic wellbeing and future prospects. The report highlighted the wide and broadening range of industries and businesses Māori are involved in. It also highlights the rapidly growing proportion of Māori in New Zealand’s workforce. Quite spectacularly, since 2013 the Māori population in New Zealand has grown by 30 percent, while the number of Māori in employment increased by 47 percent. However, the report also identified several challenges, with access to capital highlighted as one of the primary challenges inhibiting progress. Māori customers and entities report lower rates of capital accessibility than non-Māori. We are now researching the significance and root causes of the lack of access to capital. Our first finding was simply the dearth of quantitative data on the topic. However, qualitative interviews with both Māori capital seekers and providers suggests there are unique barriers to financial resources, which has implications for the efficiency and effectiveness of capital allocation in New Zealand more generally. Our work is ongoing with the publication of an Issues Paper on the near horizon. We are looking to identify any issues around accessing capital that may arise due to market failures, gaps in the New Zealand financial system, or unintended consequences of current behaviours. International literature generally highlights that minority and indigenous people and businesses face barriers to raising capital. Our own quantitative research highlights that Māori are underrepresented when it comes to business ownership. In addition, this work shows that Māori firms face persistently higher interest rates compared to other New Zealand companies. There are parallels with other indigenous peoples due to the challenges with collectively or tribally owned land. The inability to use property as Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE collateral has limited the opportunities for Māori to accumulate financial wealth and grow businesses. A scan of the market shows there has been little in the way of financial innovation for Māori. Our consultation with stakeholders has shed further light on these issues, which can be summarised across the following themes: Scale and coordination; Capability; Asymmetry of information and lack of data; Myopia in decision-making and leadership; and Missing markets and products This work will help us move towards more equitable access to capital for Māori. Conclusion In summarising, we are late to investigating the issues and adopting a Te Ao Maori view of our work. But we are committed and transparent in our activities and aspirations, while working within our legal mandate. Embedding Te Ao Māori in our approach and learning from the different perspectives and knowledge it brings, we will be a great team building a better central bank for New Zealand. Whakakapinga (conclusion) Mā te rongo ka mōhio, mā te mōhio ka mārama, mā te mārama ka mātau, mā te mātau ka ora. (Through information comes awareness, through awareness comes understanding, through understanding comes knowledge, and through knowledge comes life and wellbeing) Nō reira Tēnā koutou, tēnā koutou, tēnā tatou katoa. (Greetings to you all. Thank you.) Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Glossary Te Ao Māori (the Māori world) Kaitiaki (guardians) Tangata Māori (Indigenous people) Matangirua ki Matangireia – working in unison, to fulfil our ultimate purpose Wānanga - Innovation Tauira - Integrity Taura – Inclusion Toitū te Ōhanga, Toitū te Oranga - enabling economic wellbeing and prosperity for all New Zealanders Tāne Mahuta – Māori legend used to explain the interconnected parts of the financial system and RBNZ’s role as guardian of New Zealand’s financial system Te reo me ngā tikanga – Language and culture Whanaungatanga – Advocacy building Kaitiakitanga – Policy Impact Tikanga – cultural custom Haumi – ally, in alliance, to join Te reo Māori – the Māori language Whare - traditional houses Rōpū – group Tēnā koutou katoa - Greetings to you all Aotearoa - New Zealand Whenua - Land Iwi - Tribe Pūtea - Wealth Kaitiakitanga - Guardianship Te Pūtea Matua – Reserve Bank of New Zealand Kaitiaki - Steward Tēnā koutou, tēnā koutou, tēnā tātou katoa - Greetings, greetings, greetings to us all Tihei mauri ora! – Behold the breath of life! More information Improved Access to Capital for Māori (Information on the current status and progress of the Māori Access to Capital work programme). Te Ōhanga Māori – The Māori Economy 2018 (This report on the Maori economy was produced by BERL in 2020. It expands on their 2013 report, providing a rich description of the many roles Māori play in the economy of Aotearoa New Zealand. The Journey of Te Pūtea Matua: our Tāne Mahuta Kaitiakitanga: Te Ao Māori o Te Pūtea Matua - Guardianship: The Māori World View of the Reserve Bank. Speech delivered to the Raising Māori Investment Capability Conference 2020 in Tauranga, New Zealand Ref #X567560 v1.17 IN CONFIDENCE EMBARGOED UNTIL 11.00PM 13 JUNE Reserve bank of New Zealand (2021) Te Pūtea Matua becomes inaugural member of new, international Central Bank Network for Indigenous Inclusion. Stats NZ (2017) National ethnic population projections: 2013: 2013 (base)-2038 (update) Stats NZ (2018) Māori unemployment rate at nine-year low, but twice New Zealand rate. Ref #X567560 v1.17
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Speech by Ms Karen Silk, Assistant Governor of the Reserve Bank of New Zealand, at the KangaNews New Zealand Debt Capital Market Summit 2022, Auckland, 7 September 2022.
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UNCLASSIFIED New Zealand’s Monetary Policy Implementation Framework Speech delivered to KangaNews New Zealand Debt Capital Market Summit 2022 By Karen Silk, Reserve Bank Assistant Governor 7 September 2022 Ref #X750533 v3.4 Introduction1 E ngā mana, e ngā reo. E ngā karanga maha o te wā. Tēnā koutou, tēnā koutou, tēnā koutou katoa, It is great to be here with you all today. I would like to start by acknowledging KangaNews for their continued support of New Zealand’s capital markets and for hosting today’s event. I would also like to acknowledge my colleagues who have given an address at this forum over the last two years, covering the changes to the composition of our balance sheet during the pandemic,2 as well providing an overview of the key strategic drivers of our balance sheet into the future.3 This speech builds on what was covered in those addresses, with a focus on our monetary policy implementation framework. Today, I will talk about two aspects of this monetary policy implementation framework: first, I will outline the changes that we needed to make during the pandemic in order to implement monetary policy effectively; and second, I will talk about how we plan to use this framework into the future. There are four key messages I wish to convey in this speech: Our current monetary policy implementation framework is operationally simple, and provides flexibility for changes in the level of settlement cash. The purpose of settlement cash is to provide for the payment and settlement needs of the banking system. The level of settlement cash is a by-product of, and matching liability to, policy tools on the asset side of our balance sheet. Change to the settlement cash level is not meaningful for the stance of monetary policy, so long as the level is sufficient for payment and settlement needs and balances are remunerated at the Official Cash Rate (OCR). Our monetary policy implementation framework is what we use to ensure that short-term interest rates trade at levels that are consistent with the OCR. The OCR is the interest rate set by the Monetary Policy Committee (MPC). It influences the price of borrowing money in New Zealand and allows us to influence the level of economic activity and inflation.4 It is important to state upfront that the implementation of monetary policy is operational and distinct from the stance of monetary policy, which is determined by the MPC. The stance of monetary policy is primarily determined by the level of the OCR.5 We make changes to the OCR to achieve our monetary policy objectives, but we need it to transmit through to the wider economy for this to work. Financial markets play a key role in this transmission of monetary policy. The way we ensure effective monetary policy implementation is through a framework of facilities and operations that anchor short-term interest rates – which are the starting point for the rest of the yield curve – around the OCR. ____________ With thanks to Kate Poskitt, Michael Callaghan, David Craigie, Cameron Haworth, Lewis Kerr, Ross Kendall, Sandeep Parekh, Vanessa Rayner, and other RBNZ colleagues. Balance Sheet Speech Christian (rbnz.govt.nz) A Strategic View of Te Pūtea Matua’s Balance Sheet (rbnz.govt.nz) The official cash rate - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Monetary Policy Statement February 2022 (rbnz.govt.nz) New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 There is a relationship between our monetary policy implementation framework and the level of settlement cash. The Reserve Bank provides settlement cash so that commercial banks can settle the payments that occur on a daily basis throughout the New Zealand economy. If there is more demand for settlement cash than what we supply, this can affect short-term interest rates. The Reserve Bank manages the supply of settlement cash in order to keep short-term interest rates anchored around the OCR. Our current system of monetary policy implementation allows this to be operationally simple, as the focus is on maintaining settlement cash above a sufficient level, rather than managing every change to the settlement cash level. In part, this speech also seeks to address some of the commentary and confusion that there has been around the role of settlement cash in the economy. I will talk about how additional monetary policy tools (or AMP tools) have affected this settlement cash level, and how we think about this. What matters for monetary policy transmission is the effect that these tools have on interest rates. It is important to understand, then, that the level of settlement cash does not create inflation or deflation; in fact, in New Zealand, we have experienced periods of large settlement cash growth before, without changes to the stance of monetary policy.6 Bringing all of this together, I want to finish the speech by sharing our expectations around the future trajectory of the settlement cash level and how our monetary policy implementation framework will allow this transition to occur smoothly. Changes to our Monetary Policy Implementation Framework The Reserve Bank is the banker to the commercial banks in New Zealand. Banks hold accounts with the Reserve Bank in the Exchange Settlement Account System (ESAS). This system is where banks settle transactions between each other – on behalf of customers – throughout the day. The total amount of account balances held within this system is called the settlement cash level (SCL). While banks can raise or lower their own ESAS account balances, and transactions from the Crown can withdraw and inject settlement cash, the total settlement cash level is determined by the Reserve Bank.7 From Tiers to a Floor System Before the COVID crisis, the Reserve Bank implemented monetary policy via a corridor system, where settlement cash was kept around $7 billion.8 At this time, the Reserve Bank used a mix of tools to inject and withdraw settlement cash, as needed. These withdrawals and injections were focussed on keeping settlement cash at a level that meant short-term interest rates were anchored around the OCR. Banks earned the OCR on balances held in their accounts in ESAS up to a prescribed ‘tier’. Any balance held above a bank’s respective tier was remunerated at a lower level (typically one percentage point under the OCR). This created an incentive for banks to keep their ESAS balances at or below their tier, and to trade amongst themselves to optimise their cash holdings. Under this system, if short-term interest rates were too high, the Reserve Bank would inject settlement cash; if short-term interest rates were too low, the Reserve Bank would withdraw settlement cash. ____________ 6 Changes to the liquidity management regime - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) 7 How the Reserve Bank of New Zealand manages liquidity for monetary policy implementation - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) 8 Technically, the Reserve Bank operated a corridor system of MPI from 1999. Between 2007 and 2020, however, the Reserve Bank used a ‘tiered’ remuneration system, which was a hybrid between a corridor and a floor. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 At the start of the COVID crisis we saw significant market dysfunction, particularly in specific shortterm interest rate markets. This dysfunction caused short-term interest rates to spike, and the Reserve Bank responded by conducting operations which injected a large amount of settlement cash. Further operations to help anchor short-term interest rates were necessary; however, these risked the settlement cash level exceeding the sum of all banks’ credit tiers, meaning it would not be possible for banks to avoid incurring a penalty interest rate. This would have resulted in shortterm interest rates trading well below the level of the OCR. We made the decision to remove credit tiers and move to a floor system of monetary policy implementation, as we had seen many other central banks do since the GFC. Under a floor system of monetary policy implementation, the Reserve Bank remunerates all ESAS balances at the OCR. This means that the Reserve Bank just needs to supply an amount of settlement cash that is greater than, or equal to, the minimum amount needed to prevent upward pressure on short-term interest rates (figure 1). Supplying enough settlement cash so that shortterm interest rates are anchored ensures that payments and settlements function smoothly, as settlement cash is not scarce. By remunerating all banks’ ESAS accounts at the OCR, there is no incentive for banks to lend out their cash in the interbank market below this rate. This creates a ‘floor’, which acts to keep short-term interest rates from coming under downward pressure. The acute market dysfunction at the start of the COVID crisis was short-lived, largely due to the actions of central banks around the world to address this. However, as the crisis progressed and lockdowns were announced globally, financial market functioning deteriorated again. We started to see serious issues in New Zealand government bond and credit markets, with the spread between government and corporate bond yields widening, and the shape of yield curves distorting, as well as concerns from issuers about their ability to raise debt. Figure 1: Stylised corridor and floor systems of monetary policy implementation 9 ____________ 9 Adapted from: Reserve Bank of Australia, (2022). An international perspective on monetary policy implementation systems. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 AMP Tool Roll-Out Around this time, the MPC took the decision to introduce AMP tools, in order to provide additional monetary stimulus, as the banking system was not operationally ready for negative interest rates. Initially, this was in the form of the Large Scale Asset Purchase (LSAP) programme. There were two key objectives of the LSAP programme: first, to provide economic stimulus by lowering interest rates across the yield curve; and second, to support market functioning, in order for the economic stimulus to transmit through financial markets. LSAP bond purchases were financed by settlement cash. The Reserve Bank credited ESAS accounts with settlement cash when the bonds were purchased. This resulted in a higher level of settlement cash than what was needed for banks’ payment and settlement needs, and a higher level than what was needed to anchor short-term interest rates. For the Reserve Bank’s balance sheet, buying bonds in the LSAP programme generates an asset: the government bonds. This asset is matched by a liability: settlement cash, which is held in ESAS accounts by banks. For bank balance sheets, these purchases resulted in a new asset: settlement cash. This asset is matched by a new liability, which in many cases, are bank deposits from those who previously owned the government bond. Another AMP tool deployed by the MPC to achieve its desired level of monetary stimulus was the Funding for Lending (FLP) programme. For the Reserve Bank’s balance sheet, this generated a new liability: settlement cash that had been lent to banks. This was matched by an asset: the transaction (called a repurchase or ‘repo’ agreement) in which banks pledge collateral against this lending.10 For bank balance sheets, the FLP creates a new liability of a loan, and a new asset of settlement cash. As with the OCR, AMP tools must be transmitted through to the economy to have effect. The transmission of the LSAP programme is via three main channels: the policy signalling channel; the portfolio rebalancing channel; and the market functioning channel. The FLP transmits by lowering funding costs for banks. This in turn lowers funding costs for all banks and non-banks, by reducing demand for other funding.11 The Reserve Bank views the creation of settlement cash as a by-product of these AMP tools, not a channel through which monetary policy transmits. Changes to the Monetary Base Settlement cash has been main driver of the size of the monetary base or base money in recent years. Base money is made up of settlement cash and physical currency in circulation. Only the Reserve Bank and the Crown can change the level of the monetary base. When tax is paid, for example, this withdraws settlement cash, because banks settle the tax payments of their customers by transferring funds from their ESAS account to the Crown account. When a government bond matures, this has the opposite effect: the Crown pays funds into the ESAS accounts of the bondholder’s banks; the banks then reflect these payments in their customers’ accounts. The Reserve Bank purchasing bonds in the LSAP programme and extending loans in the FLP increased the settlement cash level, and therefore the monetary base. ____________ 10 See What is the repo market? Why does it matter? (rbnz.govt.nz) for an explanation of the repo market and how a repurchase agreement transaction works. 11 See RAMPed up: RBNZ's Additional Monetary Policy toolkit for a discussion of the channels through which AMP tools transmit. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 Does this high level of settlement cash matter? Throughout most of central banking history, this expansion of settlement cash would have been important, because central banks used to manage the amount of base money for monetary policy purposes. Several decades ago, however, central banks moved to targeting the price of money rather than the quantity of money.12 In New Zealand, this is done through the OCR, which was introduced in 1999. The expansion of the monetary base during the COVID crisis was not the first time we have had a large increase in settlement cash (figure 2). In 2006, the Reserve Bank ‘cashed up’ the system, moving from a settlement cash level of $20 million to about $8 billion, and at the time, noted that: The new regime is a technical change to the way the payment system is liquefied − there is no impact on monetary policy. Since the introduction of the OCR, the actual quantum of cash left in the payment system overnight has not been relevant from a monetary policy perspective, provided that the liquidity is supplied at a rate consistent with the OCR.13 Put differently, the monetary base has moved from being a tool of monetary policy to being a byproduct of the price-based tools of monetary policy. Figure 2: Monetary base and broad money 2001-2022, both in NZ$ billion14 Broad money (left axis) Dec 21 Feb 21 Apr 20 Jun 19 Aug 18 Oct 17 Dec 16 Feb 16 Apr 15 Jun 14 Aug 13 Oct 12 Dec 11 Feb 11 Apr 10 Jun 09 Aug 08 Oct 07 Dec 06 Feb 06 Apr 05 Jun 04 Aug 03 Oct 02 Dec 01 Monetary base (right axis) ____________ 12 For example, the Federal Reserve under Greenspan placed increasing emphasis on managing the federal funds rate, and gave less and less prominence to monetary aggregates through the 1980s and 1990s. In September 1998, the Federal Open Market Committee (FOMC) initiated the practice (which is still in practice) of announcing a target for the federal funds rate following each of its meetings. In June 2000, the FOMC stopped announcing target ranges for money growth. In 2008, the Federal Reserve was given the authority to start paying interest on reserves (called interest on reserve balances (IORB). See: Why did the Federal Reserve start paying interest on reserve balances held on deposit at the Fed? Does the Fed pay interest on required reserves, excess reserves, or both? What interest rate does the Fed pay? | SF Fed (frbsf.org) and also: Keister, T., Martin, A., McAndrews, J. (2008). Divorcing money from monetary policy. FRBNY Economic Policy Review, 41-56. And: Kiester, T. and McAndrews, J. (2009). Why Are Banks Holding So Many Excess Reserves? FRBNY Economic Policy Review, 15(8), 1-10. 13 Changes to the liquidity management regime - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) 14 All data accessible on the RBNZ website, specifically: Influences on settlement cash (D10) - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) and Depository corporations: Money and credit aggregates (C50) - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 Broad Money Creation Broad money is the sum of all liquid financial instruments accepted as a medium of exchange, plus those that can be converted into a medium of exchange at short notice. While the Reserve Bank directly controls the creation of base money, the amount of broad money depends on interactions between banks and their customers. The Reserve Bank’s monetary policy can influence the amount of broad money, but it does not directly control it. Most broad money is in the form of bank deposits. Deposits are a bank’s promise to allow their customer to withdraw base money. In practice, most depositors leave their money as a deposit, and make payments by transferring deposits to other people. Bank deposits are created through bank lending. This lending is profitable for banks, because they charge more interest on loans than they pay on deposits.15 The level of settlement cash or base money used to be a constraint on bank lending; there was a relationship between base money and broad money that could be explained by a money multiplier.16 Central banks at this time controlled the level of base money, and rules around base money holdings relative to broad money creation, in order to manage bank lending. There is now no explicit prudential requirement to hold settlement cash or base money, and a range of liquid assets can be used to satisfy liquidity requirements. Changes to base money do not, by themselves, materially change the incentives for broad money creation through bank lending.17 As was noted in the August 2022 MPS, the volume of commercial bank lending is determined by several factors including customer demand for loans, banks’ perception and appetite for risk, and prudential requirements on banks’ capital, cash and other liquid assets and funding. While AMP tools have supported bank funding and liquidity positions, there is some evidence that suggests that this is not having an impact on lending activity over and above their impact on interest rates. 18 The OCR is set by the MPC based on the assessment and forecast of economic conditions. Lowering the OCR incentivises borrowing; raising the OCR incentivises saving. The level of settlement cash held in ESAS accounts in and of itself does not impact the demand for credit.19 Credit growth has slowed recently, as would be expected in the context of rising interest rates.20 ____________ 15 See Money in the modern economy: an introduction | Bank of England for an introduction to different types of money and how money works in the economy. 16 See Teaching the Linkage Between Banks and the Fed: R.I.P. Money Multiplier | St. Louis Fed (stlouisfed.org) for understanding how this has changed from what used to be taught. 17 See Bank of England Quarterly Bulletin 2014 Q1 for a simple explanation of money creation, the role of QE, and the relationship between base money and broad money. 18 See The International Experience of Central Bank Asset Purchases and Inflation - Liberty Street Economics (newyorkfed.org), specifically: “From an economic logic perspective, the reason that the commercial banks might be reluctant to lend depends on the extent to which they assess that there are creditworthy customers, so that the return on their loans is larger in risk-adjusted terms that the return on reserves. Other formal constraints on bank lending stem from the capital requirements that relate to quantity and quality of the assets that the banks must hold to fulfil regulatory obligations…” See Bank of England Working Paper No. 511, specifically: “Our analysis suggests that QE operating through a portfolio rebalancing channel gave rise to such flighty deposits and that this is a potential reason that we find no evidence of a bank lending channel. Our evidence is consistent with other studies which suggest that QE boosted aggregate demand and inflation via portfolio rebalancing channels.” 19 Bloor, C. et al. (2008) ‘The use of money and credit measures in contemporary monetary policy’ Reserve Bank of New Zealand: Bulletin, 71(1). 20 Monetary Policy Statement August 2022 (rbnz.govt.nz) New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 Our MPI Framework into the Future AMP Tool Wind-Down At the February 2022 MPS, the MPC announced that the Reserve Bank will not reinvest the proceeds of any upcoming LSAP bond maturities, and will also sell down $5 billion in government bonds per fiscal year to New Zealand Debt Management (NZDM).21 The combination of these sales and maturities mean that the Reserve Bank’s LSAP holdings will be wound down by 2027. These sales will continue in the background, provided they remained consistent with the Bank’s monetary policy objectives, and subject to market conditions. Sales and maturities of government bonds held by the Reserve Bank do not have a direct impact on the settlement cash level, because these transactions are between the Reserve Bank and the Crown. When LSAP bonds mature, the Crown pays out par value to the Reserve Bank; similarly, when LSAP bonds are sold, the Crown pays the Reserve Bank for the market value of the bond. These payments reduce the Crown account, but do not directly impact the settlement cash level. The Crown needs to finance payments to the Reserve Bank, and the additional net debt financing or net revenue will drain settlement cash from the system.22 The exact timing of the decrease in settlement cash will depend on how the Crown manages their Crown account.23 The FLP is simpler from a settlement cash perspective: as this funding matures, banks will pay back the money that they have borrowed. This payment from banks to the Reserve Bank reduces the settlement cash level, as it has the impact of withdrawing settlement cash from ESAS. The final maturity for the FLP will be toward the end of 2025. Retaining a Floor System As announced in May this year, the Reserve Bank intends to retain a floor system going forward.24 There are two key reasons to retain this system. First, because it is flexible in allowing for effective monetary policy implementation at varying levels of settlement cash. Second, because it is operationally efficient – for both the Reserve Bank and the wider banking system. These benefits are acknowledged by other central banks who use a floor system of monetary policy implementation.25 A floor system is operationally efficient for the Reserve Bank as the focus is on managing any flows that reduce settlement cash below a sufficient level, rather than managing all flows that change the settlement cash level. A floor system is also less operationally intensive for the banking system, as banks can focus on managing their overall liquidity needs without needing to manage daily settlement cash changes. ____________ 21 Monetary Policy Statement February 2022 (rbnz.govt.nz) 22 See debtmanagement.treasury.govt.nz/investor-resources/202223-new-zealand-government-bond-programme-set-nz25-billion specifically: “From 2022/23 onwards, sales by the Reserve Bank of New Zealand (RBNZ) of NZGBs held under the Large-Scale Asset Purchase (LSAP) Programme, to New Zealand Debt Management (NZDM), are incorporated in the forecasts at a rate of NZ$5 billion per fiscal year. This leads to higher gross issuance, and NZGB repurchases, of a total of NZ$20 billion across the forecast period. Bonds repurchased from the RBNZ will be retired. Further operational details will be communicated ahead of the first transaction.” 23 See this liquidity approach here: Building resilience in the Crown’s liquidity management.pdf (treasury.govt.nz). Note that the higher liquidity buffer can come in the form of more cash held in the CSA, a larger portfolio of marketable securities, or a combination of both. This is expected to occur after the April 2023 nominal bond maturity: New Zealand Government Securities Funding Strategy 2022/23: Edition 1 (treasury.govt.nz) 24 Reserve Bank optimising New Zealands monetary policy implementation framework - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) 25 For example, see A Return to Operating with Abundant Reserves - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org) where the benefits of a floor system of ample reserves is discussed: “First, it provides effective control over short-term interest rates in a broad range of environments, including during periods when large amounts of liquidity are needed to relieve stress in the financial system or large-scale asset purchases are required to support the U.S. economy. And, second, from an operational perspective, a steady-state ample reserves regime can be simple and efficient to operate.” New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 Banks need settlement cash to meet payment and settlement needs, as well as a precautionary buffer for any payment and settlement shocks.26 The Reserve Bank will maintain settlement cash above a level that is sufficient for payments and settlement needs, plus a buffer. This buffer will mean that small changes in supply and demand have little impact on short-term interest rates. Additionally, under a floor system, settlement cash can be freely injected, should there be a situation where there is higher precautionary demand.27 Figure 3: Expected change to settlement cash level as AMP tools unwind28 Moving to a Lower Level of Settlement Cash As AMP tools wind down, the settlement cash level will decline from its current peak. The floor system will provide continuity over this period. This system is robust to changes in demand for, and supply of, settlement cash, up until the point at which we drop to a sufficient level of settlement cash. When we are nearing this lower level, the Reserve Bank will need to begin to inject settlement cash, in order to offset the impact of the AMP tool wind-down (figure 3). The sufficient level of settlement cash in the future may be higher than pre-COVID levels, but will be lower than the present level. There is uncertainty around what level of settlement cash will best anchor short-term interest rates, particularly as there has been a lot of change in the period since we introduced a floor system. In addition, this level will not be static – for example, an increase in precautionary demand for settlement cash in a crisis might necessitate a higher level of settlement cash to best anchor short-term interest rates. What we can learn from the international experience is that it is important to monitor a wide range of wholesale interest rates as we move toward this lower level. ____________ 26 Banks hold settlement cash for payment and settlement needs, as a buffer for precautionary demand and for investment demand, if the return in ESAS accounts is relatively attractive. This investment demand was a reason that we used tiers to manage settlement cash historically, however, changes in the amount of government bonds outstanding since the GFC mean that this is now less of a concern. Prior to the GFC, outstanding NZGBs were only around 10% of GDP. Post-GFC, outstanding NZGBs have increased to above 20% of GDP and there is a commitment to keep NZGBs on issue above this 20% level. 27 See Implementing Monetary Policy: Perspective from the Open Market Trading Desk - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org) for a discussion of how a buffer may work. Specifically: “To remain in a floor system, the Federal Reserve would need to supply enough reserves to satisfy bank demand along the flat portion of the reserves demand curve. It would also need to ensure that even amid shocks to non-reserve liabilities, the supply of reserves would stay on the flat part of the demand curve.” And: “An important trade-off in a floor system arises between the size of that additional buffer and the frequency and size of open market operations. In the current floor framework, the buffer is more than large enough to absorb shocks without the need to conduct offsetting open market operations.” 28 Adapted from: Hauser, A. (2021, September 13). Bigger, broader, faster, stronger? How much should tomorrow’s central bank balance sheets do – and what should we leave to financial markets? Some principles for good parenting [speech]. Oxford Conference on ‘The Financial System(s) of Tomorrow’, Saïd Business School, University of Oxford, United Kingdom. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 To anchor short-term interest rates, we will need to ensure that settlement cash does not become scarce. This means that the level in the future will be above the minimum amount of settlement cash needed for payment and settlement needs. If settlement cash becomes scarce, we may see upward pressure on short-term interest rates. As well as monitoring short-term interest rates, usage of our facilities and uptake of our operations can provide useful information. For example, frequent usage of our Overnight Reserve Repo Facility – where eligible counterparties can access settlement cash at the OCR plus a spread on a collateralised basis – would be a sign of scarcity. The Reserve Bank has a wide range of tools available to inject and withdraw settlement cash, and is able to deploy all or any one of these, depending on where demand or stress is coming from. Staff will continue to carefully monitor money market conditions, usage of our facilities and operations, and the distribution of settlement cash across banks, to ensure that the transition to a lower level of settlement cash proceeds smoothly. The Reserve Bank will regularly review the operational design of our facilities, based on usage, financial market conditions, and market feedback, to ensure that short-term interest rates trade around the OCR. As well as reviewing our facilities, the Reserve Bank will continue to consider the optimal mix of tools and operations to ensure short-term interest rates are anchored, within our floor system of monetary policy implementation. Conclusion To conclude, the AMP tools employed during the COVID crisis increased the size of the Reserve Bank’s balance sheet. On the liabilities side, this resulted in a by-product of high settlement cash. This quantity of settlement cash does not impact the implementation of monetary policy under a floor system. This is because, above a sufficient level of settlement cash, short-term interest rates are anchored by all ESAS balances being remunerated at the OCR. It is only if the amount of settlement cash falls below a sufficient level that it will have a material impact on short-term interest rates. This is different to before COVID, when, under the corridor system of credit tiers, changes to the level of settlement cash did impact the implementation of monetary policy. That is, before COVID, the level of settlement cash had to be tightly managed to ensure that short-term interest rates traded around the OCR. It is important to re-emphasise the distinction between the implementation of monetary policy – which has been the focus of this speech – and the stance of monetary policy. While changes to the level of settlement cash during COVID have resulted in changes to the implementation of monetary policy, these were not relevant for the stance of monetary policy. The quantity of settlement cash has not been important for the stance of monetary policy for a long time – as long as that settlement cash is remunerated at the OCR. It is the stance of monetary policy that sets the financial conditions for the economy, influences bank lending, and acts on inflation. The OCR remains the Reserve Bank’s primary tool for determining this stance of monetary policy. Settlement cash will decline to a lower level as AMP tools wind-down and the Reserve Bank’s balance sheet reduces. It is not expected that these changes will have an impact on financial market functioning or the broader economy. We will reach a point at which we will need to inject settlement cash via other tools, in order to maintain a sufficient settlement cash level. At this point, the liability – settlement cash – on the Reserve Bank’s balance sheet will need to be maintained, but the composition of the assets that correspond to this liability will change. These assets will change from being those corresponding with AMP tools, to those corresponding with the mix of liquidity providing tools or operations that the Reserve Bank deems appropriate. Market participants can be confident that the Reserve Bank will continue to actively monitor market conditions, provide facilities and conduct operations to ensure that short-term interest rates will remain anchored around the OCR, as the balance sheet evolves in the years ahead. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 References Afonso, G., Cipriani, M., La Spada, G., and Riordan, W. (2020). A New Reserves Regime? COVID-19 and the Federal Reserve Balance Sheet. Federal Reserve Bank of New York Liberty Street Economics Afonso, G., Giannone, D., La Spada, G., and Williams, J. (2022). Scarce, Abundant, or Ample? A Time-Varying Model of the Reserve Demand Curve. Federal Reserve Bank of New York Staff Reports, 1019. 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Bank reserves and broad money in the global financial crisis: a quantitative evaluation. ECB Working Paper Series, 2463. Copeland, A., Duffie, D., and Yang, Y. (2022). Reserves were not so ample after all. National Bureau of Economic Research Working Paper, 29090. Hauser, A. (2021, September 13). Bigger, broader, faster, stronger? How much should tomorrow’s central bank balance sheets do – and what should we leave to financial markets? Some principles for good parenting [speech]. Oxford Conference on ‘The Financial System(s) of Tomorrow’, Saïd Business School, University of Oxford, United Kingdom. Hawkesby, C. (2020, August 20). COVID-19 and the Reserve Bank’s Balance Sheet [speech]. KangaNews New Zealand Capital Markets Forum, Wellington, New Zealand. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4 Holm-Hadulla, F., Musso, A., Rodriguez Palenzuela, D., and Vlassopoulos, T. (2021). Evolution of the ECB’s analytical framework. ECB Occasional Paper Series, 277. Honda, Y., Kuroki, Y., and Tachibana, M. (2013). An Injection of Base Money at Zero Interest Rates: Empirical Evidence from the Japanese Experience 2001–2006. Japanese Journal of Monetary and Financial Economics, 1(1), 1-24. Ihrig, J., Senyuz, Z. and Weinbach, G. (2020). Implementing Monetary Policy in an "AmpleReserves" Regime: The Basics. FEDS Notes. Keister, T. (2012). Corridors and Floors in Monetary Policy. Federal Reserve Bank of New York Liberty Street Economics Keister, T., Martin, A., McAndrews, J. (2008). Divorcing money from monetary policy. FRBNY Economic Policy Review, 41-56. Kiester, T. and McAndrews, J. (2009). Why Are Banks Holding So Many Excess Reserves? FRBNY Economic Policy Review, 15(8), 1-10. Kengmana, B. (2021). RAMPed up: RBNZ’s Additional Monetary Policy toolkit. Reserve Bank of New Zealand Bulletin, 84(1). Logan, L. (2017, May 18). Implementing Monetary Policy: Perspective from the Open Market Trading Desk [speech]. Money Marketeers of New York University, New York City Logan, L. (2020, December 1). A Return to Operating with Abundant Reserves. Remarks before the Money Marketeers of New York University, New York City McLeay, M. Radia, A., and Thomas, R. (2014). Money in the modern economy: an introduction. Bank of England Quarterly Bulletin, Q1. McLeay, M., Radia, A., and Thomas, R. (2014). Money Creation in the Modern Economy. Bank of England Quarterly Bulletin, Q1. Miller, S. and Wanengkirtyo, B. (2020). Liquidity and monetary transmission: a quasi-experimental approach. Bank of England Working Paper, 891. Neild, I. (2006). Changes to the liquidity management regime. Reserve Bank of New Zealand Bulletin, 69(4), 26-31. Neild, I. (2008). Evolution of the Reserve Bank’s liquidity facilities. Reserve Bank of New Zealand Bulletin, 71(4), 5-17. Parekh, S. (2016). How the Reserve Bank of New Zealand manages liquidity for monetary policy implementation. Reserve Bank of New Zealand Bulletin, 79(9). Rayner, V. (2021, June 2). A Strategic View of Te Pūtea Matua’s Balance Sheet [speech]. KangaNews New Zealand Capital Markets Forum, Wellington, New Zealand. Reserve Bank of Australia, (2019). The Framework for Monetary Policy Implementation in Australia. New Zealand’s Monetary Policy Implementation Framework UNCLASSIFIED Ref #X750533 v3.4
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Speech (written by Maisie Prior) by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Financial Services Council, Auckland, 22 September 2022.
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Our Transformation as a Prudential Regulator A speech delivered to the Financial Services Council in Auckland on 22 September 2022 By Christian Hawkesby, Deputy Governor and General Mananger Financial Stability Written with Maisie Prior Ref #X798971 v1.2 UNCLASSIFIED Introduction Kia ora koutou katoa. Tēnā koutou katoa. It is a pleasure to speak to you today at the annual Financial Services Council Conference. This was the first speaking invitation that I received when I took up the role of Deputy Governor and General Manager of Financial Stability. It is a great opportunity to outline what’s next for the Reserve Bank, Te Pūtea Matua as a prudential regulator and supervisor. In one sense, this role is new to me. I have spent much of the past ten years being regulated rather than being a regulator. In another sense, it is familiar territory, given my time on our internal Financial Stability Committee since 2019, and experience at the Bank of England earlier in my career. As an institution we are going through the most significant changes since the Reserve Bank of New Zealand reforms of the 1980s. Phase one of these changes was to our approach to monetary policy. They came into force on 1 April 2019 and provided us with a dual mandate – price stability and contributing to maximum sustainable employment – and established our Monetary Policy Committee (MPC), replacing the single decision-maker model.1 Today, I’ll focus on the result of phase two of these reforms, relating to our institutional arrangements and approach to financial stability, as a prudential regulator and supervisor. This has been an important and exciting opportunity for us, the Treasury and Government, to lead a review of the Reserve Bank’s whole institutional and financial stability framework, almost from a ‘clean slate’. The objective has been to build a framework that fits our role and responsibilities as a modern kaitiaki (guardian) of the financial system of Aotearoa, New Zealand. I’d like to begin by acknowledging the mahi done by my predeccesor as Deputy Governor, Geoff Bascand. Much of what I’ll be covering today brings to life the approach he signalled in a speech three years ago as these reforms were first taking shape. 2 I’ll begin by providing some background to our responsibility for financial stability, and our role through history, both as an institution and as part of a global community of central banks and prudential regulators. I’ll then outline how the expectations on us are changing, and how this has translated to changes to our legislation and mandate, including our new overarching purpose to “promote the prosperity and wellbeing of New Zealanders and contribute to a sustainable and productive economy”. ____________ 1 See Hawkesby, C. (2019). Maintaining credibility in times of change. Panel remarks delivered to the Institute for Monetary and Economic Studies (Bank of Japan) in Tokyo, available at: rbnz.govt.nz/hub/publications/speech/2019/speech2019-05-30 2 See Bascand, G. (2019). Renewing the RBNZ’S approach to financial stability. Speech delivered to the 15th Financial Markets Law Conference in Auckland, available at: rbnz.govt.nz/hub/publications/speech/2019/speech2019-06-26 Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED Finally, I’ll cover what our new approach means for our mahi, and our relationships with regulated entities. In particular: How our Financial Policy Remit guides us to seek a strong, efficient, innovative and inclusive financial system. How our Statement of Prudential Policy outlines that we will be proactive, evidence-led and risk-based, proportionate, collaborative and outcomes-focussed. How our Relationship Charter holds us to account to have clear, consistent and timely communication and to work together with the industry to prioritise our shared mahi. These changes to our legislation, mandate, tools, powers, and approach provide the foundational roots for our role as a modern kaitiaki of our financial system. The Rationale for Prudential Regulation and Supervision But first, it is important to step back and briefly remind ourselves why there is a role at all for a public policy institution like Te Pūtea Matua to have responsibility for financial stability.3 A sound and well-functioning financial system – financial markets, financial institutions, payments systems – provides a public good shared by society in much the same way that physical infrastructures – such transport, energy, water and communications – provide benefits felt much more widely than by individual users of these networks. The role of the financial system is to enable saving and spending to be managed over time and through different states of the world. The financial system plays a crucial role in allocating economic resources and managing risks. Businesses, households and communities rely on a well functioning financial system to live their lives and engage in society. At the same time, we know that financial systems can be inherently vulnerable. Financial risks are not always adequently identified, priced, or allocated to those best placed to manage them. This is illustrated by plenty of examples through history of herd behaviour and irrational exuberance. In addition, the financial system is highly interconnected, meaning a failure in one part can quickly spread and endanger the wider system as a whole. Importantly, as a public good, the costs of financial instability can be felt far beyond the management, shareholders or customers of individual financial institutions. Again, history is littered with examples of financial crises that have caused widespread damage to the broader economy and society. The Global Financial Crisis (GFC) is still fresh in the mind. ____________ 3 See Orr, A. (2006). Towards a framework for promoting financial stability in New Zealand. Speech delivered to the Institution of Professional Engineers New Zealand, available at: rbnz.govt.nz/hub/publications/speech/2006/speech2006-03-22 Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED The History of Te Pūtea Matua’s Role in Prudential Regulation and Supervision Well before their more familiar role of setting interest rates to achieve price stability, central banks globally have been tasked with maintaining financial stability. The existence of central banks was born out of being the strongest financial institution, acting as the banker to the crown (government) and to the banking system (private banks). This history goes back to Sweden’s Riksbank (established 1668), England’s Bank of England (established 1696), the United States’ Federal Reserve (established 1913), and, for New Zealand, the Reserve Bank of New Zealand (established 1934). This position at the heart of the financial system made central banks the natural institution to also take a public policy role, with responsibility for the stability of the financial system as a whole. In New Zealand, the first formal responsibility for prudential regulation and supervision of banks was provided for in the 1986 Reserve Bank of New Zealand Amendment Act.4 The creation of the Reserve Bank of New Zealand Act 1989 carried over this responsibility, with the purpose of ‘promoting the maintenance of a sound and efficient financial system’. These changes followed the New Zealand financial reforms of the 1980s, including privatisation of the banking system and liberalisation of financial markets. Following these reforms, and throughout the 1990s, the Reserve Bank was well known internationally for its ‘light touch’ approach to supervision, and its focus on disclosure and market discipline.5 The absence of deposit protection was a distinguishing feature of New Zealand’s regulatory and supervisory approach. 6,7 This approach was designed to align incentives on banks’ boards and ensure the sound management of banks. It also meant that depositors had a strong incentive to monitor the financial strength of their bank. At an extreme, it was an approach of buyer beware. Broadening Expectations on Central Banks and Prudential Regulators However, there has been a significant change in the landscape since then. Lessons have been learnt from experience both domestically and internationally, especially from the Global Financial Crisis. There are also growing expectations on us, as well as on central banks and prudential regulators internationally, to take a wider view of the financial system, recognising its interconnectedness with the rest of society. Some of these broadening expectations on us include: ____________ 4 See Hunt, C. (2016), A short history of prudential regulation and supervision at the Reserve Bank. Reserve Bank Bulletin vol 79 (14), available at: rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/bulletins/2016/2016aug79-14.pdf 5 Our tradition of the importance of market discipline through disclosure still endures, and is why we have created the Bank Financial Strength Dashboard, and support the development and strengthening of mandatory climate disclosures. 6 See Brash, D. (1996). A new approach to banking supervision. Address to the Centre for the Study of Financial Innovation, available at: rbnz.govt.nz/hub/publications/speech/1996/speech1996-06-05 7 As part of the proposed Deposit Takers Act, a Deposit Compensation Scheme (DCS) is proposed to be introduced. This will allow consumers to have confidence that their deposited funds are safe in the event of an entity failing, up to a total of $100,000 per institution, per depositor. Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED Expectations to be responsible for the prudential regulation of more than just banks. For us, this means we are also responsible for the prudential regulation of non-bank deposit takers, financial market infrastructures, and insurance companies in New Zealand. These types of financial institutions serve important roles in New Zealanders’ lives, and also present different risks to the financial system. Expectations to use more than market discipline. While market discipline still plays an important role, there are expectations on us to also apply greater regulatory discipline to have a more intensive approach to supervision. This was highlighted in the International Monetary Fund’s 2017 Financial Sector Assessment Program report of New Zealand, and through lessons learned from the failure of CBL Insurance.8,9 Expectations on us to be fully prepared for crisis management. During the Global Financial Crisis, the government established a temporary deposit compensation scheme, which highlighted that our strict approach of disclosure, market discipline, and buyer beware was not enough. The Government has announced that it intends to introduce a permanent deposit compensation scheme, to bring us in line with our international peers.10 Expectations on us to recognise the role financial stability plays in enabling financial inclusion and financial innovation. Financial stability is the foundation needed to enable financial inclusion and innovation, to help create a diverse and vibrant financial system that serves all New Zealanders. Expectations on us to take a long-term perspective on issues like climate change. We are recognising the impacts that climate change can have on the financial system. We released our climate change strategy in 2018, which focuses on ways in which we can contribute to efforts to identify, understand and manage the risks of climate change for New Zealand's financial system. We are also part of the network for greening the financial system (NGFS), a global network of 114 central banks and financial supervisors.11 Expectations on us to work collaboratively with other regulators, both domestically and internationally. We are part of the Council of Financial Regulators (CoFR), along with the other financial system regulators in New Zealand: the Financial Markets Authority; the Commerce Commission; the Ministry of Business, Innovation and Employment; and The Treasury.12 We also maintain relationships with central banks and prudential regulators around the world, including as part of the Trans-Tasman Council on Banking Supervision. ____________ 8 The 2017 FSAP is available here: imf.org/en/Publications/CR/Issues/2017/05/08/New-Zealand-Financial-Sector-Assessment-ProgramFinancial-System-Stability-Assessment-44886 ; 9 Some of the lessons learned from the CBL Insurance failure are available in the 2019 Trowbridge-Scholtens independent review for the Reserve Bank, available here: rbnz.govt.nz/-/media/project/sites/rbnz/files/regulation-and-supervision/insurers/cbl-rbnz-finalreport.pdf?sc_lang=en&hash=A6F0AC8845692B6D20C6D9620E86ADD0 10 Every other OECD country, apart from Israel, currently has a formal deposit insurance scheme in place. 11 More information about the NGFS is available on their website: ngfs.net/en 12 In New Zealand, we have a ‘twin peaks’ model for financial sector regulation: prudential regulation is undertaken by the Reserve Bank of New Zealand; conduct regulation is undertaken by the Financial Markets Authority. Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED Expectations on us to incorporate a Te Ao Māori perspective and embed the strengths and benefits this provides.13 We recognise that we need to build relationships with tangata whenua to influence the long-term economic wellbeing of Aotearoa, and have developed a Te Ao Māori (Māori world) strategy. We are a co-founder of the Central Bank Network for Indigenous Inclusion,14 which aims to share knowledge and best practices, promote engagement with Indigenous Peoples, and foster greater understanding and education about indigenous economic issues and histories. Expectations on us to earn our social license to operate by being transparent, accessible and accountable to all of society. All of these expectations come together to capture our role as kaitiaki of the financial system – both part of the financial system and the long-term guardian and caretaker. They also serve to remind us that our responsibility for the stability of the financial system is a means to an end, rather than the end itself. That is, financial stability can be a powerful enabler of a virtuous circle of prosperity and wellbeing, financial inclusion, environmental sustainability and social cohesion. 15 Legislative Change to Align with these Growing Expectations In many ways, the current reform of the Reserve Bank of New Zealand Act 2021 (the Act), and other legislative changes, play catch up to these broadening expectations on us, providing us with the legislation, mandate, tools and powers to fulfil our role as a modern, agile and transparent prudential regulator. Reserve Bank of New Zealand Act 2021 The new Act came into force on 1 July 2022 and focuses on the governance and institutional arrangements here at Te Pūtea Matua. Some of the key components of this legislation are: Purpose: The Act sets out that our new overarching purpose is to ‘promote the prosperity and wellbeing of New Zealanders and contribute to a sustainable and productive economy’.16 This recognises that the financial system plays a crucial role in delivering on our purpose, by enabling saving, spending and risk to be managed through time and different states of the world. We translate our purpose in Te Reo Māori to ‘Toitū te Ōhanga, Toitū te Oranga’. ____________ 13 See Hawkesby, C. (2021). The Future is Māori. Paul remarks delivered to the Institute of Directors New Zealand Leadership Conference in Tāmaki Makaurau, available at: rbnz.govt.nz/hub/publications/speech/2021/speech2021-05-06 14 The network was established in early 2021, and the other founding members are the Bank of Canada and the Reserve Bank of Australia. The US Federal Reserve joined the network in late 2021. For further information on the network, see the 28 April 2021 media release ‘Te Pūtea Matua becomes inaugural member of new, internatilonal Central Bank Network for Indigenous Inclusion’, available at: rbnz.govt.nz/hub/news/2021/04/te-putea-matua-becomes-inaugural-member-of-new-international-central-bank-network 15 See Orr, A, (2022). Why we embraced Te Ao Māori. Speech delivered to the Central Banking Global Summer Meetings 2022, available at: rbnz.govt.nz/hub/publications/speech/2022/speech2022-06-13 16 The other purpose of the Act is to ‘provide for the contiunation of the Reserve Bank of New Zealand’, see section 3(a) of the Reserve Bank of New Zeaalnd Act 2021, available at: legislation.govt.nz/act/public/2021/0031/latest/LMS286982.html Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED Objective: The Act gives us a new overarching financial policy objective of ‘protecting and promoting the stability of New Zealand’s financial system’. This runs parallel to our economic (monetary policy) objective.17 The high level financial stability objective recognises our role in mitigating risks to the financial system, and provides direction for sector-specific regulation. It also recognises the role of our functions in stabilising the financial system during times of stress. Mandate: The Act introduces the requirement for a Financial Policy Remit, as the sister document to the Monetary Policy Remit. This outlines the matters that the Minister of Finance considers desirable for us to have regard to in relation to our financial stablity objective. Governance: The Act brings into force new governance arrangements, with an independentlyappointed Board responsible for all decision-making (except decisions made by the Monetary Policy Committee). The Board has overall responsibility for our strategic direction, functions and operations, and ultimate accountability for delivery. The Board is comprised of a diverse membership, to match the varied skills and experiences required to govern Te Pūtea Matua. 18 Collaboration: The Act provides statutory recognition for CoFR, further enabling the coordination of the agencies regulating our financial system, to support effective and responsive regulation. Transparency: The Act embeds transparency around our mahi through the requirement to publish a Statement of Prudential Policy, which outlines how we will act as a prudential regulator and supervisor. In addition, we are required to publish an annual Statement of Performance Expectations and a Statement of Financial Risk Management. Other Legislative Changes At the same time as this significant legislative change, other legislation relating to our functions is at various stages of being developed, refreshed and reviewed. This reflects the need to modernise and strengthen our prudential frameworks to reflect changes in markets, our understanding of risks and international practice. In the near term, we will be implementing significant changes to our legislative and regulatory framework, including for: Deposit Takers: through the proposed Deposit Takers Act, including the introduction of a depositor compensation scheme; Insurers: our review of the Insurance (Prudential Supervision) Act 2010, and updated solvency standards for insurers; and Financial Markets Infrastructures: implementing the Financial Markets Infrastructure (FMI) Act 2021, including developing standards for designated FMIs. A common theme of this legislative review and development is ensuring that we have a coherent framework and all the necessary modern tools to license, designate, regulate, supervise, enforce compliance, and resolve failing institutions. ____________ 17 Our economic objective is to achieve and maintain stability in the general level of prices over the medium term, and support maximum sustainable employment. See section 9(1)(a)(i) and (ii) of the Reserve Bank of New Zealand Act 2021, available at: legislation.govt.nz/act/public/2021/0031/latest/LMS287017.html 18 A list of our Board members is available on the RBNZ website: rbnz.govt.nz/about-us/our-people/our-board-members . Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED In essence, we are shifting from a world where our legalisation provided us with only a very limited set of tools, to a world that provides us with a wider range of tools and powers, and the ability to use a proportionate approach to escalate and intensify our actions as appropriate. Bringing our New Approach to Life: Principles and Application I would now like to highlight three key documents that serve to set some of the out the principles we will be following to bring our approach to life: the Financial Policy Remit, Statement of Prudential Policy, and the Relationship Charter. Financial Policy Remit Our Financial Policy Remit links the mahi we are already undertaking back to our financial stability objective. It clearly reflects our purpose and our broadening expectations as a central bank and prudential regulator, embedding and formalising these expectations in one place. The Remit outlines matters that the Minister of Finance considers are desirable for us to take into account when meeting our financial stability objective. It acts as a mechanism for dialogue between us and the government, and allows the Minister to express expectations about the significant policy powers that have been delegated to us. The first Remit was issued on 30 June 2022.19 The Remit asks us, in pursuit of our financial stability objective, to: Consider the desirability of having a strong, efficient and inclusive financial system with a low incidence of failure of regulated entities. Have regard for proportionality in relation to the costs imposed by regulation, and, encouraging investment and innovation that improves productivity and sustainable long term growth. Consider the Government’s objectives in relation to more sustainable house prices, building resilience and facilitating adaption to climate change, improving financial inclusion and improving cyber resilience. Statement of Prudential Policy The Statement of Prudential Policy provides transparency about how we will act as a prudential regulator to achieve our financial stability objective. This statement also promotes public awareness and understanding of our activities and operations. We recently published our first Statement, which outlines how we will act when:20 ____________ 19 The Remit is available here: rbnz.govt.nz/-/media/e0ab579412d24185acbc037cbddb3ad9.ashx 20 The Reserve Bank’s Statement of Prudential Policy can be viewed on the RBNZ website: https://www.rbnz.govt.nz/regulation-andsupervision/cross-sector-oversight/prudential-policy Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED carrying out prudential supervision; imposing prudential standards or other requirements; monitoring and investigating compliance with our prudential framework; and taking appropriate enforcement and resolution actions. The Statement covers the principles that we consider in making decisions, and tailors these for prudential policy, supervision, enforcement and resolution. Broadly, these principles can be summarised as being: Outcome focused: we will take actions to promote financial stability through reducing the likelihood and/or impact of instability in the financial system, as well as opportunities for pursuing our purpose of promoting the prosperity and wellbeing of New Zealanders and contributing to a sustainable and productive economy. Considerate of system-wide implications: we will consider the system-wide impacts of our decisions, including having regard for the factors outlined in the Financial Policy Remit and our purpose. Proportionate: our actions will be proportionate to the costs and risks to ourselves, the regulated population and the public good. Evidence-led and risk based: our decisions will be evidence-based and subject to robust governance arrangements. We will seek to focus our resources on addressing the biggest risk to, or opportunities for enhancing, financial stability. Collaborative and transparent: we will work collaboratively within the Reserve Bank and with industry. We will work closely with our CoFR partners in pursuing shared or interlinked objectives, including those related to climate, financial inclusion, financial innovation, and in understanding our impact on firms, consumers and the financial system. Effective prioritisation: we will prioritise on an ongoing basis, recognising trade-offs and targeting our resources to where we can have the biggest impact on the outcomes we are seeking. This includes working through CoFR on system wide priorities. Continuous improvement: we will seek to monitor and review our performance on a continuous basis and incorporate these lessons into future actions. The Relationship Charter To deliver our approach to prudential regulation and supervision, our relationships with our regulated entities remains key. Our Relationship Charter is a core part of how we manage our relationships.21 The charter itself provides the aspiration to build and maintain the best ‘regulator/regulated’ supervisory relationships possible with all the different regulated entities by outlining how we will behave and communicate with one another.22 ____________ 21 This section draws on our Relationship Charter document, available from the RBNZ website: https://www.rbnz.govt.nz/regulationand-supervision/cross-sector-oversight/our-relationship-charter-with-regulated-entities 22 We have introduced the Relationship Charter to banks and insurers, and will be discussing it with our other regulated sectors over time. Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED It represents a mutual undertaking of how we will work together to achieve this aspiration. The charter commits us and the financial sector to a mutual understanding of appropriate conduct and culture. It is underpinned by the principle of ’te whakatōpū’ – to assemble, consolidate, and combine our efforts. Our behaviours will be: honest: positions are openly stated, constructively, freely and frankly; achievement focused: work together to achieve sound and efficient outcomes; diligent: provide clear expectations and deliver on them; open-minded: each other’s perspective is constructively sought and understood; and professional: disagreements can happen on issues, not people. Our communication will be: clear: easily understood, with decisions explained; targeted: made to the right people in governance and management; consistent: one organisation, one message, one tone; and timely: communication with no surprises. Our relationships need to be built on mutual respect, ethical behaviour, and te whakatōpū. We measure and report on our progress against the charter annually, to ensure that the banks and insurers we regulate have the opportunity to provide feedback on how we are living up to the charter’s values. Our latest results show that we have continued to build on the positive gains from our survey results from previous years, but that there remains room to improve, especially with the insurance industry where our relationships are less well-established than with the banking industry.23 Capacity, Capability, Relationships and Prioritisation As you can see, we have plenty of mahi ahead of us. To deliver on our approach, we are building our own capacity and the capability of our teams to engage with the sectors we regulate. As part of this, we are documenting best practice frameworks, processes and procedures, and ensuring our systems are up-to-date. This helps us to ensure that we are consistent in how we deliver our approach to regulation and supervision. In the spirit of te whakatōpū, we are broadening and deepening our relationships, building on our relationship with the banking industry and expanding our engagement with non-bank deposit takers and insurers. We are also broadening and deepening our relationships with the wider financial sector: beyond industry groups into capital market participants and users. ____________ 23 Our 2022 Relationship Charter Survey results is available from the RBNZ website: https://www.rbnz.govt.nz//media/7bc93de9d9b34e39a509153e2c7b6e88.ashx Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2 UNCLASSIFIED As part of this, we are continuing to expand our presence in Tāmaki Makaurau (Auckland) to be closer to our regulated entities and the populations we serve. We are also integrating Climate Change and Te Ao Māori into our approaches, recognising the role they play in enabling economic prosperity and wellbeing for all New Zealanders. We recently released an Issues Paper on Māori Access to Capital,24 which is motivated by our purpose and expectations under our new legislation. We have a big regulatory agenda that we need to undertake to deliver this new approach. We are working with the rest of CoFR and industry to prioritise the work ahead, and to ensure that the impact on the firms we regulate is manageable. As part of this will be developing a risk-based criteria, to ensure that we focus on the areas that are important to promote financial stability without overburdening our regulated entities. Our biannual Financial Stability Report will continue to be an important vehicle to share our assessment of the risks to the financial system, and a key input into setting our strategy and priorities. Conclusion Thank you for the opportunity to speak to you today. As an institution we are going through the most significant changes since the Reserve Bank of New Zealand reforms of the 1980s. It has been an important and exciting opportunity for us, the Treasury and the Government, to review the Reserve Bank’s whole institutional and financial stability framework, almost from a ‘clean slate’. This has been a timely exercise, because the expectations on us as a central bank and prudential regulator have changed considerably in recent decades. In a sense, the changes that I outlined today to our legislation, mandate, tools, powers, and approach provide the foundational roots for our role as a modern kaitiaki of the financial system of Aotearoa, New Zealand. Through it all, our relationships with the industry that we regulate will be key. We stand shoulder to shoulder with you, both as a financial institution and as guardian of the financial system. Over the long-term we all have a shared purpose: to have a financial system that best serves our society. Our mahi is to enable prosperity and wellbeing for all New Zealanders. Toitū te Ōhanga, Toitū te Oranga. Kia ora koutou katoa. Tēnā koutou katoa. ____________ 24 Our Issues Paper ‘Improving Māori Access to Capital’ is available from the RBNZ website: rbnz.govt.nz//media/d8d41f52600f4c9198fdbac35bddbc80.ashx Our Transformation as a Prudential Regulator UNCLASSIFIED Ref #X798971 v1.2
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Climate Change and Business Conference 2022, Auckland, 19 September 2022.
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Climate Changed – and why climate matters to RBNZ. A speech delivered at the Climate Change and Business Conference 2022 On 19 September 2022 By Adrian Orr, Reserve Bank Governor With thanks to Billy Berek, Susan Livengood, and other colleagues from the RBNZ. Ref #X775826 v1.16 UNCLASSIFIED Introduction Kia ora koutou, Thank you to the organisers for gathering us all for this important and necessary discussion. Thank you to Bell Gully for sponsoring this session on “Disclosure and Managing Risk”, and to Simon Watt for chairing. Thank you also to the many notable speakers and dignitaries at this landmark conference for sharing your wisdom and insight. I also acknowledge the Climate Change Minister James Shaw and his personal commitment, and leadership on this very important issue. Today I will speak briefly to a few points: Why climate matters to the Reserve Bank; Why the Reserve Bank has regard to climate change risk; Our Climate Change Stategy; and Developments in the management of climate risk here in New Zealand and around the world. But before I address those points, I want to place this conference in context. As noted in our report, ’Climate Changed 2021’, the impacts of climate change are already here, and those impacts are increasing. These impacts do not happen in isolation, and compound other economic shocks such as Russia’s invasion of Ukraine as well as pandemic linked supply chain shortages. The last few months have had no shortage of extreme weather linked to climate change across the globe, with record beating tempatures and droughts. Here in New Zealand, last year set a new record for weather-related insurance payments, and this year is on track to break the record. Climate impacts are here now, and the risks of further impacts are here to stay. But there is still much within our control. How we address those risks and the steps we take to reduce them, are up to us. With appropriate identification, pricing, allocation, and management of risk, we can reduce the impacts of climate change on Aotearoa’s financial system. Disclosure provides a vital impetus for this approach. Why climate matters to the Reserve Bank At the Reserve Bank, we are the kaitiaki (guardians) of the financial system tasked to maintain and enhance financial stability. Our ’financial stability objective is to protect and promote the stability of New Zealand’s financial system. 1 ____________ Reserve Bank of New Zealand Act 2021 (as at 01 July 2022) https://www.legislation.govt.nz/act/public/2021/0031/latest/whole.html#LMS286978 ENDORSEMENT UNCLASSIFIED UNCLASSIFIED This objective is framed within the purpose of our legislation, The Reserve Bank Act, which is to promote prosperity and wellbeing for everyone in Aotearoa and contribute to a sustainable and productive economy. Historically, economic wellbeing and prosperity were built with the benefit of a stable climate. As the climate continues to change, wellbeing and prosperity are impacted. To deliver on this purpose, it’s important that we understand this context. Assessing material risks to banks and insurers, and the financial system as an ecosystem, is our core business. We see financial stability being best maintained when all relevant risks are adequately identified, priced, and allocated to those best able to manage them. To meet our financial stability objective, it’s important for us to take account of the current and future impacts of climate change. The first Financial Policy Remit issued under our new legislation by the Minister of Finance2, highlighted the desirability of the Reserve Bank having regard to climate change. This means that we think about: How we are working with our regulated entities to understand risks and contribute to the resilience of New Zealand’s economy, society and environment to the effects of climate change; and How the financial system can play an appropriate role in supporting wellbeing and resilience as it responds to increasing risks from climate change. Our Monetary Policy Remit3 defines the Monetary Policy Committee’s objectives: to focus on keeping inflation between 1% and 3% over the medium term and supporting maximum sustainable employment. While it doesn’t currently have a climate component, the macroeconomic consequences of climate change have impacts on monetary policy4, and we have recently consulted with the public on the relevance of climate change for monetary policy5. Lastly, as a full service central bank we coordinate our thinking on financial stability and monetary policy, and climate change is one aspect of this. In short, to meet our financial and monetary policy objectives, it’s important for us to consider the impacts of climate change. Our Climate Strategy Along with many other central banks we have been working to better understand and integrate climate considerations into our work. We published our climate change strategy in 2018. It has three key components: 1. Get our house in order: monitoring and managing our own climate impacts. ____________ Reserve Bank of New Zealand Act 2021 – Issuance of the Financial Policy Remit 2022 https://www.rbnz.govt.nz/about-us/responsibility-and-accountability/our-financial-policy-remit Monetary Policy Statement 17 August 2022 https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/history-of-the-remit-and-policy-targets-agreement Climate Change and Inflation, see Monetary Policy Statement November 2021 (rbnz.govt.nz) We asked the public’s views about the economy, what matters to them and how decisions that we make can affect New Zealander’s daily lives. See https://www.rbnz.govt.nz/haveyour-say/closed-consultations/monetary-policy-committee-remit-review ENDORSEMENT UNCLASSIFIED UNCLASSIFIED 2. Get the settings in place: mainstreaming climate by understanding and incorporating the impacts of climate change into our core functions, like prudential supervision and financial system analysis. 3. Show the way: leading through collaboration. Climate challenges The financial system is a critical ‘engine’ that works to identify, price, and allocate risk. Climate risks are evolving, and the market is working to come up to speed on those risks. But historically, that engine hasn’t fully addressed potential risks from climate change. This is partly because we simply do not know the true scope and scale of the environmental risks we take on during our daily economic activities. Transition risks have also proved elusive: it’s hard to identify a risk when the timing and magnitude of climate policies in New Zealand or overseas are unknown. Likewise, many of the material costs of our economic decisions are ‘externalised’, that is, borne by others including future generations. Solving the moral hazard of transition costs falling on the present generation, while the benefits of those actions (in reduced climate impacts) accrue to future generations, has proved a tall order. What this means is that we will never have perfect information on the risks of climate change. However, the mandatory climate-risk disclosure standards being developed by the External Reporting Board (XRB) and to be independently monitored and enforced by the Financial Markets Authority (FMA) will help start closing some of those information gaps. Firms’ disclosure on how they identify and manage climate change risks will help to bring those risks into focus for management and investors alike. After all, it is what gets measured that generally gets managed. And it is far often better to measure something imperfectly than ignore it completely, in particular when this helps guide investor decisions. In measuring climate risk, climate disclosure can shed light not only on those risks, but also transition opportunities. Briefly, without adequate disclosure to help identify and price risks, change may be disorderly and much more difficult to manage. Historically, the financial system has not fully accounted for the consequences of climate change. But New Zealand’s financial history is still being written – and disclosure has the potential to be a key part of that story. Integrating climate risk Now I’ll touch on some examples of how we are incorporating climate change considerations into our work to help the financial system play its role in identifying, pricing, and allocating risk. Stress Testing Here at the Reserve Bank, we began incorporating climate risks into our stress testing last year. Stress testing is a tool used to assess the resilience of financial entities to severe but plausible shocks. Traditionally, we have used this to explore financial stability risks during ENDORSEMENT UNCLASSIFIED UNCLASSIFIED economic downturns. Expanding this to include climate risks helps us and industry to build capabilities to assess and understand the impact of climate change on the financial system. In 2021, we introduced a climate change risk element into our annual solvency stress test, by including a two-year North Island drought in the scenario. Our modelling showed that the drought, on its own, did not create undue stress. However, when combined with an economic downturn, the drought caused a 40% increase in dairy loan defaults over four years, before returning to levels similar to today. This result illustrates the importance of nonlinearities in the financial impacts of climate change. Internationally, our central banking peers have also recognised the need to better understand the financial stability risks posed by climate change. In May this year, the Bank of England (BoE) published the results of its inaugural scenario analysis. Banks and insurers’ projections showed that “climate risks could cause a persistent and material drag on their profitability”, IF they “do not respond effectively” to physical and transition risks6. However, their results “suggest overall costs will be lowest with early, well managed action to reduce greenhouse gas emissions and so limit climate change”. Closer to home, Australia’s prudential regulator launched their climate vulnerability assessment last year, with results set to be revealed later this year. When we began incorporating climate risks into our stress testing last year, we used a scenario considering the impacts of drought in the North Island for large banks. We also conducted our first insurance stress test. It included a scenario with more severe and frequent weather events to gauge risks to insurers’ capital. This year, our approach entailed undertaking a series of sensitivities examining risks that climate change posed to large bank’s systemically important loan exposures: residential mortgages and agriculture. Banks are currently working on both components: an assessment of residential mortgage exposures to coastal and non-coastal flooding; and an assessment of the agricultural sector’s exposure to emissions pricing and drought risk. This year’s exercises will build our own and industry capability and inform our climate scenario stress test next year. They will help firms meet the requirements of mandatory climate-related risk disclosure, and allow us to examine physical and transition risks to financial stability. We are working with banks to create a streamlined process as part of the new disclosure regime. Currently, our climate stress testing focuses on New Zealand’s largest banks, but over time we intend to build our support for other players in the financial system as they develop their own climate risk assessment capabilities. Alongside industry, we are collectively learning through this stress-testing process. We believe this will help the financial system identify and manage climate-related risks. Guidance note on Climate Change Risk Management The Reserve Bank is working on draft text of a guidance note on climate change risk management for our regulated entities. We aim to support regulated entities by helping to ____________ For evidence, please see Results of the 2021 Climate Biennial Exploratory Scenario (CBES) | Bank of England ENDORSEMENT UNCLASSIFIED UNCLASSIFIED develop a common understanding of what is needed to identify and manage the risks arising from climate change, and sharing best practice. Our planned guidance will be part of this support. The guidance will not impose new regulatory requirements. Rather, it will be in line with the self-discipline pillar of our supervisory approach, which emphasises that responsibility for the sound and prudent management of a regulated entity rests with its board and senior management. The purpose of the guidance will be to assist those responsible for running firms to better integrate climate risks into their core risk management practises. As you may be aware, the External Reporting Board’s (XRB) final consultation for the proposed draft standards on climate related disclosures closes next week, and the standards will be published in time for the start of mandatory disclosure next year. We are coordinating with the XRB and FMA to ensure consistency, and minimise overlap between our guidance and the standards and guidance that will make up the disclosure regime. We plan to consult on our draft guidance early next year. We will consider the approach of other appropriate regulators, when developing our own, for instance the Australian Prudential Regulation Authority (APRA) and the Monetary Authority of Singapore (MAS). The guidance will focus on both physical and transition risks, and will cover governance, risk management, scenario analysis and disclosure. We have heard from industry that key challenges include establishing appropriate scenarios, managing uncertainty, data availability, and capacity. The required disclosure will incentivise regulated entities to make progress on making robust long-term plans for responding to climate change and managing the emerging risks. Supervision Supervision is key to delivering on our climate strategy. It is a critical conduit between regulated entities and the Reserve Bank and is how we assess, monitor and support firms' ability to meet our financial stability objectives and their adherence to our regulatory rules. Climate Change is an agreed priority at the Council of Financial Regulators (CoFR) and we are collaborating on our supervision of climate change, particularly with the Financial Markets Authority. Together with the FMA, we are including climate change in our scheduled supervisory engagements with management and boards. Climate was a topic of conversation at the most recent joint RBNZ-FMA workshop for banking directors and senior officers. The next 12 months will see an increase in conversations with entities as we build our understanding of the prudential implications of climate change. We will be discussing the responsibilities, oversight and implementation of entities’ climate strategies and risk management, and the practical steps they are taking toward mandatory climate-related disclosures. A crucial part of this approach includes working with regulated entities as they set out to meet the new Climate-Related Disclosure regime, and that the new disclosure requirements will deliver the best outcomes for New Zealand in terms of the management of potential ENDORSEMENT UNCLASSIFIED UNCLASSIFIED risks. Our supervision teams are working closely with the agencies who are leading on the design and implementation of disclosure obligations. We are collaborating on a survey of our regulated entities. We’ll send it to them early next year, to assess the challenges and successes of the industry in understanding, managing, and disclosing climate-related risk. Internally, we are supporting our climate supervision by expanding our training for supervisors and integrating climate risks into our supervisory frameworks and data collection. We are continuing to build our own knowledge and capability to support regulated entities by developing a common understanding of what is needed and sharing insights. Leading through collaboration, locally and globally While our efforts to incorporate climate change into our core business address some aspects of climate change risk, and the incoming mandatory climate-risk disclosure regime is a welcome advance in identifying and managing those risks, there is still much to be done. Global and local efforts to help the financial system identify, price, and allocate climate risk are still in their early days, but modifications to the financial system’s engine are coming. Collaborative efforts locally, from the public and private sector, and from international cooperation, are ushering in an era of significant change. We’re also coordinating with the New Zealand Bankers’ Association and the Insurance Council of New Zealand. Both are developing industry scenario analysis to prepare for the incoming mandatory disclosure regime. We’re also collaborating with New Zealand scientists and researchers to help improve data and our understanding of these risks. For example, we’re a member of the Deep South National Science Challenge Representative User Group and also engage with Whakahura - the Whakahura research project aims to expand our understanding of extreme weather events in New Zealand. As the financial system is truly global, any efforts to ‘modify the engine’ require collaboration and leadership across countries, and between the public and private sector. Importantly, these modifications to the financial system require some leaders to take the first steps. The Network of Central Banks and Supervisors for Greening the Financial System (NGFS) One way we’ve taken steps toward addressing climate risk is through our work as part of the Network of Central Banks and Supervisors for Greening the Financial System (NGFS). The NGFS is made up of more than 100 central banks and supervisors who are collaborating on climate change. At the Reserve Bank of New Zealand, we’re assessing the NGFS scenarios for use in our work on understanding the potential impacts of climate change on financial stability in New Zealand7. These scenarios may require additional local data sources to more accurately project climate risks that New Zealand faces. We continue to engage with research projects in ____________ Network for greening the Financial System (2021) NGFS Climate Scenarios for central banks and supervisors ENDORSEMENT UNCLASSIFIED UNCLASSIFIED New Zealand and abroad aiming to build deeper understanding of risks and transmission pathways. We take the lessons from NGFS to build into our own climate change strategy. This includes monitoring and managing RBNZ’s impact on climate, reflecting climate risks within our core functions, and contributing to wider efforts to identify, monitor and manage climate risks within our economy and financial system, and as part of the global central banking and regulatory community. We’re also active participants in the NGFS’s ongoing climate work programme. Over the next two years this will feature four workstreams and two taskforces on climate risk, climate scenarios, and monetary policy. We are co-chairing the workstream “Net-zero for Central Banks”8 with Italy’s central bank – Banca D’Italia. This workstream will cover issues and approaches on three topics: sustainable and responsible investment (SRI), central banks’ own climate-related disclosures, and greening central banks’ corporate operations. Classifying green or sustainable finance One area that has seen significant advances is how we classify ’green’, or ‘sustainable’ finance. This work has been strongly encouraged by the NGFS9. To facilitate the economic transition to a clean, resilient economy, it’s important for businesses and investors to be able to identify green investments, and potentially be aware of ‘brown’ investments. That’s where the development of classifications for green or sustainable finance comes into the picture. Here in New Zealand, Toitū Tahua – The Centre for Sustainable Finance is taking steps to jumpstart a framework for classifying sustainable finance10. Reserve Bank Assistant Governor Simone Robbers sits on the board of Toitū Tahua. Last month, Ministry for the Environment (MfE) published New Zealand’s first ever National Adaptation Plan (NAP)11. In addition to laying the groundwork for all of Aotearoa to adapt to climate change, the NAP also proposes the development of “definitional tools” to promote more investment in green projects. So we hope to soon see more work underway on the development of a common set of definitions of climate and nature-positive investments. In order for the New Zealand business community to keep pace with the international community, identifying, pricing, allocating, and managing risks will become increasingly important. Conclusion Shifting to a more sustainable, climate-resilient economy globally will need a coordinated approach. Public and private sector knowledge and capital must be mobilised together. No one group can tackle the challenge alone. The UN Environment Programme estimates, for ____________ Network for greening the Financial System (2022) NGFS publishes its 2022-2024 work program Network for greening the Financial System (22/04/27 NGFS publishes a report on enhancing market transparency in green and transition finance Through a unique combination of deep industry collaboration, high-calibre research, and exceptional education programmes, the Centre for Sustainable Finance is helping financial institutions to play a leading role in building a more sustainable economy. Ministry for the Environment (03 08 2022) Aotearoa New Zealand's first national adaptation plan released | Ministry for the Environment ENDORSEMENT UNCLASSIFIED UNCLASSIFIED example, that global greenhouse gas emissions must be cut by 7.6% a year from now until 2030 to meet a 1.5°C temperature goal12. The International Energy Agency estimates that such action will require US$ 3.5 trillion per annum until 2050 for energy sector investments alone13. Modifications to the financial system’s ‘engine’ will be an essential feature of this financial era, as the world seeks to avert the worst of climate change, while transitioning to a clean and resilient economy. The significant modifications underway and still to come point to the great duality of our time: that globally we are both doing more than we’ve ever done, and as of yet, not nearly enough. I want to thank those who already work tirelessly in this area, across the sector. From banks to insurers, policy makers, the agriculture sector, iwi and NGOs - we’ve seen a huge uptake in interest and commitment across the past two years, which is exciting and inspiring. It’s up to us all to close the gap between what we are doing and what’s needed to face into one of the most complex challenged of our time. We must look not only to New Zealand, but globally, to ensure our collective actions are making a difference. At Te Pūtea Matua we will do our part to help understand and address potential risks to the financial system and economy. Thank you. ____________ United Nations (26 11 2019) Cut global emissions by 7.6 percent every year for next decade to meet 1.5°C Paris target IEA (20 04 2017) Deep energy transformation needed by 2050 to limit rise in global temperature ENDORSEMENT UNCLASSIFIED
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Institute of Finance Professionals New Zealand Inc (INFINZ) Conference 2022 "Navigating the transition", Auckland, 27 October 2022.
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reserve bank of new zealand
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Speech by Ms Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking of the Reserve Bank of New Zealand, to Payments NZ's The Point 2022 conference, Auckland, 9 November 2022.
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New Zealand’s changing payments landscape and potential responses to it – a regulator’s view A speech delivered to Payments NZ’s The Point 2022 conference in Auckland on 9 November 2022 by Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking Ref #X909373 v3.0 Kia ora koutou katoa, greetings to you all, Thank you for this opportunity to present a “regulator’s view of the changing payments landscape in New Zealand and potential responses to it”. At six months in to my role this is possibly the last time I can claim to be a recent joiner at the Reserve Bank of New Zealand - Te Pūtea Matua where it’s my privilege to be an Assistant Governor and the General Manager of Economics, Financial Markets and Banking. In my career to date I have spent significantly greater time being regulated than regulating, but I’m enjoying the opportunity to reassess many familiar issues from new perspectives and in particular giving thought to how these may impact the prosperity and wellbeing of all New Zealanders. We are all working and living in a period of substantive change My focus today will be on some of the challenges we see impacting New Zealanders’ ability to benefit from reliable and efficient money and payment systems supporting innovation and inclusion, and on some of the work at the Reserve Bank to directly address and support others in overcoming these challenges. My overarching message is that we are all working and living in a period of substantive change one that offers enormous opportunity if embraced, and potentially greater risk if it is not. Payments are the ebb and flow of money. Increasing attention is being given to both the global evolution in payment and money forms, to which New Zealand is not immune, and to our increasing demand for better, smarter and faster forms of payments. This is not only the realm of advanced economies. Emerging economies are embracing new technologies supporting greater financial accessibility and inclusion - in some cases leapfrogging those more advanced still clinging to aged infrastructure and payment practices. Without greater ambition and innovation New Zealand will not avail itself of the opportunity that technological change is creating. We oversee, operate, regulate, and supervise core payment systems – and steward money and cash The Reserve Bank’s role in money and payments is a multi-faceted one. First, we oversee, operate, regulate, and supervise core payment systems1. Secondly, as a Steward of Money and Cash our responsibilities lie not only in the issuance of central bank money but also in the roles that it performs2. Through these systems, New Zealanders are able to save and to spend their money, manage risks, and together grow the economy and make life better. The first role of central bank money is as a value anchor for private money (versions of which are both the products and lifeblood of the people in this room) and for the financial system and economy more generally. Central bank money is a value anchor because people trust its value and can convert it at par value to private money. Physical cash – as both a concept and a choice – plays a very important role in this regard. With central bank money as a value anchor we can use ____________ RBNZ Act 2021, s10, s116(f), RBNZ Act 2021 s116(c), Part 3 subpart 4 (ss149-158) NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 monetary policy to maintain price stability and support maximum sustainable employment, which in turn enables retention of our monetary sovereignty. It allows us to operate monetary policy in a way that makes sense in the context of the New Zealand economy, rather than merely importing monetary policy decisions from other economies. Physical cash as an accessible form of payment contributes to inclusion and wellbeing across society The second important role that central bank money plays - particularly physical cash - is the contribution it makes to inclusion and wellbeing across society as an accessible form of payment. Central bank money exists within wider money and payments systems – many of them yours which are facing significant and accelerating change. The digitalisation of economic activity has had a profound effect on both wholesale and retail users of money and payments. Any significant change brings both opportunities and challenges. Keeping up with innovations that do not fall neatly into the current remit of a single regulator or central bank means that close coordination among regulators and the central bank becomes essential to keeping financial markets safe and efficient. Undoubtedly, digital transactions are faster, cheaper, and more convenient, made possible through the relentless pace of technological innovation. But for those who cannot fully access digitalised money and payments, they not only forego the benefits of such innovation, but they risk being excluded from important aspects of society as a result. We are innovating to support cash as a payment option As the central bank, we get to see the digitalisation trend first hand by comparing the usage of notes and coins we issue to the uptake of card payments. The digital displacement of cash as a preferred means to pay for goods and services has led to cash use declining steadily over the years (Figure 1a; a trend that can be inferred from the data on circulation of cash and transaction relative to GDP per Figure 1b). This is leading to the cash infrastructure network being put under significant pressure. But, this trend does not support the notion that the public no longer values cash. Responses to our Future of Money Stewardship Issues Paper3 and ongoing research reaffirm that New Zealanders value cash, even among the many who don’t use it regularly. This is because many regard cash as the most dependable form of money, particularly during a natural disaster or even less traumatic outages (and we all have collective experiences that bears this out). Cash provides choice, autonomy, and agency for all, and for some it is the only form of money they have or can use. Cash today also forms a critical part of social and cultural exchanges, for koha, social clubs, raffles, and even the tooth fairy. However, the commercial case for maintaining cash services in today’s primary channels for distribution, bank branches and ATMs, has weakened as a consequence of its declining use for basic transactions. As a result of this and channel shifts for other banking services, banks are reducing their cash and in-person footprint by closing bank branches and ATMs (Figure 2). This compounds a range of pressures on other parts of the cash system, particularly cash-in-transit firms, merchants and independent ATM providers. As a consequence cash system arrangements ____________ https://www.rbnz.govt.nz/money-and-cash/future-of-money/future-of-money---te-moni-anamata---2021-issues-papers-public-responses/future-of-money---stewardshipresponses NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 are not as efficient as they could be and, it could be argued, are in a critical state. The cash system today lacks resilience; cash handling firms are maintaining costly infrastructure to enable distribution to all corners of the country despite a shrinking platform for distribution and declining use. Figure 1a: The number of cash and e-payments as a percentage of all household payments 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Cash e-Payments (Source: Statistics NZ, Household Expenditure Survey (various years), RBNZ) Figure 1b: Domestic cash in circulation and transactional balances relative to M1 % M1 % M1 9.0 94.5 8.5 94.0 8.0 93.5 7.5 Cash in circulation 93.0 7.0 Transactional balance (RHS) 92.5 6.5 92.0 6.0 91.5 5.5 91.0 (Source: Haver, RBNZ) NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 Figure 2: Number of branches/ATMs operated by the five major banks in NZ 2011 - 2021 1,200 2,600 2,500 1,000 2,400 2,300 2,200 2,100 1,130 1,121 1,071 1,020 ATMs (RHS) 2,489 2,493 2,485 2,476 2,502 2,437 2,491 2,470 2,422 2,312 2,182 branches 2,000 (Source: KPMG New Zealand Financial Institutions Performance Survey 2011 to 2021, RBNZ data) Cash provides choice, autonomy, and agency for everyone For all people, cash provides choice, autonomy, and agency – and for some it is the only form of money they have or can use. The Reserve Bank remains committed to ensuring cash – as one form of central bank money - is available to New Zealanders for as long as people value and use it. Our current work is focused on optimising the efficiency and resilience of cash infrastructure for future demand. With the exception of banks, many submitters to the 2021 Future of Money Cash System Redesign Issues Paper4, had the view that cash accessibility needs to improve. This is consistent with what we heard during the earlier Future of Cash work that began in 2017. This feedback, and the evidence we continue to gather, points to the value in further exploring the potential net benefits of policies that support merchants having an expanded role in cash distribution to augment the current and shrinking commercial bank-centric cash system. We are working up in more detail a bundle of eight policy proposals categorised into several themes – resilience, cash acceptance, cash access and consumer demand5. This could include supporting merchants: to recycle cash at point-of-sale by remunerating them for cash out services by facilitating frequent, affordable cash delivery and collection for merchants through consolidation within the cash system with the creation of utility entities. These options could improve resilience by changing the incentives and commercial realities facing key cash system participants today. We are continuing to collaborate with various stakeholders relevant to the cash system to test the feasibilities of these policies, a result of which will be published for further consultation. We think it’s important that we understand the impacts of these ____________ https://www.rbnz.govt.nz/money-and-cash/future-of-money/future-of-money---te-moni-anamata---2021-issues-papers-public-responses/future-of-money---stewardshipresponses https://www.rbnz.govt.nz/-/media/4c7b5d93b76d4c4099c952e9ed8d98b0.ashx NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 policies before implementing them however – so we plan to explore them further with a series of small live experiments from next year. To summarise on this aspect: the Reserve Bank remains committed to ensuring cash – as one form of central bank money - is available to New Zealanders for as long as people value and use it. We are very concerned about the wellbeing and inclusion impacts for those that depend on cash to pay and save, yet no longer have free or easy access to it and are therefore looking at alternatives to bolster that. I’ll now move on to consider innovation in digital payments. Mainstream innovation in digital payments is too slow Electronic payments has been evolving at an ever faster pace globally since their introduction back in the 1970s6. For New Zealand, most notably since EFTPOS was launched in 19857, innovation in retail payments has flourished and has played a key role in supporting our economic growth. For a while, New Zealand showed leadership in the retail digital payments space through the adoption of EFTPOS with its ubiquitous agenda-free low-cost convenience, but over time this has been displaced by newer, innovative and more sophisticated payment offerings with new technological, financial and incentive offerings. As end users have become accustomed to more innovative offerings, newer entrants, many of whom originate overseas and are mainly smaller fintechs, have entered the New Zealand market seeking to replicate the first markets success of their inventions here. For emerging and developing countries, innovation in payments and broader economic growth are linked as they address many of the long-standing frictions that impaired user experiences, as a study from the World Bank Group shows8. Once fully implemented, open banking has the potential to support innovation and inclusion by opening up consented access to both existing payments capabilities and to the customer’s financial data9. Whilst digital innovation is beginning to occur both on top of, and in competition with, traditional payment rails we do not yet have scalable electronic, instant, peer-to-peer payments, and our lack of real time systems for retail payments positions us as an outlier amongst OECD countries. This slow pace of implementing promising developments is an issue for our economy, because we could become more digitally competitive, including by nurturing our homegrown fintechs in this space. And, as a society, we may see significant benefit through increased domestic competition and efficiency savings in the payment space and in the wider financial system. According to one report10, the real-time payments in Australia conferred a total estimated efficiency saving of AU $205mn for businesses and consumers, driven principally through reduction in the payment float. With the 2021 share of real-time payments in Australia accounting for 5.2% of all transactions, instant payments would unlock a total transaction value of AU$2.9bn per day through reduced float time. According to this report, the realised aggregate economic benefits of a real-time transaction were estimated to translate to economic output equivalent to 0.06% of GDP, or AU$932 million annually. ____________ The first electronic payment was by Western Union when it started the electronic fund transfer in 1871 (https://www.westernunion.com/blog/en/6-fascinating-things-about-westernunions-history/) https://www.bnzheritage.co.nz/archives/story/eftpos-and-autobank Innovation in Payments: Opportunities and Challenges for EMDEs, World Bank Group https://www.mbie.govt.nz/business-and-employment/business/competition-regulation-and-policy/retail-payment-systems/speech-to-payments-nz-the-hub/ Centre for Economics and Business Research Ltd, The Economic Impact of Real-time Payments (April 2022) Page 25 (https://cebr.com/wp-content/uploads/2022/04/Real-TimeReport_v8.pdf) NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 We can all do better: lingering reliance on legacy systems, failure to understand regulatory impetus and focus, and limitations in the co-ordination and provision of regulatory support for innovation are inhibiting real progress and broader benefits for Aotearoa New Zealand. New technologies, and new entrants, offer opportunities and risks The possibilities of new technologies are a central theme in the discussion around innovation. There is no doubt that new applications of technology – like big data, AI/machine learning and distributed ledger technology - offer opportunities to drive innovation and enhance efficiency along with countervailing risks to be recognised and managed. The emergence of new players in the payments environment is another key trend. Across the world, we have seen e-commerce powerhouses and social network providers (also referred to as BigTech) expanding their businesses into the payment system space. BigTech are getting interested in the opportunities for money and payments presented by new technology. The expansion of payment forms and providers bring significant benefits in improving efficiencies and service quality for end users and the economy as a whole. But it can also pose a number of new challenges: New and existing providers may unwittingly introduce risks into the money and payments system through flawed design or implementation of a new technology. New providers may also be tempted to avoid regulation, perhaps by attempting to keep themselves out of the regulatory perimeter to maximise their competitive edge. And, as these new digital payment means displace the use of publicly issued notes and coins, they could put at risk the core roles of central bank money as a trusted and stable value anchor and the contribution it makes to stable economy supporting wellbeing and inclusion for all. An even playing field is coming – along with new rules and nimble refs In recognition of the bourgeoning scale of the payments industry in our economy, regulators are increasingly focused on payments to ensure their reliability, efficiency, and that there’s a level playing field supporting innovation and inclusion while protecting economic and social good. Aotearoa’s regulatory payments frameworks are being enhanced, notably through: The Financial Market Infrastructures Act 2021 created a comprehensive regulatory designation regime covering key payments infrastructures; The updated RBNZ Act 2021 has refreshed our role, structure and payments mandate; The Retail Payment System Act 2022 has given the Commerce Commission the mandate to regulate the retail payment system and its participants such as merchants, banks, nonbank merchant acquirers and card schemes. The upcoming Consumer Data Right is anticipated to strengthen and support Aotearoa’s open banking regime. Regulators are increasingly cooperating with one another and coordinating their respective payments regulatory activities. The Council of Financial Regulators (CoFR) – now with statutory status - is an active forum for exchanging information on new business models and identifying any regulatory gaps. One of the objectives of CoFR’s Digital and Innovation Working Group is to NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 provide a one-stop-shop for fintechs seeking guidance on regulation11. For those fintechs unsure of navigating their way through the regulatory landscape, speaking with CoFR about their plans at an early stage could provide some regulatory clarity. But there is undoubtedly more that can be done to promote alignment across government and regulators, help provide focus, and to work with industry on a strategic vision for payments. Reserve Bank work supporting payments innovation So what is the Reserve Bank doing to improve the New Zealand’s payments system? We have a programme of work under a ‘Future of Money and Payments’ banner. This work marks something of an evolution of focus at the Reserve Bank. Traditionally, we have been the issuer of cash, a regulator of payment systems, and the operator of the Exchange Settlement Account System (ESAS) which along with Real-time Gross Settlement (RTGS) allows individual transactions between financial institutions to be settled electronically as the transactions happen, and of NZClear which provides financial markets with clearing and settlement services for high-value debt securities and equities. As stated earlier, we are now taking a more unified outlook across money and payments, which includes taking an increased interest in retail payments. As we take forward our own Future of Money and Payments work programme at the Reserve Bank, we have developed an objective, which will be our guiding star for what ‘good’ looks like for Aotearoa’s money and payments systems, and for shaping how our work contributes to that. Our objective is that: New Zealand has reliable and efficient money and payments systems that support innovation and inclusion. This objective’s reference to both ‘money and payments’ together in the same statement is deliberate. Money and payments have always been intertwined, but the digitalisation trends I referred to earlier makes it even more important to view money and payments together. This objective is a system objective and not something the Reserve Bank can achieve on its own. Achievement will rely on the buy-in and collective effort of industry, communities, regulators and government. For our part, we are looking closely at the role that both the forms of central bank money and central bank exchange settlement systems can play in supporting this objective. Each of these forms of central bank money do, or could, play a critical role in the payments landscape. Our work on payment systems focuses on enhancing these to better support their ability to deliver reliable, efficient, innovation and inclusion outcomes. Two notable projects are underway. We are working alongside ESAS settlement account holders and Payments NZ to upgrade our ESAS system to meet the March 2023 date for enabling ISO20022 messages for cross-border payments. In addition, we are supporting Payment NZ’s SBI 365 project enabling New Zealanders to make and receive value payments on every day of the year. Looking beyond these projects, we are also working to share our view on the future of New Zealand’s payment systems capabilities. Today (Wednesday, 9 November 2022), we are publishing a primer on the payment landscape in New Zealand describing current arrangements and roles, ____________ https://www.cofr.govt.nz/priority-themes/digital-and-innovation.html NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 giving us all a clear and common starting position from which work on shaping the future of money and payment systems can build. In anticipation of the future payment landscape, more industry participants are seeking direct access to clearing and settlement systems, including those operated by the Reserve Bank. The primary purposes of the exchange settlement system we operate are to support our implementation of monetary policy and to make the financial system as a whole more robust by reducing interbank and trade settlement risk. We are conscious that undue restrictions may stifle healthy competition, impair market efficiency, and limit cash system innovation, but we are also cognisant of the need to ensure the robustness and financial integrity is maintained. We are reviewing the extent to which the existing access criteria remain fit for purpose noting these points. Greater access could increase competition and innovation in our payments landscape going forward but it needs to be weighed against the central importance of ESAS to our core functions and the risks that may arise from a wider range of institutions having direct access. Central Bank Digital Currency work scoping design and benefits approaches As you’ll be well aware, we are also exploring how a Central Bank Digital Currency, or CBDC, may support the role and use of central bank money in the digital age. Our work on CBDC so far has already attracted a lot of interest from fintechs, financial institutions and the general public alike. We received more than 6,000 responses to our 2021 CBDC Issues Paper as part of our first work stage12. Many of these were from concerned individuals fearing the imminent removal of cash and assertion of state control through a CBDC. While misinformation drove some of this response, it was a timely confirmation that the people of New Zealand still keenly value cash, along with the privacy and autonomy it provides. The key insight from this consultation was the need for any potential CBDC to be privacy centric. We have now embarked on the second stage of our CBDC exploration (Figure 3). In this phase, we are expanding beyond the desktop research to explore various aspects to design of a potential CBDC. We are undertaking thematic research on how a CBDC might support wider digital financial inclusion and wellbeing, and also enable an open, innovative and competitive payments ecosystem whilst maintaining user privacy. Alongside our thematic CBDC research we will be undertaking proof of concept experiments to better understand what is possible and feasible. ____________ https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/consultations/future-of-money/future-of-money-summary-of-responses.pdf NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 Figure 3: CBDC exploration roadmap Stage 1: Develop policy case (completed March 22) • Develop public policy issues analysis and collect feedback • Present findings and set design principles Stage 3: Prepare Stage 4: Implement Stage 2: Define We are here •Policy research on key areas: privacy, innovation, interoperability, resilience, governance •Develop proof of concept/prototype CBDC •Shortlist CBDC design options (Source: RBNZ) Responses to our 2021 CBDC Issues Paper13 also indicated the need for early and ongoing public engagement. We have set up a standing external group to facilitate this, and are consulting with industry stakeholders on technical aspects of CBDC. However, more needs to be done and we are committed to listening to the views of New Zealanders, including Māori. We will continue to engage with stakeholders across the payment system and society as we investigate a CBDC. Cryptoassets may need more regulatory oversight Earlier, I mentioned the technology-driven innovation in new forms of money and the potential entry of BigTech in this space. Such innovations may deliver money or payments instruments more efficiently and at lower cost, and could serve niche use-cases that are not commercially viable or strategic fits for banks. There are also potentially significant risks to consumers arising from some of this innovation, and gaps exist in regulatory tool kits to address these. From our perspective as a central bank, it is important that new forms of money, whatever their size: reinforce trust in our money, neither reduce competition nor the reliability and efficiency of our money and payments system, and that they don’t undermine our monetary sovereignty. The time is right for us to ask what, if any, additional regulatory powers are needed to appropriately balance the risks and opportunities, and to provide regulatory certainty in support of beneficial innovation. It is also important to understand how we can meet cross-cutting challenges of existing regulation, such as AML/CFT issues, in a consistent and holistic manner. We will publish an issues paper on private innovations in money early next month, seeking feedback on the content by March 2023. And I hope we hear your views on how we collectively best support opportunities and manage risks emerging in this area. ____________ https://www.rbnz.govt.nz/money-and-cash/future-of-money/future-of-money---te-moni-anamata---2021-issues-papers-public-responses/future-of-money---central-bankdigital-currency-responses NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0 Responding to the changing payments landscape in New Zealand It is clear that the pace of change in money and payments will only escalate. It is important that all market participants step up to meet the money and payments challenges and opportunities to improve the wellbeing and prosperity of New Zealanders. We recognise there are significant upsides for New Zealand if we embrace changes in money and payments - but also risks if we do not, or are not quick enough about it. Our objective is that New Zealand has reliable and efficient money and payments systems that support innovation and inclusion. We look to all of you in the industry, to ourselves and to others in the government sector to collaborate to enable this. Collectively, we need to make sure we do not fall further behind in advancing our money and payments landscape and that we soundly position ourselves – along with Aotearoa New Zealand - to benefit. NZ’s changing payments landscape and potential responses to it Ref #X909373 v3.0
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Opening remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 24 November 2022.
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Opening remarks to Finance and Expenditure Committee. Adrian Orr, RBNZ Governor 24 November 2022 Ref #X954866 v1.8 Tēnā koutou katoa It is good to be with you this morning to present our November Monetary Policy Statement. I’m joined by Assistant Governor/General Manager of Economics, Financial Markets and Banking, Karen Silk, and our Chief Economist Paul Conway, and I acknowledge our other Monetary Policy Committee (MPC) colleagues some of whom are with us today or watching online. Today we are here to outline our most recent Monetary Policy Statement and the reasoning for our OCR decision. To provide the best context possible for the Committee’s decision I will refer briefly to the Reserve Bank’s recently published Review of our monetary policy actions over the five years endedSeptember 2022.1 The Review – undertaken in conjunction with the Board of Te Pūtea Matua and peer reviewed by two independent international experts – is a legislative requirement. It is also a timely requirement from the Committee’s perspective. Over the period reviewed, the global and New Zealand economy has experienced historically significant economic shocks, in large part due to the COVID-19 pandemic and exacerbated by Russia’s invasion of Ukraine. Policymakers, including the Reserve Bank’s Monetary Policy Committee, are currently dealing with the significant and ongoing implications of these shocks. Our Monetary Policy Statement is our most recent analysis of the economic implications for the New Zealand economy. On behalf of the Committee, we are sorry that New Zealanders are being buffeted by significant shocks and inflation is above target. As we’ve said before, inflation is no one’s friend and causes economic costs.2 We also want to reaffirm the Committee’s determination and confidence we will return annual inflation to within our 1 to 3 percent target range. The Review highlights several lessons that we are adopting, and we are continuously learning as things evolve. ____________ https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/rafimp https://www.rbnz.govt.nz/hub/news/2022/07/monetary-policy-review As our Chief Economist Paul Conway explained when we released the Review with the benefit of 100 percent hindsight: The Committee would have had to lift the OCR to around 7 per cent in early 2020 to have achieved annual CPI inflation within our 1-3 percent target range now. Such a policy shift would have been inconsistent with the Committee’s Remit and led to many other severe and persistent economic challenges. The Committee could have commenced its tightening cycle earlier in 2021 than it did, in order to better contain core (domestic demand-led) inflation pressure. However, the subsequent rise in international food and energy prices would still have led to headline CPI inflation exceeding 6 per cent now. Chart 1: CPI inflation split between ‘core’ and ‘headline’ Source: Stats NZ. The blue bars represent ex-food and energy inflation, an internationally comparable measure of core inflation. These examples are not excuses for inflation not being at 2 percent. They highlight the extent of the economic shocks that buffeted the economy, and the importance of being forward-looking when setting policy, with flexibility in achieving our targets. The lags between our monetary policy actions and inflation outcomes remain long and highly variable. Other central banks are in the same boat, and we are learning the lessons together. In an absolute sense, actual and expected inflation is too high and needs to be reduced. However New Zealand is in a strong macroeconomic position relative to most OECD nations. Chart 2 – International Inflation and Unemployment Rates Note: The data are sourced from the OECD database. The latest available data points have been used; inflation data for 2022Q3 for all countries, and unemployment data for 2022Q3 for all countries except Switzerland for which 2022Q2 data is used. Turkey has been omitted since it is an outlier with an exceptionally high inflation rate of 81%. We are in the lowest quartile for both inflation and unemployment in the OECD. We have a stable and well-functioning financial system that is resilient to a wide range of interest rate and employment shocks.3 And, as outlined in our Statement released yesterday, we have resilient household, public, and business sector balance sheets in aggregate. Now turning to the Monetary Policy Statement. The Monetary Policy Committee yesterday increased the Official Cash Rate (OCR) from 3.5 percent to 4.25 percent. The Committee agreed that the OCR needs to reach a higher level, and sooner than previously indicated, to ensure inflation returns to within its target range over the medium-term. Core consumer price inflation is too high, employment is beyond its maximum sustainable level, and near-term inflation expectations have risen. ____________ https://www.rbnz.govt.nz/hub/publications/financial-stability-report/2022/nov-2022/fsr-nov-22 Global consumer price inflation is broad based and remains heightened. Food and energy prices, and persistent core inflation, have combined to create very high headline inflation in many countries. Central banks are tightening monetary conditions in an effort to slow spending and reduce inflation pressure. The ongoing slowdown in global growth will affect New Zealand through both financial and trade channels, and impact on people’s confidence due to uncertainty. In New Zealand, household spending remains resilient, especially considering the rise in debt servicing costs, the fall in house prices, and low levels of consumer confidence. Employment levels are high, and income growth and household savings are supporting spending. The rebound in tourism is also supporting domestic demand. The productive capacity of the economy is being constrained by broad-based labour shortages, and wage pressures are evident. Aggregate demand continues to outstrip New Zealand’s capacity to supply goods and services, with a range of indicators continuing to signify broad-based inflation pressure. Committee members agreed that monetary conditions needed to continue to tighten further, so as to be confident there is sufficient restraint on spending to bring inflation back within its 1-3 percent per annum target range. The Committee remains resolute in achieving the Monetary Policy Remit. Meitaki ma’ata Tēnā koutou, tēnā koutou, tēnā koutou katoa.
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Opening remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Finance and Expenditure Committee (FEC), Wellington, 14 December 2022.
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Adrian Orr: Opening remarks to Finance and Expenditure Committee Opening remarks by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 14 December 2022. *** Introduction Tn koutou katoa It is again a privilege to be here with you today – alongside other members of the Executive Leadership Team – to report on the Reserve Bank of New Zealand's activities for the 2021/2022 financial year. With me at the table are Greg Smith and Juliet Tainui-Hernandez, Assistant Governors of Finance and People respectively. The remainder of the Executive Leadership Team are also with me in the room to assist on any questions you may have. I do wish to pass on to the committee that our Board chair, Professor Neil Quigley, very much hoped to be here but the challenges in re-scheduling and a graduation ceremony which he attends as Vice-Chancellor have precluded it this time. I know the committee has seen a lot of us recently. I have valued all of our meetings, and want to thank the committee for your ongoing interest in our work. The 2021/22 Annual Report covers the last year under our old governance arrangements. The refreshed Reserve Bank of New Zealand Act 2021 was operationalised on 1 July 2022. A lot of the year under review was thus spent building the foundational systems and processes we need to support our new Act. I will briefly outline this work and then respond to questions the Committee may have. But, first, I will reflect on the economic environment we were operating in during 2021 /22 financial year. Delivering our monetary policy mandate During the 2021/22 financial year we operated in an environment of extreme uncertainty. In most part the uncertainty was due to the global economy experiencing historically significant shocks – in particular to global supply capacity. During the year, in the face of rising inflation pressures, our Monetary Policy Committee was one of the first in the world to start tightening monetary conditions. In July 2021 we ended our Large Scale Asset Purchase programme, and in October 2021 we commenced raising the Official Cash Rate (OCR). The OCR move was 1/7 BIS - Central bankers' speeches delayed from August due to the imposition of Level 4 COVID-19 restrictions across the country. As outlined in our recently released Review of monetary policy, in hindsight the Committee could have commenced its tightening cycle earlier in 2021 so as to better contain core inflation pressure. Nonetheless, the subsequent rise in international food and energy prices would still have led to headline Consumer Price Index inflation exceeding 6% now. In an absolute sense, actual and expected inflation is too high and needs to be reduced. Subsequent Monetary Policy Committee decisions have seen the OCR rise from 0.25% in August 2021 to the current rate of 4.25%. Our actions display the Monetary Policy Committee's determination and confidence in returning annual inflation to within our 1% to 3% target range. Our focus on low and stable inflation is the best contribution we can make to the overall wellbeing of New Zealanders. In a relative sense, New Zealand is in a strong macroeconomic position relative to most OECD nations. We are around the lowest quartile for both inflation and unemployment relative to other OECD nations. We have a stable and well-functioning financial system that is resilient to a wide range of interest rate and employment shocks. And, as outlined in our most recent Monetary Policy Statement, we have resilient household, public, and business sector balance sheets in aggregate. New Zealand has a near record low unemployment rate of 3.3% and exceptionally high labour force participation rates. Households have accumulated financial savings, with average household incomes rising in line with inflation. Nominal wage rates have risen, with incomes further bolstered as people moved jobs to earn more, worked longer hours, or gained promotions. Average hourly earnings growth for the private sector was 8.6%1 in the year to September 2022, compared with Consumer Price Index inflation of 7.2% in the same period. As interest rates rise, we expect spending to slow and unemployment levels to increase as more people join the workforce over the coming year. Even with the expected slowdown in the period ahead, it is anticipated that the level of employment will remain high. Large Scale Asset Programme 2/7 BIS - Central bankers' speeches I'd like to briefly comment on the Large Scale Asset Purchase and Funding for Lending programmes which featured during the 2021/22 financial year. The Review and Assessment of Monetary Policy over the past five years showed that the Large Scale Asset programme was highly effective in response to the liquidity crisis that emerged in early 2020 and in lowering longer-term interest rates. The Funding for Lending programme also gave banks confidence that a stable and secure funding source was available during a period of heightened financial market uncertainty. Banks were able to continue their business of financial intermediation, avoiding a credit squeeze or worse. This lending programme needed a period of commitment from the Reserve Bank in order to provide banks the confidence to include the use of the facility in their forward plans. In hindsight, it could have been designed with more flexibility. The additional allocation drawdown window for the programme ended on 6 December this year. The interest rate charged for accessing funding under this programme rose in line with the OCR, and the volume accessed accounted for only about 2 percent of bank funding. Our experience with both these tools has built our capability to respond to unexpected events in future. Delivering financial stability As highlighted in the recent Financial Stability Report, while our financial system as a whole is resilient, some households and businesses will be challenged by the rising interest rate environment needed to curb inflation. Financial institutions must take a long-term view when supporting customers and allocating credit to the wider economy. The New Zealand banking system is well positioned to do this, with higher capital buffers and low non-performing loan rates. Banks also have strong profitability and funding profiles, and liquidity is strong. Our recent stress tests have demonstrated banks' resilience to severe but plausible economic scenarios. That said, financial institutions will need to continue investing in their systems, governance, and risk management to build their long-term resilience. In coordination with our regulatory partners – the Council of Financial Regulators- we are committed to continuing to work with the industry to support financial stability, and ensure our priorities are risk-based, evidence-led and outcome-focused. Developing our 'regulator-regulated' relationships 3/7 BIS - Central bankers' speeches We are responsible for the prudential supervision of 27 banks, 17 Non-Bank Deposit Takers, and 90 insurers. We also supervise 5 designated Financial Market Infrastructures, as well as 79 institutions under the Anti-Money Laundering and Countering the Financing of Terrorism Act 2009. In response to the most recent IMF Financial Sector Assessment Program review, we are building a more intensive approach to prudential supervision, while also building strong and productive relationships with stakeholders. Our current priorities are monitoring and responding to risk, strengthening the regulatory framework, and building our policy, supervision, and enforcement capabilities. We have focused our resource in Auckland, where many financial institutions are headquartered. Relationship with the sector In 2018 we introduced a Relationship Charter with our regulated institutions to ensure we build on our supervision performance. We have surveyed these institutions annually to ensure we are meeting the Charter commitments. As at the end of the 2021/22 financial year, regulated banks rated our relationship highly. 93% of bank participants gave a rating of 4 or 5 out of 5, compared to 91% in 2021 and 68% in 2020. No bank participants gave a low rating. In this the second year the insurance sector has been surveyed, 72% of insurer participants rated their relationship with us highly (4 or 5 out of 5), which was an increase from 67% last year. Overall, banks and insurers' responses to the 2022 survey indicate that we have continued to build on the gains made on our key performance measures. Our people and capability We have also been in a period of deliberate growth in people to build the capacity and capability where we need it. And at the same time we've been working to ensure our people are well supported, appropriately paid, and feel valued and included. I want to take this opportunity to acknowledge my colleagues for their many, significant, contributions during this period. Growth and transformation 4/7 BIS - Central bankers' speeches Our transformation strategy has been well planned so as to keep pace in a changing operating environment. Our Funding Proposal 2020-25 identified the need for significant investment in people, technology, and systems, and has detailed information on what it means for each area of our work. The formal questions included in your pack also contain a wealth of facts, figures, and five-year history. I will summarise by saying we are implementing the new Reserve Bank of New Zealand Act that maintains our mandates while modernising the way we operate. The Act has significant implications for our broader legislation (the Deposit Takers Act currently in consideration in Parliament), as well as governance, digital capability, business services, and capacity and capability development. During the year we completed a bank-wide function and leadership review, and resulting reorganisation. This included the creation of reshaped business units, an expanded Executive Leadership Team, and a supporting tier of operational leaders undertaking 28 functions in total. The roles are designed to have balanced portfolios and an appropriate span of control to improve efficiency and depth of knowledge. We are pleased that many of our existing senior leaders filled these new or reshaped positions. Overall, the turnover rate for Te Ptea Matua as at 30 June 2022 was 21.7%. This aligns with the overall public sector rate of 21.7% for the same period, but includes the necessary bank-wide re-organisation. Similar to other organisations we are experiencing higher than normal levels of staff turnover, in part promoted by the ongoing impact of COVID-19. We are however seeing strong demand in the marketplace for our roles and a high calibre of candidates coming on board. Wellbeing The lingering COVID-19 health challenge created a difficult work environment for many over recent years. We run a number of initiatives and training to support staff wellbeing. We have operated and modernised our corporate policies to best support our people – with policy topics including, for example: Wellbeing; Support for Flexible Working; Prevention and Management of Harassment and Bullying; Whistleblowing; and an Employee Assistance Programme available to all staff at any time. In August 2022 we ran an employee engagement survey to check in on all aspects of work life at Te Ptea Matua. 5/7 BIS - Central bankers' speeches 79% of our people completed the survey and the aggregate Health & Wellbeing score was 7.7/10 consistent with our benchmark. Overall, there were many positives around health and wellbeing, but more support was requested in managing workloads. Diversity and inclusion We are committed to a goal of the representation of ethnic groups: our workforce should reflect modern Aotearoa, and we are focused on ensuring it does while building our capabilities. In order to achieve our goal we have: Refreshed our Diversity, Equity and Inclusion strategy; Commenced measuring critical areas of activity for gender and ethnic pay gaps; Commenced a Women Leaders programme; and Piloted a number of programmes in unconscious bias and cultural intelligence. Te Ao Mori We have also continued to build out our Te Ao Mori strategy. We recognise Mori as tangata whenua, and commit to working in a manner that gives effect to Te Tiriti o Waitangi. As a kaitiaki of the financial system, we want to both enable a thriving Mori economy and support economic wellbeing for all New Zealanders. Our activities included: Our Te Moni Anamata work programme included partnering with Mori to explore how access – or lack thereof - to physical currency impacts financial inclusion; We completed our collaborative work identifying barriers to Mori accessing capital, and are now partnering with Mori, financial institutions, and government agencies to reduce these barriers; and We are an active member of the Central Bank Network for Indigenous Inclusion, which shares knowledge and practices aimed at better financial engagement with Indigenous Peoples. Cyber security I also just wanted to touch on the progress we made this year in cyber security. We have made significant progress in uplifting all elements of our protective security controls, monitoring systems, and associated governance frameworks to ensure we provide our functions with stability and continuity. Our work includes building capabilities to improve cyber resilience, data management, and security awareness and event monitoring. The work has included undertaking priority investments in critical infrastructure. Climate Change 6/7 BIS - Central bankers' speeches To turn then to another topic that has received considerable interest, and that is climate change. Climate change brings significant physical risks and transition challenges to a low-carbon economy. We are now reporting on our own carbon footprint, and we will be sharing our emissions targets and planning early in 2023. In collaboration with the Financial Markets Authority, we are including climate change in our scheduled supervisory engagements with our regulated institution's management and boards. We are also including regular climate change risk elements into our banks stress test, and we are finalising formal guidance on climate change risk management for our regulated entities. Conclusion We have made continued good progress on our transformation as set out in the fiveyear funding agreement. However, there is much more to be done especially as we build for the new Deposit Takers Act. I am very proud of, and thankful for, our new governance arrangements and Board, the Monetary Policy Committee, our Leadership team, and all of our people. It has been a year of considerable commitment, effort, and determination in supporting all New Zealanders during a very challenging year. Thank-you once again to this Committee, for your attention and support, and for holding us to account to the public of New Zealand. Meitaki ma'ata Tn koutou, tn koutou, tn koutou katoa 1 Quarterly Employment Survey, September 2022 7/7 BIS - Central bankers' speeches
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Keynote speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the 2023 New Zealand Economics Forum, Waikato University, Hamilton, 3 March 2023.
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Promoting economic wellbeing: Te Pūtea Matua optimisation challenges Speech to the NZ Economics Forum at Waikato University Adrian Orr, Governor 3 March, 2023 Introduction Tēnā koutou, tēnā koutou, tēnā koutou katoa. Thank you for inviting me today – it's great to be back again at this forum. First, I would like to acknowledge the extreme hardship that many people in Aotearoa are experiencing at present as a result of the recent extreme weather events. Today I’ve been asked to talk about how our work at the Reserve Bank of New Zealand – Te Pūtea Matua can best contribute to the economic wellbeing and prosperity of the people of Aotearoa New Zealand. That is our legislative purpose – our reason for being. In doing so, I will outline our navigation lights – our legislation and policy remits, how these commitments shape our work, and how we manage the policy trade-offs we inevitably face from time to time. There are three main strands to the work of Te Pūtea Matua. The first strand is our monetary policy work. Through our role as the supplier of a fiat currency – the New Zealand dollar – we aim to keep consumer price inflation low and stable through time. Our desire is to maintain the purchasing power of our currency through time, by moderating economic demand to broadly match the supply capacity of the New Zealand economy. In doing so we meet the necessary criteria of a trusted currency – it is seen as a unit of account, a means of exchange, and a store of value. We aim to slow (or accelerate) domestic spending and investment if it is outpacing (or falling behind) the supply capacity of the economy. We do this by influencing people’s incentives to spend or save by altering the level of short-term interest rates. However, we are humble in our ability to achieve stable consumer price inflation all of the time. Our monetary policy tools are limited, and there are long and uncertain lags between what we do with interest rates and the inflation outcomes. Meanwhile, economic shocks are just that. For example, in my short time as Governor of the Reserve Bank we have endured COVID-19, the impact of Russia’s invasion of Ukraine, and now the severe weather events impacting many parts of the North Island. These events have led to historically significant fluctuations in output, employment, and inflation. Te Pūtea Matua does not determine the economic context we operate in. Instead, we react to the economic context with a clear purpose – aiming for price stability – thus building on a reputation for delivering low and stable inflation expectations. We are tacking into the inflation headwinds right now by raising interest rates at times of severe capacity constraints in the economy and high inflation. We continued to do that last week, raising the Official Cash Rate from 4.25% to 4.75%. The Monetary Policy Committee agreed that the OCR still needs to increase, as indicated in the November Statement, to ensure inflation returns to within its target range over the medium term. While there are early signs of price pressures easing, core consumer price inflation remains too high, employment is still beyond its maximum sustainable level, and near-term inflation expectations remain elevated. Low and stable inflation is a necessary outcome for economic wellbeing in the longer term. Inflation is no one’s friend. Inflation makes people poorer. The second strand of our work is promoting financial stability. We aim to lower the probability and impact of deposit taking institutions and insurers getting into financial trouble, so that they can continue to provide the critical services the public rely on. The third main strand of our work is delivering our other central banking functions – ensuring the supply of cash throughout the economy, transaction banking the banks, and using, overseeing and operating critical payment and settlement systems. In delivering on these three strands of work there is a lot of balancing and trade-offs we must undertake. We use a wide range of knowledge and insights, conventional economic tools and frameworks, and financial capital and resources to succeed. In doing so, we aim to be transparent and understood by the broad public – our customers. Looking ahead, in striving to be exceptional in our work, we are working to act holistically across all aspects of the Reserve Bank’s work strands to draw data, gain insights, and most importantly manage trade-offs. Most of the goals of our work are mutually supportive, but we will meet tradeoffs from time-to-time. If we wanted to write the algorithm to replace central bankers, we are trying to maximise several objective functions, subject to taking on no undue operational, legal, financial, and reputation risk. We thus need to have clarity on our objective functions (purposes); secondary criteria outlined in our Remits; and what is reasonable and undue risk. In practical terms, some examples include: Pursuing low and stable inflation and contributing to maximum sustainable employment, without creating undue volatility in output, interest rates and the exchange rate; Maximising financial system soundness while supporting efficiency, competition, innovation, and inclusion; Promoting certainty of cash availability while promoting technology innovation in payments and settlement systems; Ensuring robust payment and settlement systems, while encouraging competition; and Being the liquidity provider in extreme financial market events while minimising moral hazard in market behaviour and operating prudently with the Bank’s balance sheet. These trade-offs have always existed in economic practice, but they have varied in their definitions, importance, and presence in the Reserve Bank’s legislation, and societies expectations. Our task is to build a consistent, coherent, and transparent approach to managing and explaining these objectives, trade-offs, and our risk appetite across all aspects of our work. Figure 1 Our purpose, vision and values 1 Our context Let me set out the hierarchy of our objectives which form the basis of many of the trade-offs we need to consider. At the top of the pyramid, the Reserve Bank is given authority to carry out a broad set of tasks via its legislation. The RBNZ Act 20212, which came into effect in the middle of 2022, replaced our previous legislation from 1989. This new legislation sets out our purpose of ’promoting the prosperity and wellbeing of all New Zealanders and contributing to a sustainable and productive economy’. As outlined in the relevant Cabinet papers3, this purpose is an explicit recognition that central bank functions are not ends in themselves, but contribute towards much broader policy and societal goals. We pursue our purpose through our statutory objectives, i.e. price stability, financial stability and providing the functions of a central bank. Underneath this legislation sit our Remits from the Minister of Finance. While we have statutory independence from the Government – meaning we have considerable operational autonomy to achieve our objectives and intended outcome – the Remit documents explicitly outline what the Government of the day wishes us to take into account of when pursuing our objectives. ____________ Statement of Intent 1 July 2022 - 30 June 2026 https://www.rbnz.govt.nz/hub/-/media/project/sites/rbnz/files/publications/statements-of-intent/rbnz-soi-2022.pdf Bank of New Zealand Act 2021 https://www.legislation.govt.nz/act/public/2021/0031/latest/LMS286978.html RBNZ Act Review – Final Cabinet Papers https://www.treasury.govt.nz/sites/default/files/2021-06/rbnz-4436698.pdf The Financial Policy Remit4 states in pursuing Financial Stability: the government seeks strong institutions; proportionate regulation; consistency of treatment; maintaining competition; and efficiency; inclusion; innovation; and a low incidence of failure of entities regulated by the RBNZ. The Monetary Policy Remit5 outlines the Government’s desire for: medium-term price stability and maximum sustainable employment; soundness of the financial system; and avoiding unnecessary instability in output, interest rates and the exchange rate. These Remits, and our legislation, tell us where we are headed, but it is up to us to work out how to get there. There is another stage at which the Minister can provide direction – by issuing each year a Letter of Expectations6, which is intended to guide us in developing our Statement of Intent7 and Statement of Performance Expectations8. These letters are also publicly available. Last year’s Letter of Expectations informed our business planning and preparation for the new Reserve Bank Act. The 2023 letter will be published alongside our next Statement of Performance Expectations. ____________ Financial Policy Remit 2022 https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/about/financial-policy-remit/mof-letter-to-governor-and-chair-financial-policy-remitissuance.pdf Monetary Policy Remit 2021 https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/monetary-policy/about-monetary-policy/remit-for-monetary-policy-committee-order-feb2021.pdf?sc_lang=en Letter of Expectations 2022 https://www.rbnz.govt.nz/hub/publications/corporate-publications/letters-of-expectation/letter-of-expectations-2022 Statement of Intent 1 July 2022 - 30 June 2026 https://www.rbnz.govt.nz/hub/-/media/project/sites/rbnz/files/publications/statements-of-intent/rbnz-soi-2022.pdf Statement of Performance Expectations 2022 https://www.rbnz.govt.nz/hub/publications/corporate-publications/statement-of-performance-expectations/statement-ofperformance-expectations-2022-to-2023 Figure 2: Summary of our governance and accountability9 Our Optimisation challenge: dealing with trade-offs So, there is quite a lot of guidance in our endeavours. But there is no single, first-best, optimal calibration of our work. Instead, we are tasked with optimising various outcomes over various time horizons, subject to managing other specific risks related to legal, financial, reputation, and operational risks. We are maximizing our aims subject to no undue risk in all we do. This is about trade-offs to a defined risk appetite, so let me explain with a few examples. ____________ Statement of Intent 1 July 2022 - 30 June 2026 https://www.rbnz.govt.nz/hub/-/media/project/sites/rbnz/files/publications/statements-of-intent/rbnz-soi-2022.pdf Monetary policy The best example of this trade-off in action is our Monetary Policy Remit. It requires us to keep inflation within target and to support maximum sustainable employment, while having regard to efficiency and soundness, and avoiding unnecessary instability in output, interest rates, and the exchange rate, discounting transitory events, and assessing the impact of MPC decisions on the Government’s policy on house prices. The first part of the trade-off for monetary policy relates to the dual mandate of low and stable inflation and maximum sustainable employment. There is no trade-off when inflation is high, employment is strong, and unemployment is low as it is now. Both point to raising interest rates, to control inflation by slowing domestic spending and encouraging saving. But there would be a trade-off to consider if we faced stagflation – which is a period of low growth, rising unemployment and still high inflation. At that point, do you raise interest rates to control inflation, or lower rates to encourage growth and jobs?10 History and economic theory tell us that we need to be resolute to bring inflation down, but we may need to bring inflation back to target over a reasonable horizon so as not to unnecessarily impede maximum sustainable employment. The second part of the trade-off is how far and how fast do we go to rein in inflation without creating a worse outcome overall? We need to have regard to other principles such as financial stability, unnecessary volatility in economic output, interest rates and exchange rates, and we need to have regard to the efficiency and soundness of the financial system. Lifting the Official Cash Rate (OCR) too fast or too far could, for example, lead to a severe downturn in spending and investment, and a much higher exchange rate as international investors chase higher returns, crushing the export sector. Financial stability versus efficiency gains and innovation There is a similar trade-off challenge in the financial stability space. The Remit says that the Government wants a financial system that is strong, efficient, and inclusive. In financial stability, if you want to make a bank strong, you may limit the amount of higher risk transactions institutions can make. However, by doing that, Te Pūtea Matua may undermine financial efficiency and inclusion. Clearly, these are impacts which do not align to our overall objective of wellbeing and prosperity. ____________ Monetary Policy Handbook Version 2, 1st September 2020 https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/monetary-policy/monetary-policy-handbook/monetarypolicy-handbook-september-2020.pdf An extreme way to make banks safer would be to just stop them from expanding the money supply – as they have for hundreds of years through a process known as fractional reserve banking. Instead, banks could be restricted to holding all deposit funds in risk free assets with similar maturity periods – so-called narrow banking. Of course doing this would be completely out of line with the actual scale of the risks posed and would stifle lending to the wider economy. So, what is efficient and what is the trade-off between soundness and efficiency? Modern banks and regulators realise that lending out deposits is a manageable risk, with low risks of a bank failure; and that maturity transformation – borrowing money on shorter timeframes than they lend money out – contributes to a productive economy. A simple analogy is preventing car crashes. All fatal crashes could likely be avoided if the speed limit was cut down to 5kph. But is that sustainable or sound? No, because we need to get people moving in an orderly and timely way. But where is the grey area of acceptable risk? With proper infrastructure in place, 30kph in some areas or 100kph on the open road are desirable options. We accept these risks every day. It is a manageable risk and the alternative of walking everywhere is not the best solution. As a more specific example, we impose loan-to-value restrictions (LVRs) to limit the amount of higher-risk/lower deposit lending banks can make. We do not want too many people borrowing with no equity to back it up, because any sudden drop in value could lead to stress on household balance sheets, instability in the banking sector, and widespread effects on the economy. These are the good financial stability reasons for imposing LVRs. However, it also means that the rules may exclude some creditworthy borrowers from buying a home. A first-home buyer may not have a $100,000 deposit, but have a steady job and a good salary and good prospects for a growing income, so may be able to honour mortgage commitments. For them, borrowing all of the cost of a home would be seen as efficient, but it may be prevented by LVR rules. This is why we have exceptions within the LVR regime to help accommodate these special cases. Lenders are not prevented from making any high LVR loans, but there is a limit on how many they can offer. Such trade-offs mean that the Reserve Bank needs to define what we mean by terms such as financial stability and efficiency, and how they relate to the overall aim of prosperity and wellbeing of all New Zealanders. The Financial Policy Remit says there should be a low incidence of failure, but the financial system should be competitive, to ensure ongoing financial efficiency and inclusion, and the Remit sets out the benefits that the Reserve Bank should have regard to. Financial inclusion Financial inclusion is another key component of wellbeing. It is also specifically referenced in our Financial Policy Remit. The Reserve Bank is more actively playing its part in financial inclusion, working to ensure people can access the financial system and enjoy its benefits.11 This work is an important part of our approach to promoting a sound and efficient financial system. A lack of financial inclusion can lead to, for example: poor availability of accessible and safe financial products; restricted access to banking and insurance services; and societal problems from the impact of high-cost short-term loans, for example payday loans. We are working with the finance sector and other stakeholders to develop a deeper understanding of the interaction between our policies and financial inclusion. The long-term aim is to ensure that consideration of financial inclusion is firmly embedded in the Reserve Bank’s normal business practices. As part of this, the Reserve Bank is also leading the Council of Financial Regulators’ work on financial inclusion. Financial inclusion is more important for some elements of our statutory objectives than for others. For example, financial inclusion is particularly relevant for central bank functions when we talk about access to cash, whereas the link between inclusion and stability is more indirect. There are many examples across our activities where we need to articulate our appetite for actively addressing barriers to inclusion and define what the trade-offs are. A current example is the new Deposit Takers legislation that will govern how we supervise all deposit takers and the choices we will need to make on regulatory proportionality. We are also considering financial inclusion in our new role of stewarding the cash system – producing, storing, and distributing cash to the public in concert with a wide range of private sector participants. Inclusion is also a key principle behind our design work on a Central Bank Digital Currency. Finally – there is not a one way relationship between financial inclusion and our other objectives of stability. There are clear feedback loops and trade-offs between ensuring something is stable or efficient, and inclusive. Let’s explore some of these trade-offs. ____________ Future of money Te moni anamata https://www.rbnz.govt.nz/money-and-cash/future-of-money Money and cash How does financial inclusion relate to the central bank’s role in the provision of money and cash? Some communities rely more heavily on cash than others. Ensuring wide access to cash, and its accepted use, is very expensive for banks, businesses, and customers. However, to ensure financial inclusion for all New Zealanders, not just those with online bank accounts, there is a trade-off. It would be very efficient – cheaper, easier and even more climate friendly – to become a totally cashless society. But many people rely on cash to buy their groceries or other goods and services they need. So, we must juggle that efficiency argument against financial inclusion. This ‘juggle’ could not be more obvious than during the depths of the most recent severe weather crisis. Power was out, cell phone connectivity was dead, and cash was again king in enabling a means of exchange. Society cohesion is stressed quickly and severely if there is suddenly no agreed means of exchange. We also want to have a payments system that encourages and enables innovation. This may be a Central Bank Digital Currency to foster innovation, reduce costs in banking, enable faster and more secure payments, and encourage greater competition in the banking sector.12 However, doing that may have implications for the resilience of the system. The more competing players there are with access to the banking system, the more reliance there is on third party services and hence new and different risks to manage. The balancing act So what are the criteria to manage all these trade-offs and what is our appetite for risk? We are thinking about these questions and the goal is to always be able to calibrate, collate, and explain our overall framework for decision-making. Our new, empowered, Board own our ‘Risk Appetite Statement’ and understand its economic underpinnings i.e, when we are standing on facts versus beliefs. Beliefs need continuous testing, evidence, research and insight. In simple terms, our Board looks to ensure we have: clarity of our objectives; an understanding of the hierarchy involved across our legislation, Remits, and other expectations; an articulated risk appetite to achieve our outcomes and manage any trade-offs; awareness of the facts our decisions stand on; and trust in the underpinnings of the beliefs we hold that drive our economic, financial, and operational activities. ____________ The Future of Money – Private Innovation: Issue Paper Dec, 2022 https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/consultations/future-of-money/fom-privateinnovation.pdf It is only then that the Board can have full confidence that the activities the Reserve Bank undertakes, and the capability and capacity we need to succeed, are appropriate. These activities and capability will change through time – most often driven by factors outside of the Bank’s control such as technology, demographics, and changing societal preferences. Of course, bringing it all together are our values and culture the Board set and expect of our people. This comes to the heart of why we have been introducing a Te Ao Māori view of our work into the Reserve Bank’s behaviours – it is an Aotearoa home-grown link between prosperity, inclusion, sustainability, and cohesion. Building our institutional cultural capability – recognising the unique position of tangata whenua and the role of Te Tiriti o Waitangi – also builds the holistic thinking we need, to move from being a good to a great Central Bank.13 Building cultural capability also provides appropriate insights into a critical and growing component of the Aotearoa economy, with its own unique challenges and opportunities. Our recent work on looking to improve access to capital for Māori and Māori entities has been eye opening for all of the financial institutions that operate in New Zealand. We have important innovative and inclusive work ahead of us to ensure that the financial system is fit for purpose. Similarly, we are growing our climate risk expertise. Again, this is about understanding the challenges and opportunities our regulated firms, and we ourselves, are facing into from climate change. As we have seen recently, we all have work to do to build a more climate-resilient Aotearoa and we too have a key part to play. We are building multi-disciplinary skills where our climate risk people are embedded right across the Bank to ensure we incorporate climate considerations in our decisions. The Reserve Bank Act makes it clear that we must hold a wider view of our activities to serve the public good. While the central bank purpose of maintaining inflation within a specified range remains critical and necessary, it is not sufficient alone. Our research programme Te Pūtea Matua has a long tradition of pursuing policy-relevant research and as a full service central bank our research programme covers all three strands of work we are tasked to deliver. The Review and Assessment of the Formulation and Implementation of Monetary Policy (RAFIMP)14 that we published late last year yielded several lessons. These will shape our economic research agenda in the coming years. Projects that model the contributions of supply-driven versus demand-driven inflation, and deepen our understanding of the transmission of climate change shocks to economic activity and inflation, are underway. ____________ Our purpose, vision and values - https://www.rbnz.govt.nz/about-us/our-purpose-vision-and-values Review and Assessment of the Formulation and Implementation of Monetary Policy (RAFIMP) https://www.rbnz.govt.nz/monetary-policy/about-monetary-policy/rafimp Our research to support our financial stability work is extensive. This includes work to inform the development of the Depositor Compensation Scheme and calibrating our new role as part of the Deposit Takers Act. We are also working on developing our understanding of ‘macroprudential’ tools (such as the LVR and debt-to-income ratios) and how they intersect with our more traditional prudential tools such as capital ratios and liquidity requirements. We need to be able to articulate how these work together, and what calibrations work best through the financial cycles. Also, how these instruments and their calibration intersect with our expectations around promoting efficiency and inclusion. Our future of money programme has seen us engage extensively with New Zealanders to better understand their money and payments preferences. This research has been critical to inform cash and Central Bank Digital Currency, CBDC, policy development, and better understand the opportunities and challenges of a CBDC. As I’ve already mentioned, financial inclusion is a focus for us and we are also continuing our work to better understand how to enhance access to capital for Small and Medium Enterprises (SMEs) and the Māori economy in particular15. Finally, what role can and does the financial system play in mitigating climate risk and promoting adaptation to a lower carbon planet? We have a broad range of climate-related initiatives underway. For example, the focus of our bank stress testing over recent years, and again this year, is weather-event scenario analysis aimed to improve capability in the industry to manage and monitor climate-related risks. We are working with the climate research community in New Zealand to anchor our insights in the best available science. Internationally, we are engaged with the Network for Greening the Financial System, co-leading a Net Zero for Central Banks16 workstream with the Bank of Italy. The focus of this work is to better understand central bank roles in sustainable investment, greening their own operations, and developing climate-related disclosures. This is helping to inform our focus on demonstrating leadership in our stewardship of the financial system by beginning work on our own climaterelated disclosure. ____________ Improved access to capital for Māori - https://www.rbnz.govt.nz/about-us/how-we-work/te-ao-maori---an-evolving-and-responsible-strategy/improved-access-to-capital-formaori Workstream “Net Zero for Central Banks” Mandate - April 2022 / April 2024 - https://www.ngfs.net/sites/default/files/worksteam_net_zero_for_central_banks_mandate.pdf Concluding remarks As you’ve no doubt have gleaned, the world of central banking comes with many trade-offs to be made and uncharted waters. The Reserve Bank needs your help – to build our knowledge from our wider community for the benefit of all New Zealanders. We all have a role to play in helping to deliver economic wellbeing and prosperity for New Zealanders. We are a learning institution and we enjoy collaboration. The wero I will lay down is – for you to work alongside us. “He waka eke noa, engari me takitahi te hoe” When you want to go fast, paddle alone. When you want to go far, paddle together. Thank you.
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Remarks by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Institute of Directors, Canterbury, 21 April 2023.
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Christian Hawkesby: Central banking and financial inclusion Remarks by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Institute of Directors, Canterbury, 21 April 2023. *** There is no shortage of challenges as a central banker in the current environment, with domestic and global inflation too high and persistent, and the recent fragilities exposed by bank failures in the United States and Europe. Today I'll touch briefly on these topics, with a particular focus on financial inclusion and the impacts on different parts of our society. In doing so, I'll highlight some material from our upcoming Financial Stability Report (to be published on 3 May) and reiterate some of the messages from our most recent Monetary Policy Review (5 April). Periods of high consumer price inflation hit hardest for those with low or fixed incomes such as a government benefit or pension, and those without significant wealth or savings to draw on. At the same time, lifting interest rates to cool the economy, and ultimately combat high inflation, also has consequences for those on the margins of the workforce with the least job security. This is why it is so important to foster an ongoing environment of low and stable inflation. Over the course of the past 18 months, the Monetary Policy Committee (MPC) has increased the Official Cash Rate (OCR) from 0.25% to 5.25%. At the most recent Monetary Policy Review, the Committee noted that: the full impact of the monetary policy tightening is yet to be fully realised, there are early signs that growth in the domestic economy is beginning to slow, and the extent of this moderation will determine the direction of future monetary policy. The recent high profile failures of Silicon Valley Bank (SVB) and Credit Suisse have proven pertinent reminders of the importance of financial stability. Particularly, the importance of sound financial risk management by banks in an environment with large changes in interest rates. In New Zealand, all registered banks are required to have systems in place to monitor and control their material risks, including interest rate risks. Our banks also operate different business models that mean that they are not as exposed to the risks that have led to the issues with SVB. Our banks undertake a regular and rigorous stress testing programme, and our Bank Financial Strength Dashboard displays data on the financial health of registered banks in New Zealand. 1/2 BIS - Central bankers' speeches Our work to promote a sound and stable financial system is not just to avoid and mitigate periods of instability, but to enable an environment that promotes the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy. We do this by seeking a strong, efficient, innovative and inclusive financial system, consistent with our Financial Policy Remit. Central banks around the world continue to contribute towards improving financial inclusion, defined as individuals and businesses having access to useful and affordable financial services delivered in a responsible and sustainable way. Globally, initiatives from central banks include delivering inclusive payment systems, factoring inclusion into regulatory settings, collaborating with public and private networks, delivering financial literacy programmes and undertaking research to fill evidence gaps. Financial stability is the highest contribution Te Ptea Matua can make to financial inclusion. A well-functioning financial system with low probability of insurers and deposittakers getting into trouble increases the likelihood that people can access, and have trust in, the products and services they rely on. Financial inclusion can also contribute to stability. Providing financial services to a larger customer base can promote a higher share of customer deposit funding, contributing to stability. Inclusion efforts, such as increased lending to smaller firms, can also help to diversify asset portfolios and reduce the relative size of any single borrower. A review of 2,600 banks in 86 countries found a higher level of inclusion contributes to greater bank stability, particularly in countries with strong institutions and sound regulatory settings. We explore this further in an excerpt from our May 2023 Financial Stability Report that we are pre-releasing today. Our Kimihia te mea ngaro – Mori access to capital programme was launched to better understand Mori access to capital in the New Zealand economy and bring a more deliberate approach to financial inclusion. An efficient, effective, and stable financial system is one where capital is allocated on the basis of risk and return, one in which there is equitable access to capital for all firms, including Mori firms. Since we released our issues paper on Mori Access to Capital in August 2022, we have been working with retail banks to find solutions, including working collaboratively on how banks assess lending against whenua Mori, which has the potential to improve access to capital for Mori landowners and collectives. Similarly, our Future of money – Te moni anamata programme has been working to ensure that the money we issue as a central bank continues to enjoy trust and confidence and promotes financial and social inclusion. The devastating impact of Cyclone Gabrielle highlighted the lack of resilience in the cash system and its vulnerability to outages of power, data and roading networks. Given the increased likelihood of extreme weather events in the future as a result of climate change, this resilience needs to be enhanced. We will continue to explore synergies between inclusion and stability as we develop our approach to financial inclusion. We are doing so in concert with our Council of Financial Regulators partners, for which 'Financial Inclusion' is one of 5 priority themes. 2/2 BIS - Central bankers' speeches
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Speech (virtual) by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Institute of Directors, 7 September 2023.
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UNCLASSIFIED Towards good governance in the financial system of Aotearoa A speech delivered online to the Institute of Directors on 7 September 2023 by Christian Hawkesby, Deputy Governor and General Manager Financial Stability Written with Esther Bonaparte Ref #20585968 v1.0 UNCLASSIFIED Introduction E nga mana, e nga reo. E nga karanga maha o te wa. Tihei mauri ora! (To all authorities, all voices, to the many chiefs gathered here. Behold the breath of life!) E nga rangatira Karanga mai Mihi mai Whakatau mai Tena koutou katoa (Thank you to the leadership of the Institute of Directors who have called us here; who have welcomed us here; who have looked after us here. Thank you very much) I am delighted to be with you this morning, both as Deputy Governor of the Reserve Bank of New Zealand and as a fellow member of the Institute of Directors. In recent years, I have presented to the Institute of Directors a number of times, at the annual conference and at branch functions around the country. Some of the topics I’ve covered have been the Māori Economy 1, Financial Inclusion 2 and the Future of Money. All of these issues are at the heart of central banking in New Zealand. They are also topics that I’ve found directors and trustees are very keen to understand for their roles. Today I am here to discuss a topic at the very heart of the governance and the territory of the Institute of Directors – the path towards good governance in the financial sector of Aotearoa. • • • First, I want to explain the role of governance in Reserve Bank’s approach to prudential supervision and regulation; Second, I want to look back through history to reflect on past governance lessons learned, and discuss how these have shaped governance guidance; and Finally, I will share the outcomes of our recent Thematic Review on Governance and take any questions. I should first acknowledge that at the Reserve Bank, Te Pūtea Matua we have been undergoing our own very significant changes in governance. Under our 1989 Act, the powers and responsibilities of the Reserve Bank were held by the Governor, with the Board playing an oversight and advisory role. Now under our new 2021 Act, the Monetary Policy Committee is responsible for formulating monetary policy and the Reserve Bank Board is responsible for all other governance functions. Under this new approach, our Board of Directors looks much more like a standard corporate board like our regulated entities. The past couple of years has been an intense period setting up the foundations for our new Board to succeed in its role. ____________ See Hawkesby, C. (2021). The Future is Māori. Panel remarks delivered to the Institute of Directors New Zealand Leadership Conference in Tāmaki Makaurau, available at: The Future is Māori (rbnz.govt.nz) See Hawkesby, C. (2023). Central banking and financial inclusion. Remarks by Deputy Governor Christian Hawkesby to the Institute of Directors, Canterbury Branch, available at: Central banking and financial inclusion - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED However, today I am here to talk about our role as the prudential regulator of deposit takers and insurers, and the crucial role that good governance has on the stability of those institutions and the financial system, as well as the ability of the financial services industry to meet the needs of New Zealanders. More specifically, I’d like to share the findings of our Governance Thematic Review 3 which we jointly undertook with the Financial Markets Authority (FMA), New Zealand’s financial conduct regulator. This work follows on from the joint Conduct and Culture Review we published in 2018. That work highlighted the critical role of culture and conduct from the Board and Senior Management of financial institutions to ensure trust in their services 4. The scope of this latest Governance Thematic Review was around the thoroughness and discipline boards follow in governing their activities. Systems, processes, documenting lessons, and transparency were a key focus of our work. What sat behind this was a view that if appropriate fixed investment and care are taken at the outset, governance will be more efficient and effective. With these foundations in place, more time is available to focus on strategy, conduct, culture and behaviours, reducing the likelihood of the worst-case outcomes we have seen through history financial failures, bailouts, systemic crises, misconduct and mis-selling. A common theme we identified was the need for boards to set themselves up for success now and into the future. This is the essence of a being a good kaitiaki. It’s about being a temporary guardian or caretaker, with responsibility to hand things over to the next generation in a better position and ready for the future. The results of the Thematic Review will inform our institutional supervision priorities and input into our supervisory standards and guidelines as we embed the new Deposit Takers Act 2023 (DTA) and review of the Insurance Prudential Supervision Act 2010 (IPSA). We also hope that this work is of wider value, providing a unique opportunity to learn from others, both for other financial institutions and those outside the financial industry. Our approach to prudential regulation and supervision Effective governance is critical to the financial soundness, success, and long-term sustainability of New Zealand’s financial institutions and to ensuring their customers are treated fairly. As Dr John Laker says in the introduction to the Review, there is no ‘one size fits all’ governance framework for financial institutions and no single best practice for governance, but there are essential foundational elements in governance policies, processes and practices that underpin good decision-making at board level. Before getting into the Review, it is important to step back and briefly remind ourselves why there is a role for a public policy institution like Te Pūtea Matua to have responsibility for financial stability. ____________ See RBNZ, FMA(2023). Governance Thematic Review for additional information, available at: RBNZ and FMA Governance Thematic Review report In 2018 the Reserve Bank and Financial Markets authority undertook a joint review into the conduct and culture issues present in life insurers and banks in New Zealand, and looked to understand how banks and life insurers identify and remediate issues. Available here for life insurers life-insurer-conduct-and-culture.pdf (rbnz.govt.nz) and here for banks banksconduct-and-culture-review.pdf (rbnz.govt.nz). Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED A sound and well-functioning financial system – financial markets, financial institutions, payments systems – provides a public good shared by society in much the same way that physical infrastructures do. Transport, energy, water and communications infrastructure provides benefits that are felt much more widely than by individual users. As a public good, the costs of financial instability can also be felt far beyond the management, shareholders, or customers of individual financial institutions. Sound financial institutions and financial systems are core responsibilities for us at the Reserve Bank and the organisations we regulate. We want to ensure that we have a resilient financial system that can withstand shocks and provide the financial services that all New Zealanders rely on. It is a privilege to be a deposit taker or insurer in our society; it comes with the safeguard of being prudentially regulated and supervised. Our approach to prudential supervision relies on three interdependent pillars – self discipline, market discipline and regulatory discipline5 6. • Self discipline: relates to the role of directors and senior managers 7. Boards of financial institutions are responsible for setting the strategic direction; the tone and culture of the entity; the risk appetite of the organisation; ensuring there are strong systems, policies, processes and procedures; making critical decisions; and holding management to account. In many ways the governance Board is the financial institution. • Market discipline: relates to the role of financial market participants in monitoring the risk profile, and the financial performance and position, of financial institutions, and in influencing their behaviour. An aim of the market discipline pillar is to reduce the information asymmetry between firms and market participants so that they can effectively monitor and influence financial institutions 8. • Regulatory discipline: relates to the role of regulation, such as minimum capital and liquidity requirements, to enhance the effectiveness of market and self discipline, and to minimise the costs of financial instability if they do occur 9. It’s hard to overstate the importance of good governance in all this. No matter how strong the regulatory discipline and market discipline are, if there are governance failings, or even weak governance, the stability of the organisation and the financial system as a whole, are at risk. ____________ See Hunt, C. (2016), A short history of prudential regulation and supervision at the Reserve Bank. Reserve Bank Bulletin vol 79 (14), available at: A short history of prudential regulation and supervision at the Reserve Bank - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) The Reserve Bank’s approach to prudential supervision is available here: Our approach to supervision - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) See Fiennes, T, (2016). New Zealand’s evolving approach to prudential supervision. A speech delivered to the NZ Bankers’ Association in Auckland, available at New Zealand’s evolving approach to prudential supervision - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz). See O’Connor-Close, C. & Austin, N. (2016), The importance of market discipline in the Reserve Bank’s prudential regime. Reserve Bank Bullitin vol 79 (2) , available at: The importance of market discipline in the Reserve Bank’s prudential regime - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) See Bascand (G). (2019). Renewing the RBNZ’s approach to financial stability. A speech delivered to 15th Financial Markets Law Conference in Auckland On 26 June 2019, available at: Geoff Bascand: Renewing the RBNZ’s approach to financial stability (bis.org) Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED Figure 1 - Three pillars of prudential regulation and supervision History and importance of good governance Over the past 20 years we have learnt a lot about governance failings and weak governance. Internationally, the Global Financial Crisis (GFC) highlighted governance failures of financial institutions that experienced the most trouble managing their financial risks 10 11. Some common themes of governance failures on the board during the GFC included: • • • A lack of financial industry experience amongst directors; An inability of board members to accurately identify and understand financial risks; and Boards failing to receive timely, relevant, and digestible information. Unfortunately, in New Zealand we are not immune to governance failures and lessons. Around the same time as the GFC, the failure of finance companies was further precipitated by governance weaknesses. South Canterbury Finance is a prime example of the importance of having effective board dynamics and procedures amongst directors. Governance failings included: • • • The board had few formal meetings between all directors; Independence was hindered as the chairman doubled as the controlling shareholder, creating a challenge for the board to make collective decisions; and The board did not sufficiently review the content of papers or financial statements 12. More recently, CBL Insurance serves as a reminder of public concerns being raised in relation to financial institutions’ governance. For CBL Insurance these included: ____________ See Farrar, J H. (2010) The global financial crisis and the governance of financial institutions, Australian journal of corporate law, 24 (3), 227-243, available at http://epublications.bond.edu.au/law_pubs/334 See Laker, J. (2013). The importance of good governance. Speech delivered to the Australian British Chamber of Commerce, available at: The importance of good governance | APRA See House of Representatives. (2011). Inquiry into finance company failures, available here: Inquiry into finance company failures (selectcommittees.parliament.nz) Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED • • • • Ceasing to follow up on recommendations from the Appointed Actuary; Failing to sufficiently oversee the risks facing the insurer; Breaching regulatory directions 13; and Failing to disclose material information to the market 14. Scandals in Australia over conduct and culture in 2018 also highlighted governance failings in managing non-financial risks. The Royal Commission noted several prominent governance issues including: • • • • Not receiving the right information, and not doing enough to seek further information; Not doing enough with the information they had to oversee and challenge management; Putting the pursuit of profit above all else, in particular above the interests of customers and compliance with the law; and Unclear lines of accountability which resulted in a lack of consequences when outstanding issues were left unresolved 15. The Royal Commission’s review prompted the FMA and the Reserve Bank to jointly review Conduct and Culture here in New Zealand 16. For the Reserve Bank a key takeaway was that an entity’s culture is the key driver of its conduct and risk management. Creating the right culture requires an ongoing conscious effort, led from the top. Boards need to take ownership for ensuring the appropriate culture is embedded within an organisation17. A scan of governance in New Zealand’s financial sector would not be complete without mentioning the section 95 reviews that we requested on governance from ANZ in 2020 18 and Westpac in 2021 19. Both resulted in a significant uplift and strengthening of governance that should be acknowledged and recognised. Finally, yet again this year we were reminded of the importance of governance through the highprofile collapse of Silicon Valley Bank (SVB) in the United States. SVB saw failings in governance including: • • • The board not receiving adequate information about the risks faced; Directors failing to ‘lean in’ and hold management liable for the mismanagement of the organisation’s risks; and The board as a whole possessing limited banking experience 20. ____________ See Trowbridge, S. Scholtens, M (2019). An Independent Review for the RBNZ for the Supervision of CBL Insurance Ltd. Final Report available at CBL RBNZ Final Report. See FMA. (2023). FMA reaches agreement with CBL Corporation and four independent directors on continuous disclosure breaches, available at FMA reaches agreement with CBL Corporation and four independent directors on continuous disclosure breaches | Financial Markets Authority See Haynes K, M. (2019). Final Report – Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Volume 1). Final report available at Final Report - Volume 1 (treasury.gov.au) In 2018 the Reserve Bank and Financial Markets authority undertook a joint review into the conduct and culture issues present in life insurers and banks in New Zealand, and looked to understand how banks and life insurers identify and remediate issues. Available here for life insurers life-insurer-conduct-and-culture.pdf (rbnz.govt.nz) and here for banks banks-conduct-and-culture-review.pdf (rbnz.govt.nz). See Orr, A. (2019). Conduct, Culture and Financial Inclusion A speech delivered at The Westpac Massey Fin-Ed Centre - Building Financially Capable Communities: Our Pathways To Success Conference, available at: Conduct, Culture and Financial Inclusion (rbnz.govt.nz). See Deloitte (2019). Section 95 – Review of ANZ Bank New Zealand Limited – Effectiveness of the directors’ attestation and assurance framework, available at anz-nz-section-95director-attestation-and-assurance-review-december-2019.pdf (rbnz.govt.nz) See Oliver Wyman. (2021).Risk Governance Review – Section 95 Review of Westpac New Zealand Limited for additional information on material shortcomings in the Board’s Oversight, available here Section 95 Risk Governance Review of Westpac New Zealand Limited (rbnz.govt.nz) See Barr, M S. (2023) Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank, available at: Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED Individually, these factors may not have had a material impact on the failure of SVB, but when considered collectively, the inadequate governance processes and behaviours resulted in the board having inappropriate oversight of the risks facing SVB. Principles, policies and guidelines Historically, the OECD has been the leading international organisation on principles of good governance across all sectors - financial and non-financial 21. They have periodically released corporate governance principles to support boards and policy makers in improving economic efficiency, sustainable growth and financial stability. While ineffective governance was not the sole contributor to the GFC, it highlighted the risks faced when boards fail to grasp the magnitude of their financial risks and acted as a catalyst for improving corporate governance across the world. Organisations and regulators looked to increase the expectations and accountability on directors. In 2010, the Bank for International Settlements (BIS)22 published the first edition of its corporate governance principles for banks. Given the central importance of governance to banks, it seems remarkable that these were not published until 2010 when you consider the foundations of modern banking regulation have been in place since the first Basel Accord of the 1980s. Around the same time, the Group of Thirty – a private sector organisation, which we at the Reserve Bank are proud to be a part of, along with other global central banks, international financiers and academics - published its comprehensive document which took a global perspective on good governance practices 23. Its guidance provided key insights and recommendations for enhancing governance effectiveness of financial institutions. Here at the Reserve Bank, our governance guidelines for insurers were published in 2011 24 and our corporate governance policy for banks (BS14) was published in 2014 25. The FMA also has its own corporate governance guidance as a financial conduct regulator26. To further promote good governance and recognise the critical role that boards play in both protecting the interests of shareholders and providing long term value, the NZX released the latest version of their Corporate Governance Code this year 27. The code strikes a balance between promoting strong governance practices and providing flexibility to boards to tailor their governance practices to the unique needs of their business. The Institute of Directors published its Four Pillars of Governance to provide guidance on good practice governance, global trends and the contemporary operating environment in New Zealand. Now in its fourth edition28, it is the go-to reference guide for governance, within arm’s reach of ____________ See OECD. (2023). G20/OECD Principles of Corporate Governance, available here: G20/OECD Principles of Corporate Governance - OECD Bank of International Settlements. (2010). Basel Committee on Banking Supervision – Principles for enhancing corporate governance, available at Principles for enhancing corporate governance - final document (bis.org) See Group of Thirty. (2012). Toward Effective Governance of Financial Institutions available at G30_TowardEffectiveGovernance.pdf (group30.org) See Insurance Prudential Supervision Department Governance Guidelines for Licensed Insurers for additional guidance: IPSA Guideline - Governance - May 2011 (rbnz.govt.nz) See BS14 – Corporate Governance (2014) for additional guidance on the RBNZ’s governance expectations for banks, available at: BS14 - Corporate Governance (rbnz.govt.nz) See Corporate governance in New Zealand (Principles and guidelines) for additional guidance on the Financial Markets Authority’s handbook to assist those in governance roles to think about, apply and report on corporate governance, available at: 180228-Corporate-Governance-Handbook-2018.pdf (fma.govt.nz). See NZX (2023). NZX Corporate Governance Code (Appendix 1), available at: NZX Corporate Governance Code (amazonaws.com) See Institute of Directors (2021). Four Pillars of Governance Best Practice for New Zealand Directors for additional guidance. Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED directors, trustees and governors across all sectors of the economy: from financial, to nonfinancial; private sector, public sector. Our joint Governance Thematic Review with FMA With all this context and background in mind, in late 2021 we teamed up with the FMA to undertake a joint review of governance. Our shared objective was to examine the policies, processes, and operational practices of boards of financial institutions we regulate. We wanted to focus on key areas of governance to: • • • Determine the extent to which these aligned to our regulatory requirements and guidance; Understand how these allow boards to provide oversight and govern effectively; and Promote effective board practices by outlining areas of good practice that all boards should consider, as well as highlight areas for improvement. Figure 2 – Areas of focus for effective governance We reviewed a sample of 29 entities regulated by the Reserve Bank and/or FMA, across the banking, insurance, non-bank deposit taking and investment management sectors. For each entity, we reviewed a range of documents related to board and governance policies, procedures and record keeping. This was followed up with in-depth onsite reviews where we interviewed board members and executive management, focusing on eight key areas of governance: • • • • • • • Roles and responsibilities; Board and committee composition and structure; Challenge; Board and committee performance; Board training; Board meetings; Board capacity; and Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED • Conflicts of interest. We assessed the entities against our expectations for governance, as set out in relevant legislation and the Reserve Bank and FMA guidance. Where we did not have guidance on a specific area we looked beyond our internal guidance and considered international good practices to gain an understanding of what other jurisdictions and regulators consider when assessing governance. When forming a view on international good practice we looked to governance guidance from a range of regulators from Bank of England, Federal Reserve, Australian Prudential Regulation Authority and OECD. Good practices and areas for improvement We observed a variety of governance practices across the industry; there were a number of good practices, as well as practices that were below our expectations. There is still room for improvement for most entities to ensure robust policies and processes are in place. Some areas where we generally saw good practices included: • • • • • • • Formal and clear processes for planning and formulating strategy. Strong processes for selecting and appointing new directors and the CEO. Boards being composed of a majority of independent directors. Clearly documented succession planning for CEOs and senior management. Formal standalone conflicts of interest policies. Formal annual planning processes and work plans for board and committees. Regular education sessions for the board, including in-depth sessions on specific risk topics. While we observed good practices across the sample, many of these practices were not embedded into policies and processes, and those that were documented often lacked sufficient detail and clarity. Through our review we have seen boards make positive changes to their governance structures, with their practices evolving over time. However, we observed changes which were not often reflected in the organisation’s governance frameworks. Formalising practices into these foundational documents: • • • Fosters transparency and accountability; Sets the tone from the top, supporting good practice being embedded into the values and culture of the organisation; and Sets boards up for success not only now, but into the future. In addition to formalising processes, some of the key areas for improvement across the sample included: • Processes for selecting and appointing the board chair and committee members were not robust. Several entities did not have clear or comprehensive processes in place for the chair and board committee members. Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED • • • • • Succession planning for the board was not as formal and rigorous as we expected. While discussions were taking place and processes existed, almost none of the locally incorporated entities had documented plans for the board, committees, or the board chair. Whilst the review identified that most entities were performing some form of internal evaluation of the board, the evaluations lacked formal, clearly defined, and comprehensive criteria. Performance of the board was not independently reviewed for most entities. Although capacity of directors was assessed prior to appointment and on an ongoing basis, these assessments were mostly informal in nature and not comprehensive. This was due to the absence of a formal framework to ensure consistent and robust assessment of capacity. In the absence of a formal framework, organisations generally took varying and ad-hoc approaches to identifying the ongoing training needs of the board. While organisations had diversity policies for staff, these diversity policies did not apply to the board. Being future focused and embedding good practice A common theme running through these findings of the Governance Thematic Review is the ability of boards to change and evolve, setting themselves up for success not only now but into the future. The environment facing governance boards is forever changing: • • • • • • • • Changing economic developments. Changing global geopolitical trends. Changing structural factors, such as climate change. Changing threats, such as cyber scams and attacks. Changing opportunities, from new markets and technologies. Changing expectations to embrace diversity to better arm boards to navigate these varying developments, trends, threats and opportunities. Changing expectations to embed a Te Ao Māori perspective and the strengths and benefits this provides, as a unique comparative advantage of Aotearoa, New Zealand 29. Changing expectations to earn and retain the social licence to operate by being transparent, accessible and accountable to all of society. As this evolution occurs, we need boards to ensure that they have the appropriate processes, capabilities and culture in place which allows them to ask the right questions and provide appropriate direction, challenge and oversight. One of the key roles of the board is to use the learned experience of previous boards to guide the organisation. With this in mind, one of the most valuable assets that directors leave an organisation with is their lessons learned so future generations can learn from their experience. In order to be future focused and embed a continuous improvement mindset, some of our key recommendations that all boards should consider include: ____________ See Institute of Directors (2023). Kotahitanga – Principles of Māori Governance, for more information. Available here: Kotahitanga – Principles of Māori Governance | IoD NZ Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED • • • • • • Undertaking robust suitability assessments which outline the skills, diversity and capabilities required on the board. This will assist the board in maintaining the collective skills and experience to guide and oversee the organisation’s long-term strategy; Ensuring that succession planning is thorough and well thought out to mitigate future composition risks, maintain an appropriate balance of skills, experience and diversity, and ensure continuity; Actively considering the diversity needs of the board to support them in their role; Assessing director capacity against a formal framework to ensure directors have sufficient time to be effective in their role; Conducting regular and robust evaluations to drive effective board performance. This includes having a clearly defined, and comprehensive criteria and ensuring improvements are identified and implemented; and Providing effective and appropriate challenge to one another and management. This continuous improvement mindset is the essence of a being a good kaitiaki. It is about being a temporary guardian or caretaker, with responsibility to hand things over to the next generation in a better position and ready for the future. Next steps and conclusion Thank you for this opportunity to join you this morning, as Deputy Governor and as a fellow member of the Institute of Directors. If you were directly involved in the Governance Thematic Review, thank you for your willingness to participate. The examples of good practice we observed in your entities are shared in our report so others can learn from them. I also hope you will embed any good practices that you don’t currently have in place. If you weren’t involved in the Governance Thematic Review, we hope that this work is of wider value, providing a unique opportunity to learn from others – both for other financial institutions and those outside the financial industry. At the Reserve Bank, the insights will inform our supervisory priorities and input into standards and guidelines as we embed the new Deposit Takers Act 2023 (DTA) and review of the Insurance Prudential Supervision Act 2010 (IPSA). Finally, I wanted to finish with a whakataukī (proverb) first said in 1858 by Pōtatau Te Wherowhero in 1858, a Waikato chief and the first Māori King. “Kotahi te kōhao o te ngira e kuhuna ai te miro mā, te miro pango, te miro whero” The literal translation is “through the eye of the needle pass the white thread, the black thread and the red thread”. Pōtatau was highlighting the importance of connection, collaboration and a common vision, and the strength this can create. Three strands woven strongly together are much stronger than one. At the same time, much like threading three strands through the eye of one needle, achieving this is not easy, and requires much deliberate focus and effort. Towards good governance in the financial system of Aotearoa UNCLASSIFIED UNCLASSIFIED In the world of financial stability, the strands of self-discipline, market-discipline and regulatorydiscipline together make for a strong financial system that meets the needs of New Zealanders. In the world of governance of financial institutions, the connected strands of past, present and future directors enable the learned experience of previous boards to guide the organisation into the future. Kia kaha, kia maia, kia manawanui, kia ora koutou katoa. Be strong, be bold, be patient, be well and good luck. Towards good governance in the financial system of Aotearoa UNCLASSIFIED
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Keynote speech by Ms Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking of the Reserve Bank of New Zealand, to KangaNews New Zealand Dept Capital Market Summit 2023, Auckland, 13 September 2023.
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Restricted UNCLASSIFIED Liquidity: One word, Three Meanings. Speech delivered to KangaNews New Zealand Debt Capital Market Summit 2023 By Karen Silk, Reserve Bank Assistant Governor 13 September 2023 Ref #20582948 v2.8 UNCLASSIFIED “Day after day, day after day, We stuck, nor breath nor motion; As idle as a painted ship Upon a painted ocean. Water, water, every where, And all the boards did shrink; Water, water, every where, Nor any drop to drink.” - The Rime of the Ancient Mariner Introduction E nga ngā mana, e ngāa reo. E ngāa karanga maha o te wā. Tēnā koutou, tēnā koutou, tēnā koutou katoa, Good morning. It’s wonderful to see so many familiar faces at this event, which has become a staple of the New Zealand capital markets calendar. I am grateful to KangaNews for their continued efforts to support debt capital markets in New Zealand and to all the sponsors who help to make this event possible. I am also grateful for the opportunity to speak to you today, for the second time at this event in as many years. Let me begin within a familiar disclaimer. As most of you will be aware, I am a member of the Reserve Bank’s Monetary Policy Committee. In my remarks today I will briefly touch on an aspect of monetary policy transmission. However, this speech is not an MPC communication and contains no guidance on the future path of monetary policy. The latest views of the MPC can be found in our recently published Monetary Policy Statement. My topic today – Liquidity. It references what might be one of the most used words in the financial markets lexicon. But it is a word with many meanings. In the most quoted lines of Samuel Taylor Coleridge’s Rime of the Ancient Mariner, the sailor recounts being becalmed in the doldrums, his ship surrounded by water, but none of it of the drinking kind. Consider a 21st century reimagining of this tale, within the context of financial markets. Instead of a seafarer, it features a fixed income trader. Our protagonist might bemoan that markets are awash in liquidity but that they are not able to execute a trade. Most of this audience will understand this (admittedly not very subtle) metaphor, but people not involved in financial markets could be forgiven for feeling confused. We need to understand the difference between salt water and fresh water to appreciate the cruel irony that befell the Ancient Mariner. In the same way, we also need to understand the different forms of liquidity to appreciate why it is possible to have both an abundance of liquidity in the financial system, and a lack of liquidity in financial markets. UNCLASSIFIED UNCLASSIFIED In my remarks today I will differentiate between three types of liquidity and how at Te Pūtea Matua we have an interest in each of them. I will also talk to how these forms of liquidity interact with one another and how efforts to improve some can have an adverse effect on others. The three forms of liquidity I will cover are: Funding Liquidity: which for our purposes today, will refer to how well banks are funded and their ability to meet their financial obligations as they fall due1. System Liquidity: which refers to the amount of settlement cash in the banking system. Market Liquidity: which refers to how easy it is to transact in markets without moving prices. Funding Liquidity This is obviously important for any entity, but it is core to the business of banking. Banks generally do a good job of it, but we really notice when they don’t. During the Global Financial Crisis (GFC) we learned that banks had become too reliant on short-term wholesale funding and when those markets froze, it came at a great cost to the global economy. More than a decade of global regulatory reform has sought to reduce the risks of that happening again. In New Zealand, we were at the forefront of that regulatory change when the Reserve Bank published its Liquidity Policy (BS13) in 2010. This policy introduced two types of liquidity ratio that banks would need to measure and maintain. The first, the Core Funding Ratio (CFR), considers how much of a bank’s lending is funded from stable sources, including capital, retail deposits and long-term wholesale funding. The second, Mismatch Ratios (MMR), consider how adequate a bank’s stock of liquid assets is to meet their net cash outflows over a one-week and one-month horizon during a period of stress. In combination, the CFR and MMR are designed to ensure that banks maintain a sufficient stock of high-quality liquid assets and that they have a sufficiently stable, diverse, and distributed funding profile. This ensures that they can weather disruptions in wholesale funding markets and otherwise withstand periods of liquidity stress. Since inception the system CFR has trended higher and is now close to an all-time high (figure 1). The system ratio of 90.7% at the end of July, versus a regulatory minimum of 75% represents a surplus of core funding relative to the minimum of around $82 billion. Mismatch ratios, which are naturally more volatile, are also currently near record highs supported in the last couple of years by strong retail deposit growth and the Funding for Lending scheme which will begin to roll off at the end of this year, through to the end of 2025. ____________ Funding liquidity could also refer to how easy it is for banks to raise or refinance funding UNCLASSIFIED UNCLASSIFIED Figure 1: RBNZ Prudential Liquidity Ratios2 In the years since the GFC, the Basel Committee on Banking Supervision (BCBS) coalesced around agreed liquidity standards that are very similar in their intent. The Liquidity Coverage Ratio (LCR), analogous to the RBNZ’s MMR, started to be used by BCBS members in 2015. The Net Stable Funding Ratio (NSFR), analogous to the RBNZ’s CFR, followed in 2018. One of the main differences between the BCBS and RBNZ ratios is around how run-off assumptions for deposits vary. The RBNZ approach differentiates between “market” and “nonmarket” depositors, with the former essentially intended to capture financial institutions. The nonmarket category is further segmented by size band, with larger deposits subject to outflow assumptions approaching that of “market” funding. The BCBS methodology is more granular, defining more types of depositors, but importantly does not apply any size banding. The recent bank failures in the United States, and in particular the failure of Silicon Valley Bank, with its funding concentration of very large deposits from a non-financial industry, highlights how funding risks have evolved since the GFC. It is now not only large financial institutions that have the awareness and the means to move their money at short notice. The RBNZ’s current Liquidity Policy Review represents the first full review of the policy since its inception in 2010. As both markets and global regulators have evolved in the period following, it should not be a surprise that globally regulators are once again giving thought to the calibration of regulatory policies. With the establishment of a BCBS standard utilised in many comparable jurisdictions, a key question we are posing is: whether we should look to adopt that standard here? There are some obvious attractions to this, especially in being able to make a harmonised international comparison of New Zealand’s banks with global peers. However, transitioning to a new liquidity measurement framework would also not be costless. The benefits of such a change would need to outweigh the costs. We also need to consider whether adopting the LCR and NSFR over our existing metrics would result in a material change in banks’ management of underlying liquidity risk? It is also worth remembering that regulators are not the only stakeholders concerned ____________ 2 1-week and 1-month mismatch ratios are charted at rolling 3-month averages. Source: RBNZ UNCLASSIFIED UNCLASSIFIED with banks’ funding liquidity. Rating agencies and investors closely scrutinise this too, using a range of measures including deposit-to-loan ratios and funding concentration risk among others. The second consultation document also considers what should be counted as a liquid asset for prudential purposes. Again, it is timely to compare ourselves to the global BCBS standards. Global standards judge that a high-quality liquid asset (HQLA) is one whose liquidity generating capacity in markets is assumed to remain intact even in periods of stress. While HQLAs should ideally be eligible for central bank liquidity facilities, the LCR standard states that such eligibility does not inand-of-itself justify HQLA status. As outlined in the consultation, application of such judgement in New Zealand might imply tighter criteria for HQLA status than currently exists in our definition of primary and secondary liquid assets. Outside of claims on the RBNZ and the Government, the liquid asset holdings of banks (figure 2) are skewed toward internal Residential Mortgage-Backed Securities (iRMBS) for which there is no liquid secondary market. Should the eligibility criteria for liquid assets be tightened, a Committed Liquidity Facility (CLF) to provide for any shortfall of liquid assets would likely be required. Any assets eligible for existing RBNZ repurchase (“repo”) facilities would likely qualify for the CLF. We are not considering any change to repo-eligibility as part of this Review. Figure 2: Liquid Assets Holdings of Registered Banks3 A benefit of a committed liquidity facility over existing repo-eligibility is that it provides a contractual guarantee of central bank liquidity, in exchange for eligible collateral. The certainty a CLF provides has value and therefore there would need to be a standing fee for the facility, in addition to any usage cost. This would help to ensure the economic cost of liquidity is more appropriately measured and distributed across the financial system. ____________ 3 This chart shows the value of liquid assets (after haircuts) under RBNZ BS13, which may be different from the assets’ face value and their market value. Source: RBNZ UNCLASSIFIED UNCLASSIFIED Submissions in response to the consultation have outlined some rationale supporting the retention of securities such as Kauri and LGFA bonds as qualifying liquid assets. Reasons highlighted by submitters included: greater diversification of banks’ liquid asset holdings; supporting the development of New Zealand’s debt capital markets in general; and in the case of Kauri bonds, supporting a balanced cross-currency basis swap market. As I will come to, there are trade-offs to consider in formulating this policy. As a “full service” central bank we wear multiple hats. As prudential regulator we seek a strong, efficient, and inclusive financial system, with a low incidence of failure of regulated entities. Under our Financial Policy Remit, we must also have regard to other considerations, including encouraging the allocation of financial resources in a way that maximises the sustainable long-term growth of the New Zealand economy. We recognise that a well-functioning capital market that meet the needs of borrowers and investors is key to this. We are grateful to all who contributed to a submission. We are also conscious that such proposals can create uncertainty in markets but it is also important that we take sufficient time to understand and consider the points raised before reaching a decision. We expect to release a summary of the submissions and key decisions document before the end of the year. System Liquidity Prudential liquidity policy relates to funding liquidity at the firm level. But the liquidity of the financial system is also important. When people talk about system liquidity, they are usually referring to the amount of cash in the banking system. In New Zealand we refer to this as the Settlement Cash Level (SCL), while elsewhere in the world it is often referred to as the level of bank reserves. The monetary policy response to the COVID-19 crisis, in particular the use of Additional Monetary Policy (AMP) tools like Large Scale Asset Purchases (LSAP) resulted in a significant increase in system liquidity in New Zealand and in other comparable jurisdictions around the world (figure 3). In New Zealand, this necessitated a change to our monetary policy implementation framework, as explained in my speech to this conference last year and further outlined in a recently published Bulletin. UNCLASSIFIED UNCLASSIFIED Figure 3: Exchange Settlement Balances 4 Individual settlement account (ESAS) holders can influence their own settlement cash balance, but the level of liquidity in the system is ultimately controlled by the RBNZ. It is also subject to influence from the borrowing, revenue raising, and spending activity of central government. As AMP tools continue to unwind over the next few years, we can expect the SCL to decline. Ultimately this will require more active management of the SCL by the RBNZ to ensure that there is sufficient system liquidity, as was the usual practice pre-pandemic. The return to a sufficient liquidity environment from an abundant liquidity environment is one that several central banks around the world are contemplating. There are some different approaches being considered around how system liquidity is best managed close to the “sufficient” level5. To that end we have commenced an internal Liquidity Management Framework Review which will consider the future management of system liquidity. As I discussed in my speech last year, we expect the “floor” system of monetary policy implementation to remain robust under different levels of settlement cash. But there is more to be learned about where the sufficient level of settlement cash is and how it changes over time. Our Liquidity Management Framework Review will also consider how we manage system liquidity in a crisis. The review will address questions such as: do we have the right toolkit of facilities and operations and how do we calibrate these to best effect? The first part of our Liquidity Management Framework Review will focus specifically on the deployment of RBNZ tools and facilities that had the objective of quelling market dysfunction in the COVID-19 crisis. Whilst the LSAP programme was a tool of monetary policy, it was also very important in restoring market functioning. Other tools were also deployed alongside LSAP at the peak of market dysfunction in 2020, including our Bond Market Liquidity Support (BMLS) scheme and the Term Auction Facility (TAF). In addition to looking at data from this period, we want to gain a qualitative perspective on which tools were most impactful and efficient. To gain this perspective, we are talking to market participants about their experiences during that unprecedented time. ____________ 4 Source: RBNZ and Reserve Bank of Australia 5 Refer Schnabel 2023 UNCLASSIFIED UNCLASSIFIED This COVID retrospective will help to inform the subsequent forward-looking parts of the review which will aim to ensure we have best practice business-as-usual management of system liquidity, as well as the right crisis-fighting toolkit. We will share our key findings from this work as it progresses. Market Liquidity Turning now to market liquidity: this effectively describes how easy it is to trade in a reasonable timeframe, at a reasonable cost, without moving the price. There have been long-standing and well-publicised concerns about market liquidity in fixed income markets in the years since the GFC. So much so that the US-based financial columnist Matt Levine had a long-running segment titled simply “People are worried about bond market liquidity”. These concerns have existed across instruments and jurisdictions, including what should be the most liquid fixed income market in the world, that of US government debt (figure 4). Figure 4: ICE BofA MOVE Index6 In the case of US Treasuries, there have been industry supported studies into market liquidity, which have aimed to examine the causes of the decline in liquidity and originate proposals to address it. We would welcome any industry-led efforts that would shed light on market liquidity in New Zealand and lead to improvements in market functioning. In financial markets, liquidity begets liquidity, but unfortunately the other side of that coin is that illiquidity begets illiquidity. A lack of liquidity makes prices more volatile and can cause more participants to withdraw from the market. Bond markets are relied on by businesses, governments, and other entities for raising funding. Prolonged bouts of volatility make these markets inaccessible to issuers with resultant consequences for the real economy. This was one of the reasons central banks, including the RBNZ, intervened so aggressively when liquidity evaporated from fixed income markets in March and April 2020. ____________ 6 The ICE BofA MOVE index measures U.S. bond market volatility by tracking a basket of options on U.S. interest rate swaps. Source: Bloomberg. UNCLASSIFIED UNCLASSIFIED Acute episodes of market illiquidity are relatively infrequent and obvious when they do occur. But there can also be instances of a more chronic deterioration in market liquidity. Liquid markets require large numbers of willing buyers and sellers. When the number of participants is small, or heavily skewed to one side of the market, this can make it challenging to find counterparties. We saw, and more so heard, evidence of this during the rapid global monetary policy tightening that occurred over 2022. As interest rates re-priced to the new inflation and monetary policy reality, markets became increasingly one-sided (figure 5). Figure 5: New Zealand dollar 2-year interest rate swap rate7 In the New Zealand interest rate swap market, major banks are typically on the same side of the market as they look to hedge interest rate risks arising from originating fixed rate mortgages. This “pay-side” flow, if not met with an equivalent “receiving” interest8, will all else equal tend to put upward pressure on swap rates. Often it is offshore market participants that provide this receiving interest, but in late 2021 and into 2022, as global interest rate volatility exploded, the willingness and ability of these participants to engage in New Zealand dollar interest rate trading was diminished. This resulted in an illiquidity premium in New Zealand swap rates. This has implications at the margin for monetary policy, as market-based expectations for policy rates, which help to inform policymakers, will include this illiquidity premium. Furthermore, the increased cost of hedging faced by banks may ultimately be passed through to the retail interest rates faced by their customers, impacting monetary policy transmission at the coal face. We are confident, informed by our market intelligence gathering, that an illiquidity premium exists, though it varies over time and can be difficult to quantify. It adds noise to the signal that we get from market pricing and may impact, at the margin, the financial conditions that policymakers are seeking to influence. ____________ 7 Daily NZFMA swap close rate for 2-year swap. Source: Reuters 8 The “payer” or “pay side” of an interest rate swap refers to the counterparty who pays a fixed rate of interest and receives a floating rate. A “receiver” receives a fixed rate of interest and pays a floating rate, UNCLASSIFIED UNCLASSIFIED Liquidity interactions Having talked about the three definitions of liquidity, I would like to finish by discussing how they interact with each other and why we as policymakers should be mindful of these interactions. The need to strengthen prudential liquidity policy was made unambiguously clear by the global financial crisis. For New Zealand, a small open economy, with a current account deficit in part funded via the banking sector, it is important that strong liquidity buffers are maintained to support confidence and financial stability. The benefits of a strengthened prudential liquidity regime since 2010 have already been demonstrated as banks have been able to withstand periods of wholesale funding market closure that have occurred periodically since the GFC. But larger liquidity buffers for banks require them to hold larger portfolios of qualifying liquid assets. Securities that are held in banks’ liquid asset portfolios become securities that are not turning over as frequently in the market. This can lead to the somewhat paradoxical conclusion that the more liquid assets banks hold, the less liquid, at the margin, those particular assets become. In a similar vein, the provision of additional settlement cash makes the financial system more liquid. However, an abundance of settlement cash reduces the need and incentives for institutions to trade it between one another, thereby decreasing the market liquidity of cash instruments, such as bank bills. In turn, a reduction in interbank trading might diminish the efficacy of benchmark indices linked to that trading. Furthermore, there are some who argue that interbank trading imposes a degree of market discipline on banks and their liquidity management. If there is a shortage of funding liquidity or system liquidity it can have disastrous consequences for banks, the financial system, and the economy. Deteriorations in market liquidity can be harder to detect but should not be ignored. Liquid markets are necessary to support New Zealand’s economic growth and as kaitiaki or guardian of the financial system, the Reserve Bank has an interest in seeing the breadth and depth of markets improve over time. This doesn’t mean that we would sacrifice financial stability for market liquidity, but it does mean that we recognise there are trade-offs in seeking to strengthen funding liquidity and we want to avoid unnecessary adverse impacts on market liquidity. Conclusion Today I have covered three important forms of liquidity. At the Reserve Bank we have an interest in all of them. Funding liquidity is critically important to us from a prudential perspective in ensuring the strength and stability of our deposit takers. System liquidity is ultimately our responsibility as a central bank. Given its importance for monetary policy transmission and financial stability, we are not complacent about the need to monitor and manage system liquidity closely. Market liquidity, while not an explicit responsibility of the Reserve Bank, is something we take an interest in for its impact on policy transmission and ultimately its importance in helping to grow the vibrant capital markets needed to support New Zealand’s economy. UNCLASSIFIED UNCLASSIFIED The Ancient Mariner felt he was cursed for having killed an albatross that his fellow sailors believed was the bird “that made the breeze to blow” and his punishment was to wear the deceased bird around his neck. We want to see wind in the sails of our capital markets and we certainly don’t want an albatross around our neck. As market participants we all have an interest in ensuring that we have well-functioning and liquid markets, and not the Mariner’s “painted ocean”. As prudential regulator, the RBNZ also needs to ensure that deposit taking vessels are seaworthy. Thank you. UNCLASSIFIED UNCLASSIFIED References Silk, K (2022) ‘New Zealand’s monetary policy implementation framework’, speech at KangaNews New Zealand Debt Capital Market Summit, Auckland, New Zealand, https://www.rbnz.govt.nz/hub/publications/speech/2022/speech2022-09-07 Callaghan, M, Haworth, C, and Poskitt, K (2023) ‘How the Reserve Bank implements monetary policy’, Reserve Bank of New Zealand Bulletin 86(3). Reserve Bank of New Zealand (2022) ‘Prudential Policy Department Document BS13: Liquidity Policy’, https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/regulation-andsupervision/banks/banking-supervision-handbook/bs13-liquidity-policy.pdf. Reserve Bank of New Zealand (2023) ‘Liquidity Policy Review Consultation Paper #2 (significant policy issues)’, https://www.rbnz.govt.nz/have-your-say/2022/review-of-liquidity-policy. Reserve Bank of New Zealand (2022) ‘In retrospect: monetary policy in New Zealand 2017 to 2022’, https://www.rbnz.govt.nz/hub/publications/monetary-policy-statement/rafimp. Schnabel, I (2023) ‘Back to normal? Balance sheet size and interest rate control’, speech at ‘A Conversation with Isabel Schnabel’ to SGH Macro Advisors, New York City, NY, https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230327_1~fe4adb3e9b.en.html Bailey, A (2023) ‘Monetary and financial stability: lessons from recent times’, speech at ‘The Shifting Risk Landscape’ to the Institute of International Finance, Washington, DC, https://www.bankofengland.co.uk/speech/2023/april/andrew-bailey-remarks-at-the-institute-ofinternational-finance Logan, L (2023) ‘Remarks on liquidity provision and on the economic outlook and monetary policy’, speech to the Texas Bankers Association Convention, San Antonio, TX, https://www.dallasfed.org/news/speeches/logan/2023/lkl230518 BIS Markets Committee (2022) ‘Market dysfunction and central bank tools’, BIS Markets Committee Working Group Insights, https://www.bis.org/publ/mc_insights.htm Estenssoro A, and Kliesen, K (2023) ‘The mechanics of Fed balance sheet normalization’, Federal Reserve Bank of St. Louis Economic Synopses 18. Kendall, A (2016) ‘Developments in financial market liquidity’, Reserve Bank of New Zealand Bulletin 79(6). Levine, M (2015) ‘People are worried about bond market liquidity’, Bloomberg, https://www.bloomberg.com/opinion/articles/2015-06-03/people-are-worried-about-bondmarket-liquidity UNCLASSIFIED
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, delivered to Chapter Zero New Zealand, Auckland, 3 November 2023.
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No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change A speech delivered to Chapter Zero New Zealand in Auckland By Adrian Orr, Governor, Reserve Bank of New Zealand 3 November 2023 Ref #20681799 v3.43 Introduction Kia orana tātou kātoatoa, tēnā tātou katoa, Thank you for again inviting me to speak with members of the Institute of Directors. I want to begin by acknowledging the mana whenua, Ngāti Whātua Ōrākei. I’d also like to thank Chapter Zero New Zealand for organising this event and for the work they are doing. You have created a truly meaningful network of business leaders, as highlighted by your recent publication that provides directors’ guidance in the development, analysis, and review of climate scenarios. In my inaugural speech as Governor1 in 2018, I spoke about the perils of short-termism in economic and business decision making. Taking a short-term view means we risk ignoring social and environmental harms (or negative externalities), leaving them as issues for our future selves to resolve. Former Bank of England Governor Mark Carney termed it a ‘Tragedy of the Horizon’2 citing climate change as the prime example. The need to take a longer-term view when approaching business was one of the reasons the Reserve Bank of New Zealand developed its climate strategy in 2018. We have been working to implement it ever since. Overcoming Carney’s ‘Tragedy of the Horizon’ doesn’t have to be rocket science. For example, as a prudential supervisor, we can help the participants and entities in the financial system to be more aware of the risks and the opportunities in front of them, so that they can prepare for a rapidly changing world. Today I will talk about: • Our climate-related work with prudentially regulated entities; • Our climate and sustainability collaborations domestically and internationally; and • Our future intentions. But before I do that, let me start by telling you about what our Act sets us up to do, and the role of central banks in encouraging efficient financial risk management. The Reserve Bank of New Zealand Act 2021 You may know that the RBNZ’s governing legislation has been refreshed. The new Reserve Bank of New Zealand Act was enacted in 2021, enabling us to evolve into a modern, fit for purpose, transparent central bank. Our Act gives us a legislative purpose of promoting the prosperity and wellbeing of all New Zealanders and contributing to a sustainable and productive economy. Our roles include: • • Managing inflation to keep prices stable while supporting maximum sustainable employment; Protecting and promoting stability within NZ’s financial system; ____________ 1 Orr , A. (2018, September). Geopolitics, New Zealand and the Winds of Change. Presented at the Shaping Futures National Conference. Retrieved from https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/speeches/2018/speech-geopolitics-new-zealand-and-the-winds-of-change.pdf 2 Carney, M. (29 C.E., September). Breaking the tragedy of the horizon - climate change and financial stability [Review of Breaking the tragedy of the horizon - climate change and financial stability]. https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability 1 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 • • Producing New Zealand’s banknotes and coins; and Operating effective wholesale payment and settlement systems. As our 2018 climate strategy outlines, climate change intersects with and relates to all our mandated roles. Integrating climate-related risk in our financial stability efforts Central banks are not the key drivers or arbiters of climate adaptation or transition finance. Governments and markets, and in many respects good folk such as yourself, hold the keys in that regard. Collectively, New Zealand has recognised the need to adapt to climate change and efficiently decarbonise. These needs are recognised in New Zealand’s emissions reduction efforts to meet the Government’s stated Nationally Determined Contribution3 under the Paris Agreement. However, an important role for a central bank is to help ensure the financial system functions efficiently. An efficient system better recognises, prices, allocates, and manages economic risk as information becomes available to do so. Climate change is one such risk. Our financial stability objective4 compels us to adequately prepare for potential climate-related risks to come. We do this through our policy settings and prudential supervision and oversight of our financial institutions. And we are not alone in this regard. More than 120 other central banks around the world have joined the Network for Greening the Financial System with the express purpose of better understanding and responding to climate-related risk. As my counterpart at the Reserve Bank of Australia, Governor Michele Bullock, recently remarked “climate change and the actions taken in response will have broad-ranging implications for the economy, the financial system and society at large.”5 The RBNZ is aligned with central banks all over the world in taking the financial risks of climate change seriously. Long-term financial stability must not fall victim to short-term thinking. I’ll now touch on some work we are doing in that regard. Our work with prudentially regulated entities Stress testing Stress testing is a tool used to assess the resilience of financial entities to severe but plausible shocks. We’ve recently begun to include climate-related risks in our stress testing, primarily to help ourselves, and the banking and insurance sectors, build capability in assessing the impact of climate on financial stability. ____________ 3 New Zealand. (2021). Submission under the Paris Agreement New Zealand’s first Nationally Determined Contribution. Retrieved from https://unfccc.int/sites/default/files/NDC/202206/New%20Zealand%20NDC%20November%202021.pdf 4 Reserve Bank of New Zealand Act 2021, (2021). https://www.legislation.govt.nz/act/public/2021/0031/latest/whole.html#LMS286981 5 Bullock, M. (2023, August 29). Climate Change and Central Banks [Speech Climate Change and Central Banks]. https://www.rba.gov.au/speeches/2023/sp-dg-2023-08-29.html 2 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 Our General Insurance stress test in 2021 included a severe weather events scenario,6 and our 2021 bank solvency stress test incorporated drought coinciding with a severe economic recession. The outcome was a spike in dairy loan defaults far greater than would otherwise be the case. In 2022 our stress testing work with banks included assessments of a range of climate-related risks, including coastal and inland flooding, drought, and emissions pricing. I encourage you to view the results of those tests on our website. New Zealand’s five largest retail banks are currently undertaking a further Climate Stress Test,7 which is used to assess the resilience of their balance sheets to combined physical and transition risks out to 2050. This scenario is now available on our website and we aim to publish the results of the analysis in the first quarter of 2024. Our banks are using the stress test to prepare themselves to better cope with the disruption climate change will continue to bring. I also encourage you to read the Financial Stability Report8 published earlier this week which illustrates some of the potential impacts of drought and emissions pricing in the sheep and beef, and dairy sectors. Guidance for regulated entities on managing climate-related risks Something else that helps bring longer-term risks into focus is the guidance on managing climaterelated risk we provide to our prudentially regulated entities. We have prepared this guidance in alignment with guidance from the XRB and FMA, but it is specifically tailored to the needs of our prudentially regulated entities. These are New Zealand’s registered banks, licensed insurers, licensed non-bank deposit-takers, and operators of designated financial market infrastructures. Our guidance is intended to help all of our prudentially regulated entities, whether engaged in mandatory disclosure or not, to manage climate-related risk efficiently and effectively. We published a draft version in March and received some helpful feedback that we’re now working through. When it’s revised and in place, the guidance will also provide additional structure to our supervisory conversations with our entities on climate. Supervision Which brings me to our supervisory role. Supervision is a critical conduit between prudentially regulated entities and the RBNZ. It is how we assess, monitor, and support firms’ ability to meet our financial stability objectives and their adherence to our regulatory rules and expectations. Climate-related risk is a priority theme at the Council of Financial Regulators (CoFR)9 and we are collaborating on our supervision of climate change, particularly with the FMA. ____________ 6 Nicholls, K. (2021). Outcomes of the 2021 General Insurance Industry Stress Test. Reserve Bank of New Zealand Bulletin , 84(2). Retrieved from https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/bulletins/2021/rbb2021-84-02.pdf 7 The Reserve Bank of New Zealand . (2023, October 10). Overview of the Climate Stress Test. Retrieved from https://www.rbnz.govt.nz/financial-stability/stress-testing-regulatedentities/climate-stress-test Reserve Bank of New Zealand . (2023). 11/2023 Financial Stability Report . Retrieved from https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/financial-stabilityreports/2023/nov-2023/fsr-nov-23.pdf 9 Climate-related risks | Kaunihera Kaiwhakarite Ahumoni - Council of Financial Regulators (cofr.govt.nz) Council of Financial Regulators. (n.d.). Climate-related risks. Retrieved from https://www.cofr.govt.nz/priority-themes/climate-related-risks.html 3 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 We are also including climate change as a topic in our scheduled supervisory engagements with management and boards, as well as standalone meetings with technical experts from the banks, non-bank deposit takers and insurers that we prudentially supervise. In doing so we discuss the responsibilities, oversight and implementation of entities’ climate strategies and risk management, and the practical steps they are taking toward preparing climaterelated disclosures and transition plans. Our domestic and international collaborations Leading through collaboration, locally… It takes collaboration for our financial system to better account for risks and develop resilience in the face of climate challenges over the long term. Alongside our domestic collaborations through CoFR we are also working with New Zealand scientists and researchers to help identify data gaps and enhance our understanding of the mechanics of climate-related risks. We, and our prudentially regulated entities, are also collaborating more with Māori. Iwi, and Māori more broadly, have distinct challenges, opportunities, and aspirations in the transition to a low emissions economy. Iwi are already leading the charge in some cases to develop climate solutions. For example, Ngāti Porou, Ngāti Tūwharetoa, and Te Arawa have taken up collective group insurance policies for marae, lowering their costs through risk pooling and ultimately improving access to financial buffers in the case of extreme weather events.10 Access to capital will also be crucial to accelerate investment in the Māori economy and diversification towards lower emissions sectors. At present the Māori economy is heavily invested in land-based sectors, primarily agriculture,11 which have high emissions profiles. Māori business activities are also heavily invested in transport, construction, and manufacturing – high emissions industries which require significant capital investment to reduce emissions. Collective work that is underway to improve Māori access to capital will help to reduce transition risks. Last year we published an Issues Paper on Māori Access to Capital.12 Now we are working with retail banks, government agencies and iwi Māori to play our part to contribute to improving access to capital. …and globally Efforts to improve systemic risk management require collaboration and leadership across jurisdictions, and between the public and private sector to build the momentum they need to persist. ____________ McLeod, R., & Lam, V. (2021). Māori Financial Services Institutions and Arrangements. Reserve Bank of New Zealand. Retrieved from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/analytical-notes/2021/AN2021-04.pdf Ministry of Business, Innovation & Employment , & Ministry for Primary Industries . (2021). Māori economy emissions profile. Retrieved from https://www.mbie.govt.nz/dmsdocument/17448-maori-economy-emissionsprofile#:~:text=Greenhouse%20gas%20emissions%20from%20the,6.4%25%20of%20New%20Zealand%27s%20GDP. Improving Māori Access to Capital. (2022, August 9). Retrieved from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/have-your-say/improving-maori-access-tocapital 4 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 As I highlighted earlier, we’re deepening our understanding of climate-related risk through our involvement in a global central bank network, the Network for Greening the Financial System (NGFS). We are co-chairing an NGFS workstream: ‘Net-zero for Central Banks’13 with Italy’s central bank – Banca d’Italia – covering three topics: sustainable and responsible investment (SRI), central banks’ own climate-related disclosures, and greening central banks’ corporate operations. We hope what we learn in these collaborations will be of use not only to central banks, but to the financial sector as a whole. Looking to the Future In the five years since I spoke about the need for a longer-term view in the financial system, we’ve made solid progress on establishing necessary practices and procedures. But much more needs to be done. Our own disclosure To help structure our thinking we’ve committed to developing our first climate-related disclosure. Like the 200 or so entities across New Zealand developing mandatory disclosures under the XRB’s New Zealand Climate Standard (NZ CS 1), we fully understand that effective disclosure processes involve more than adding emissions data to an Annual Report or a declaration that we’ve talked to a consultant about the future climate. Developing a meaningful disclosure requires an in-depth interrogation of how your organisation’s strategy and core functions are affected by climate-related risks. For us that is a slightly different ask – we need to look at our core functions as a central bank, including monetary policy, our balance sheet, currency and payment systems, and our actions as a prudential regulator and supervisor. Monetary Policy Like central banks around the world, we are growing our understanding of how climate change, the macroeconomy, and monetary policy intersect. Disruptive supply-side shocks like those from Russia’s invasion of Ukraine and the pandemic foreshadow potentially similar supply-side shocks from worsening climate impacts and an economy in transition. Understanding the work to be done to transition to net zero will give us a sense of the potential impact on employment and inflation in New Zealand. Observing policy developments domestically and in other countries will help to develop our sense of how risks may affect the domestic economy. On the physical risk side, evidence for the macroeconomic significance of drought for the New Zealand economy is well-established. ____________ NGFS publishes its 2022-2024 work program. (2022, May 30). Retrieved from NGFS Central Banks and Supervisors website: https://www.ngfs.net/en/communique-de-presse/ngfspublishes-its-2022-2024-work-program 5 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 Our own research14,15 found that drought was an exacerbating factor during recessions, including those triggered by the 1974-1977 oil price shocks, the 1997 Asian Financial Crisis, and the 2008 Global Financial Crisis, and that the drought of 2013 was macroeconomically significant. While drought has historically been the greatest climate-related exposure the New Zealand economy faces, climate change will also increase the frequency and severity of other events such as storms and floods, as unfortunately seen last summer. Climate-related risks demand our attention, but we shouldn’t ignore the tremendous opportunities the transition to net zero can bring. Disruption often brings opportunity. For example, research and development in low-emissions technologies, new ideas which decouple economic activity from material through-put, and novel adaptation-related goods and services.16 Vision for balance sheet Related to their work on monetary policy, central banks around the world are increasingly identifying and addressing the climate-related risks and opportunities in their own balance sheets. RBNZ’s balance sheet consists primarily of sovereign bonds for monetary policy implementation and foreign reserves management. Assessing a sovereign bond for its past and potential future exposure to climate-related risk requires data and careful consideration – especially when we are trying to minimise our credit and liquidity risks. Again, the NGFS workstream we are co-chairing with Banca d’Italia is a vital resource for us, with a sub-group researching these new areas, identifying better practices, and sharing them amongst central banks. Climate resilient money and payments infrastructure We’re also working to ensure that central bank money continues to be available to the public when and where they need it. Crisis situations like Cyclone Gabrielle demonstrated only too clearly the lifeline nature of cash and payment systems. Some retail banks have lost local capability through closing branches and reducing ATM numbers, making them more reliant on roading, data and electricity networks at increasing risk of disruption due to climate change. The cash system will need to adapt over time to continue to meet the needs of New Zealanders, potentially including a new digital New Zealand dollar, to circulate alongside physical cash. What’s on the horizon In our work with other central banks and supervisors internationally we’re fortunate to be part of many discussions regarding the future direction of climate and broader sustainability issues. ____________ Reddell, M., & Sleeman, C. (2008). Some perspectives on past recessions. Bulletin , 71(2). Retrieved from https://www.rbnz.govt.nz/ /media/project/sites/rbnz/files/publications/bulletins/2008/2008jun71-2reddellsleeman.pdf Kamber, G., McDonald, C., & Price, G. (2013). Drying out: Investigating the economic effects of drought in New Zealand. The Reserve Bank of New Zealand Analytical Note . Retrieved from The Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/analytical-notes/2013/an2013-02.pdf Ministry for the Environment. (2020). National Climate Change Risk Assessment for New Zealand Arotakenga Tūraru mō te Huringa Āhuarangi o Āotearoa. In https://environment.govt.nz/assets/Publications/Files/national-climate-change-risk-assessment-main-report.pdf. Ministry of the Environment. . 6 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 Earlier this year, Australia and New Zealand’s Ministers of Finance and Climate Change met in Wellington, where among other things they agreed to align approaches regarding the development of a sustainable finance framework. Toitū Tahua – the Centre for Sustainable Finance, and the Ministry for the Environment, are leading the development of a taxonomy from the New Zealand side and I encourage you to engage with them on that process. Taxonomies can support the development of markets for climate and sustainability linked loans and bond issuances, by providing clarity on performance expectations and reassurance to investors that their climate and sustainability objectives are being met. This work is vital where legitimate concerns around greenwashing could undermine investment in the shift to a climate-resilient, low emissions economy. In a similar vein, blended finance arrangements have also been a key topic of recent NGFS17 and Bank of International Settlements discussions.18 Catalysing private sector finance flows with public resources has been identified as a key lever of transition. However, to get the public-private capital mix flowing, policy makers and private sector actors need better data, information transparency, and certainty on the development and rollout of emissions targeted technologies and regulations. Conclusion Tackling climate change is both an enormous challenge and an opportunity that we all have an obligation to respond to. It remains within our power to take the steps required to transition our economic and financial systems. It will take concerted, collaborative efforts, but remains eminently achievable. More than that, these are critical shifts we need to make if we want our New Zealand companies to be best positioned to thrive in a net zero world. Central banks have a supporting role to play. We can provide the financial system with processes and functions like stress testing and prudential supervision which help keep long-term goals in focus, and we can keep the risks front of mind for financial entities. We can also provide guidance and information to help markets function more efficiently, reflecting global advances in risk management and climate-related risk analysis. And we can facilitate collaboration between those developing and sustaining transition finance mechanisms. Many of you are already engaged in this work and I want to thank you for your efforts. I’d also like to thank the banks, insurers, policy makers, agriculture sector organisations, iwi and NGOs – who have taken such a keen interest, made demonstrable commitments and taken actions over the past few years. This has been both exciting and inspiring to witness, and it’s just the start. Changing the future will take us all putting our shoulders to the wheel. But there’s many of us engaged in this mahi, and none of us are carrying the burden alone. ____________ 17 New Zealand. (2021, November 4). Submission under the Paris Agreement New Zealand’s first Nationally Determined Contribution [Review of Submission under the Paris Agreement New Zealand’s first Nationally Determined Contribution]. https://unfccc.int/sites/default/files/NDC/2022-06/New%20Zealand%20NDC%20November%202021.pdf Menon, R. (2023, March). A supervisory push for transition planning and blended finance. Presented at the Green Swan conference 2023. Retrieved from https://www.bis.org/review/r230601g.pdf 7 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 At RBNZ we are doing our part to provide some of the key tools and processes that allow our financial system to more clearly see that future and realise it. I hope you’ll join us in that. Thank you. 8 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 References Bullock, M. (2023, August 29). Climate Change and Central Banks [Speech Climate Change and Central Banks]. https://www.rba.gov.au/speeches/2023/sp-dg-2023-08-29.html Carney, M. (29 C.E., September). Breaking the tragedy of the horizon - climate change and financial stability [Speech Breaking the tragedy of the horizon - climate change and financial stability]. https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizonclimate-change-and-financial-stability Council of Financial Regulators. (n.d.). Climate-related risks. Retrieved from https://www.cofr.govt.nz/priority-themes/climate-related-risks.html Improving Māori Access to Capital. (2022, August 9). Retrieved from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/have-your-say/improving-maori-access-to-capital Kamber, G., McDonald, C., & Price, G. (2013). Drying out: Investigating the economic effects of drought in New Zealand. The Reserve Bank of New Zealand Analytical Note . Retrieved from The Reserve Bank of New Zealand Analytical Note website: https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/analytical-notes/2013/an2013-02.pdf McLeod, R., & Lam, V. (2021). Māori Financial Services Institutions and Arrangements. Reserve Bank of New Zealand. Retrieved from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/analytical-notes/2021/AN2021-04.pdf Menon, R. (2023, March). A supervisory push for transition planning and blended finance. Presented at the Green Swan conference 2023. Retrieved from https://www.bis.org/review/r230601g.pdf Ministry of Business, Innovation & Employment , & Ministry for Primary Industries . (2021). Māori economy emissions profile. Retrieved from https://www.mbie.govt.nz/dmsdocument/17448-maorieconomy-emissionsprofile#:~:text=Greenhouse%20gas%20emissions%20from%20the,6.4%25%20of%20New%20Zeal and%27s%20GDP. Ministry for the Environment. (2020). National Climate Change Risk Assessment for New Zealand Arotakenga Tūraru mō te Huringa Āhuarangi o Āotearoa. In https://environment.govt.nz/assets/Publications/Files/national-climate-change-risk-assessmentmain-report.pdf. Ministry of the Environment. New Zealand. (2021). Submission under the Paris Agreement New Zealand’s first Nationally Determined Contribution. Retrieved from https://unfccc.int/sites/default/files/NDC/202206/New%20Zealand%20NDC%20November%202021.pdf NGFS publishes its 2022-2024 work program. (2022, May 30). Retrieved from NGFS Central Banks and Supervisors website: https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-its2022-2024-work-program Nicholls, K., & Samarasekera, R. (2021). Outcomes of the 2021 General Insurance Industry Stress Test. [Review of Outcomes of the 2021 General Insurance Industry Stress Test.]. Reserve Bank of 9 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43 New Zealand Bulletin, 84(2). https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/bulletins/2021/rbb2021-84-02.pdf Orr , A. (2018, September). Geopolitics, New Zealand and the Winds of Change. Presented at the Shaping Futures National Conference. Retrieved from https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/speeches/2018/speech-geopolitics-new-zealand-andthe-winds-of-change.pdf Reddell, M., & Sleeman, C. (2008). Some perspectives on past recessions. Bulletin, 71(2). Retrieved from https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/bulletins/2008/2008jun71-2reddellsleeman.pdf Reserve Bank of New Zealand Act 2021, (2021). https://www.legislation.govt.nz/act/public/2021/0031/latest/whole.html#LMS286981 Reserve Bank of New Zealand. (2023). 11/2023 Financial Stability Report. Retrieved from https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/publications/financial-stabilityreports/2023/nov-2023/fsr-nov-23.pdf Reserve Bank of New Zealand. (2023, October 10). Overview of the Climate Stress Test. Retrieved from https://www.rbnz.govt.nz/financial-stability/stress-testing-regulated-entities/climate-stresstest 10 No longer tomorrow’s problem: How the Reserve Bank is working with its stakeholders to respond to Climate Change Ref #20681799 v3.43
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Speech by Ms Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking of the Reserve Bank of New Zealand, to the UBS Australasia Conference, Sydney, 14 November 2023.
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Opening statement by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 9 February 2024.
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Christian Hawkesby: Opening statement to Finance and Expenditure Committee Opening statement by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 9 February 2024. *** Kia ora koutou katoa Ahi ahi marie koutou E nga rangatira Karanga mai, mihi mai, whakatau mai Tna koutou katoa I'm Christian Hawkesby, Deputy Governor and General Manager of Financial Stability. The Governor and I are joined today by Director of Prudential Policy Kate le Quesne and Manager System Monitoring and Analysis Chris McDonald. Also present with us are some of the very capable team that contributed to the November Financial Stability Report (FSR), which provides our latest assessment of the resilience of the financial system, and our strategy and priorities in the face of that assessment. As we said when we released the FSR in November, our assessment is New Zealand's financial system remains strong as it adjusts to a higher interest rate environment. New Zealand's financial sector is strong and well placed to handle both the current adjustment to higher interest rates and other more severe economic scenarios. We remain in a global high interest, high inflation environment: while central banks globally have slowed the pace of tightening, the impact of previous interest rate increases is yet to be fully felt a weakening in global demand, particularly in China, has contributed to lower key commodity prices for New Zealand, and we are monitoring developments in the Middle East closely. Domestically, New Zealand households continue to face higher debt servicing costs. Although most borrowers have been able to manage the increases by using their savings buffers and reducing their spending in other areas, we know that some people are struggling and there has been an increase in borrowers who are falling behind on mortgage payments. Businesses are continuing to service their debt. Although the dairy and commercial property sectors are facing challenges, partly due to higher debt servicing costs. I'll briefly provide a few updates on developments since we published the FSR in November. In January we launched a consultation on activating debt to income (DTI) restrictions and loosening loan-to-value ratios (LVR) for residential lending. DTI 1/2 BIS - Central bankers' speeches restrictions set limits on the amount of debt borrowers can take on relative to their income, and we see them as a complementary tool to LVRs that will enable us to more efficiently target financial stability risks. We've continued the mahi around implementing the new Deposit Takers Act, which will transform our approach to the regulation of banks and other deposit takers, while helping to ensure the safety and soundness of deposit takers. The Act introduces a new Depositor Compensation Scheme (DCS) so depositors can have confidence that their deposits, in the event of a deposit taker failure, are eligible for compensation up to $100,000 per depositor, per institution. A substantial work programme is underway to implement the new prudential framework for deposit takers. Parts of the current Banking (Prudential Supervision) Act 1989 relating to the regulation and supervision of registered banks and the Non-bank Deposit Takers Act 2013 will remain in force until the remaining parts of the DTA have been fully implemented. We've also continued our collaboration and engagement with industry around improving Mori access to Capital. We are working collaboratively with retail banks to help them understand the flexibility of the regulator regime, and it's been heartening to see some banks delivering innovative ways to support Mori to build homes on their whenua/land. We look forward to our continued engagement with Finance and Expenditure Committee and we welcome your questions. 2/2 BIS - Central bankers' speeches
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Opening statement by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 7 February 2024.
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Adrian Orr: Opening statement to the Finance and Expenditure Committee Opening statement by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, to the Finance and Expenditure Committee (FEC), Wellington, 7 February 2024. *** Tn koutou katoa, and thank you Chair. When I spoke to this Committee following the release of our November Monetary Policy Statement, I explained why the Monetary Policy Committee had agreed to maintain the Official Cash Rate (OCR) at 5.50%. In short, consumer price inflation at 4.7% remains too high, and we remain wary of ongoing domestic inflation pressures. The OCR remains at a restrictive level to slow spending growth in the economy and reduce inflation pressures. The Monetary Policy Committee will be giving its full assessment of the latest economic data at our February Monetary Policy Statement, due out at the end of this month. It is worth noting that this will be the first reflecting our new remit. You've just heard from the Bank regarding our November Financial Stability Report. I won't repeat what has already been covered, but I would like to note some other financial stability highlights from the past year. In December we completed our Outsourcing Policy. This ensures major New Zealand banks can continue to operate if their parent bank fails. Our review of our insurance legislation continues, and we have published a new interim solvency standard. The new Deposit Takers Act, as mentioned by our Chair, will strengthen and simplify our approach to the regulation of banks and other deposit takers, and introduce the Depositor Compensation Scheme. We are well advanced in building the capacity, capability, and resilience needed to support the new legislative expectations. The recent variation to our Five-Year Funding Agreement was triggered primarily by the Deposit Takers Bill becoming legislation, as well as progress in some multi-year investment programmes. The likelihood of the variation was signalled at the outset of our current Funding Agreement. We are progressing investment in the Bank's critical infrastructure, including cyber and physical resilience, cash management, investigating a Central Bank Digital Currency, enhanced data collection, and more intensive regulatory supervision given our expanded mandate. As a full-service Central Bank, we work continuously on being cost-effective and fit for purpose. Our international comparators highlight we are on course. We work closely with our Council of Financial Regulators partners. We have achieved significant progress on the regime for financial market infrastructures, cyber resilience, and a range of shared issues including financial inclusion, technology, and climate change. 1/2 BIS - Central bankers' speeches We retain strong relationships internationally, including with other central banks and regulators, and through relevant international institutions such as the Trans-Tasman Banking Council, the South Pacific Central Bank Governors, the International Monetary Fund, the Bank for International Settlements, and the Executives' Meeting of East Asia Pacific Central Banks. These relationships enable us to support initiatives and meet international standards and best practice. I would like to thank the Board, the Monetary Policy Committee, and our Leadership team for their support. I am tremendously proud of the people at Te Ptea Matua and all they have achieved. I now welcome your questions. Meitaki ma'ata Tn koutou, tn koutou, tn koutou katoa 2/2 BIS - Central bankers' speeches
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Keynote speech by Mr Christian Hawkesby, Deputy Governor and General Manager of Financial Stability of the Reserve Bank of New Zealand, at the annual Financial Services Council Conference (FSC24), Auckland, 5 September 2024.
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UNCLASSIFIED Resilience as a pathway to Prosperity A speech delivered to FSC24 Conference in Auckland on 5 September 2024 By Christian Hawkesby, Deputy Governor/General Manager Financial Stability With special thanks to Chris Hunt, Patrick Carvalho and Kerry Watt Ref #21580721 v1.14 UNCLASSIFIED Introduction E nga mana, e nga reo. E nga karanga maha o te wa. Tihei mauri ora! (To all authorities, all voices, to the many chiefs gathered here. Behold the breath of life!) E nga rangatira Karanga mai Mihi mai Whakatau mai Tena koutou katoa (Thank you to the leadership of the Financial Services Council Conference who have called us here; who have welcomed us here; who have looked after us here. Thank you very much) I want to acknowledge the recent passing of The Māori King, Kiingi Tuheitia Pootatau Te Wherowhero VII. Kiingi Tuheitia has been instrumental in advocating for Māori in uniting people through kotahitanga and will be sorely missed. I also want to thank him for his collaboration with Te Pūtea Matua on the history of Māori banking. I send my aroha to his whānau during this time. It is a pleasure to speak to you today at the annual Financial Services Council Conference. This is my third time joining you since becoming Deputy Governor and General Manager of Financial Stability. Thank you for continuing to invite me back! It is always a pleasure to discuss with you what's next for the Reserve Bank of New Zealand, Te Pūtea Matua. The theme of this year’s conference is Consumer Resilience and Prosperity. Today I’d like to pick up this theme by discussing the role of the Reserve Bank as a central bank and prudential regulator, and how we think about financial stability. In particular, I’ll talk about three things. First, how we focus on the resilience of the financial system as a pathway to enabling a productive and sustainable economy, and ultimately prosperity and wellbeing. Second, how we do this while also having regard to other important enabling features of the financial system, including competition, innovation, efficiency and inclusion. Third, how this all comes together in our Strategic Themes, mirroring those of the Council of Financial Regulators (CoFR) 1. ____________ Council of Financial Regulators. (n.d.). Kaunihera Kaiwhakarite Ahumoni. Council of Financial Regulators. https://www.cofr.govt.nz/ Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED We do this all in the context of being part of the international financial system, where trust and confidence is built by following international best practice as a modern prudential regulator. 2 The rationale of public policy in the financial system Central banks have been in the business of financial stability for centuries. Maintaining financial stability was one of the key motivations for the establishment of the Riksbank in Sweden as the first central bank in 1642, and the Bank of England shortly after. At the Reserve Bank of New Zealand, we’ve been in the business of financial stability since we were founded 90 years ago, and more formally as a prudential regulator since the 1980s. It is important to step back and briefly remind ourselves why a public policy institution, such as Te Pūtea Matua, is tasked with the responsibility for ensuring financial stability. The role of the financial system is to enable saving and spending to be managed over time and through different states of the world. The financial system plays a crucial role in allocating economic resources and managing risks. Businesses, households and communities rely on a well-functioning financial system to live their lives and engage in society. A sound and well-functioning financial system—encompassing markets, institutions, and payment systems—serves as a public good, much like physical infrastructures such as transport, energy, water, and communications, which benefit society broadly beyond individual users At the same time, we know that financial systems can be inherently fragile and vulnerable. Financial risks are not always adequately identified, priced, or allocated to those best placed to manage them. This is illustrated by plenty of examples through history of herd behaviour and irrational exuberance. In addition, the financial system is highly interconnected, meaning a failure in one part can quickly spread and endanger the wider system as a whole. The Global Financial Crisis (GFC) occurred 17 years ago. For some of you in this room, the impact might feel distant or unfamiliar, while those of us who experienced it firsthand may find our memories fading. It is important to remember that the costs of financial instability can be felt far beyond the management, shareholders or customers of individual financial institutions. Again, history is littered with examples of financial crises that have caused widespread damage to the broader economy and society. The fiscal cost of cleaning up a financial crisis is substantial. Global studies estimate that the fiscal burden can range from 5-10% of GDP. For the New Zealand context, this translates to about $2040bn. And that’s before you count the costs of lost economic activity and the costs to society of prolonged high unemployment. It is easy to lose sight of the human impact behind these figures – people’s jobs, incomes, savings and retirement funds are all at stake. This is why our key financial stability legislation for banks is called the Deposit Takers Act – its primary goal is to protect depositors, who are individuals like you and me. ____________ Hawkesby, C. (2022, September 22). Our transformation as a prudential regulator. Reserve Bank of New Zealand. https://www.rbnz.govt.nz/hub/publications/speech/2022/speech2022-09-22 Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Defining financial stability What do we mean by “financial stability”? It’s not enough to say that financial stability is the absence of financial instability. Even in the absence of a financial crisis, we know from experience that large imbalances and vulnerabilities can develop during periods of apparent calm, sowing the seeds of bigger troubles further down the track. Equating stability with the absence of instability is a bit like saying that peace is the absence of war. Again, this is too simple. In practice, we know that enduring peace and prosperity involves many preconditions, like strong relationships with neighbouring countries, common rules, treaties and trade agreements, acceptance of international law, and much more. To understand what financial stability means for New Zealand, we need to start by looking at the pieces of legislation that underpin the Reserve Bank’s responsibility for financial stability.3 More specifically, the Purposes, Objectives and Principles we need to follow along the way (see appendix A). This is an exercise that many central banks and prudential regulators overseas have undertaken over the years, distilling their legislation, frameworks and approaches down into a succinct definition of what financial stability means to them (see Appendix B). Recently we’ve undertaken a similar thought exercise, in part in response to our new legislative underpinnings, to build a common understanding of our role and approach to decision-making on financial stability and practically setting prudential policy. I’d like to share some of that thinking with you today. A stable financial system is one where resilient financial markets, institutions and infrastructures enable a productive and sustainable economy, and ultimately prosperity and wellbeing. In my view, this simple way to describe financial stability has several desirable features. 1. Outcome focused. This definition is outcome-focused, aligning with our overarching statutory purpose in the Reserve Bank Act (2021) to “promote the prosperity and well-being of all New Zealanders and contribute to a sustainable and productive economy”. 2. Pre-condition. It acknowledges that a resilient financial system is a precondition to achieving the broader desired outcomes for New Zealand. Our principal contribution to achieving these outcomes is through the provision of a resilient system. 3. Dynamic. The concept suggests resilience is dynamic, meaning that a stable financial system should not only absorb shocks but also anticipate, prepare for, recover from, and learn from ____________ RBNZ Act (2021), the Deposit Takers Act (2023), the Banking (Prudential Supervision) Act 1989, the Non-bank Deposit Takers Act (2013), the Insurance (Prudential Supervision) Act (2010), and the Financial Market Infrastructures Act (2021). Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED them. Furthermore, our approach needs to serve both the current financial system, and how it might evolve in the future. 4. Enabling. Finally, this definition acknowledges that a truly resilient financial system must perform its functions effectively and reliably. Such a system ensures that people can save their money, handle everyday transactions, access credit for both consumption and investment and insure against risks. But it must also do so efficiently and in an inclusive manner in part driven by competition and innovation. I will return to these concepts in a minute, but meeting these conditions will foster public trust and confidence in the system and the economy as a whole. While this definition for financial stability has been put together in a New Zealand context, it bears a striking resemblance to the efforts of prudential regulators in other countries. That shouldn’t come as a surprise, as we all operate collectively as part of the international financial system. At the Bank for International Settlements (BIS) in Basel global standards are set for prudential regulators. And the International Monetary Fund (IMF) review the capability and capacity of countries to meet these standards and approaches through their 10 yearly Financial System Assessment Programmes (FSAPs). Within these organisations and globally there is recognition that financial stability is not an end in itself but one of the best tools for supporting growth and prosperity. The Financial Stability Frontier While a resilient financial system needs to be at the centre of our efforts as a prudential regulator, our definition importantly recognises that resilience alone will not enable a pathway to prosperity and wellbeing. While stability is a necessary precondition, other important enablers include having a financial system that is: competitive, innovative, efficient 4 and inclusive. These all directly or indirectly feature in our legislation and the Financial Policy Remit from the Minister of Finance (Appendix C). So, while resilience is our primary objective and underpins our contribution to financial stability, we must also consider these other factors whenever we make financial policy decisions. Sometimes a policy decision that improves the resilience of the financial system may also improve competition, innovation, efficiency or inclusion. At other times, there may be a trade-off between resilience and these other factors, especially over the short-term. ____________ Reserve Bank of New Zealand. (2011). Understanding financial system efficiency in New Zealand. Reserve Bank of New Zealand Bulletin, 74(2), 1-10. https://www.rbnz.govt.nz//media/ReserveBank/Files/Publications/Bulletins/2011/2011jun74-2.pdf Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Today, I want to introduce the concept of a ‘Financial Stability Frontier’ to demonstrate how we weigh up financial policy choices and how they affect these important enablers of the financial system. 5 For illustrative purposes, I’ll just keep it to just two dimensions of weighing up the resilience of the financial system with the amount of competition in the financial system. However, this is a concept that could equally be illustrated weighing up resilience with any one of innovation, efficiency or inclusion. Figure 1. Financial Stability Frontier Let me step you through the idea. On the Financial Stability Frontier, resilience and competition are shown on the Y axis (vertical) and X axis (horizontal) respectively. Both resilience and competition are enablers of a productive and sustainable economy, and so we prefer to have both factors. In other words, outcomes in the top right-hand side of the diagram are better and outcomes at the bottom left-hand side are worse. The shaded area represents all the possible combinations of resilience and competition that can come about from our choices of financial policy settings. ____________ Students of economics will recognise its parallels with a Production Possibility Frontier, but don’t let that be a barrier to others Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED The dotted lines represent the minimal levels of acceptable resilience and competition respectively. Below these levels are not acceptable setting for our financial policy decisions (these can be thought of as something akin to risks appetites). The thick dark line represents the Financial Stability Frontier, which are the limits of what our financial policy can achieve. When on the Financial Stability Frontier, gaining either more resilience or more competition involves a trade-off of accepting a lower amount of the other. Figure 2. Financial Stability Frontier The Financial Stability Frontier diagram then helps illustrate how different financial policy setting weigh up against each other. For example, Moving from point A to point B is a situation where our financial policy improves resilience and competition. There is no trade off from this policy choice. Moving from point C to point D involves giving up a lot of resilience in the financial system for a small amount of additional competition, which may be considered an unattractive trade-off to accept. Moving from point E to point F involves gaining a small amount of additional resilience in the financial system but results in an unacceptably low amount of competition. While this is a conceptual framework, it is a powerful discipline to be transparent and communicate how our financial policy decisions affect the important enablers of the financial system, and how we have weighed up these considerations. It’s a process that is more art than science. However, Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED talking to my counterparts in foreign central banks and prudential regulators, this is a framework that we all carry around in our heads. Furthermore, our public consultations are designed to gather evidence and information on these dimensions, to support our analysis of the costs and benefits, and to share this in regulatory impact statements. All of this contributes ultimately to sound and transparent policymaking consistent with our mandate. To bring this more to life, I want to touch on some practical examples. Capital Review. In 2019 we concluded the review of prudential capital requirements for banks. A key feature of this review was to lift capital requirements to strengthen the resilience of the financial system. At the same time, we amended a number of capital rules to reduce the gap between capital requirements for large banks and other banks. As a result, the Capital Review both increased resilience and took steps to improve the landscape for competiton. Mutual capital instruments. One unresolved issue from the Capital Review was a request for a capital instrument for mutual banks which could qualify as tier 1 capital (without this, mutual banks are limited in their options to raise tier 1 capital due to their mutual structure). Last year we decided to establish new mutual capital instrument rules which will help provide new capital raising options for these banks. Again, this will help to support both resilience and competition. Māori Access to Capital. Following the Māori Economy Report (2018) 6, we have been working with the banking industry and other government agencies to remove barriers to access capital, especially around the treatment of collectively owned land. Through deepening their understanding of our prudential frameworks, financial institutions have been able to develop more innovative ways to manage the risk of lending against Māori land. As a result, we have been able to achieve a similar amount of resilience in the financial system, while enhancing innovation and expanding inclusion in the financial system. Macroprudential tools. Earlier this year we activated a new macroprudential tool, Debt-toIncome (DTI) restrictions, as a guardrail to reduce boom-bust cycles in mortgage lending and asset prices. Having both DTI restrictions and the existing Loan-to-Value (LVR) restrictions meant that we could better focus each tool on the risk it was designed to manage. Activating the DTI tool enabled us to ease the LVR settings, resulting in more efficient use of these tools while retaining a similar amount of system resilience. Deposit Takers Act. Finally, we are currently consulting on prudential standards under the new Deposit Takers Act, including how to apply the new Proportionality Framework. Under the Proportionality Framework, we can set different prudential requirements for different groups of deposit takers determined by their size and nature of business. This provides us with scope to ensure these different groups have a minimum level of resilience appropriate for their characteristics, while have also having regard for how our decisions can influence competition, innovation, efficiency and inclusion. A practical example is that we are consulting on the ____________ Reserve Bank of New Zealand. (2018). Te Ōhanga Māori – The Māori economy 2018. Reserve Bank of New Zealand. https://www.rbnz.govt.nz/hub/research/additional-research/teohanga-maori---the-maori-economy-2018 Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED minimum amount of capital to hold as a deposit taker, which is a potential barrier to new entrants. Our strategic themes 2030 Those are just a few examples from our role as a prudential regulator. However, many of these same principles apply more broadly to our role as a central bank, particularly as we seek to adapt to our changing economy and society. This work includes enhancing the cash system, exploring the launch of a central bank digital currency (CBDC), and considering whether to open access to settlement accounts more widely to non-bank deposit takers and other Fintechs. Of course, these enabling characteristics of the financial system do not exist in isolation of each other. For example, a competitive and efficient financial system cannot exist in a sustainable way in the absence of resilience. These features of a well-functioning financial system all interact and enable each other over a long-term horizon. Reflecting this, in pursuing our operational objectives as a central bank and prudential regulator, our strategic themes highlight these areas of focus, as we look to the future and our contribution to a productive and sustainable economy. As outlined in our Statement of Intent 7, our strategic themes are: Promoting trust and confidence, Improving resilience, Strengthening efficiency and competition, Increasing participation in the financial system, Leveraging data, information and technology, Putting people front and centre. ____________ Reserve Bank of New Zealand. (2024). Statement of intent 2024–2028. Reserve Bank of New Zealand. https://www.rbnz.govt.nz//media/project/sites/rbnz/files/publications/statements-of-intent/statement-of-intent-2024---2028.pdf Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Figure 3. Our operational objectives and strategic themes In New Zealand, our regulators of the financial system come together as the Council of Financial Regulators (CoFR), each with distinct and connected responsibilities. These strategic themes mirror those of our colleagues on CoFR. Our outcomes focused and enabling definition of financial stability requires us to work closely with our regulatory counterparts. The Financial Markets Authority for conduct, the Commerce Commission for competition, and the Reserve Bank for financial stability. Strikingly, in our engagements with Boards and executive teams of regulated entities, these strategic themes resonate with what they too are seeking to achieve. It is a reminder that we are all in this together. It is a reminder that when we lift up from the day-to-day challenges in the financial services industry, we all want a financial system that ultimately contributes to the prosperity of all New Zealanders. Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Conclusion Thank you again for the invitation to speak with you today at the annual Financial Services Council Conference. And congratulations for the choice of Consumer Resilience and Prosperity as one of your themes. It is a theme that is close to my heart as a central banker and prudential regulator. For you, the resilience of your customers, the consumers of New Zealand, is a pathway to their prosperity. For the Reserve Bank, resilience of the financial system is a pathway to enabling a productive and sustainable economy, and ultimately the prosperity of all New Zealanders. Standing here today, I am reminded that achieving all this is a collective effort. For all New Zealanders to thrive, we must work together. I look forward to your engagement and insights. I am also reminded of a whakatauki; Nō reira Nau te rourou, naku te rourou, ka ora ai te iwi. With our contribution, and your contribution, the people will prosper. Tēnā koutou, tēnā koutou, tēnā tatou katoa. Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Appendices Appendix A - The Purposes, Objectives and Principles we need to follow along our way Reserve Bank of New Zealand Act 2021 Purposes The purposes of this Act are to— (a) provide for the continuation of the Reserve Bank of New Zealand; and (b) promote the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy. Bank’s objectives 1. The Bank’s main objectives are— Economic objective a. the economic objective of achieving and maintaining stability in the general level of prices over the medium term; and Financial stability objective b. the financial stability objective of protecting and promoting the stability of New Zealand’s financial system; and Central bank objective c. otherwise acting as New Zealand’s central bank in a way that furthers the purposes of this Act. Deposit Takers Act 2023 Purposes 1. The main purpose of this Act is to promote the prosperity and well-being of New Zealanders and contribute to a sustainable and productive economy by protecting and promoting the stability of the financial system. 2. To that end, this Act has the following additional purposes: a. to promote the safety and soundness of each deposit taker: b. to promote public confidence in the financial system: Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED c. to the extent not inconsistent with subsection (1) and paragraphs (a), (b), and (d), to support New Zealanders having reasonable access to financial products and services provided by the deposit-taking sector: d. to avoid or mitigate the adverse effects of the following risks: ii. risks to the stability of the financial system: iii. risks from the financial system that may damage the broader economy. Insurance (Prudential Supervision) Act 2010 Purposes 1. The purposes of this Act are to— a. promote the maintenance of a sound and efficient insurance sector; and b. promote public confidence in the insurance sector. 2. Those purposes are achieved by— a. establishing a system for licensing insurers; and b. imposing prudential requirements on insurers; and c. providing for the supervision by the Reserve Bank of New Zealand (the Bank) of compliance with those requirements; and d. conferring certain powers on the Bank to act in respect of insurers in financial distress or other difficulties. Financial Market Infrastructures Act 2021 Purposes 1. The purposes of this Act are to— a. promote the maintenance of a sound and efficient financial system (including by responding to threats to the stability of, or confidence in, the whole or a significant part of the financial system); and b. avoid significant damage to the financial system that could result from problems with an FMI, an operator of an FMI, or a participant of an FMI that threaten the stability of, or confidence in, the whole or a significant part of the financial system; and c. promote the confident and informed participation of businesses, investors, and consumers in the financial markets; and d. promote and facilitate the development of fair, efficient, and transparent financial markets. Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED 2. Those purposes are to be achieved by— a. establishing a system for designating systemically important FMIs and FMIs that apply for designation; and b. imposing regulatory requirements on designated FMIs; and c. providing for the supervision of compliance with those requirements by the Reserve Bank of New Zealand and the Financial Markets Authority (acting as the regulator); and d. conferring certain powers on the regulator to gather information; and e. conferring certain powers on the regulator to act in respect of distressed FMIs. 3. See also section 77 (which sets out the purposes for which the regulator’s powers under Part 4 may be exercised). Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Appendix B – Definitions of Financial Stability across the world Bank of Korea ◦ Europe Central Bank (ECB) ◦ “Financial system stability refers to a state in which the financial system functions properly, and participants, such as firms and individuals, have confidence in the system.” Deutsch Bundesbank ◦ “Financial stability is a key prerequisite for the functioning of a national economy and for the effective implementation of monetary policy. A stable financial system can be defined as a system whose individual components—financial intermediaries and the financial market infrastructure—fulfil their respective functions and prove resistant to potential shocks.” Bank of Japan ◦ “A stable financial system is one in which financial intermediaries, markets and market infrastructure facilitate the smooth flow of funds between savers and investors and, by doing so, help promote growth in economic activity.” Swiss National Bank ◦ “A stable financial system is one that has sufficient resilience to be able to facilitate and supply vital services by financial institutions, markets and market infrastructure to households and businesses, in a manner that absorbs rather than amplifies shocks.” Reserve Bank of Australia (in line with the Australia’s Council of Financial Regulators) ◦ “A financial system is considered stable when its markets and institutions—including banks, savings and loans, and other financial product and service providers—are resilient and able to function even following a bad shock.” Bank of England (in line with the UK Prudential Regulation Authority) ◦ “Financial stability can be defined as a condition in which the financial system—which comprises financial intermediaries, markets, and market infrastructures—is capable of withstanding shocks and the unravelling of financial imbalances.” Federal Reserve ◦ “Financial stability can be defined as ‘a condition in which the financial system is not unstable’. It can also mean a condition in which the three components of the financial system—financial institutions, financial markets, and financial infrastructure—are stable.” “A stable financial system fulfils its central macroeconomic functions smoothly and at all times. This embraces, in particular, the efficient allocation of financial resources and risks as well as the provision of an efficient and secure financial infrastructure.” Monetary Authority of Singapore Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED ◦ World Bank ◦ “MAS seeks [financial stability] to reduce the risk and impact of a failure. … Promoting a stable system…requires MAS to meet the other five objectives [safe and sound financial intermediaries; safe and efficient financial infrastructure; fair, efficient and transparent organised markets; transparent and fair-dealing intermediaries and offerors; and wellinformed and empowered consumers.]” “A stable financial system is capable of efficiently allocating resources, assessing, and managing financial risks, maintaining employment levels close to the economy’s natural rate, and eliminating relative price movements of real or financial assets that will affect monetary stability or employment levels.” The IMF (Working Paper No. 2004/187) ◦ “A financial system is in a range of stability whenever it is capable of facilitating (rather than impeding) the performance of an economy, and of dissipating financial imbalances that arise endogenously or as a result of significant adverse and unanticipated events.” Appendix C - Financial Policy Remit from the Minister of Finance 2022 Financial Policy Remit Purpose This Financial Policy Remit is issued by the Minister of Finance under section 203 of the Reserve Bank of New Zealand Act 2021 (the Act). The Financial Policy Remit provides for matters that are desirable for the Reserve Bank to have regard to in relation to one or more of the following, in accordance with section 204(1) of the Act Achieving the financial stability objective Acting in a way that furthers the objectives or purposes of the prudential legislation Acting as a prudential regulator and supervisor under the prudential legislation. The Reserve Bank Board must have regard to the Financial Policy Remit when acting in relation to prudential strategic intentions and standards, as set out in section 49 of the Act. Matters specified in accordance with section 204 Protecting and promoting financial stability can have implications for the Government’s broader policy objectives and the wider economy. It is desirable for the Reserve Bank to have regard to the following matters. The Government’s desired outcomes for the financial system It is desirable to have a financial system that is strong, efficient and inclusive, with a low incidence of failure of entities regulated by the Reserve Bank. Resilience as a pathway to Prosperity UNCLASSIFIED UNCLASSIFIED Within the appetite of a low incidence of failure, a competitive financial system should be encouraged so as to best ensure ongoing financial efficiency and inclusion. In this respect, the Reserve Bank should have regard to the benefits of: imposing regulatory and supervisory costs that are proportionate to the expected risks and benefits to the financial system and society; encouraging new investment and financial innovation that raise the productive potential of the economy; and encouraging the allocation of financial resources in a way that maximises the sustainable longterm growth of the New Zealand economy. If a regulated entity does fail, the Reserve Bank is expected to manage the failure in a manner that minimises the costs of failure and disruption to the broader economy, and prioritises protections for vulnerable consumers, depositors and public funds. Other Government policy priorities The Minister also considers it is desirable for the Reserve Bank to have regard to the following matters. Housing The Government has a policy objective to support more sustainable house prices, including by dampening investor demand, which would improve affordability for first home buyers. This is part of the broader Government Policy Statement on Housing and Urban Development, which provides a vision that everyone in Aotearoa New Zealand lives in a home and within a community that meets their needs and aspirations. Climate change The Government has a priority of building resilience and facilitating adaptation of New Zealand’s economy, society and environment to climate change. It is important that the financial system continues to play an appropriate role in supporting community wellbeing and resilience as it responds to that transition and increases in underlying risks as a result of climate change. Financial inclusion The Government has a priority of improving financial inclusion and maintaining financial sector diversity, including supporting access to finance and financial services for those who are less wellserved by traditional institutions, including rural communities, disabled persons, low-income individuals, and small businesses. Cyber resilience The Government has a priority of improving New Zealand’s cyber resilience, with a vision that New Zealand is confident and secure in the digital world. In light of evolving cyber risks, it is important that the public and private sector work closely together to achieve this objective. Resilience as a pathway to Prosperity UNCLASSIFIED
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the MyFiduciary Conference, Taupō, 14 October 2024.
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Improving Māori Access to Capital A speech delivered to MyFiduciary Conference in Taupō On 14 October 2024 By Adrian Orr, Governor Ref #21743343 v1.2 Introduction Kia orana tatou katoatoa, tēnā tātou katoa Ngāti Tūwharetoa, te whare tapu o Te Heuheu, tēnā koutou Ko Tongariro te maunga Ko Taupo te moana Ko Taupo te whenua tipu Heoi, nō Atiu ōku tīpuna Nō reira tēnā koutou, tēnā koutou, tēnā tatou katoa I would like to acknowledge Tā Tumu Te Heuheu and the iwi of Ngāti Tūwharetoa, whose leadership continues to inspire and guide us. Ngā mihi nui ki a koutou. All of you will be familiar with the kaupapa kōrero today, Māori access to capital. Kiingi Tawhiao established Te Pēke o Aotearoa in around 1885 to support a growing Māori economy. At that time the financial system was excluding Māori.1 Te Pēke o Aotearoa was a response. It was a vehicle for Māori to participate in this new system. Te Peeke o Aotearoa was a pioneer for financial inclusion that was for all New Zealanders. Historians point to an inscription on each of the banknotes saying ‘e whaimana ana tenei moni ki ngā tāngata katoa’, meaning ‘this money is valid for all people’.2 This highlights the inclusive goal that was pursued, a mindset we can all learn from. Why Māori access to capital matters Financial inclusion means that people have access to financial products and services that meet their needs. All New Zealanders should be able to benefit from inclusion in the financial system. At the Reserve Bank, we would be at a loss if we did all the hard work to promote a financial system that was strong, stable, and efficient, only for people to tell us that they are unnecessarily excluded. Financial exclusion is a serious issue for some New Zealanders, impacting their lives and livelihoods. In 2021, the World Bank estimate that around 1.25 percent of adults in New Zealand (circa 50,000 people) did not have a bank account.3 In 2022, the New Zealand Financial Markets Authority estimated that around 6 percent of New Zealanders had no banking products.4 As you can see, it’s hard to get precise numbers on financial exclusion, but it is significant. We are working to source data, and engage with community groups, banking staff, and customer groups, to understand the barriers to participation. Māori are too often in the category of being under-served by the financial system, in both access and relevant financial products. This should disappoint all New Zealanders, in part given that the Māori economy remains one of the largest potential sources of economic growth. ____________ Comyn, C. (2022) The financial colonisation of Aotearoa. Tāmaki Makaurau Auckland, Aotearoa New Zealand: Economic and Social Research Aotearoa. Rogers, K. A. (2024). Te Peeke o Aotearoa, in Australian Coin Review World Bank Group (2024). Global Financial Inclusion | DataBank (worldbank.org) Financial Markets Authority (2022) Consumer experience with the financial sector. FMA-Consumer-Experience-with-the-Financial-Sector-Survey-2022.pdf Improving Māori Access to Capital BERL’s most recent report on the Māori economy calculated that it grew at nearly twice the rate of the total economy over the 2013-2018 period. 5 The Māori population is also young and will make up a significant proportion of the labour force in the coming years – circa 20 per cent by 2040.6 Meanwhile, Māori land titles make up approximately 5 percent of the total land area in Aotearoa, but around 80 percent of this land is deemed as being underused.7 And, at present, only 8 percent of New Zealand businesses are deemed to have Māori owners, despite being circa 17 percent of the total population.8 Improving Māori access to capital has been, and remains, a powerful enabler for prosperity, sustainability, cohesion, and inclusion. We should collectively prioritise this goal. In 1931, Sir Apirana Ngata, the Native Minister (and the person featured on our $50 note), addressed Parliament outlining challenges Māori faced in accessing capital for Māori land (whenua). These challenges included multiple landowners and an inability to put a mortgage on the land. That is almost 100 years ago. At Te Pūtea Matua, in 2022 we released our Māori Access to Capital Issues Paper. In making that report, we interviewed 42 capital seekers from a cross-section of the Māori economy and financial sector.9 They all shared similar experiences. The key themes raised from the discussions were a shortage of data on Māori businesses, the complexity and opaqueness of the funding landscape, difficulties lending on Māori land, and a lack of leadership across the ecosystem to address access barriers. From the financial sector engagements, it was clear that there was a lack of understanding of Māori business values and models. There was also a general agreement that New Zealand’s capital market falls well short of meeting the capital needs of Māori business. At the Reserve Bank we take these issues seriously. Under our Act, our core purpose is to enable the prosperity and wellbeing of all New Zealanders. In part response, we have developed a strategy to incorporate Te Ao Māori values and perspectives into how we work.10 This includes publicly releasing our Te Tiriti statement.11 Our commitment recognises our legislated purpose, and the constitutional and legal significance of Te Tiriti o Waitangi. Our approach reinforces the importance of ensuring that Māori are enabled by New Zealand’s financial system, as are all New Zealanders. Beyond getting our own house in order, we have broader work streams underway, both under the umbrella of “Financial Inclusion”, and our strategic themes outlined in our Statement of Intent. Our strategic themes are trust, resilience, competition and efficiency, inclusion, leveraging data and technology, and people front and centre.12 ____________ Reserve Bank of New Zealand. (2018). Te Ōhanga Māori 2018: The Māori economy. https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/research/te-ohanga-maori-report2018.pdf BERL. (2019). The future Māori workforce: Part three. BERL. The future Māori workforce - Part three, BERL Ministry for Primary Industries. (2013). Growing the productive base of Māori freehold land. https://www.mpi.govt.nz The Reserve Bank of New Zealand (2022). Improved Māori Access to Capital Issues Paper (rbnz.govt.nz) The Reserve Bank of New Zealand (2022). Improved Māori Access to Capital Issues Paper (rbnz.govt.nz) Reserve Bank of New Zealand. (2024). Statement of intent 2024–2028. Te Pūtea Matua. Statement of Intent 2022-2026 (rbnz.govt.nz) Reserve Bank of New Zealand. (n.d.). Te Tiriti o Waitangi statement. Te Pūtea Matua. Te Tiriti o Waitangi statement - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (2024). Statement of intent 2024–2028. Te Pūtea Matua. Statement of Intent 2022-2026 (rbnz.govt.nz) Improving Māori Access to Capital Financial Inclusion Māori access to capital is a significant part of our broader work on Financial Inclusion so that the financial system is fit for all New Zealanders.13 We are working collaboratively with the Council of Financial Regulators to identify and address any barriers to accessing banking services from two perspectives:14 From a service delivery lens, we have a research project with a third party on what an inclusive process of opening a bank account looks like, and what are the best practices. There is a strand looking specifically at issues for Māori Trusts, Rangatahi (youth) Māori, and Māori businesses. From a product lens, we are collaborating with the Council of Financial Regulators to look at the concept of a basic bank account, with fewer features but is easier to open and manage. Our findings will be public later this year and should have flow on impacts for Māori access to capital. For example, it is complicated for a small Māori landowning trust to open an account given it is a collective entity with multiple owners. Short-term work arounds to this problem can lead further financial access challenges in the years ahead. Our work on Māori access to capital and broader financial inclusion efforts go hand in hand. We are also currently creating, with a view to publishing, a dashboard that measures progress on Māori financial inclusion across the banking system. What gets measured gets managed, and lessons learnt should be shared. Progress is positive. As part of our recent Financial Inclusion Thematic Review, we spoke with a significant number of deposit-taking entities to understand their internal policies and practices on inclusion, and how they measure and report progress.15 Lessons from this work will guide us on what banking data infrastructure and indicators are useful. We are also working on a pilot with some retail banks on a Māori data project, again related to the dashboard. The data pilot will include Māori data governance principles, including sharing with iwi, hapū and Māori organisations where appropriate. We are working with the Stats NZ Māori Business Definition Standard where possible – to overcome a long existing inertia to bank data collection.16 Earlier this year Te Kooti Whenua Māori, the Māori Land Court, released a practice note regarding lending on whenua Māori.17 Their aim is to help landowners, lawyers, and the banking sector understand the mortgage process on whenua Māori. Shared knowledge will reduce transaction costs and broaden finance options.18 ____________ Reserve Bank of New Zealand. (2023). Financial inclusion approach 2023. Financial Inclusion Approach 2023 (rbnz.govt.nz) Council of Financial Regulators. (n.d.). Kaunihera Kaiwhakarite Ahumoni | Council of Financial Regulators. Kaunihera Kaiwhakarite Ahumoni | Council of Financial Regulators (cofr.govt.nz) Reserve Bank of New Zealand. (2024). Thematic review on financial inclusion. Thematic review on financial inclusion - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Statistics New Zealand. (2022). Data standard for Māori business. Stats NZ. Data standard for Māori business | Stats NZ Māori Land Court. (2024). Practice note for lending on whenua Māori. Reserve Bank of New Zealand – Te Pūtea Matua. Practice Note for Lending on Whenua Māori - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Māori Land Court. (2024). Practice note for lending on whenua Māori. Reserve Bank of New Zealand – Te Pūtea Matua. Practice Note for Lending on Whenua Māori - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Improving Māori Access to Capital Alongside the Māori Land Court, we are presenting the document to Tāwhia Māori Bankers Rōpū and the Council of Financial Regulators before the end of year, with the option of running more intensive workshops with individual organisations later. We are also working with the Ministry of Business, Innovation and Employment to get an updated Māori economy report, which, with the help of BERL, is coming out next year. The 2018 Māori economy report has been foundational in our understanding.19 We are streamlining our engagements with Māori more broadly. No two projects are the same, and we want to make sure Māori voices are heard when our work impacts Māori communities. For example, our Central Bank Digital Currency and cash monitoring consultations are coming up in 2025,20 and our Exchange Settlement Account System (ESAS) access review is already underway.21 Finally, our membership in the Central Bank Network for Indigenous Inclusion is an invaluable platform for us to hear from indigenous communities internationally – including here in Aotearoa.22 The central banks of Canada, the United States, Australia and New Zealand are involved, as well as indigenous networks across these countries. Improving Māori access needs collaboration and capability Te Pūtea Matua has the mandate to help address Māori access to capital, but we will not succeed alone. Success requires the whole system to work towards improving the current situation, which involves the government, private sector financial institutions, iwi and Māori decision makers being in the same waka paddling together. There are signs this is occurring, but it remains early day. We have seen some great work happening in recent years across the ecosystem: Iwi Chairs, Pou Tahua,23 have been working to get an iwi-led financial intermediary, Rauawa, running. It would be a Māori intermediary that would act as a conduit between capital seekers and providers, supporting effective capital allocation and risk management. The tasks include identifying opportunities and matching them with capital, while providing investment support and capability to drive success. Some retail banks are also taking positive steps. Policies to enable lending on whenua Māori are progressing, alongside building internal capability and capacity to work with Māori businesses. It is this type of progress we want to showcase in the dashboard discussed. We have the already mentioned Tāwhia Māori Bankers Rōpū - a brave group of bankers who are championing the cause collectively, and within their organisations, on improving Māori financial inclusion.24 ____________ BERL. (2021). Te Ōhanga Māori – The Māori economy 2018. Te Ōhanga Māori – The Māori Economy 2018 (rbnz.govt.nz) Reserve Bank of New Zealand. (n.d.). Digital cash. Digital cash - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (2023). Exchange settlement account system (ESAS) access review. Exchange Settlement Account System (ESAS) access review - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (2023). Central Bank Network for Indigenous Inclusion. Central Bank Network for Indigenous Inclusion - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Iwi Chairs Forum Secretariat. (n.d.). Pou & ILG contacts. Sharing the Vision of Kotahitanga. Pou & ILG Contacts | Iwi Chairs Forum Secretariat Sharing The Vision of Kotahitanga Reserve Bank of New Zealand. (2021). Māori Bankers Rōpū established. Māori Bankers Rōpū established - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Improving Māori Access to Capital Government agencies – including The Treasury, The Ministry of Business Innovation and Employment, and Te Puni Kōkiri, - are working on streamlining funding and support systems for Māori business, with the goal to reshape their offerings to be most effective and measurable in outcomes. I believe that the Pou Tahua proposed Rauawa will support this picture. Access, Capability and Capital makes an Opportunity I have outlined many workstreams, much collaboration, and a great will to improve Māori access to capital. I have also highlighted why it is important for all New Zealanders, and the Reserve Bank. If we can improve access to resources, and then apply the appropriate capability to the resource – including capital, then opportunities arise for prosperity, cultural inclusion, social cohesion, and environmental sustainability. Despite the great work that is already happening, there is much left to be done. A clear signal of the task is highlighted in the recent Commerce Commission’s market study into personal banking services,25and the agenda for the forthcoming Parliamentary inquiry into banking.26 Both have a specific focus on lending on whenua, access to bank accounts, and experiences accessing banking products and services. At Te Pūtea Matua we will continue to highlight the importance of collaboration, and the need to focus on solutions to improve Māori access to capital. My hope is that bank leaders retain their commitment to this effort. I also encourage a broader group of equity providers to improve their capability to provide Māori access to capital. We have yet to see the collaboration and investment scale that will unleash New Zealand’s full economic potential. Thank you for listening today. Meitaki ma’ata Tēnā koutou katoa. ____________ Commerce Commission. (2024.). Market study into personal banking services. Commerce Commission - Market study into personal banking services (comcom.govt.nz) New Zealand Parliament. (2024.). Inquiry into banking competition. Inquiry into banking competition - New Zealand Parliament (www.parliament.nz) Improving Māori Access to Capital References BERL. (2019). The future Māori workforce: Part three. BERL. The future Māori workforce - Part three, BERL BERL. (2021). Te Ōhanga Māori – The Māori economy 2018. Te Ōhanga Māori – The Māori Economy 2018 (rbnz.govt.nz) Commerce Commission. (2024.). Market study into personal banking services. Commerce Commission - Market study into personal banking services (comcom.govt.nz) Comyn, C. (2022) The financial colonisation of Aotearoa. Tāmaki Makaurau Auckland, Aotearoa New Zealand: Economic and Social Research Aotearoa. Council of Financial Regulators. (n.d.). Kaunihera Kaiwhakarite Ahumoni | Council of Financial Regulators. Kaunihera Kaiwhakarite Ahumoni | Council of Financial Regulators (cofr.govt.nz) Financial Markets Authority (2022) Consumer experience with the financial sector. FMA-ConsumerExperience-with-the-Financial-Sector-Survey-2022.pdf Iwi Chairs Forum Secretariat. (n.d.). Pou & ILG contacts. Sharing the Vision of Kotahitanga. Pou & ILG Contacts | Iwi Chairs Forum Secretariat Sharing The Vision of Kotahitanga Māori Land Court. (2024). Practice note for lending on whenua Māori. Reserve Bank of New Zealand – Te Pūtea Matua. Practice Note for Lending on Whenua Māori - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Ministry for Primary Industries. (2013). Growing the productive base of Māori freehold land. https://www.mpi.govt.nz New Zealand Parliament. (2024.). Inquiry into banking competition. Inquiry into banking competition - New Zealand Parliament (www.parliament.nz) Reserve Bank of New Zealand. (2018). Te Ōhanga Māori 2018: The Māori economy. https://www.rbnz.govt.nz/-/media/project/sites/rbnz/files/research/te-ohanga-maorireport-2018.pdf Reserve Bank of New Zealand. (2021). Māori Bankers Rōpū established. Māori Bankers Rōpū established - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) The Reserve Bank of New Zealand (2022). Improved Māori Access to Capital Issues Paper (rbnz.govt.nz) Reserve Bank of New Zealand. (2023). Central Bank Network for Indigenous Inclusion. Central Bank Network for Indigenous Inclusion - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (n.d.). Digital cash. Digital cash - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Improving Māori Access to Capital Reserve Bank of New Zealand. (2023). Exchange settlement account system (ESAS) access review. Exchange Settlement Account System (ESAS) access review - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (2023). Financial inclusion approach 2023. Financial Inclusion Approach 2023 (rbnz.govt.nz) Reserve Bank of New Zealand. (2024). Statement of intent 2024–2028. Te Pūtea Matua. Statement of Intent 2022-2026 (rbnz.govt.nz) Reserve Bank of New Zealand. (2024). Thematic review on financial inclusion. Thematic review on financial inclusion - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Reserve Bank of New Zealand. (n.d.). Te Tiriti o Waitangi statement. Te Pūtea Matua. Te Tiriti o Waitangi statement - Reserve Bank of New Zealand - Te Pūtea Matua (rbnz.govt.nz) Rogers, K. A. (2024). Te Peeke o Aotearoa, in Australian Coin Review Statistics New Zealand. (2022). Data standard for Māori business. Stats NZ. Data standard for Māori business | Stats NZ World Bank Group (2024). Global Financial Inclusion | DataBank (worldbank.org) Improving Māori Access to Capital
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Speech by Ms Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking of the Reserve Bank of New Zealand, at the Citi Australia and New Zealand Investment Conference, Sydney, 16 October 2024.
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SENSITIVE ENDORSEMENT Transmission of monetary policy to financial conditions By Karen Silk, Assistant Governor/General Manager Economics, Financial Markets and Banking A speech delivered to the Citi Australia & New Zealand Investment Conference in Sydney, Australia on Wednesday 16 October1 Ref #21718115 v1.12 With thanks to Chris Stephens for his help in preparing these remarks. Introduction: E ngā mana, e ngā reo. E ngā karanga maha o te wā. Tēnā koutou, tēnā koutou, tēnā koutou katoa. Good morning. I would like to start by thanking Citi for hosting today’s event and inviting me to speak. As a member of the Monetary Policy Committee, with my colleagues, I spend a fair amount of time considering the effectiveness of monetary policy transmission through wholesale markets and banking channels as we seek to influence economic outcomes and inflation. It is this area that I’m going to address today. The transmission of policy rate changes to inflation is a gradual process. It’s surrounded by uncertainty and impacted by the prevailing economic and financial conditions. It requires ongoing monitoring, and the Monetary Policy Committee (MPC) meets regularly to assess the extent to, and speed at, which the current stance is influencing the financial system and the economy. Should data indicate that conditions are evolving differently to those expected, or if we judge that the balance of risks to the inflation outlook have changed, then we are able to adjust our approach to reflect this. Today I will discuss: our assessment of the level of restrictiveness of monetary policy settings through the postCOVID period, factors that have influenced the transmission to tighter financial conditions, and how these may influence the transmission to financial conditions in the period ahead. What does it mean for the policy rate to be restrictive and how do we know when it is? Monetary policy settings are a key determinant of financial conditions.1 These financial conditions include the interest rates at which households and businesses save and borrow, the level of the exchange rate and credit availability. To drive inflation lower over recent years, it has been necessary for us to tighten policy settings, which have in turn restricted overall financial conditions.2 This has contributed to a weakening of aggregate demand in the economy and increased our confidence that consumer price inflation (CPI) is moving sustainably back to its target mid-point of 2 percent. There are a range of ways in which we assess the restrictiveness of our monetary policy stance. One way is to compare the level of the Official Cash Rate (OCR) with our estimates of the nominal neutral OCR. This is a useful concept to help us understand whether our current stance is encouraging or acting as a brake on economic activity, or holding it steady.3 However, its inherent uncertainty means that at any point in time we can’t pinpoint the neutral level with complete accuracy4. To help manage this uncertainty, the RBNZ maintains a suite of neutral OCR estimates, ____________ For example, see Lane (2022), Mann (2023) and Kent (2024). Hawkesby (2021) provides an explanation of the conditions that led up to the period of tightening and the RBNZ’s approach to navigating these conditions. For example, see Richardson and Williams (2015). For example, see Ellis (2022). based on different models and assumptions.5 Our neutral OCR measures, shown in this chart, indicate that monetary policy is currently restrictive and has been for an extended period of time. Figure 1: OCR versus nominal neutral OCR estimates Source: RBNZ estimates. Note: The shaded area indicates the range between the minimum and maximum values from our suite of long-run nominal neutral OCR indicators. We also keep a close eye on a range of indicators of domestic financial conditions. These indicators help us gauge how our monetary policy stance is impacting broader financial conditions faced by households and businesses, and in turn how they may be influencing spending, investment, and borrowing decisions across the economy. Figure 2: Financial conditions overview Source: RBNZ, Bloomberg, Interest.co.nz, Stats NZ. Note: All data is shown as of the 4 October 2024, apart from the mortgage interest as a % of household disposable income, which is quarterly (latest quarter is Q2 2024) and yield on business loans, which is monthly (latest month is August). ____________ 5 Castaing, Chadwick, Galimberti, Sing and Truong (2024) explains how the RBNZ construct, use and think about indicators for the neutral interest rate. This chart, which includes some of the indicators that we look at, provides a snapshot of current financial conditions in New Zealand and indicates how they have moved since the start of the year. The scale on the chart reflects the historical distribution of each measure since 2009, moving from very loose on the left to very tight on the right. The pink dot shows the current value, while the blue dot shows the values at the start of the year. These indicators paint a similar picture to our neutral interest rate estimates. Wholesale, bank lending, and bank deposit rates all remain broadly restrictive. This is despite some loosening over 2024 as markets anticipated the start of the easing cycle. Home loan interest costs as a proportion of disposable income have risen to their highest level since 2010 but remain lower than the period following the Global Financial Crisis (GFC). Conversely, bank credit has remained more accommodative, in line with strong bank funding positions. The downstream effects on the domestic economy also indicate the stance has been restrictive. High interest rates are reducing demand in New Zealand. Weak household consumption and business investment, easier labour market conditions and lower wage growth, along with declining inflation expectations, are providing reassurance that our monetary policy stance has been sufficiently restrictive to support CPI to fall back to our target mid-point. Monetary policy transmission to financial conditions during the recent tightening cycle Transmission from a change in the OCR to domestic financial conditions occurs in two stages.6 During the first stage, policy rate changes and expectations for future interest rates influence the level and direction of wholesale interest rates. Figure 3: OCR and New Zealand wholesale rates Source: RBNZ, Bloomberg Short-term rates are more heavily influenced and responsive to the level of, and near-term expectations for, the OCR, while longer-term rates can be significantly influenced by broader factors like inflation expectations and global investor risk sentiment. As a result, the magnitude and pace of influence on long-term rates can vary significantly7. ____________ 6 For example, see Lane (2022), Mann (2023) and RBNZ (2024). 7 See Lewis and Rosborough (2013). For example, market expectations for higher global inflation during 2021 contributed to higher long-term global interest rates8. We can see in this chart that this led the New Zealand 10-year swap rate to increase earlier than short-term wholesale rates and the OCR. The second stage is the transmission from wholesale rates to bank lending and deposit rates. During a tightening cycle, banks face higher funding costs which they pass through to higher lending rates. Higher debt servicing costs reduce free cashflow and in turn limit the ability of households and businesses to consume and invest. Higher interest rates also increase incentives for saving, reduce incentives for investing, and impact household wealth through lower asset prices, which further influence spending behaviour. This occurs gradually, and its effectiveness in New Zealand and Australia is often shaped by an interplay between structural and cyclical factors impacting banks. Structural and cyclical factors influencing monetary policy transmission to financial conditions Two important structural factors are the level of outstanding household debt and the importance of the banking system as a provider of debt capital. In countries with higher levels of household debt, all else equal, tighter monetary policy more effectively reduces free cash flow. This feeds through to lower consumption and investment, compared to countries with lower levels of household debt.9 If a large proportion of debt capital is provided via the banking system, policy rate changes directly affect the borrowing costs for a significant portion of households, as banks adjust mortgage rates accordingly. Figure 4: Household debt as a proportion of GDP Source: Haver Analytics ____________ 8 For an overview of some of the influences on New Zealand government bond yields during and after the COVID period see Gregan and Jones (2023). 9 Kim and Lim (2020). This chart shows that household debt as a proportion of Gross Domestic Product (GDP) is higher in New Zealand and Australia than in the United States and euro area. As banks are the primary source of lending to households in our two countries, transmission through the banking channel will also play a prominent role. A second key factor is the interest rate structure of household debt. There is a notable difference between Australia and New Zealand in this regard. In New Zealand, the majority of home lending carries a fixed interest rate, with historically terms of 1 or 2 years being most popular. In contrast, most Australian home loans are referenced to a floating interest rate. This means that typically it takes slightly longer for changes in the monetary policy stance to pass-through to the average outstanding home loan rate in New Zealand relative to Australia. This chart shows the impact of this variance over the recent tightening cycle. The Reserve Bank of Australia (RBA) raised its policy rate for the first time in May 2022, seven months after the RBNZ. Despite this, Australia experienced a larger increase in its average outstanding home loan rate in 2022 compared to New Zealand. This highlights the difference in the pace of monetary policy transmission to housing loan rates, but not the overall increase in the OCR, which was greater in New Zealand. Transmission via this channel for both New Zealand and Australia occurs faster than for many other economies. For example, in the US and some European countries, where 25- or 30-year fixed rate mortgages are fairly common10. Despite this, monetary policy is still effective in these countries, with other transmission channels playing a more important role11. Figure 5: Average outstanding mortgage rates in New Zealand and Australia Source: RBA and RBNZ While the effectiveness of various monetary policy transmission channels can differ across countries for structural reasons, these can also differ within countries but across business cycles depending on the prevailing economic and financial environment. ____________ 10 International Monetary Fund (2024) provides insight into the effects of monetary policy across countries through the lens of the mortgage and housing markets. 11 This point is covered in more detail in Kent (2023). An example of a cyclical factor is the ongoing influence of the COVID-era fiscal expansion and monetary policy easing. A combination of fiscal policy measures such as the COVID-19 Wage Subsidy and the implementation of additional monetary policy tools in New Zealand, led to a significant increase in liquidity within the financial system contributing to strong deposit growth in commercial banks and an abundance of liquid assets. In turn this bolstered banks’ stability with prudential liquidity measures12 rising well above their minimum requirements. Alongside this, the composition of bank deposits changed significantly with deposit volumes shifting from more traditionally expensive term to cheaper on-call deposits, in part driven by a narrowing in the difference in rates as supply increased13. This chart shows how the proportion of savings held in term deposits, in blue, quickly declined during the COVID period, as the rate premium for holding term deposits relative to on-call savings accounts fell. Figure 6: Saving deposit rates and the term deposit share of total saving deposits Source: RBNZ Bank Balance Sheet survey, RBNZ estimates Deposits account for around 65 percent of total bank funding in New Zealand and so the change in composition and overall increase in supply contributed to a significant decline in bank funding costs through that period. As wholesale rates began to increase from mid-2021 in line with more restrictive monetary policy, banks were however able to maintain lower term and on-call deposit rates for longer largely as a consequence of the higher COVID-period level of savings, higher levels of liquidity, and weakening credit demand. Further, and despite the re-emergence of a premium on term deposits over oncall deposits through 2022, reversion to the pre-COVID composition of term deposits is yet to fully occur. Despite deposit rates increasing slower than usual in this cycle, the increase in average outstanding deposit costs has been greater in New Zealand and Australia than in many other peer economies after accounting for the degree of monetary policy tightening.14 This is largely due to differences in the interest rate structure of bank balance sheets. Assets and liabilities in New Zealand and ____________ 12 These include the core funding ratio (CFR) and liquidity mismatch ratio. 13 See Box C in RBNZ (2023). 14 See Box B in RBA Bulletin (April 2024). Australia tend to be shorter in nature and therefore changes to interest rates more quickly flow through to average interest costs and revenues. Figure 7: Weighted average bank funding costs in New Zealand (spread to BKBM) Source: RBNZ estimates, Bloomberg This chart shows our estimate of weighted bank funding costs compared to the 90-day Bank Bill Benchmark Rate (BKBM)15, which is New Zealand’s equivalent of your 90-day Bank Bill Swap Rate (BBSR). It shows that the lower cost and higher volume of deposits has been a large drag on bank funding costs since mid-2020. Monetary policy transmission to lending rates An on-going assessment of bank funding costs is important as they are a key influence on bank lending rates. We can use a simplified home loan pricing model to understand the influence of bank funding costs and other factors on the transmission of monetary policy. There are three component parts to the model: 1. The level of wholesale rates e.g. the 2-year swap rate. 2. The size of funding spreads. The funding spread is our estimate of the relative cost of bank funding and reflects the difference between the rates that banks pay for retail deposits and wholesale funding versus wholesale rates. 3. A residual or mark-up. This is the difference between the home lending rate and the prior two components. This broadly reflects banks’ gross profit on home loans. This simplified framework is a useful tool for identifying – in a big picture sense – which component is driving home loan rate changes. It is valuable because the implications for monetary policy can vary depending on how each component behaves. For example, traditionally there has been a significant degree of pass-through from changes in wholesale rates into home loan pricing,16 which is important for monetary policy transmission as wholesale rates are influenced by future expectations for the OCR level. However, the effectiveness of this channel of monetary policy transmission can also be influenced by changes in bank funding spreads and the residual or ____________ 15 This is a key reference interest rate used to assess bank funding costs in New Zealand. This rate roughly represents the rate at which banks can borrow for 90 days in wholesale financial markets and is primarily influenced by expectations of the level of the OCR over the 90-day period. 16 For example, see Cook & Steenkamp (2018). mark-up component, both of which depend mostly on factors other than monetary policy rate decisions. Utilising this framework, the chart below shows how the 2-year mortgage rate and its component parts have evolved since 2016. The wholesale component, in this case the 2-year swap rate, has broadly tracked the path of the monetary policy rate, as we’d expect. The funding spread, however experienced a major shift from mid-2020 as a result of the higher volume of low-cost deposits within the bank funding mix. This shift has had meaningful implications for the pass-through of policy rate changes to home loan rates. Figure 8: Decomposition of the 2-year mortgage rate Source: RBNZ estimates, Bloomberg Through the tightening cycle, the trough-to-peak increase in the New Zealand 2-year swap rate was 570 basis points. However, the lower cost of funding experienced through that period by banks, as represented by the funding spread, meant that this increase was not fully passedthrough to home loan rates, with a trough-to-peak increase in the 2-year mortgage rate of 450 basis points. Our estimate of the average bank mark up on a 2-year mortgage through the same period increased from around 2.0 to 2.8 percent. As home loans account for a large proportion of total bank assets (currently around 50 percent on average), this contributed to an increase in the net interest margin generated by banks through this period. As shown in the chart, from the first OCR increase in October 2021 to the last one in May 2023, the biggest four banks in New Zealand, on average, saw their net interest margins increase by about 35-40 basis points. Figure 9: Bank net interest margins Source: RBNZ Income Statement survey The upshot of this is that financial conditions were less restrictive during the recent tightening cycle for the same level of the OCR when compared with previous cycles. However, through ongoing monitoring we have been able to identify and factor this into our decision-making to ensure that financial conditions have been where we needed them to be to achieve our monetary policy objectives. The OCR, and wholesale rates, have been slightly higher than they otherwise would have been to account for this. Monetary policy is working, and we have confidence that inflation is moving back to its target level I will finish today by talking briefly to how these factors may continue to influence the path ahead. Over recent meetings the Committee has become increasingly confident that monetary policy has had the desired effect, and that economic conditions are supporting the convergence of CPI back to the target mid-point of 2 percent. However, the building blocks of transmission from lower policy rates to domestic financial conditions may once again be slightly different than experienced in previous easing cycles. In the current low credit growth environment, home loan rates have responded to falling wholesale rates as markets have pre-positioned future OCR cuts. Likewise, borrowers have been fixing interest rates for shorter terms, which all else being equal, should reduce the time it takes for lower interest rates to be reflected in household and business cashflows. Our latest New Credit Flows survey shows that around 75 percent of new home loan flows currently carry interest periods of 1-year or less and circa 70 percent of existing home loans will be repriced within the next 9 months. Bank funding spreads, however, have gradually increased this year, and this is expected to continue as excess liquidity is drained from the banking system with the progressive wind down of additional monetary policy tools. Over time this is likely to influence the amount of the decline in bank lending rates, even in the face of lower wholesale rates, as banks seek to maintain their net interest margins. However, given bank funding spreads have already begun to normalise, this offset will likely be much smaller than was the case during the tightening cycle, which will reduce the need to factor this into OCR decisions to the same degree in the years ahead. In summary: Monetary policy has been sufficiently restrictive to ensure that broader financial conditions are supporting the achievement of RBNZ inflation objectives The monetary policy stance however is not the only influence on financial conditions. Ongoing monitoring of structural and cyclical factors influencing its’ transmission through financial channels to the economy is required to ensure that the stance of monetary policy reflects these. Reversion to pre-COVID funding conditions for banks is underway and, all else being equal, will constrain how far lending rates will fall as banks seek to preserve their net interest margin. Ultimately however, while factors discussed in this speech are important for understanding the pace and magnitude of monetary policy transmission, there are clearly many others that are considered in monetary policy decision-making. While we have increased confidence that CPI is moving back towards our 2 percent target mid-point we are also conscious of the broader set of economic conditions required to manage inflation back to target. We will continue to assess and respond to risks, on both sides of the ledger. Thank you. References Castaing, A, Chadwick, M, Galimberti, J.K, Sing, M and Truong, E (2024) ‘Estimates of NZ’s Nominal Neutral Interest Rates’, Reserve Bank of New Zealand Bulletin, 87:4. Cook, B and Steenkamp, D (2018) ‘Funding cost pass-through to mortgage rates’, Reserve Bank of New Zealand Analytical Note, AN2018/02. De Zoysa, V, Dunphy, J and Schwartz, C (2024) ‘Bank Funding and the Recent Tightening of Monetary Policy’ Reserve Bank of Australia Bulletin, April, pp 20–30. Ellis, L (2022) ‘The Neutral Rate: Pole-star Casts Faint Light’, Reserve Bank of Australia speech. Gregan, J and Jones, E (2023) ‘New Zealand government bonds – through the pandemic and beyond’, Reserve Bank of New Zealand Bulletin, 86:8. Hawkesby, C (2021) ‘A least regrets approach to uncertainty: Hawks, Doves and the White Heron (he Kōtuku), Reserve Bank of New Zealand speech. International Monetary Fund (2024) ‘Feeling the pinch? Tracing the effects of monetary policy through housing markets’, World Economic Outlook Steady but Slow: Resilience and Divergence , April, Chapter 2 Kent, C (2024) ‘Restrictive Financial Conditions in Australia’, Reserve Bank of Australia speech. Kim, Y and Lim, H (2020) ‘Transmission of monetary policy in times of high household debt’ Journal of Macroeconomics, 63, 103168. Lane, P (2022) ‘The transmission of monetary policy’, European Central Bank speech. Lewis, M and Rosborough, L (2013) ‘What in the world moves New Zealand bond yields?’ Reserve Bank of New Zealand Analytical Note, AN2013/8. Mann, C.L. (2023) ‘Expectations, lags, and the transmission of monetary policy’, Bank of England speech. Reserve Bank of New Zealand (2022), ‘Monetary Policy Tools and the RBNZ Balance Sheet’. Reserve Bank of New Zealand (2023), ‘Trends in bank deposits through the period of monetary policy tightening’, Financial Stability Report, November, pp.39-41. Reserve Bank of New Zealand (2024), ‘Monetary Policy Handbook’, Version 3, Chapter 5, pp. 51-62. Richardson, A and Williams, R (2015) ‘Estimating New Zealand’s neutral interest rate’, Reserve Bank of New Zealand Analytical Note, AN2015/5.
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Speech by Ms Karen Silk, Assistant Governor and General Manager for Economics, Financial Markets and Banking of the Reserve Bank of New Zealand, at the Commonwealth Bank of Australia (CBA) Global Markets Conference, Sydney, 22 October 2024.
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Liquidity management: Principles for liquidity provision and the end of an abundant era By Karen Silk, Reserve Bank Assistant Governor On 22 October 2024 A speech delivered to CBA Global Markets Conference in Sydney Ref #21748793 v1.4 Introduction E ngā mana, e ngā reo. E ngā karanga maha o te wā. Tēnā koutou, tēnā koutou, tēnā koutou katoa, Good morning. It’s great to be back in Sydney representing Te Pūtea Matua, the Reserve Bank of New Zealand. I want to thank CBA for hosting this event and inviting me to speak with you today. Over the past year or so we have undertaken significant work reviewing both the composition and use of our balance sheet in delivering our objectives. In prior speeches I have addressed both the reviews of our foreign reserves’ framework and our financial resources, plus the multiple roles we play in ensuring stable financial markets.1 In my comments today I will focus on how we are considering the future use of our balance sheet to manage liquidity in the financial system and the principles that will inform that. We manage liquidity to support financial stability not only during periods of market dysfunction, but also to ensure the efficient settlement of payments and anchoring of short-term interest rates near the Official Cash Rate (“OCR”). There are three key messages I would like you to take away from my remarks today. First, the Reserve Bank is resourced and ready to provide liquidity to support market functioning when necessary to meet our objectives. Second, we will apply a principles-based approach to the provision of liquidity to financial markets. The intention of our principles is to preserve incentives for market participants to seek market-based solutions to their own liquidity needs in the first instance and not rely on the Reserve Bank as a ‘lender of first resort’.2 Third, our liquidity management framework will ensure we have the right facilities and operations in place to maintain settlement cash at an ample level, as we decline from the post-COVID abundant levels. However, market participants should also be prepared to be more active in the management of their own liquidity. A principles-based approach to addressing domestic market dysfunction In March 2020, at the onset of the COVID-19 pandemic, the Reserve Bank deployed a range of balance sheet tools in response to dysfunction in the New Zealand Government Bond (NZGB) market and the foreign exchange (FX) swap market.3 In 2023, we undertook a review of our actions to support ____________ 1 See Silk (2023a) and Silk (2023b). 2 A risk Schnabel (2023) discusses in the context of central banks providing system liquidity through lending operations. 3 The Facilities at a Glance page on our website outlines the full suite of facilities and operations we have available to provide liquidity both during normal times and in crisis periods like March 2020. Kengmana (2021) further discusses the transmission of monetary stimulus through LSAPs. markets, bringing together empirical evidence and reflections from a range of financial markets participants.4 The overarching conclusion from our review was that our response to market dysfunction in 2020 was both timely and effective, but there were lessons to consider for the future. These lessons are detailed in a Bulletin we published at the start of this year.5 In response, we have adopted a set of principles designed to guide our approach to future dysfunction in New Zealand dollar financial markets. The substance of these principles is not new, but we have taken the opportunity to formalise them to ensure our approach represents best practice for the future. Avoiding the risk of moral hazard It is somewhat non-negotiable for any central bank speech on crisis support to reference Bagehot’s formulation of the lender of last resort function. He advised central banks, in times of stress, to calm market panic by lending “freely and vigorously” for good collateral and at backstop pricing.6 In other words, we should be ready and willing to provide possibly significant amounts of liquidity during episodes of stress — but how we provide this liquidity really matters. Generous and low-cost crisis liquidity provision might be highly effective, at least initially, but can also create incentives for excessive risk taking by market participants. Defined as moral hazard risk, it is traditionally discussed in relation to central bank support of individual institutions but can also apply when providing liquidity to a broader set of counterparties.7 Market participants may hold fewer or lessor quality liquid assets on their balance sheet in pursuit of return if they believe the central bank will always step in to provide low-cost liquidity during periods of stress. Stronger prudential liquidity requirements in the wake of the Global Financial Crisis (“GFC”) have in part served to mitigate some of this risk. However, US regional bank stress in 2023 and UK gilt market volatility in 2022 serve as reminders that market dysfunction is always a risk, and central banks need to keep their eye on the ball. Principles for addressing financial market dysfunction The principles we have adopted will assist in the design and deployment of our liquidity support tools during a crisis. At its best, central bank liquidity should support financial markets by enabling more stability in market conditions, improve market liquidity, and reduce volatility, without encouraging moral hazard and undermining market discipline.8 A tall order indeed! ____________ Summarised in Robinson and Watson (2024). See Robinson and Watson Walter Bagehot, Lombard Street: A Description of the Money Market, at 51 and 96–97. For example, see Buiter et al. (2023). See papers and speeches from the Bank of Canada, the Reserve Bank of Australia, the Bank of England, the Sveriges Riksbank, De Nederlandsche Bank, and from Paul Tucker. 1. Firstly, we should intervene only in circumstances where the Reserve Bank’s remits are likely to be compromised. We have financial resources to intervene to promote financial stability and market functioning.9 When stability is threatened, it is within our risk appetite to use our financial resources to intervene and support markets before conditions deteriorate further. However, our interventions should be limited to scenarios where our remits are likely to be compromised. Space should be provided for markets to self-correct.10 2. Secondly, our interventions should target the source of dysfunction, and have a high chance of success. Ensuring the tools we deploy have a high chance of success requires us to identify and target the likely source of dysfunction. We should endeavour to match our tools to the drivers of the dysfunction and, importantly, adapt them as we develop our understanding. Effective communication at the time of deployment is also essential to ensure a greater chance of success. 3. Thirdly, our interventions should mitigate moral hazard. Robust prudential regulation and supervision can help minimise moral hazard, and the design of our interventions should seek to ensure entities are incentivised to manage their own liquidity risks. This means our interventions should be appropriately sized, be priced as a backstop and have a clear exit strategy. These features ensure interventions are targeted and temporary. 4. Fourthly, we should aid price discovery and support monetary policy implementation. Our interventions should catalyse market recovery, which enables the transmission of monetary policy, rather than replacing market pricing of risk. Backstop pricing and a clear exit strategy support these goals, by incentivising market participants to return to the market, instead of becoming reliant on central bank liquidity support.11 5. Finally, we should not expose the public balance sheet and Reserve Bank to undue risks. Expanding our balance sheet entails taking on greater risk, so any expansion requires justification against our policy objectives. This principle also implies our collateral framework should be chosen carefully. To reiterate my first two key messages: The Reserve Bank stands ready to support market functioning if that is what is necessary to achieve our legislated objectives. But we intend to do this in a way that leaves room for markets to self-correct and ensures risk is appropriately priced. The principles we have adopted should ensure our actions are consistent with these objectives. ____________ 9 See the Reserve Bank’s 2022–23 Annual Report for a discussion of the Review of Financial Resources. Central banks have the unique capacity to rapidly expand their balance sheet size to support their statutory objectives (Tucker, 2014). 10 Bindseil (2016), Jackson Hole at 205-206. 11 Walter Bagehot, Lombard Street: A Description of the Money Market, at 96–97. The future of our liquidity management framework So far, I have focused on how the Reserve Bank provides liquidity during crisis events. I now want to turn to how we should manage liquidity in the cash system as COVID-19-era balance sheet tools wind down. Settlement cash is moving from an era of abundance to one of ample liquidity where there will be sufficient cash to anchor interest rates to the OCR, and support an efficient payments system, but not much more. As stated earlier, in an ample era, market participants need to be ready to be more active in their management of cash. The balance sheet tools we used during COVID-19 were funded through an increase in settlement cash balances, which you can see in Figure 1.12 These are known as Exchange Settlement balances here in Australia,13 or bank reserves in other jurisdictions. As our COVID-era balance sheet tools mature, the settlement cash created as a by-product is drained from the cash system. Our focus now is to ensure that our liquidity management framework includes the appropriate mix of market operations and standing facilities to maintain ample liquidity in the cash system. Figure 1. Settlement cash level as of 30 September 2024 Source: RBNZ D12 table ____________ See Callaghan et al. (2023) for further details on settlement cash and the impact of the COVID response on the settlement cash level. See this RBA explainer. Moving from ‘abundant’ to ‘ample’ settlement cash To illustrate the transition to a lower settlement cash level, Figure 2 shows a stylised representation of the demand curve for settlement cash. The greater the settlement cash level, the lower the interest rate, within the bounds imposed by our standing facilities. Settlement cash currently sits within the ‘abundant’ region, where we would expect to see short-term interest rates being less responsive to modest movements in the settlement cash level. Figure 2. Scarce, ample, and abundant settlement cash Interest rate Scarce Ample Abundant Overnight Reverse Repo Facility Settlement cash demand Interest on ESAS balances (paid at OCR) Settlement cash level Source: RBNZ Note: The demand curve does drop below the OCR in this chart at the very highest levels of settlement cash. This captures the ‘leaky floor’ effect, where short-term interest rates in some markets can still drop below the OCR if settlement cash is highly abundant. This is discussed in more detail in Callaghan et al. (2023). More active management of settlement cash is required by the Reserve Bank at our intended ample level. A decline back into scarce levels would result in short-term interest rates rising above the OCR. This occurs because market participants would be willing to pay more for settlement cash to meet their liquidity needs. This would result in small movements in settlement cash causing large movements in short-term interest rates14 Our intention to maintain settlement cash at an ample level is an easy statement to make. However, what constitutes an ample level is uncertain and may change over time. There is also no historical precedent for the level of decline in settlement cash that is underway. Current internal estimates of ample carry a wide range, reflecting the inherent uncertainty surrounding the many factors that can influence the demand for settlement cash. As a consequence, we do not intend to publish a point estimate of ample but will monitor indicators and market intelligence to maintain it. To borrow a phrase, we will know the ample settlement cash level by its works. ____________ 14 Although it is important to note that the Overnight Reverse Repurchase Facility provides a limit on how high interest rates should rise above OCR, since counterparties can always borrow cash overnight at OCR plus 25 basis points if they have eligible collateral. As an example of one of the influencing factors, consider the timing of net government debt issuance, spending and taxation flows. Government debt issuance and tax revenue drain cash from the system, reducing the settlement cash level. Conversely, government debt maturities or expenditure inject cash back into the system, increasing the settlement cash level. As shown in Figure 3 and Figure 4, the influence of these factors has become more significant in the wake of the COVID-19 pandemic due to the scale of the fiscal response and resulting increase in government debt.15 Figure 3. Government bond issuance impact on settlement cash Figure 4. Government cash influence on settlement cash (12-month moving-average) March 2020 March 2020 NZD Millions NZD Billions -5 -10 -500 -15 Bonds issued Bond maturities Note: Issuing bonds drains liquidity from the cash system as cash is paid into the Crown Settlement Account, and bond maturities inject cash into the system as the cash is paid back into ESAS accounts. Bond issuance includes syndications and weekly tenders by NZDM. Source: RBNZ D10 Spreadsheet. -1000 Note: Government cash influence is government revenue (taxes provided through Inland Revenue Department and Customs), less government expenditure and interest paid on government bonds and Treasury bills. Source: RBNZ D10 Spreadsheet. Other policy factors potentially impacting the demand for settlement cash, and its distribution throughout the system, will include the implementation of a Committed Liquidity Facility (CLF) as part of our updated liquidity standard, the outcome of our ESAS access review, and longer-term developments like digital cash.16 While noting the uncertainty, our internal projections suggest it is possible we may reach an ample settlement cash level in the second half of 2025. Participants in the cash market should prepare for an end of the abundant liquidity environment we have become used to in recent years, and likewise we are preparing to support a smooth transition to an ample settlement cash level. That leads to the question: what is the best way for the Reserve Bank to provide liquidity to reach and maintain ample settlement cash? ____________ 15 Callaghan et al. (2023) explain the interactions between settlement cash, the Crown Settlement Account, and the Reserve Bank. 16 See the consultation on Deposit Takers Core Standards, and information on digital cash. The appeal of a ‘hybrid’ approach to liquidity provision Approaches to liquidity provision have begun to be characterised in the central banking community as ‘supply-driven’, ‘demand-driven’, or a ‘hybrid’ of the two.17 In a supply-driven approach, the central bank determines the quantum of liquidity required and supplies that amount. This essentially reflects the RBNZ’s current approach and in our case is largely achieved through transacting in the FX swap market. We do not currently foresee a need to use additional asset purchases to form part of our supply-driven toolkit as is being contemplated in other jurisdictions. In a demand-driven approach, the central bank provides cash through regular collateralised lending operations or standing facilities. In the New Zealand context, a feasible way to do this would be through our existing Open Market Operations.18 We believe that the most pragmatic and flexible way to provide liquidity in New Zealand is to use a hybrid approach, combining supply- and demand-driven elements. This should require only a modest adjustment to our current framework. There are 3 main reasons we think a hybrid approach makes sense for New Zealand: 1. The use of FX swaps for monetary policy implementation (MPI) The first is because of the relevance of FX swaps for monetary policy implementation in New Zealand. Implementing monetary policy means keeping short-term wholesale interest rates trading close to the OCR. In New Zealand, that has increasingly meant keeping short-term FX swap implied interest rates trading close to the OCR, due to the relative lack of activity in the domestic interbank and repo markets. To transact on both sides of the FX swap market – that is to be able to add and withdraw New Zealand dollar liquidity – we need to maintain a stock of liquidity management reserves. The act of raising those reserves itself injects New Zealand dollar liquidity as we fund the purchase of reserves through the creation of settlement cash. In this way, the structural balance of our liquidity management reserves can be thought of as a supply-driven element of our liquidity provision. Around that structural level of liquidity provision, our Portfolio Management team can make tactical adjustments to add and withdraw liquidity to meet our MPI objectives. As market participants will be aware, this is something we have been doing for some time. 2. Market discipline and a leaner central bank balance sheet The second benefit of a hybrid approach relates more to the demand-driven component. If we relied purely on supply-driven liquidity provision to maintain an ample settlement cash level we would need to forecast an ample level with great accuracy, or – more likely – provide a buffer to our best estimate of this level, such that liquidity was always tending towards abundant. ____________ 17 Schnabel (2023). 18 Prior to COVID-19, Open Market Operations were regularly used as part of our management of the settlement cash level (Parekh, 2016). Instead, by providing a demand-driven element we should be able to run a slightly “leaner” balance sheet as market participants can take confidence that central bank liquidity is available (subject to good collateral) on demand, thereby removing unnecessary precautionary demand which can have a “ratcheting” effect on the central bank’s balance sheet. Not overly relying on supply-driven liquidity provision also places a greater onus on market participants to forecast and manage their own liquidity. 3. More flexibility to deal with market segmentation The third reason we favour a hybrid approach is that segmentation between different short-term interest rate markets means we need flexibility to ensure liquidity reaches where it is needed. During 2024 we have at times observed a divergence in the cost of borrowing New Zealand dollars between the repo market and the FX swap market (Figure 5). Downward pressure on FX swap rates was particularly intense over the September quarter end. In recent weeks the Reserve Bank has withdrawn New Zealand dollar liquidity in the FX swap market to push back against that downward pressure in rates, while simultaneously injecting liquidity through Open Market Operations to alleviate funding pressure in the repo market. In both cases, these actions support short-term wholesale interest rates to trade close to the OCR. -25 -6 -50 -12 Q3 Quarter End -75 Aug 22 Basis Points Basis Points Figure 5. Short-term borrowing costs in NZD/USD FX swap market and general collateral repo market (spread to OCR, five-day moving average) -18 Nov 22 Feb 23 May 23 Aug 23 FX swap implied rate (tomorrow-next) Nov 23 Feb 24 May 24 Aug 24 Overnight general collateral repo rate (RHS) Source: Bloomberg, RBNZ estimates Prior to the pandemic our framework included the use of tiered ESAS remuneration as a means to ensure distribution of liquidity with a targeted settlement cash level. As we are no longer targeting an explicit settlement cash level, a return to a tiered remuneration approach would create added and potentially unnecessary complexity. However, we retain the ability to adapt our framework at any time as needed to support our objectives. Should distribution of settlement cash within the system become an issue, it is always possible for us to look at tiering again. An aside on shrinking our balance sheet while interest rates fall As you are no doubt aware, the Monetary Policy Committee has started to ease the restrictiveness of monetary policy in New Zealand. Simultaneously, our Additional Monetary Policy (“AMP”) tools are continuing to roll off the balance sheet. A natural question people might ask is whether the MPC is intending to continue with balance sheet reduction during an easing cycle. The answer is yes. The wind-down of the Large Scale Asset Program (“LSAP”) is consistent with the MPC’s stated objectives of minimising impact on monetary stimulus; avoiding harming the efficient functioning of financial markets; and ensuring the MPC has the capacity to use the LSAP tool effectively again, if it were ever warranted. We do continue to monitor for any impact, but the normalisation of our balance sheet is generally not indicative of our monetary policy stance. The monetary policy stance will continue to be communicated via changes to the OCR and the MPC’s communication around the outlook for the economy and the policy rate. Conclusion To conclude, I will reiterate the three key points I want you to take away from today. Firstly, the Reserve Bank is resourced and ready to support the functioning of key New Zealand dollar financial markets that are relevant to the transmission of monetary policy and for financial stability. Secondly, we have adopted a principles-based approach to addressing domestic market dysfunction. Application of these principles in the future should allow for markets to self-correct where possible, mitigate moral hazard risks, and protect the Reserve Bank balance sheet from undue risk. Lastly, the settlement cash level will decline from current abundant levels to an ample level, possibly as early as the second half of next year. The Reserve Bank intends to adopt a hybrid approach to ensuring there is ample liquidity in the cash system, with operational details now under development. It is likely this ample level of liquidity will place greater onus on market participants to understand, forecast and manage their individual liquidity needs than has been necessary during the abundant liquidity era. My intention in this speech was to provide further insight into the progression of our thinking on the future management of system liquidity. Throughout our review we have benefitted from generous and frank feedback from market participants, and we intend to continue proactive engagement over the coming months to ensure transparency as we refine our approach. Thank you. References Bagehot, W. (1962). Lombard Street: A description of the money market. In EliScholar – A Digital Platform for Scholarly Publishing at Yale. Hyperion Press. Retrieved from https://elischolar.library.yale.edu/ypfs-documents/12721/ (Original work published 1873) Bats, J., van den End, J. W., & Thoolen, J. (2018). Revising the central bank’s lender of last resort function. DeNederlandscheBank Occasional Studies, 16(4), 1–50. Retrieved from https://www.dnb.nl/media/ytzjhmf0/201807_nr_4_-2018-_revisiting_the_central_banks_lender_of_last_resort_function.pdf Bertsch, C., & Molin, J. (2016). Revisiting the role of central banks as liquidity providers - old and new challenges. Sveriges Riksbank Economic Review, 2016(2). Retrieved from https://www.riksbank.se/globalassets/media/rapporter/pov/filer-fore2017/artiklar/rap_pov_artikel_3_160922_eng.pdf Bindseil, U. (2016). Evaluating monetary policy operating frameworks. Presented at the 2016 Economic Policy Symposium held at Jackson Hole, Wyoming. Retrieved from https://www.kansascityfed.org/documents/7036/BindseilPaper_JH2016.pdf Board of Governors of the Federal Reserve System. (2023). Review of the Federal Reserve’s supervision and regulation of Silicon Valley Bank. Board of Governors of the Federal Reserve System. Retrieved from Board of Governors of the Federal Reserve System website: https://www.federalreserve.gov/publications/files/svb-review-20230428.pdf Buiter, W., Cecchetti, S., Dominguez, K., & Sánchez Serrano, A. (2023). Stabilising financial markets: Lending and market making as a last resort. ESRB: Advisory Scientific Committee Reports, 13(January). https://doi.org/10.2139/ssrn.4338209 Callaghan, M., Haworth, C., & Poskitt, K. (2023). How the Reserve Bank implements monetary policy. Reserve Bank of New Zealand Bulletin, 86(3), 1–15. Retrieved from https://www.rbnz.govt.nz/hub/publications/bulletin/2023/how-the-reserve-bank-implementsmonetary-policy Engert, W., Selody, J., & Wilkins, C. (2008). Financial market turmoil and central bank intervention. Bank of Canada Financial System Review, June. Retrieved from https://www.bankofcanada.ca/wpcontent/uploads/2012/01/fsr-0608-engert.pdf Hauser, A. (2021). From lender of last resort to market maker of last resort via the dash for cash: Why central banks need new tools for dealing with market dysfunction. Presented at the Reuters, London. Retrieved from https://www.bankofengland.co.uk//media/boe/files/speech/2021/january/why-central-banks-need-new-tools-for-dealing-withmarket-dysfunction-speech-by-andrew-hauser.pdf Hauser, A. (2023). “Less is more” or “less is a bore”? Re-calibrating the role of central bank reserves. Presented at the Kings College London’s Bank of England Watchers’ Conference. Retrieved from https://www.bankofengland.co.uk/-/media/boe/files/speech/2023/november/re- calibrating-the-role-central-bank-reserves-speech-by-andrew-hauser.pdf Jones, B. (2023). Bagehot and the Lender of Last Resort - 150 years on. Presented at the 36th Australasian Finance & Banking Conference. Retrieved from https://www.rba.gov.au/speeches/2023/pdf/sp-ag-2023-12-14.pdf Kengmana, B. (2021). RAMPed up: RBNZ’s Additional Monetary Policy toolkit. RBNZ Bulletin, 84(1), 1– 32. Retrieved from https://www.rbnz.govt.nz/hub/publications/bulletin/2021/rbb2021-84-01 Kent, C. (2024). The future system for monetary policy implementation. In Reserve Bank of Australia. Presented at the Bloomberg Australia Briefing. Retrieved from https://www.rba.gov.au/speeches/2024/sp-ag-2024-04-02.html Parekh, S. (2016). How the Reserve Bank of New Zealand manages liquidity for monetary policy implementation. Reserve Bank of New Zealand Bulletin, 79(9), 1–19. Retrieved from https://www.rbnz.govt.nz/hub/publications/bulletin/2016/rbb2016-79-09 Reserve Bank of Australia. (2024). How the Reserve Bank implements monetary policy. Retrieved August 26, 2024, from Reserve Bank of Australia website: https://www.rba.gov.au/education/resources/explainers/how-rba-implements-monetarypolicy.html Reserve Bank of New Zealand. (2022a). In retrospect: Monetary policy in New Zealand 2017 to 2022. Reserve Bank of New Zealand. Retrieved from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/hub/publications/monetary-policy-statement/rafimp Reserve Bank of New Zealand. (2022b). Facilities at a glance. Retrieved August 26, 2024, from Reserve Bank of New Zealand website: https://www.rbnz.govt.nz/financial-markets/domesticmarkets/our-monetary-policy-implementation-framework/key-facilities/facilities-at-a-glance Robinson, F., & Watson, D. (2024). In retrospect: RBNZ’s support of financial market functioning at the onset of COVID-19. Reserve Bank of New Zealand Bulletin, 87(1), 1–37. Retrieved from https://www.rbnz.govt.nz/hub/publications/bulletin/2024/rbnzs-support-of-financial-marketfunctioning-at-the-onset-of-covid-19 Rustia, F., Schwartz, C., & Stenner, N. (2024). The Committed Liquidity Facility: 2015–2022. RBA Bulletin, (January), 43–50. Retrieved from https://www.rba.gov.au/publications/bulletin/2024/jan/thecommitted-liquidity-facility-2015-2022.html Schnabel, I. (2023). Back to normal? Balance sheet size and interest rate control. In Www.ecb.europa.eu. Presented at the Event organised by Columbia University and SGH Macro Advisors. Retrieved from https://www.ecb.europa.eu/press/key/date/2023/html/ecb.sp230327_1~fe4adb3e9b.en.html Silk, K. (2023a). Building a balance sheet to support financial stability. Presented at the UBS Australasia Conference. Retrieved from https://www.rbnz.govt.nz//media/project/sites/rbnz/files/events/2023/11/building-a-balance-sheet-to-support-financial- stability.pdf Silk, K. (2023b). Liquidity: one word, three meanings. Presented at the KangaNews New Zealand Debt Capital Market Summit 2023. Retrieved from https://www.rbnz.govt.nz/news-andevents/events/2023/september/karen-silk---kanganews Tucker, P. (2014). Re-thinking the lender of last resort. BIS Papers, 79. Retrieved from https://www.bis.org/publ/bppdf/bispap79.htm
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Speech by Mr Adrian Orr, Governor of the Reserve Bank of New Zealand, at the Peterson Institute, Washington DC, 23 October 2024.
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Navigating Monetary Policy Through the Unknown By Adrian Orr, Governor A speech delivered to the Peterson Institute, Washington DC at 1pm on 23 October 2024 (6am 24 October 2024 NZDT) Ref #21721194 v1.12 With special thanks to Lewis Kerr for significant input to this speech. Introduction It is a privilege to be invited to speak here at the prestigious Peterson Institute. I have travelled from afar – the nation of New Zealand or Aotearoa. The latter is the name settled on by the descendants of the courageous Polynesian navigators who were the first explorers to arrive sometime between 1200 and 1300AD. These people are now known as New Zealand Māori. Our ancestors travelled long distances across the South Pacific Ocean to make Aotearoa their home. People tell the story of Kupe, the Polynesian navigator who centuries ago set out from an island by the name of Hawaiki on a voyage and discovered Aotearoa.1 From the outset of this voyage, his starting point would have been approximate, the destination was well beyond the horizon, and the expected time of arrival unknown. During the voyage the performance of the vessels would be sorely tested and the information to navigate on continuously changing. The challenges of the voyage were unknowable. They had to sail smart. It can only be assumed there was a strong collective belief in the existence of the destination among the crew and passengers, and equal faith in their navigator.2 The premise of the navigator’s challenge resonates with the everyday challenges that leaders confront, and it is pertinent to guiding monetary policy through recent times of both calm – the great moderation – and storm – the recent years of COVID-19 induced radical uncertainty. The voyage to New Zealand is believed to have been over 2,500 kilometres (around 1,600 miles) and to have taken several weeks. But Kupe had a sturdy waka (vessel) and a fine crew – all fit for the task. They had knowledge of the ocean, weather and navigation, accumulated over centuries and passed on through generations. They were able to update their navigation as conditions changed. But most importantly, they had a clear goal in mind – the islands of Aotearoa. This week I have the pleasure of attending the IMF and World Bank Annual Meetings, where policymakers are discussing how they are navigating their own waters. It’s an incredibly valuable opportunity to share notes with others from around the world, to talk about the challenges we have in common, and the ones we don’t share but can learn from. There’s never a shortage of emerging issues and perennial challenges to talk about. New means of assessing our current economic position, better means of forecasting ahead, improved strategies for managing through uncertainty, and shared experiences of communicating with confidence during uncertain and unpleasant times – keeping focused on our goals. I take great comfort from what I see and hear. As monetary policy decision makers we have retained clear goals – primarily focused on achieving and maintaining low and stable inflation. This helped central banks guide monetary policy through a period of extreme conditions. We retained confidence in ‘visualising the island’ – or our goal of restoring low and stable inflation. ____________ 1 In Māori oral history and storytelling ‘Hawaiki’ refers to the original home of the first inhabitants of Aotearoa. 2 Like all good stories told over centuries, accounts differ. For example, by some accounts Kupe had initially set out to slay an octopus Te Wheke-o-Muturangi, who had been stealing bait from the fishermen’s lines. By other accounts, Kupe had set out to discover new land, perhaps having observed the Pīpīwharauroa – migratory birds that would fly off into the ocean horizon every year – or the whales that would journey south and then return. We also know that Polynesian navigators had ways to place themselves within the expanse of the ocean. With no GPS, they used the stars, they looked for the presence of certain fish and bird species, and they observed patterns in the waves and reflections on the clouds. But, far away from landmarks and reefs, no one method could tell them exactly where they were. Crowe (2018) discusses the voyaging achievements of Māori and their Polynesian ancestors. Retaining this confidence is critical given the significant time between making our policy decision and seeing its full effect on inflation. Our inflation goal is always 1 to 2 years ahead, that is, over the horizon. At the Reserve Bank of New Zealand, this future focus is coded into our Monetary Policy Remit, which tasks us with targeting future inflation over the medium term. Globally, we have been able to rely on robust monetary policy tools and decision-making frameworks, built upon years of research and experience, and have many bright minds to advise us. Advanced economy central banks are typically strong and credible institutions, with the tools and independence to get on with the navigation task at hand. Our clarity of purpose, tools, and capabilities make the task simple, but never easy. The institutions, the frameworks, the knowledge and the commitment to a low inflation goal are valuable because the task is hard. Let me talk about some of these challenges. Heightened volatility since the pandemic Central banks dedicate significant resources to understanding the present and divining the future, publishing forecasts and discussions of the economic outlook. But this all happens in the context of widespread uncertainty. Over the past few years central banks have faced radical uncertainty. We see some of this volatility in the data (figure 1), our own forecasting performance3, our communication challenges, ebbs and flows in inflation expectations, and price setting. Figure 1: Illustration of shocks and volatility in data for New Zealand Source: Stats NZ, Sense Partners, Shanghai Shipping Exchange. Note: ‘GDP growth’ is quarterly real GDP growth (seasonally adjusted). ‘Uncertainty Index’ is the New Zealand Economic Uncertainty index from Sense Partners. ‘Net migration’ is monthly net immigration (seasonally adjusted). ‘Shipping costs’ is the Shanghai Shipping Exchange China Containerized Freight Index (rebased). Shaded areas denote 2020 to today. Central banks have faced significant challenges assessing the state of their economies in real time. What is our starting point? Like Kupe, central bankers have had to piece together a view of their current location and path ahead with partial and imperfect information. ____________ 3 See Bohm and Sing (2022). Statisticians have faced real measurement challenges since the pandemic. Historical economic relationships have broken down, and seasonal patterns have shifted and reverted as spending and mobility patterns changed (figure 2). At the most basic level, in-person surveys were hampered by COVID-19 restrictions. In New Zealand, data has been subject to large revisions and at times we could not take our official measures of household spending at face value.4 Figure 2: Seasonal fluctuations in New Zealand’s population due to tourism Source: Stats NZ, RBNZ estimates. Note: Population accounting for tourism is resident population plus the number of visitors temporarily in New Zealand minus the number of New Zealand residents temporarily abroad. Every data source has its strengths and weaknesses, so we cast a wide net and make use of as much relevant information as possible. We use suites of indicators, with each one telling a slightly different story (figure 3). To hark back to Kupe, Polynesian navigators observed waves, birds, clouds, changing flotsam and jetsam, and the stars – among other high frequency indicators – to constantly update their navigating decisions. Another significant challenge is that official data are often released with a considerable lag, so we draw heavily on timelier or higher-frequency information.5 This includes information from surveys of households and businesses, traffic information, energy consumption, tax data, and financial market data, among other sources. This information is timelier, but it has its own shortcomings: it tends to be noisier and isn’t always rigorously constructed. ____________ 4 See Gross domestic product: March 2024 quarter | Stats NZ. 5 Significant work is dedicated to testing indicators (e.g., Fitchett and Robinson (2021) and Ball et al. (2020)), combining indicators quantitatively (e.g., Karagedikli and Özbilgin (2019) and Richardson et al. (2019)) and constructing suites of indicators (e.g., Robinson and Jacob (2019), Ball (2024), and Castaing et al. (2024)). Figure 3: Our suite of indicators for estimating the output gap Source: New Zealand Institute of Economic Research, Ministry of Business, Innovation and Employment, Stats NZ, RBNZ estimates. Note: Figure is based on data available at the time of our August 2024 Monetary Policy Statement. The output gap indicators based on information from labour market surveys are shown separately from the other indicators. For each group of indicators, the shaded area shows the range of values, and the line shows the mean value. Other considerations also influence our estimate of the output gap. Measurement is not the only challenge. We must also attempt to separate out what is short-run volatility and what reflects a genuine signal about the underlying state of the economy. These judgements are inherently difficult, and high levels of volatility have made them more so, and more consequential too. As Polynesian navigators understand, following an ocean-going bird can lead you to land, but it is best to follow them in the evening when they are heading home. Once we’ve taken a view on the current state of the economy – our starting point – we then consider how the economy will evolve and what this will mean for things we care about, like output, employment, and inflation. What is a reasonable model for how our economy will operate? New Zealand is a small open economy, of around five million people. We are buffeted by global economic swings and round-abouts – travel, exports, capital flows, trade relationships, climate conditions, and global investor sentiment. This is why we have an operationally independent central bank, a free-floating exchange rate, and a clear monetary policy remit. Decisions by foreign central banks are important to our decision making, but not sufficient for our monetary policy purposes. The extreme events we’ve experienced in recent years – especially following the onset of the COVID-19 pandemic – have fundamentally challenged many of the economic relationships we rely on. Globally, government policy responses to the initial COVID-19 disruptions were necessarily swift, leaving little time to learn from gradual policy changes. The suite of government policy interventions was unprecedented in modern economic times – health, mobility, trade, fiscal policies – as was the impact on economic activity and the role of central banks. Understanding the macroeconomic effects of novel fiscal policy tools – such as the wage subsidy in New Zealand – presented real challenges. I cannot think of a time in modern economic history when independently, yet simultaneously, so many governments provided countercyclical fiscal support via direct income to their citizens. New Zealand’s ‘Phillips curve’ – the relationship between capacity pressures and inflation – appears to have steepened since the beginning of the COVID-19 pandemic.6 Likewise, investors’ and consumers’ preferences changed significantly, as mobility restrictions and supply chain squeezes waxed and waned. And then there were the changing preferences for, and performances of, our monetary policy instruments. At the time of the COVID-19 outbreak many central banks were already sailing in shallow waters, near the ‘Effective Lower Bound’ for their official interest rates. Central banks had to quickly learn how best to use a wider range of policy instruments together as conditions in the economy evolved.7 Modern ‘quantitative’ monetary instruments were comparatively new for many central banks and in the case of New Zealand had not been used before. What will the impacts on output, employment and inflation be from the use of quantitative rather than price-based instruments? Communications became very complicated. Finally, while we could observe in real time the growing threat of COVID-19, we had no way to predict what events or ‘shocks’ would happen in the future. And, as we learnt of ‘shocks’ we had to make assumptions around how big they would be, how they would impact the economy and inflation – is it a demand or supply shock, or a bit of both – and how long their effects would be felt – ‘team transitory’ versus ‘team persistent’. Policymakers have had to grapple with many large shocks, including national lockdowns, travel restrictions, significant armed conflict between nations, supply-chain breakdowns, energy price spikes, and the impact of extreme climate events on food prices. It has been a long time since we’ve experienced calm sailing conditions. How should policymakers deal with uncertainty? Navigating monetary policy, with a 1 to 2-year lag between policy action and ultimate outcome, is akin to ocean circumnavigation. Ocean-going sailors do not need to ‘tack’ when other boats do. They are in their own vessel pursuing their own ultimate destination. Further, navigators can’t change the weather, but they can change their course and alter their pace as conditions change. However, given the time and distance being travelled, they must also retain the confidence of their crew and passengers over the long term. Mutiny is not a sign of success. As central bankers, we can improve the way we measure and interpret information. We can research the economy and update our models of how it works. We can think ahead to future shocks, modelling them and gaming them out, and we can learn from past ones. But this can only take us a small way to reducing the uncertainty we face. We therefore accept uncertainty, and we navigate through it. We chart a course, and then look for signs that tell us whether we need to deviate and chart a new one. When we experience a shock, it doesn’t change the goal, the island doesn’t move, it just changes how we will get there (figure 4). We focus on the goal over the horizon that matters to us. ____________ 6 See Alanya-Beltran et al. (2024). 7 There have been numerous reviews of central banks’ policy responses over recent years. Our own Review and Assessment of the Formulation and Implementation of Monetary Policy (RAFIMP) provides nine lessons from the Reserve Bank of New Zealand’s experience between 2017 and 2022. Figure 4: Revisions to our inflation outlook since 2020 Source: Stats NZ, RBNZ estimates. Note: Past projections and scenarios are from our published Monetary Policy Statements. Between the May 2020 and February 2021 Monetary Policy Statements these outlooks were ‘baseline’ scenarios. Of course there are some basic safety strategies. In stormy weather it’s best to avoid sailing too close to the shore or reef. When setting monetary policy, we think not only about the most likely scenario for the economy (a central projection) but also the risks around it. Some outcomes are so bad that we must steer forcefully away from them if they become probable. We really don’t want to experience a long and persistent downturn, with monetary policy stuck at the effective lower bound, or an inflationary spiral. First, stay afloat. Of course, there are times when policymakers can afford to progress with circumspection. When we’re uncertain about the performance of our policy tools, gradual adjustments can sometimes keep us closer to course.8 Risk management has featured heavily in our Monetary Policy Committee’s (MPC) decision making. In 2020 when COVID-19 was bearing down on the economy, the MPC was humble in its ability to gain sufficient conviction in any one economic scenario playing out. The Committee did however consider the worst-case scenario to avoid was one of doing ‘too little too late’ in response to the global shutdown. The reasonable threat of a deep and sustained recession, and a dysfunctional financial system, led the Committee – and broader Reserve Bank decision makers – to take swift and dramatic action with our policy instruments. We did everything possible to stay in deep waters, stay afloat, and remain aware of the opportunities ahead to plot a new course. Our response was a ‘least regrets’ approach. On a personal note, I often reflect to early 2020 and ask myself the question: If someone offered me a peak of 7.3 percent inflation and unemployment around 3 percent in two years’ time – would I have accepted it? Yes! That sounded like nirvana compared to what the world was leaning into at the time. This was the eventual outcome in New Zealand – with many lessons learnt – and new shocks having been faced ____________ 8 These approaches to navigating uncertainty are reflected in the policy literature through ideas such as robust control (e.g., Hansen and Sargent (2008)) and Brainard conservatism (Brainard, 1967). on the voyage, such as Russia’s invasion of Ukraine, energy price spikes, and weather-related food price shocks. By early-2022 the navigational signs had changed. The risk of a deep and sustained recession had receded, and persistent inflation had begun to permeate the economy. Inflation expectations had risen significantly. The biggest risk to our objectives was now that of high inflation becoming entrenched, and the economic and social costs that would be required to subsequently bring it back down. We soon reversed our quantitative easing programme. One of our key navigational stars – the estimated neutral interest rate – was a long way north of where we sat, so we again moved swiftly to get back on course. Again, the MPC steered policy forcefully to avoid the most serious risk – the worst-case – by tightening our policy setting to return inflation to target. This meant risking a shallow recession in the short-term to avoid the risk of deeply entrenched inflation, and a much deeper recession in the long term. A monetary policy ‘mutiny’ needed to be headed off, with inflation expectations rising and price setting behaviour changing. I am pleased we are now in relatively calmer waters and the crew and passengers are believing again in low and stable inflation. Communicating in an uncertain environment Central bankers are given great responsibility, and to earn the trust to lead we need to display perspective, empathy and courage. We cannot rest on our legal remit alone or over-rely on the credibility earnt over recent decades of inflation targeting. When it comes to our decisions, we must communicate them clearly and be humble and transparent about the uncertainties we face. A key part of monetary policy communication is often published central projections that summarise and communicate changes in our views on the economic outlook from meeting to meeting. Because central projections offer a simple narrative they draw a lot of focus by financial audiences. On their own, however, a central projection can create an unhelpful sense of accuracy, which does a poor job of communicating uncertainty and contingency. As a navigator, imagine drawing a single line on your ocean map to chart your voyage, knowing only limited things about your location, the weather and currents ahead, and the performance of your boat. It is blindingly obvious that this line is very unlikely to be the eventual course followed for the rest of the journey. This chart is going to be updated on a frequent basis. Central banks have adopted quantitative tools to help provide a sense of the uncertainty around the central projection (e.g., alternative scenarios and fan charts) and discuss ‘what ifs’ in terms of outlining a reaction function to news. But there is no silver bullet to outline the real uncertainty faced. Scenarios support a rich discussion of key risks and their policy implications. However, the choice of which scenarios to publish is often interpreted as a policy signal, and it’s a signal that is challenging to fine-tune and balance. Likewise, the sheer width of most fan charts hammers home the idea of uncertainty, but they can provide their own spurious sense of precision. And once you’ve seen one, you’ve seen them all. Qualitative discussion – simply talking about uncertainty – is just as important. You can see the theme through my talk – central bankers must be trusted leaders. Both navigators and leaders need to tell a story that people can understand. They need to show perspective – we are not losing sight of our goal. They need to show empathy – seeing things through the eyes of many and speaking in plain language. And leaders need to display courage – central bankers need to make the necessary calls even in times of radical uncertainty and discomfort. This storytelling is an important feature of the MPC’s Record of Meeting which provides the public with a window into the MPC’s discussions. All navigators talk to their crew and passengers on a regular basis, updating their position, their outlook, and their next preferred sailing course. I will note, however, that few people appear to read our official documents (our Monetary Policy Statements including our Record of Meeting) first hand. And I am surprised how few economic experts refer to or query the Record of Meeting. This is not a criticism of the public or economic commentators, it is a continual communications challenge for us as a central bank. We need many ways to reach multiple audiences on a continuous basis. Otherwise, our story is retold in sound bites and through others’ filters. The best way of communicating policy will no doubt depend on the circumstances. For example, at the time of our May 2020 Monetary Policy Statement, uncertainty was so extreme that we switched to publishing three scenarios instead of a central projection (figure 5). It was a year before we used the term ‘projection’ again. Figure 5: Scenarios for New Zealand GDP from the May 2020 Monetary Policy Statement (2019Q4 = 100) Source: Stats NZ, RBNZ estimates. We deliberately told our citizens that we were experiencing an unprecedented storm, and we would be sitting it out in high water, far from the reef, but remaining focused on the destination. In this regard, uncertainty shouldn’t be equated with helplessness. We are guided by robust frameworks, and we can adapt course as new information comes to light. It is also an iterative process. You often see this in central bank communications phrases like ‘meeting by meeting’ or ‘data dependent’. 9 Signalling our ‘reaction functions’ can also help interest rates and exchange rates to adjust appropriately as the facts change. It is somewhat pleasing that for the most part our interest rate decisions come as little surprise to financial market observers during calm periods – with surprise moves in the policy rate appearing mostly during storms (figure 6).10 Figure 6: Estimated policy surprises for Official Cash Rate decisions Source: RBNZ estimates. Note: Chart is based on Grant and Poskitt (2024). For the purposes of this chart, a material surprise is one that exceeds ±5 basis points. The surprise measure is based on Overnight Index Swap pricing. The indicated GFC period covers two technical recessions in New Zealand and the period in between. The indicated COVID-19 period reflects the duration of significant COVID-19-related public health restrictions in New Zealand. Price-setting in a changing economic environment ”He ao! He ao! He ao tea roa!”: A cloud! A cloud! A long white cloud! By some accounts this is what Kuramārōtini, Kupe’s wife, announced upon spotting a large cloud. They both knew that the cloud meant land. In fact, Aotearoa – the Māori language name for New Zealand – is usually translated as the “land of the long white cloud”. Our ‘monetary policy island’ is again in sight. In New Zealand, Aotearoa, consumer price inflation is now at 2.2 percent, within our 1–3 percent target range (figure 7). That’s something to celebrate. But I say in sight. We have been able to ease monetary policy, but it’s still at a level we think is contractionary. It’s still working to lean against the last of the inflationary pressures that have lingered on from the recent burst in inflation. ____________ 9 Stronger policy signals – such as forward guidance – have a place, but they should be used with caution. Our recent Review and Assessment of the Formulation and Implementation of Monetary Policy recommended that the Reserve Bank should be cautious in providing forward guidance in uncertain times. 10 See Grant and Poskitt (2024). Figure 7: Headline and core measures of annual inflation Source: Stats NZ, RBNZ. Note: The dashed lines represent the MPC’s 1 to 3 percent target range for inflation over the medium term. The shaded area shows the range of core inflation measures. The core inflation measures include the sectoral factor model, factor model, trimmed mean (30%), weighted median, and CPI excluding food and energy. A key question now for policymakers globally is how long it will take for these lingering inflationary pressures to dissipate. The sooner this happens, the sooner we will be able to truly claim to have put the inflationary pressure of the COVID-19 period behind us. The answer to this question depends heavily on how firms make their price-setting decisions, and how persistent that process is. Firms tend to set their prices based on a broad range of price signals in the domestic and global economy – the prices of competing and complementary products, wage rates and the broader costs of labour and capital, transport, exchange rates and so on. Because these prices and costs all move with general inflation, firms’ pricing decisions will reflect recent actual and expected inflation. The same goes for wages. These interdependent price changes can see actual inflation persist even if demand and supply in an economy are broadly balanced. We see this in New Zealand in persistence in domestic and services inflation, despite significant spare capacity now emerging in the economy. This isn’t surprising given the recency of high inflation. Has price-setting behaviour changed? We are alert to changes in price setting processes. In New Zealand, firms’ inflation expectations have returned towards our 2 percent target midpoint, after having risen materially (figure 8). Household inflation expectations have also declined. This is encouraging. However, surveyed inflation expectations alone don’t explain the persistence in inflation we’ve observed over the past year. Figure 8: Inflation expectations Source: RBNZ Survey of Expectations (Business). Note: The shaded area represents the MPC’s 1 to 3 percent target range for annual CPI inflation over the medium term. We’ve found that accounting for observed inflation in our models helps us to better explain inflation. This is likely to reflect – among other things – that following a period of high (or low) inflation, some prices may need to adjust by more (or less) to restore relative prices to equilibrium. Contracts and government policies that index charges to inflation also contribute to this persistence. Reflecting this, we often model this part of the price-setting process using a moving average of past inflation, with more weight on the recent past than on the distant past. Our approach implied that the recent bout of high inflation would be embedded in firms’ price-setting decisions for years to come. But is this a good assumption in all conditions? At the time of our recent August Monetary Policy Statement, we altered our price-setting assumptions so that they adapt more quickly to a low inflation environment. This is a judgement that we have had to make with perspective, empathy and courage. The outcome was material to our policy decision in August, giving us more confidence to reduce our policy interest rate. Other changes in pricing behaviour are equally challenging to model. For example, it’s possible that firms’ price-setting behaviour has been ‘scarred’ by the recent period of high inflation. But it could also normalise more quickly. There is evidence to suggest that people (businesses and households) pay more attention to the state of the economy when inflation is high and volatile. By contrast, when inflation is low and stable, people have less to gain from understanding the nuances of the inflation outlook as they often have better things to do. This is coined ‘rational inattention’.11 Firms also adjust prices more frequently when inflation is high as it becomes more costly not to keep up.12 Alan Blinder famously remarked that price stability is when “ordinary people in their ordinary course of business are not thinking and worrying about inflation”.13 ____________ 11 We observe ‘rational inattention’ in survey data of New Zealand households (Bayarmagnai, 2023). 12 This dynamic is influenced by rigidities arising from menu costs and strategic complementarities in firms’ pricing decisions. 13 Blinder (1995). These dynamics give us reason to assume that price-setting behaviour may normalise quickly as we return to a low inflation environment. Rationally, attention will go elsewhere. Implications for the MPC’s monetary policy strategy In New Zealand, uncertainties about firms’ price-setting behaviour and the persistence of inflation continue to influence the MPC’s thinking. However, these uncertainties are now set against a lower central outlook for inflation. Inflation has declined back to within our target band, as have inflation expectations. We are in a situation where we can credibly provide the perspective of an economy returning to low and stable inflation, interest rates becoming less restrictive, and economic activity being revitalised. But that is just the most recent navigational plot on the ocean chart. References Alanya-Beltran, W., Brennan, M., & Jacob, P. (2024). The resurgence of the New Zealand Phillips curve. Reserve Bank of New Zealand Analytical Note, AN2024-02, ISSN 2230-5505. Ball, C. (2024). Assessing and communicating labour market indicators of inflationary pressure. Reserve Bank of New Zealand Analytical Note, AN2024-01, ISSN 2230-5505. Ball, C., Richardson, A., & van Florenstein Mulder, T. (2020). Using job transitions data as a labour market indicator. Reserve Bank of New Zealand Analytical Note, AN2020-02, ISSN 2230-5505. Bayarmagnai, G. (2022). Rational inattention to inflation among New Zealand households, Reserve Bank of New Zealand Analytical Note, AN2024-04, ISSN 2230-5505. Blinder, A. S. (1995). The Strategy of Monetary Policy. Remarks before The Minnesota Meeting, Minneapolis, Minnesota. Bohm, T., & Sing, M. (2022). Evaluating the Reserve Bank’s forecasting performance. Reserve Bank of New Zealand Bulletin, Vol. 85, No. 4, ISSN 1177-8644. Brainard, W. C. (1967). Uncertainty and the Effectiveness of Policy. The American Economic Review, 57(2), 411-425. Castaing, A., Chadwick, M., Galimberti, J. K., Sing, M., & Truong, E. (2024). Estimates of New Zealand's nominal neutral interest rate. Reserve Bank of New Zealand Bulletin, Vol. 87, No. 4, ISSN 1177-8644. Chadwick, M., & Smith, T. (2023). Great Expectations: Performance of survey inflation expectations at improving model-based inflation forecasts. Reserve Bank of New Zealand Analytical Note, AN2023-2, ISSN 2230-5505. Crowe, A. (2018). Pathway of the Birds: The Voyaging Achievements of Māori and Their Polynesian Ancestors. University of Hawai’i Press. Fitchett, H., & Robinson, F. (2021). Down to business: Which QSBO measures are the best at forecasting?. Reserve Bank of New Zealand Analytical Note, AN2021-01, ISSN 2230-5505. Grant, R., & Poskitt, P. (2024). Financial market reaction to monetary policy surprises, Reserve Bank of New Zealand Analytical Note, AN2024-08, ISSN 2230-5505. Hansen, L., & Sargent, T. (2008). Robustness. Princeton University Press. Jacob, P., & Robinson, F. (2019). Suite as! Augmenting the Reserve Bank’s output gap indicator suite. Reserve Bank of New Zealand Analytical Note, AN2019-08, ISSN 2230-5505. Karagedikli, Ö., & Özbilgin, M. (2019). Mixed in New Zealand: Nowcasting labour markets with MIDAS. Reserve Bank of New Zealand Analytical Note, AN2019-04, ISSN 2230-5505. Richardson, A., van Florenstein Mulder, T., & Vehbi, T. (2019). Nowcasting GDP using machine learning algorithms: A real-time assessment. Reserve Bank of New Zealand Discussion Paper, DP2019-03, ISSN 1177-7567.
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Speech by Mr Amando M Tetangco, Deputy Governor of the Central Bank of the Philippines, at the 2004 Convention of the Professional Risk Managers¿ International Association Philippine Chapter, at the Asian Institute of Management, Manila, 13 September 2004.
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Amando M Tetangco: The importance of risk profession and sound risk management practices Speech by Mr Amando M Tetangco, Deputy Governor of the Central Bank of the Philippines, at the 2004 Convention of the Professional Risk Managers’ International Association Philippine Chapter, at the Asian Institute of Management, Manila, 13 September 2004. * * * Ladies and Gentlemen, I am pleased to speak today at this important event - the 2004 Philippine Risk Convention. I wish to congratulate AIM-JBF (Asian Institute of Management-Jose B. Fernandez) Center for Banking and Finance and the Professional Risk Managers’ International Association for organizing and sponsoring this gathering; the number of participants speaks well of the great interest in risk management and the risk profession. My topic is the importance of the risk profession and sound risk management practices in the Philippines. The risk profession is an area that has become a growth industry; and it is the one that is particularly relevant to banks given their fiduciary functions, the complexity of risks inherent in their working environment, and the stability and efficiency of the payments and settlement system which greatly rest on them. Allow me to tackle this presentation from the perspective of the BSP, both as a regulator of the Philippine financial institutions and an institution which in itself is an end-user and a staunch promoter of risk management. The BSP performs a dual role. First, as the county’s monetary authority, the BSP sees to it that the monetary policy is supportive of its mandate of maintaining price stability conducive to balanced and sustainable economic growth. Second, as the regulator of financial institutions, the BSP seeks to promote the soundness of the financial system, which in turn, would support overall macroeconomic stability and growth. I would first focus on the current and future thrusts of the BSP in line with the second role as they relate to risk management and then proceed to the importance of risk management, risk profession and risk management practices. The need to change regulatory approach A crucial moment in the development of risk management occurred in February 1995 when it was announced that the Barings PLC, the oldest bank in England had lost over GBP600 million and was insolvent as a result of the derivative trading activities of a single trader in Singapore. At the time of its collapse, Barings was known to be very conservative, well capitalized and historically profitable. The Barings case brought to light that the real issue was not derivatives per se, but the quality of management and control required in modern financial environment. The collapse called into question the strength of existing internal controls in the investment industry and the aptness and adequacy of external monitoring done by the exchanges and regulators. The event demonstrated very clearly that their existing regulatory frameworks were no longer appropriate for the continuously changing and complex market environment. This led to a critical reassessment of the regulatory approach and brought changes in the banking supervision approaches by the Bank of England and other regulators around the world. Financial regulatory initiatives in Philippines on internal risk management The BSP, for its part, in its role as bank supervisor has taken a number of initiatives to improve internal risk management among banks by adopting the Basel framework. In March 2001, the BSP adopted the original Basel I through Circular No. 280. This Circular provided the guidelines for the computation of risk-based capital for credit risk. This was further enhanced by the issuance of Circular No. 360 in December 2002 incorporating market risk into the risk-based capital framework. We also issued Circular No. 400 in September 2003, extending the risk-based capital adequacy requirement to Quasi-Banks. The BSP’s focus on supervision is ultimately intended to give banks greater flexibility to respond to challenges and changing opportunities under a more deregulated and globalized environment and amidst rapid technological advances. Traditional bank supervision tended to instruct banks to avoid risks that seem too high. The new approach to supervision favors assessment of the quality of risk management practices, and generally allows banks to take risks so long as they demonstrate the ability to assess, measure and manage them. We believe that a good first step to good risk management is good corporate governance. We have thus issued a number of guidelines instituting good corporate governance. These include laying down the guidelines to govern the responsibilities and duties of the board of directors (Circular No. 130, June 1997); requiring banks to develop and implement a compliance system and appoint/designate a compliance officer to oversee implementation (Circular No. 145, October 1997); implementing the fit and proper standards for directors and officers of banks and non-banks including the requirement for a mandatory orientation program on corporate governance (Circular No. 296, September 2001). This year, the BSP issued anew a number of guidelines that aimed to further enhance the risk management practices in banks. In January, the BSP issued the guidelines for managing large exposures and credit risk concentrations of banks (Circular No. 414). Also in the same month, the BSP issued the guidelines for the capital treatment of banks’ investment in credit-linked notes (CLNs) and similar credit derivative products (Circular No. 417). In April 2004, the BSP issued guidelines for the treatment of compliance risk and to further strengthen banks’ compliance function (Circular No. 429). And more recently, in June 2004, the BSP issued the guidelines for the development and implementation of banks’ internal risk rating systems(Circular No. 439). Journey to Basel II The simplified approach of Basel I has been successful in boosting capital levels in the global banking system from what were considered uncomfortably low levels throughout the late 1970s and early 1980s. Its major shortcoming, however, is that the “risk weights” poorly represent the likelihood of sustaining losses and such lack of risk sensitivity can lead to misallocation of scarce financial resources and hamper long-term economic growth. The New Capital Accord otherwise known as Basel II, formally unveiled last June 26, is seen to make capital requirements to be more risk sensitive than Basel I. It allows greater reliance on the banks’ internal systems for setting the capital requirements. More importantly, it provides incentives for banks to continuously improve their risk management practices. However, Basel II poses challenges to Philippine Banks and the BSP. Banks will have to develop a more disciplined, rigorous, and auditable approach to risk assessment. This challenge has many dimensions and technology will only address some of them. For the BSP, our challenge is to build up technical knowledge and supervisory resources to validate bank’s risk management systems. We will also need to examine our existing charter to see to it that we have the necessary powers to implement Basel II, particularly Pillar 2. The risk management standards and practices embodied in Basel II are real and are drawn from the best practices of large internationally active banks. It reflects the many insights gathered through practical experience, including both successes and failures in risk management. It contains many useful lessons and can serve as a good roadmap on how to improve internal risk management. However, we acknowledge that not all aspects of Basel II will be of use to every bank. For example, some of the quantification tools used in large complex institutions may not be necessary for the smaller and less sophisticated institutions. And some risks inherent in the activities of banks which are internationally active may be remote to those which are merely active domestically. This is the reason for modifying the Philippine framework by taking into account, the local banks’ state of readiness, local conditions and practices consistent with the nature, complexity and materiality of the local institution’s activities. This is also the reason for providing a breathing space for thrift and rural banks in implementing Basel II. The BSP has lined up certain projects which involve the study of the applicability of certain Basel II requirements to local conditions. These projects are expected to culminate in a set of comprehensive guidelines for banks which we plan to release not later than end-2006, for implementation in 2007. As you may be aware, Pillar 1 of Basel II proposes standard and advance approaches to credit and operational risks. Universal/commercial banks are expected to implement the standardized approaches to Basel II by 2007. However, implementation of the more advanced approaches is not expected to occur until perhaps 2010 to allow banks time to build-up reliable historical database to estimate default probabilities and other variables as important inputs to the advanced models. Foreign banks whose head offices are using the advanced approaches, will be allowed to use them provided that they can show that their models are suited to domestic conditions. With regard to Pillar 2, we will continue to push banks to improve their risk management practices and risk assessment capabilities and corporate governance. With respect to Pillar 3, the appropriate disclosure requirements under Basel 2 are targeted by 2007. BSP’s view of the importance of risk management and sound risk management practices On the topic of the importance of the risk profession and risk management practices in the Philippines, I believe this could be best approached by presenting our views on the significance of risk management and our expectations from risk managers. • Risk management is more than a regulatory reporting and compliance exercise; it is a necessary risk-reducing tool to promote long-term profitability and stability of the firm and enhance the competitive advantage of firms. We encourage banks to have the flexibility to use their internalmodels not merely for computing the level of capital needed to absorb possible losses inherent in their activities, but to encourage them to make rational decisions on the basis of risk and return considerations. Good internal models provide timely information on how much risk the bank is taking in order to achieve specific business objectives. Internal models must also allow banks to compare and select, on a timely basis, from among the alternative business opportunities or strategies not solely from the profit angle but also from a risk standpoint. The Philippine adoption of Basel II will certainly obligate banks to cover more types of risks and on the basis of our calculations, the banks’ capital requirements will surely increase with said adoption. However, if a bank has right risk management systems that can effectively capture the risk exposures, there is an opportunity for them to lower their capital charges. As financial markets progress towards the market transparency mechanism that is promoted under Pillar 3, risk management will be seen as a potential differentiator and a source of competitive advantage. Ultimately, it will reward banks that manage their risks effectively, and penalize those that do not. Good risk management practice is thus even more essential for banks to maintain competitiveness over the long run. • Corporate governance is not a mere risk compliance measure; It is vital to the institution’s health. As far as the banking industry is concerned, corporate governance relates to the manner in which businesses and affairs of the individual banks are directed and managed by the board of directors and senior management. It provides the structure though which the objectives of the institutions are set, the strategy of attaining those objectives is determined and the performance of the institution is monitored. Corporate governance is essential to the institution’s health. It seeks to meet legal requirements and uphold fiduciary responsibilities to investors, creditors and depositors. It attracts and retains good senior management, officers and employees. It also makes the organization attractive to investors, clients and business partners. Equally important, corporate governance reduces exposure to reputational risks or the potential that a negative publicity regarding an institution’s business practices will cause a decline in the customer base or lead to costly litigation. • Risk management matters are necessary parts and parcel of sound strategic planning. The need to include risk management in strategic planning cannot be overemphasized as we have seen a number of banks getting into trouble where the root cause can be traced to inconsistencies between the bank’s strategic goals and risk management objectives or simply the lack of risk management objectives. Sound strategic planning should involve not only setting targets such as revenue, assets under management, and the number of new accounts, but also include the establishment of control and risk management systems. Specifically strategic planning should lead to an objective assessment of the institution’s risk profile and highlight areas of strengths and weaknesses. It should help the firm determine the risks it wants exposure to, the risk it cannot avoid, risks that the firm is not prepared to face and the risks it can reduce. Strategic planning should involve the use of internal risk assessment as such could uncover natural hedges, or countercyclicalities, that exist across different businesses of a firm. Such knowledge helps the firm focus on its net exposures and more effectively allocate resources. Risk assessment often results in a better understanding of the internal and external environment, which can be a source of competitive advantage by the uncovering of business opportunities or the early assessment of threats which in turn allow the firm to have competitive lead over less informed competitors. • Stress testing enhances management of risks. Many of us here today may wish that we have the ability to predict with certainty when the next crisis will strike. Regrettably there appears to be no existing technology that would allow us to predict it with accuracy. However, we can prepare for it well in advance it if we know how it would impact on us, if and when it comes, and plan in advance the right level of resources to withstand it. We can do this if we have the capability to perform on a regular basis, the suitable stress testing and scenario analyses. • A proactive risk culture must exist in an institution to ensure effective risk management A proactive risk culture means there is awareness of risk within an institution which permeates the actions and words of all the members of the firm. This can be done through regular risk awareness activities, education, open communication lines among units/groups concerned, and continuous interaction with senior management. When considering the importance of risk culture, it may be asked why some firms fared better than others at risk management. Nick Leeson’s actions at Barings would have been less likely if a meaningful “risk culture” had been in place which institutionalized management oversight, upheld segregation of duties, and permitted closer monitoring of the trading in books that appeared to be profitable. Risk culture is important today because the complexity of modern financial instruments makes it possible for even a single, unsupervised trader to gamble and lose, the entire capital of a firm. A good example of recent failure of risk culture is that of the National Australia Bank. In January of 2004, the National Australia Bank(NAB), Australia’s largest bank and second biggest company was reported to have lost $360 million in foreign currency trading. A report released by the Australian Prudential Regulation Authority attributes the losses to the four currency options traders who, possessed of an abundance of self confidence, positioned the NAB’s foreign currency options portfolio in the expectation that the fall in the US dollar that occurred mid last year would reverse and that volatility would eventually stabilize. Rather than closing their positions as the market moved against them, the traders chose to conceal their true positions - allowing those positions to deteriorate unchecked over a period of three months before they were finally discovered. The traders were able to paint a rosy picture of P&L and masked losses by amending trades and using fictitious trades. By the time they were discovered, the positions held were totally out of control. The report highlighted that the risk control failures have more to do with poor implementation than poor design. On paper, NAB’s existing control framework should have been able to identify and contain risk positions of the traders. There are many layers to NAB’s internal control framework, the risk management group and the board included, but they failed at every level to detect and shut-down the irregular currency options trading activity. The NAB’s internal governance model, which should have enabled timely identification and effective and quick escalation of serious risk issues on the currency options desk, simply did not function. Had the risk control framework been implemented effectively, the losses would certainly have been substantially less, or quite possibly, averted altogether. Expectations from risk managers • Risk management team requires diverse set of skills and knowledge. The many complex risks across an organization are too varied for any one discipline to claim mastery over. As the role of risk management is complex and comprehensive, the ideal risk management team must be made up of multiple individuals, with different sets of skills and knowledge to effectively address the risks confronting the institution. Integrating staff from such areas as trading, research or financial control and legal, can enhance the group’s understanding of the business implications of risks, and its ability to interact with other areas that either feed the risk analysis process or are affected by its results. • Risk management team must be independent of business units but needs to interact and communicate with other parts of the firm. Risk management needs to be performed as an independent function, sponsored and supported by senior management. The group in particular needs to be separate from the business units such as front office, otherwise there would be conflicts of interest and firm’s risk would not be independently measured. However, this independence is a delicate balancing act because the risk management group needs to communicate with the business and operations groups to have a clear understanding of their views on the markets, products, positions, strategies and operational procedures before it can accurately assess risks. In addition to business units, the risk management group would also have to interact with other internal and external entities, typically, the senior management, financial control, operations, legal/compliance units, regulators, auditors, rating agencies, investors and clients. To illustrate some of these interactions, risk management and financial control (accounting) must have a close relationship since performance evaluation is no longer confined to simply reporting returns and total profit figures, but has increasingly incorporated the measure of risks taken. And since financial control maintains the books and records with respect to P&L while the risk control group has responsibility for risk data, the two departments must invariably work together. Further, public and supervisory reports used to require disclosure on the traditional financial accounting information only; however under Pillar 3, banks may be required to make public certain material risks information such as tier capital. In order to ensure consistency in providing regulatory and public reports, the financial control and risk group must necessarily share the same database. External auditors in other countries now frequently include an assessment of risk management in the annual audit, in part because of the trend to include risk management information in the annual report and to comply with the regulatory approach of ensuring the soundness of the financial institution. With the adoption of the Basel II Framework, we expect this trend to grow globally, including in the Philippines. The risk management group must hence work closely with the auditors to demonstrate clearly the measurement methodology used, as well as the completeness of the supporting procedures. • Risk managers must look beyond organization’s boundaries. The corporate demises of Enron and WorldCom have shown the need to achieve the organization’s vision, mission and objectives under any stress or extreme events. The proactive risk manager must therefore look beyond the organization’s boundaries and assess the impact of its action on the wider environment where the firm operates, including those of its stakeholders, i.e., customers, employees, retirees, suppliers, communities, borrowers, creditors and regulators. Speaking of regulators, internationally active banks need to take into account regulations in the various jurisdictions in which they operate, and the fact that regulatory standards may shift over time. • Risk managers must be effective communicators and leaders in the organization. The risk manager must be well versed in the risk management process and be able to effectively communicate and lead the processes within the organization to mitigate exposure to business risks. In support of this he must have a good understanding of the environment and community served by the organization, the operations of different units and relationship between different levels of the organization. • Risk managers must address corporate governance issues and contribute to improved corporate governance. The increased anxiety among shareholders due to the celebrated cases of accounting scandals and corporate bankruptcies have highlighted the need for good corporate governance. Corporate governance has become an issue for a growing number of risk managers who are now given an active role in managing corporate governance standards. Risk managers are therefore expected to address corporate governance issues and contribute to improved corporate governance to prevent losses and enhance long-term sustainability of the organization. • Risk profession must embrace good business ethics. Allow me to tackle this subject by way of Enron’s experience with risk management. Enron maintained a risk management function with capable employees. Lines of reporting were reasonably independent in theory, but less so in practice. The group’s mark-to-market valuations were subject to adjustment by management and in this context, the mark-to-market accounting became a mark-to-model accounting. The traders who were performing the trades, too, had considerable influence on how the deals were marked-to-model. With their bonuses depending upon the profitability of the deals, there was an unaddressed conflict of interest. Trading businesses were generating considerable profits, but much of these were dubious mark-to-model profits. Enron maintained a fluid workforce. Employees were constantly on the lookout for their internal transfer. Those who rotated through risk management were no different. A trader or structurer whose deal a manager scrutinized one day might be in a position to offer that risk manager a new position the next. Astute risk managers were careful not to burn bridges. Risk managers knew that they would suffer if they blocked deals or did not support the favorable management-approved mark-to-model valuations. Even worse, risk managers were subject to Enron’ “rank and yank” system of performance review. Under that system, anyone could contribute feedback on anyone, and the consequences of a bad review were high. Risk managers who blocked deals could expect to suffer in “rank and yank”. Risk management, thus, became little more than a rubber stamp and a stepping stone for employees moving around the company. The Enron’s case clearly describes the importance of ethics in risk management profession and the consequences of the lack of it. A code of ethics which sets forth a discipline of moral duty and conduct in support of the demanding standards of risk management profession must necessarily be in place. At the minimum, the code of ethics should cover the standards for integrity and dignity, trust, confidentiality, competence and professional practice. Conclusion To conclude, in the longer term, the power of computers to create and analyze huge databases will change the very nature of risk management. Real time, on-line risk analysis and reporting, scenario analysis and stress testing will become more and more standard tools for day- to- day operations. But more important than these sophisticated systems is the development andadherence of institutions to good corporate governance ? one that permeates a proactive risk culture. We believe that this is the first step to good risk management which an institution can implement even in the absence of sophisticated systems. If one has a good risk management process that it follows strictly, then the institution has a better chance of preventing the occurrence of losses even during extreme events. The requirements of Basel II are amazing even for the sophisticated risk professional. Not only does he need new set of improved risk techniques and technology, he also needs to unlearn old traditional techniques that have now became obsolete or unreliable. He needs to be constantly aware of new market developments, good or bad, and learn from the experiences and mistakes of others. Not only that, the Basel world would require vast amount of data inputs, analysis and reporting that would place pressure on the risk professional to do a better job. Our views on risk management and our high expectations from risk practitioners as presented, point to the varied and difficult roles that the risk professional must play. It is incumbent upon him to be prepared for them and accept the challenge. The lessons learned from the financial disasters, some them I mentioned here, and the challenging tasks on the road to Basel II, the need to integrate risk management in strategic planning to maintain competitive advantage and ensure company long-term survival, - all these highlight the growing importance and broadening application of risk management and consequent increased challenges for risk management practitioners. In playing these increasingly challenging roles, risk practitioners, in whatever capacity he/she is in ? as an in-house risk manager or risk specialist or an external risk management adviser-- may be faced with key issues as lack of independence, lack of competence in specific areas, unclear scope of responsibility, unclear legal or contractual liability, conflict of interest, inconsistency of treatment and approaches, inadequate or inappropriate risk management tools and processes, and uncertainty of the results of advise or recommendation. Therefore, in order to face these issues squarely, it would be ideal to have a professional approach to risk management by instituting a system of guidance as to the appropriate and standard behavior, work practices and ethics to observe in the provision of risk management services, and a framework or benchmark for a professional risk management service. It is also important to have a system of qualification, training and education as well as a forum to share experiences and ideas to improve competency among risks management practitioners. These are our views on the importance of risk profession and sound risk practices employed in the Philippines. May I clarify, nonetheless that most suggestions here also apply to non-bank entities. Let me re-emphasize that risk management is not merely for compliance, but is a vital aspect of protecting and enhancing an institution’s corporate image, gaining competitive advantage and ensuring its longterm viability. Thank you.
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Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Bank Marketing Association of the Philippines¿ (BMAP) 30th anniversary of upgrading bank-marketing practice, Makati City, 26 August 2004.
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Rafael Buenaventura: Raising the bar on consumer banking service Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Bank Marketing Association of the Philippines’ (BMAP) 30th anniversary of upgrading bank-marketing practice, Makati City, 26 August 2004. * * * Introduction Distinguished officers and members of the Bank Marketing Association of the Philippines (BMAP), follow bankers, ladies and gentlemen: good evening. I am deeply honored to take part in this celebration, marking BMAP’s 30th year of upgrading bankmarketing practice in the country. This year’s theme of “Customer service in the marketing mix of financial products” rightly emphasizes the importance of banks’ clients in influencing an institution’s success. Consumer banking Over the last couple of years, the Philippine banking system has experienced strong growth in consumer banking services. Credit card receivables for example, grew by an average 25.2 percent annually from 2000 to 2003. This has allowed more ordinary people without access to credit to now have access and on clean basis. However, this growth has also come with a price in the form of increased volume of bad accounts. Many of the problems were traceable to the fact that some new cardholders did not really understand the obligations and responsibilities that came with them. As a result, past due credit card accounts rose an average 40.4 percent, a pace much faster than the new ones granted. The number of credit card-related complaints also rose dramatically. It is in this regard that we should work hand in hand in channeling more efforts towards customer education and protection. For its part, the Bangko Sentral ng Pilipinas (BSP) issued various regulations geared towards protecting both the industry and the public. For instance, in 2002 we issued Circular No. 349 which significantly tightened rules on credit card and other lending operations by requiring banks and their subsidiary credit card companies to ascertain that cardholders are capable of fulfilling their commitments and by setting credit limits based on their net take home pay. Moreover, the BSP took a more proactive stand by creating the Consumer Education Committee in January of this year to help improve basic financial literacy. I commend BMAP together with the Credit Card Association of the Philippines (CCAP), the Bankers Association of the Philippines (BAP), the Chamber of Thrift Banks (CTB) and the Rural Bankers Association of the Philippines (RBAP) for taking a similar stand and creating a multi-sectoral team for the conceptualization of a service code for consumer banking in the Philippines. Service code for consumer banking The service code that is expected to be out in the next quarter of this year is a voluntary code that sets minimum service standards to be observed by banks in the conduct of consumer banking services. It is aimed at strengthening relationships between banks and its clients, and promoting transparency for clients to have better understanding of what to expect from banking products and services. Conclusion In closing, I strongly encourage everybody to support our initiatives to improve consumer banking in the Philippines. Subscribing to the code will be advantageous to both you and your clients, and to the banking system as a whole. At the end of the day, our banking industry, like any business, stands or falls on the goodwill of our customers. Again, congratulations and a pleasant evening to all!
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Keynote address by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the 2nd International Forum on Microfinance, INAFI-Philippines, Quezon City, 25 August 2004.
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Rafael Buenaventura: Central Bank of the Philippines’ commitment to microfinance Keynote address by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the 2nd International Forum on Microfinance, INAFI-Philippines, Quezon City, 25 August 2004. * * * It is my pleasure to be invited to deliver this keynote speech in this 2nd International Forum on Microfinance sponsored by INAFI Philippines. I welcome this opportunity to share with you the progress that we have achieved thus far in promoting microfinance in the banking sector. In year 2000, the BSP took up the challenge of promoting the development of sustainable microfinance. Since then we have focused on creating an enabling regulatory policy, supporting training and capacity building, drumming up support from potential practitioners, and strengthening working ties with other institutions for a broader microfinance network. Through these various initiatives, the banking sector has been able to directly contribute to the growth of sustainable and viable microfinance institutions. In our own little way, we have been able to make a positive transformational impact in the fight against poverty. Translated into numbers, the banking system has so far provided a total of P2.9 billion microfinance loans to 485,136 micro-borrowers as of end-May 2004. All in all, we have 2 microfinance-oriented thrift banks, 4 microfinance-oriented rural banks and 115 rural and cooperative rural banks with some level of microfinance operations that finance the credit requirements of the entrepreneurial poor (e-poor). We anticipate further expansion in microfinance activities in the banking sector judging by the applications for microfinance-oriented banks that are currently in the pipeline, and by the number of banks that have expressed their intention to set up branches for their microfinance operations. Even as we strongly encourage the establishment of more microfinance-oriented banks, our focus is not merely confined to statistics. We also aim to provide the appropriate policy and regulatory environment for continued viability and sustainability of microfinance institutions. Without sound financial and credit policies, microfinance can never be an effective intervention for poverty alleviation. With this goal in mind, we are building up on our current initiatives to mainstream microfinance within the BSP and the banking community. BSP microfinance agenda Creating an enabling policy and regulatory environment High on the list of BSP’s agenda on microfinance is the continuous review of existing policies and regulatory guidelines to make them even more attuned to the growing needs of the microfinance sector. We believe that with a well-defined vision and strategy for microfinance, we can easily identify and fully address the capacity development needs of microfinance players. Initially, we have defined our policy agenda which is to encourage the establishment of new microfinance-oriented thrift and rural banks and the setting up of microfinance operations in existing banks. Through this approach, the banking system can more effectively reach a larger number of e-poor. This would complement other microfinance delivery channels like credit cooperatives and NGOs that have their own strengths and weaknesses. Three important provisions in the General Banking Law (GBL) of 2000 formally authorized the BSP to fully support microfinance. In carrying out this mandate, we have drawn up a set of banking regulations that take into consideration the peculiarities of microfinance lending: cash flow-based, typically unsecured and short-term, high frequency collections, and often featuring group guarantee and other non-traditional forms of security. Specifically, the BSP has issued the following circulars: • Circular 272 (January 2001) implements the provisions of Sections 40, 43 and 44 of the GBL and sets out the regulatory guidelines for engaging in microfinance. • Circular 273 prescribes additional requirements for licensing of microfinance-oriented banks. This was issued primarily to encourage banks to adhere to best practices and high performance standards. Another requirement is for the organizers to have a good track record in microfinancing. As a minimum operational requirement, banks should have a loan tracking system in place that can adequately monitor and manage a microfinance portfolio. The same circular also provided for the partial lifting of the moratorium on the opening of new thrift and rural banks and branches to allow the entry of microfinance-oriented banks. • Circular 282 (April 2001) specifies the guidelines governing the rediscounting facility for microfinance loans of rural and cooperative banks. • Circular 324, issued in 2002, expanded the coverage of the rediscounting facility to include thrift banks. In relation to this, we have provided rediscounting for 26,966 micro-borrowers amounting to P219.5 million, as of end-July 2004. We have issued several other regulations to provide further incentive to banks to engage in microfinance in a sustainable and prudent manner. These are: • Circular 340, circular 365, and Circular 369 which further liberalized the rules and regulations for the establishment of bank branches provided these are microfinance-oriented. • Circular 409 prescribes guidelines for the measurement of portfolio-at-risk and the respective provisioning requirements to ensure sound and prudential microfinance operations of banks. To complement these regulatory initiatives, we are also strengthening our ability to supervise the activity of microfinance-oriented banks. We are currently finalizing revisions to the BSP manual of examination to incorporate microfinance operations. We have started to train a core group of bank examiners knowledgeable in microfinance operations. We are also intensifying our efforts, in partnership with the national credit council, to set up a credible and comprehensive credit information bureau. We have just completed the first phase of the project which we highly think will greatly benefit microfinance practitioners, in terms of promoting stronger credit discipline and reducing the risk of credit pollution. Enhancing training and capacity building Another priority area in the BSP microfinance agenda is our continuing training and capacity building program for bank examiners, officers and employees, as well as the microfinance practitioners, in the banking sector. This is being implemented through a series of trainings, workshops and study tours. For the benefit of the banking sector, the BSP has begun incorporating microfinance into the basic rural and thrift banking courses .So far, these courses have already been offered to 1,500 participants. In June 2004, we launched a series of seminars designed to educate banks on the importance of internal controls, performance standards and best practices for sound microfinance operations. To further augment our capacity to effectively supervise microfinance activities within the banking sector, we have created a top-level microfinance committee to oversee BSP’s microfinance initiatives. Likewise, we have set up a microfinance unit within the BSP to implement and coordinate all microfinance activities. We are among the first central banks in the Asia-Pacific region with a permanent office dedicated to microfinance. Encouraging promotion and advocacy Our ongoing initiative on microfinance is also focused on promotion and advocacy. In 2003, we launched a regional advocacy program where we conducted microfinance seminars in strategic regions in the country. To date, we have been successful in conducting information seminars for a total of 1,350 participants in 9 regions across the country. Our advocacy program is aimed at encouraging potential practitioners from the banking, cooperative and NGO sectors, as well as establishing links with corporations, foundations and international organizations that could lend support to existing microfinance institutions (MFIs) by way of technical assistance and other capacity development needs. All of these initiatives underscore BSP’s strong commitment to promote the development of microfinance. Concluding remarks Let me just point out that although the BSP’s mandate is to focus on the banking sector, our involvement in microfinance extends beyond the banking community. We are also interested in working with other microfinance practitioners and organizations, such as NGOs and credit cooperatives, so that together we can ensure the long-term viability and sustainability of microfinance. Possible areas for collaboration include the transformation of non-bank MFIs into banks, development of a uniform set of standards, and the promotion of best practices for sustainable operations within banks, NGOs and cooperatives. It is vital that we pool our resources if we are to achieve progress in this crusade against poverty. On that note, I would like to wish everyone a pleasant day and a meaningful discussion ahead. Thank you.
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Opening remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Inflation Report Press Briefing, Manila, 29 October 2004.
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Rafael Buenaventura: Brief overview of inflation in the Philippines Opening remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Inflation Report Press Briefing, Manila, 29 October 2004. * * * Good morning, everyone. Transparency is a hallmark of good monetary policy, and for this reason the BSP continually strives to bring across its policy message to the public and its reading of the outlook for inflation. This is the main reason why we publish a quarterly inflation report, and we would like to thank everyone here for joining us at this morning’s presentation. Conducting monetary policy in the present economic environment is a considerable challenge for the BSP. The continued rise in inflation during the last few months has led to public concern over its likely effects on both the public’s purchasing power and economic activity. In our previous public statements on monetary policy, we have been careful to emphasize that the inflation uptrend over the past year has been driven mainly by supply-side factors arising in large part from a series of shocks coming from the sharp increases in oil prices, food and other key non-food commodities particularly fuel and transport. This view has led to the BSP’s prevailing policy stance of accommodating the supply shocks which are one, transitory in nature and two, if addressed by monetary action, could have adverse impact on growth and in turn inflation itself. The inflation report we will be presenting today outlines the reasons why we have kept our policy interest rates unchanged so far despite perceptions of a need to tighten monetary policy. We believe that supply-side developments continue to play a dominant role in the inflation outlook, and we find as yet no preponderant evidence of demand-driven inflationary pressures or second-order inflationary effects from the ongoing supply shocks. The expected path of future inflation continues to be hump-shaped, as supply factors push headline inflation above the 4-5 percent target in 2004 and 2005 before quickly tapering off and reverting to the 4-5 percent range by 2006. We find no compelling reason, therefore, to modify the settings for monetary policy at this time. In closing, let me emphasize that the BSP remains strongly committed to good monetary policymaking. We try to ensure our accountability by formally submitting ourselves to public judgment on the basis of how we go about achieving our inflation targets. We also make sure that the stance of monetary policy is properly communicated to our constituency, the Filipino public, through such documents as the inflation report and regular press statements. We welcome your comments on the contents of the report and hope that you will continue to actively participate in the public dialogue on the monetary policy process. Thank you and good morning.
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Welcome remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Exporters¿ Forum, Manila, 25 October 2004.
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Rafael Buenaventura: Exports performance in the Philippines Welcome remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Exporters’ Forum, Manila, 25 October 2004. * * * Ladies and gentlemen, good morning: Once again, I welcome you to this gathering of exporters and policymakers, which we have been doing since 2002 to discuss issues and concerns of common interest. I am glad to see familiar faces around. I also extend a special welcome to the new attendees for finding the time to join us today. Let me also congratulate you for working hard to keep exports performance one of the few bright spots in our macroeconomy. I hope that we can go beyond the 13.7 percent growth we had in August for the rest of the year. I am sure that this is possible given that the outsourcing of manufacturing of electronics and motor vehicle parts from other regions continues to benefit the Asia Pacific Region, including the Philippines. Garments, which posted a double-digit growth in August, the first time since March of 2003, hopefully, will continue to pick up ahead of the holiday season. Meanwhile, the improving world price of agro-based products bodes well particularly for the coconut oil industry. These are signs of good times ahead. Overall, we expect a full year growth of 10 percent in 2004 and 2005. Mr. Guinigundo will discuss the details later and we will take this opportunity to validate with you our forecasts. Being with the industry, your expertise in reading where the market is leading to is a major input to our projections. While export growth for next year looks promising, we all believe that there is more to be done to catch up with our Asian neighbors who are making major inroads into the world market. We have been discussing the problems besetting the export sector - high power cost, poor infrastructure, security concerns, labor unrest - and I know the growing impatience in some of you on the seemingly slow progress in addressing them. However, you must also recognize that the government has been doing its best given its limited resources. This is the reason why we invited officials from other departments - Department of Energy, Department of Labor, Department of Finance, Department of Trade and Industry, the Board of Investments, the Philippine Economic Zone Authority and the Philippine National Police, among others - to hear your concerns as well as share with you the various reforms currently being undertaken to promote a more favorable business and investment climate. Let me end by saying that overcoming the challenges we face can be made easier if we maintain an open line between private enterprises and the government sector and recognize the important role each one has to play. This is the reason why the BSP is taking the initiative of bringing us together regularly in this Exporters’ Forum. Previous discussions had been quite fruitful and in fact yielded positive results for some. I hope this forum will be productive and will serve to open more avenues for mutual linkages within the export industry. Thank you very much and I look forward to hearing your views.
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Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at The Asset Forum, ASEAN Capital Markets Forum Series, Makati City, 20 October 2004.
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Rafael Buenaventura: Laying the foundation for a progressive financial system Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at The Asset Forum, ASEAN Capital Markets Forum Series, Makati City, 20 October 2004. * * * Ladies and gentlemen, good morning. Introduction We are indebted to the Asset Magazine, headed by its dynamic editor-in-chief, Mr.. Danny Yu, for organizing this forum on Philippine capital markets. This is an issue that should be high in our agenda for reform. Clearly it is critical for the government to immediately deal with a looming fiscal crisis but that should not distract us from the equally important task of accelerating the development of the domestic capital market. Indeed, these two reforms are closely linked. Fiscal stability is an important precondition to financial system stability. A well developed capital market enhances flexibility in fiscal management. BSP agenda The BSP, as the monetary authority and supervisor of the banking system, is firmly committed to the prioritization of domestic capital market development. First, well-functioning financial markets support the more effective conduct of monetary policy that is key to achievement of price stability. Second, a robust domestic capital market complements the banking system in financial intermediation and can even relieve pressure especially during times of crises by providing alternative means of financing to the economy. Third, the banking system has greater flexibility in managing and re-distributing its risks via the capital market particularly through securitization and hedging. An even more basic reason is the need to improve on the current low domestic saving rate. According to comparative data from ADB as of 2003, the gross domestic saving rate in the Philippines was only 20.1% of GDP compared with Hong Kong (31.6%), Thailand (33.1%), Malaysia (42.9%) and Singapore (46.7%). Even Indonesia is slightly higher at 21.5%. A low domestic saving rate is a basic constraint to achieving higher levels of investment needed to support a faster pace of economic growth. To promote savings, the Philippine financial market needs to offer a broader array of financial instruments beyond bank deposits and equity. We are particularly keen on seeing the faster development of the domestic debt market. As of 2003, total outstanding domestic bonds accounted for just around 40 percent of GDP, compared with 85 percent for bank assets and 69 percent for equity. Most of these bonds are in the form of government securities. In developed countries, where capital markets are deep, the bond market size ranged from 88 percent of GDP in Euroland and 151 percent in the united states. Our initiatives The BSP’s most fundamental contribution to the development of financial markets is fully consistent with its primary mission - price stability. A low and stable inflation environment is a major factor that supports a healthy financial system that is less vulnerable to crises. Under our inflation targeting framework adopted since 2002, headline inflation is being kept within the 4-5 percent range. This range may be temporarily breached due to intense supply side pressures such as what we are seeing today due to abnormal oil markets, but we expect inflation to eventually revert to within the target range. However, we realize that achieving price stability is not enough if we are to help fast track capital market development. More direct action is necessary. In this regard, our initiatives include advocacy of better corporate governance and transparency, widening of investor base, and promotion of sound market infrastructure. We are championing better corporate governance and financial transparency so that investors will have more confidence in placing their funds and have more reliable financial information to guide their judgments. Although our natural starting point has been the banking system, the impact goes well beyond that as banks themselves enforce better standards of governance in their corporate clients that prepare them for the capital market. In the same vein, we are demanding higher standards of conduct from external auditors so that reliable financial statements can be properly enforced. We are complementing the governance initiative by developing a program to promote improved financial literacy so that investors can impose proper market discipline. You will also note that we have been enforcing more stringently mark-to-market regulations and looking at their further strengthening. Our aim is not just to improve financial transparency but also to promote more active secondary market trading. In a further move to improve financial transparency, we are also gearing towards aligning local financial accounting standards with the International Accounting Standards (IAS). We are optimistic that adopting the standards will help promote fairness, accuracy and transparency in the financial statements of banks and other supervised institutions. This would help in strengthening market discipline, encouraging sound risk management practices, and stimulating the domestic capital market. Other related initiatives aimed at improving transparency in the financial markets include the nurturing of domestic credit rating agencies and the establishment of a unified credit bureau. We expect to have the latter to be up and running by mid-2005. A major project being implemented currently is the institutionalization of a system of independent securities custodians. This is primarily aimed at protecting investors from fraudulent acts of multiple securities sales and to discourage undocumented transactions. More positively, the custodian system will support the eventual growth of securities borrowing and lending that will help promote market liquidity. We have systematically tightened prudential and risk management standards. This will definitely strengthen the banking system. In the process, risk-based capital requirements based on the Basle framework have stimulated the issuance of tier 2 subordinated debt as part of the recapitalization process. Down the road, as the stock market recovers, banks should be issuing more equity to bolster tier 1 capital. We intend to bring the banking system in compliance with Basle 2 by 2007. In preparation, we are now requiring universal and commercial banks to formally set up a minimum internal credit risk rating system for the underwriting and ongoing administration of corporate credit exposures. This is embodied in Circular No. 439 which also requires that in rating corporate clients, banks use only financial statements audited by sec-accredited external auditors. Moreover, in quick succession, we have issued tougher standards on the management of large exposures, on single borrower limits, and on DOSRI lending. These will likely spur corporate borrowers to diversify their funding sources beyond the usual friendly banks and in the direction of the capital market. But not all regulatory initiatives have been towards tightening. We have also introduced changes to remove obstacles to capital market development and create opportunities for banks with respect to capital market related business. These include selective lowering of reserve requirements for repo transactions that meet certain standards as well as for other financial products. Over the medium-term, we hope to effect a phased generalized lowering of reserve requirements to be more competitive with low reserve requirement regimes found in most other countries. We have likewise allowed the introduction of new and innovative financial instruments in the domestic market, including complex structured products under appropriate regulatory arrangements. Recently, we have launched an initiative to reform the common trust fund (CTF) and replace it with a better product called the unit investment trust fund (UITF). It will be better in the sense that its assets will be marked-to-market daily so that investors will not be misled as to the real performance of their investments. These should avoid any residual risks to the bank as asset manager. As an investment product, UITFs will be more competitive as it will no longer be subject to reserve requirements as these are no longer effectively considered as deposit substitutes. We expect UITFs to eventually evolve into major institutional investors in the capital market competing against mutual funds and other collective investment schemes. We are also intensifying our coordination efforts with other financial regulators so that we can achieve a more level regulatory playing field. In July 2004, a Memorandum of Agreement was signed by the BSP, the Securities and Exchange Commission (SEC), the Insurance Commission (IC) and the Philippine Deposit Insurance Corporation (PDIC) to formally establish a Financial Sector Forum (FSF). This further enhances coordination arrangements among the concerned agencies, particularly with regard to more effective supervision of financial conglomerates, to information exchange, and to consumer protection. Aside from developing a more conducive regulatory environment, we are helping develop appropriate market infrastructure. In this regard, we are strongly supporting the private sector initiative, led by the BAP, to establish the fixed income exchange and its related infrastructure to ensure efficient and safe clearing and settlement of securities transactions. Finally, our reform initiatives are benefiting from the support of Congress which has decisively acted on certain vital pieces of legislation including the elimination of DST on secondary trading, the SPV Law and the Asset Securitization Law. All of these measures will help spur the domestic capital market. The BSP has worked hard with other interested partners to get these laws enacted and we will continue to do so for other pending legislation that support capital market development. Although much progress has already been made, the work is still far from over. The BSP will continue to push for more reforms in the financial system, specifically: (1) a special legislation to support a strong credit reporting system; (2) the enactment of a more balanced bankruptcy resolution framework; and (3) the enactment of the proposed changes to the BSP Charter to strengthen our ability to clean up the banking system and properly enforce prudential standards. We particularly attach great importance to the amendment of the BSP Charter. Unless we are able to properly police the banking system with sufficient powers, we will be constantly plagued by a vulnerable banking system. A vulnerable banking system will not be responsive to our financing needs. And because banks play important roles in support of the capital market whether as investors, underwriters, managers, market makers, issuers and guarantors, a weak banking system will also hamper their development of the domestic capital market. Conclusion The financial sector reform agenda is a truly major task. We need to move boldly across a broad front. Neither the BSP nor the government as a whole can do the job alone. We need to work together, the public and the private sector, to build a truly progressive financial system. Thank you very much. I hope my remarks will stimulate a lively discussion that should move us to action.
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Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Financial Executives Institute of the Philippines (FINEX) forum on ¿Deepening reforms, strengthening core values¿ and Induction of FINEX Officers, Makati City, 19 January 2005.
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Rafael Buenaventura: Deepening domestic financial reforms Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Financial Executives Institute of the Philippines (FINEX) forum on “Deepening reforms, strengthening core values” and Induction of FINEX Officers, Makati City, 19 January 2005. * * * It is my great honor and pleasure to speak before the FINEX today, a stalwart partner and moving force, in shaping our domestic financial system. Indeed, I am happy to note that your incoming president is one of our own. Today, allow me to focus on my presentation mainly on our efforts to strengthen our financial system and develop, in particular, our domestic capital market. It is pleasing to note that 2005 started off with a slew of very good economic data. First of all, 2004 GDP growth is expected to reach more than 6% on account of increased private consumption and exports; robust services and agriculture growth despite increased inflationary pressures in the second half of the year. The fiscal accounts are more or less in line with program. This has prompted recent declines in the bell weather 91-day Treasury bill rate. Our dollar reserves ended at a very comfortable level US$16.1 billion, at the high end of our target range. The positive news have spilled over to our foreign exchange market, with rates averaging now well below the PhP56/US$ mark, and to the stock exchange. Year-to-date, the PHISIX has posted an 8% growth, easily making our exchange among the top ten performing markets in the world. However, in order to sustain all of these positive developments in the long-run, we must continue our concerted efforts in further strengthening the financial system, particularly, the development of the domestic capital market. Without this, the whole package of reforms being shepherded will not be sustainable in the future and we will constantly be in a roller-coaster ride. A more stable and stronger financial sector ensures a more efficient mobilization of capital and resources. These are in turn channelled to the best and most productive investment activities thereby supporting higher economic growth. With a stronger domestic financial system, the economy will become more resilient in coping with negative external shocks and disturbances and less vulnerable to contagion and reduced access to international capital markets. Furthermore, monetary policy will be able to operate more efficiently as a wider array of market-based tools become available for calibrating economic activity and maintaining price stability. A fundamental initiative of the BSP to support capital market development is the shift to inflation targeting, and the higher level of policy transparency that it requires, as basis for the conduct of our monetary policy in achieving price stability. A stable price environment is a central pillar towards securing overall macroeconomic stability, in turn a necessary pre-condition to capital market development. Although recent acceleration in inflation has been mostly supply side driven, the BSP remains very cautious with its monetary policy stance while retaining the flexibility to support economic growth. This is the usual balancing act that is the traditional measure of the mettle of a central bank. But preserving price stability is really a cooperative endeavor and the government has responded with measures to mitigate supply-side pressures through increased price monitoring of staple foodstuff, ensure supply of commodities through higher productivity in agriculture and industry, and lessening dependence to imported fuel and energy prices. The BSP has launched major reform initiatives in the banking sector where we have direct responsibility as its supervisor. Key initiatives include strengthening corporate governance and transparency, clearing-out non-performing assets and strengthening bank balance sheets through better liability management and recapitalization, upgrading risk management standards, and improving consumer protection. Consistent with these objectives, we have been systematically aligning our regulations with key international standards such as the Basle Committee recommendations on supervisory practices and on capital adequacy, the IAS/IFRS Standards for the proper accounting and disclosure of financial transactions, OECD principles on good corporate governance. We are likewise closely consulting with our peer central banks and bank regulators to learn from their rich experiences. These have yielded a slew of regulatory changes and others yet to come that will radically change the rules of the game for our banking industry. For the better, we are convinced. We believe that the changes will also further hasten the long overdue consolidation in our banking industry that is essential to make it stronger. The rigors of international standards and the growing presence of international level competitions will inexorably hasten the exit of weak institutions that are unwilling to reform. The proposed amendment of the BSP Charter is a very critical element in the banking reform agenda. We are particularly seeking changes to strengthen the institutional arrangements for banking supervision that will enable us to fully comply with best international practice. The most critical changes include strengthening the basic legal protection of bank supervisors in the course of performing their official duties and improving the ability of the BSP to resolve problem banks. Without these vital amendments, we will be unable to properly enforce the reforms embedded in the regulatory changes. These are very basic arrangements that are widely adopted internationally, precisely to achieve a healthy banking system. The BSP is likewise spearheading the initiative to establish a world-class credit information system. We have recommended a bill to congress creating such a system anchored by central credit information bureau that will have the ability to collect, consolidate, and distribute credit information to credit providers and analysts. World Bank studies and other independent studies have established that a good credit information system will significantly increase access to credit especially by small borrowers, lower credit transaction costs, lower cost of borrowing, and improve management of credit risk. These are the two major pieces of legislation that the BSP is prioritizing in its advocacy with Congress. We hope that the FINEX collectively can help us in this effort that is so vital to strengthening the financial system. There are other pieces of vital legislation that we should all be working closely together on to have enacted. One of these is an improved bankruptcy framework through the proposed Corporate Recovery Act. We are in critical need of a modern framework for orderly resolution of failed organizations that even-handledly settles potentially conflicting interests of borrowers and creditors. A bias for the former will lead to a weak financial system while a bias for the latter will sow the seeds of inequity and instability. Other important pieces of legislation are oriented to furthering the development of the domestic capital market. These include the proposed RICA and PERA bills. Even more basic is the necessity to re-think the whole approach on the taxation of the various financial instruments to encourage a deep capital market that is able to offer a wide array of investment outlets catering to diverse risk preferences and investment objectives. I understand this is now the subject matter of a comprehensive study in preparation for a specific legislative proposal. The high degree of interconnectedness of our financial system has compelled the BSP to play a more active role in developing the domestic capital market and to collaborate more closely with other financial regulators. Let me mention a number of key initiatives. One initiative is to broaden the array of available capital market instruments such as Tier 2 Paper, LTNCDs, documented repos, structured debt, collateralized debt obligations, and credit derivatives. We have gone out of our way to overhaul our regulations to allow financial innovation but under appropriate risk management standards. On the demand side, we have initiated a major reform of the trust business beginning with common trust funds that are being converted to a better product called the unit investment trust fund (UITF). Other managed funds are next in line primarily to create a wider domestic investor base where both sophisticated and unsophisticated investors can participate under adequate safeguards. We are also encouraging the entry of high quality rating agencies, a critical actor in a capital market that is transparent and efficient in discovering fair prices commensurate to risk. In the last few months, we have struggled to operationalize the fix income exchange [which FINEX and other organizations are major stakeholders] and to institutionalize an independent securities custody system that will improve investor protection, defeat market malpractices such as multiple selling of securities and undocumented transactions, and reduce systemic risk overall. Sad to say, we encountered fierce resistance from some market players and even government provider. Fortunately, that issue now appears to have been decisively resolved by the Department of Justice to allow BSP-accredited third party custodians to finally operate. I hope all will now act with goodwill to achieve full implementation as soon as possible. We have already wasted too much time. Why is the third party custody system so vital to the reform effort? It’s really very simple. To an important extent, the root of current problems lie in the basic fact that securities already sold by dealers remain undelivered to investors and effectively stay under dealer control. By requiring delivery of securities directly to investors or their designated independent custodians, we hope to break the back of bad practices that rob our domestic capital market of its credibility to investors. The new system will also lead to greater investor empowerment by allowing them more flexibility to choose the best possible price from the market and break free from the stranglehold of potentially leonine dealer partnerships. The financial system, being a large and complex sector, has necessitated the need for a stronger consolidated supervision mechanism among the different financial services regulators. One such initiative in this direction was the creation of the Financial Sector Forum or FSF last year. Composed of the BSP, SEC, PDIC and Insurance Commission, the FSF is currently undertaking its agenda of harmonizing supervisory and regulatory efforts, strengthening of the exchange of information among the different regulators and promotion of better consumer protection. We intend to continuously strengthen this coalition. The road ahead for full financial system reform is indeed still long and complex. It is a historic struggle seemingly most genteel but no less tougher than military battles fought with real blood and tears. It is a struggle against entrenched interests that seek to preserve the mediocre status quo that has led our country’s financial system to nowhere. We appeal for the full support of our reform-minded financial professionals, the kind of professionals that FINEX has placed under its wing. Your authoritative and rational voices are badly needed both in advocacy for the reforms and for educating the broader public to understand the complex issues and changes. We should be working together to build an unbreakable coalition for deep reform in the financial sector. My term, as Governor, is almost finished and there will be a major change at the Monetary Board. But I am confident that, with your support, the process of reform will march on relentlessly. Thank you and good day!
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Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Annual Reception for the Banking Community, Manila, 18 January 2005.
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Rafael Buenaventura: New Year message 2005 Speech by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the Annual Reception for the Banking Community, Manila, 18 January 2005. * * * A warm welcome to all! Let me begin by thanking all of you for joining us tonight at this traditional annual reception to officially welcome 2005. But more than your presence tonight, we thank you for your full cooperation and support in working with us to keep our economy steadily moving forward, to preserve overall confidence, and to steadfastly implement reforms. The year 2004 was again another very challenging year for the banking community, being a presidential election year with all the uncertainty that usually surrounds such a major political event. We also bore witness in the second half to a sharp increase in oil prices that inevitably had major impact on the whole economy. But in spite of all these, the economy still turned in a very respectable outcome. GDP growth is estimated at 6.2 percent. Headline inflation has picked up to around 7.9 percent in December 2004, due mainly to the feed through from energy price adjustments and other supply side shocks, but more broad-based inflationary pressures were held in check. Our accumulation of international reserves, at $16.1 billion at end-December 2004, was at the high end of our expectations. The peso exchange rate finished firmly at P56.267 and has been appreciating since then. Undoubtedly, record remittance inflows that will definitely exceed P8 billion for the whole of 2004 has once again shored up our economy. Commendable outcomes were also contributed by our export sector. On the domestic front, healthy consumer demand helped keep the economic momentum going. In the financial system, the reform agenda relentlessly forged ahead undeterred by all the potential distractions. The long overdue asset cleanup finally got going under the SPV law. As of end 2004 about P26 billion was already done and another P54 billion was firmly in the pipeline or a total of P80 billion so far. Assuming these transactions would all be completed in due course, we can look forward to a lowering of the NPL ratio to less than 10 percent by end-2005 from the current 13-14 percent level, given 2005 economic growth projection. Still, the improving NPL outlook would still be more than double than the pre-1997 crisis ratio of less than 5 percent. This underscores the enormity of the remaining clean-up task ahead. The incentives under the SPV Law expire on April 8, 2005. There isn’t much time left. There is a possibility of an extension on the basis of strong representations being made by the banking industry. As a practical matter, the BSP will not object to an extension, but candidly speaking, we will have serious concerns over an overly long extension that will only likely weaken the resolve to face the music. Another year should be reasonable. If this results in another P100 billion in transactions, then we can see the NPL ratio going down further to around 7.5 percent in 2005. Whatever extension is given by Congress, all our banks that still carry large NPAs in their portfolio are well advised to bite the bullet soonest and clean up their balance sheets. Don’t do it because the BSP says so. Do it because it is primarily in your interest to do so. Going forward, that burden can only become heavier especially as regulations evolve to force fair valuation of all financial assets in the context of migration to IAS in reckoning accounts. The implementation of Basle II will also lead to heavier risk weighting on NPAs. In general, the prudential standards on the banking system will continue to keep rising as we seek closer alignment with international standards. We have already announced that banks should be IAS compliant by end-2005. We really have no choice on this. Our ratings cannot afford it. We have likewise defined the roadmap to make the banking system compliant with Basle II by 2007. Given the complexity and deep impact of these changes, it is necessary to begin preparations right away. The ultimate success of the banking reform agenda depends to a very large extent on Congressional action to amend the BSP Charter primarily to strengthen the institutional arrangements for banking supervision. This especially pertains to providing better legal protection to BSP personnel in the course of the performance of their official duties. Other countries protect their regulators which make them more effective. Hopefully, the necessary legislation will be finally delivered this year. We are also keenly advocating the enactment of a law that will enable us to establish a strong credit information bureau that will anchor a comprehensive credit information system. The benefits of this are enormous in providing wider credit access especially to small borrowers, in lowering the cost of borrowing of responsible borrowers, and in reducing the credit risk exposure of the banking system. You are also aware that we have been trying to leverage the fruits of banking reform with a complementary effort to develop the domestic capital market. Clearly, given the dominant role of the banking system in our financial system, our banks will need to play a major role. Here the challenge is the willingness to reform market practices to achieve greater transparency, efficiency, and investor protection. We need our banks and other major market players to be willing to sacrifice the acceptable but mediocre status quo for something that is better for the economy in the long run. Even now our commitment and resolve is being tested as we endeavor to stamp out long-standing market malpractices. Rating agencies have criticized us on some practices that we are now trying to correct. These practices have also prevented us from developing a deeper capital market. The complexity of the financial reform agenda has required the financial regulators to cooperate more closely. Last year, we took an important step in this direction. In partnership with the SEC, the Insurance Commission, and PDIC, we formed the Financial Sector Forum (FSF) last July. The FSF has steadily gained momentum and we are now working on a full agenda to harmonize our supervisory and regulatory efforts, to strengthen information exchange and to promote better consumer protection. We expect the FSF to hit its full stride this year. Even as we have strived to forge an efficient and modern financial system, the access of the poor to the financial system has been our constant special priority. And indeed, the success of microfinance has been a pride and joy of the BSP. By the way, we are observing this year the International Year of Microcredit under the leadership of the United Nations. We look forward to further strengthening our commitment to sustainable microfinance. In less than six months, there will be a changing of the guard at BSP as the majority of the Monetary Board and I complete our full six year term. The famous Manila Bay sunset beckons. But we are not yet quite ready to follow its inviting siren call. The challenge of upholding financial stability is a never ending one. Rest assured that we will pursue the necessary reforms to the very last day we are in office before we gladly yield the drivers seat to our successors. Let me end by thanking the BAP and its enlightened leadership for working with us to implement many essential but often times painful reforms. A happy new year to all!
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Keynote address by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Strategic Planning Conference, Manila, at the signing of the Memorandum of Agreement for the Effective Implementation of BSP rules on Physical Cross-border Transport of Currencies, Manila, 17 January 2005.
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Rafael Buenaventura: Implementation of BSP rules on the transport of currencies Keynote address by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Strategic Planning Conference, Manila, at the signing of the Memorandum of Agreement for the Effective Implementation of BSP rules on Physical Cross-border Transport of Currencies, Manila, 17 January 2005. * * * Good afternoon, friends, ladies and gentlemen. I would like to thank the agencies represented here for their full cooperation in the preparation of the Memorandum of Agreement (MOA) for the effective implementation of BSP rules on the physical cross-border transport of currencies, which will be signed today. We know that, each agency has more than enough work in its hands, and therefore, it is not easy to define and accept additional responsibilities, as would be the case in this MOA. I also want to thank the following signatories to this MOA who have taken time off from their busy schedules for this signing ceremony: 1. Bureau of Customs Commissioner George M. Jereos, 2. Manila International Airport Authority General Manager Alfonso G. Cusi, 3. Philippine National Police Director General Edgar B. Aglipay, 4. Bureau of Immigration Commissioner Alipio F. Fernandez 5. Air Transportation Office Executive Director Helen N. Camua, and 6. Philippine Ports Authority General Manager Oscar M. Sevilla. Of course, I am also a signatory under two hats, as BSP Governor and as Chairman of the Anti-Money Laundering Council. This MOA seeks to ensure the effective implementation of BSP rules on the physical cross-border transport of foreign currencies and the Philippine peso (PhP). BSP Circular No. 308 dated 15 November 2001, as amended, requires any person who brings in or out of the Philippines in excess of US$10,000 or its equivalent to declare the same in writing using the prescribed foreign currency declaration form. Other countries such as the United States, South Korea, and Malaysia broadly require similar customs procedures in the transport of foreign currency. The Circular was issued as part of a package of measures to help curb money laundering activities. As early as June 2000, the BSP has adopted anti-money laundering measures to be at par with international practices. The monitoring of the cross-border transport of currencies is covered under the 9th Special Recommendation of the Financial Action Task Force (FATF), the body that evaluates the anti-money laundering regimes of individual countries. Meanwhile, Section 4 of Circular No. 1389 dated 13 April 1993, as amended, requires any person who brings in or out of the Philippines an amount exceeding PhP 10,000 to obtain prior BSP authorization therefore. The rule was promulgated to help prevent speculation against the peso and maintain the convertibility of the currency. Vigilance in the implementation of the BSP rules, particularly in the transport of foreign currencies, is important in addressing incidents such as recent events involving the discovery by U.S. customs authorities of large amounts of undeclared foreign currency found in the possession of Filipino citizens arriving in the U.S. We are glad that we will be assisted by other government agencies in this regard. The MOA defines the functions and responsibilities of the various government agencies involved and aims to promote harmony and maximum cooperation in the implementation of BSP rules on the transport of currencies. The MOA demonstrates the strong commitment of the government, thru the heads of the various agencies who are signatories to the agreement, in instituting measures versus money laundering in the Philippines. Again, thank you for your support and we look forward to the smooth implementation of the MOA.
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Opening and closing remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Strategic Planning Conference, Manila, 10 January 2005.
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Rafael Buenaventura: Strengthening the cornerstones of excellence Opening and closing remarks by Mr Rafael Buenaventura, Governor of Bangko Sentral ng Pilipinas (Central Bank of the Philippines), at the BSP Strategic Planning Conference, Manila, 10 January 2005. * * * Introduction Business planning with a strategic perspective has paved the way for the Bangko Sentral not just to get by but more importantly, to get ahead. At a time when the national economic agenda is confronted with sometimes seemingly insurmountable roadblocks, our institution is left with no other option but to tackle them head on. And faced with the temptation to give up most of our strategies because of numerous risks and uncertainties, we have remained steadfast in our mission and unyielding in our convictions. Building on diversity It is my pleasure and privilege to welcome you to part three of the 2004 BSP-Strategic Planning Conference, the assembly of bold visionaries in the BSP. All of us here today have performed a diversity of roles and contributed a diversity of gifts to this endeavor. This planning conference is yet another opportunity to weave those disparate fibers together, to gauge how far we have come and determine what the overall picture is telling us. Understandably, there are still sizeable gaps, and as in the past, we ought to be decisive in dealing with the challenges we face. “Strengthening the cornerstones of excellence.” This is the theme of our strategic planning exercise for this year. In the previous years’ planning initiatives, we set forth to establish the direction we intended to pursue and consequently laid the groundwork upon which to propel our aspirations. This time around, we embarked on a journey of introspection, stepping back a little and indulging ourselves in inward examination - deliberating about how we could further fortify the cornerstones of excellence, from people to business processes to information systems to infrastructure. This undertaking ultimately guides the refinement of our strategies - an inevitable course towards more effectively executing our ideas and more successfully implementing our plans. Legacy for excellence They say the best way to deal with the future is to take a hold of it. In so doing, it becomes vital to secure our own design of the future, which, I am proud to mention, is precisely what we have in our hands right now. The BSP medium-term blueprint is an embodiment of the tradition of world-class excellence we have envisioned to unify our energies and ignite inspiration in our workforce. It likewise symbolizes our hope that the resolve we now possess to deliver on our commitments will be sustained by the ones we shall eventually bequeath it to. Nothing appeases a parent more than the assurance of a formidable future he/she could leave behind. Today is the time Strengthening the structures around which we have built our vision and upon which we enable the fulfillment of our objectives is the order of the day. I am well aware that the road to accomplishing our operational plans has left not merely a handful of us battered and bruised, hardly getting time to breathe, more so, to regroup or reflect. But today provides the moment for us to recognize and celebrate our milestones, identify and accept the challenges that lie ahead and renew our vigor to move forward with our mandate. Let us, at all times, be encouraged by the unwavering importance of our mission and the promise of better times before us. Let us draw strength from the very resilience of the people we serve and the allies we have in each other. Let us, most of all, remember that the route to excellence may never be simple and easy but the journey itself, a rewarding experience. Good morning and good luck! * * * Introduction We have come to the close of the three-part Annual Planning Conference this year, the last during my term as Bangko Sentral ng Pilipinas (BSP) Governor. Strategic planning in BSP Though it may be said that we are in the early stage of strategic planning, we have already achieved several milestones in promoting strategic management thinking and in institutionalizing a synchronized planning and budgeting process in the bank. The creation of the Corporate Planning Office in 2001 to oversee the strategic management process was a decisive step towards this goal. In 2002, for the first time in the planning efforts of the Bank, participants to the planning conference underwent the complete strategic planning process - from crafting the vision and mission of Bangko Sentral, to the formulation of corporate level objectives and strategies, and down to the formulation of departmental/office level operational plans. In 2003, again for the first time in the history of the Bangko Sentral, we drafted a medium-term plan focusing on our twin mandates of maintaining price and financial sector stability. The plan defined the strategic intent, key objectives, strategies and key operational plans in performing our core functions of monetary policy formulation and bank supervision and examination. It also defined our approach toward organizational capability building, specifically in the areas of human resource, information technology, infrastructure, and service excellence. A synchronized planning and budgeting cycle was approved by the Monetary Board in March of 2004, institutionalizing the top-to-bottom strategic planning approach and synchronizing the annual planning and budgeting processes of the bank. As we continue to improve our strategic planning processes, we shall endeavor toward enhancing our framework for goal setting, performance measurement, monitoring and evaluation. This calls for further strengthening our strategic planning capabilities that would include the department and business unit levels. Journey towards our vision We have made significant strides in our journey towards becoming a world-class monetary authority. The Chairman of the Corporate Monitoring Committee presented earlier a report on our accomplishments. I personally would like to congratulate all of us, the members of the “Bangko Sentral team”, for these significant achievements in this “not so best of times”. Together we withstood external pressures and hurdled operational bottlenecks, as we continued to edge our organization closer to our vision. The road ahead With our blueprint done, and the deliverables by end-March 2005 already defined and prioritized, our real work has just begun. The road ahead calls for heightened cooperation and tighter coordination among the different sectors and departments/offices of the bank to ensure that the imperative programs are successfully implemented. In simple terms, what needs to be done has to be done. In gratitude and in recognition It is but fitting to conclude this last planning conference during my term with words of gratitude for, and in recognition of, the dedication and hard work of all of you, including the valuable assistance provided by the technical staff and the secretariat. Our strategic planning exercises have benefited greatly from the direction and guidance provided by the members of our Monetary Board. On behalf of the management team of the Bangko Sentral, I would like to thank you for your active participation, your insights and inputs, which provided an independent perspective that enhanced the quality of our planning outputs. I would like to thank the management team of Bangko Sentral - our Deputy Governors, Assistant Governors and Managing Directors, and the heads of the different departments and offices. Your commitment, energy and hard work have produced this very important document – the medium term plan of the Bangko Sentral ng Pilipinas which translates our vision into operational terms. This same commitment, energy and hard work of both the leaders and members of this institution will put life to this plan and transform our organization into one that will make the Filipino people proud. Let me also acknowledge the significant contributions made by our consultants in crafting the medium-term plan and in the implementation of our projects. To the Corporate Planning Office, I thank you for all your efforts and I wish you good luck in meeting the challenges ahead as you continue to spearhead the strategic management initiatives in the bank. When I turn over the reigns of leading this organization in July this year, I am confident that the Bank’s management team shall carry on what we have started, strengthen what we have put in place, and sustain the gains of our collective efforts. For all your support and cooperation, thank you and I wish you all the best.
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Speech by Mr Amando M Tetangco, Governor of the Central Bank of the Philippines, to the Investment House Association of the Philippines (IHAP), Manila, 23 August 2005.
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Amando M Tetangco, Jr: Capital market - a cornerstone of BSP financial reform agenda Speech by Mr Amando M Tetangco, Governor of the Central Bank of the Philippines, to the Investment House Association of the Philippines (IHAP), Manila, 23 August 2005. * * * Distinguished officers and members of the Investment House Association of the Philippines (IHAP), ladies and gentlemen, good afternoon! Allow me to first of all congratulate the incoming board of directors and officers of IHAP. Let me also thank you for this invitation to be your keynote speaker and inducting officer. Since 1973, investment houses under the IHAP umbrella have carved their place in the economy as important financial intermediaries. You are therefore a vital partner of the BSP in building a more resilient and efficient financial system and a more expedient capital market development. More recently, your participation in establishing the fixed income exchange is one manifestation of your significant contribution toward taking the steps to develop the local securities market. Former BSP Governor Paeng Buenaventura has laid down the blueprint of capital market development as a vital component of the country’s financial reform agenda for sustainable economic growth. As his successor, I am equally committed to ensure the continuity and consistency of our policy reforms. This afternoon, I will discuss the policies and programs of BSP on capital market development. Economic overview To put things in perspective, let me first give you an assessment of the economy. Overall, our economic fundamentals remain generally sound in the midst of political noise. For the first quarter of 2005, the country’s gross domestic product (GDP) grew by 4.6 percent and driven primarily by growth in the services and industrial sectors. BSP’s prudent monetary policy, anchored on inflation targeting, kept key overnight policy rates steady. Ample liquidity in the market and improvement in the government’s fiscal position served to push the yields of bellwether 91-day Treasury bill rates down to 5.6 percent. Headline inflation decelerated to 7.1 percent in July, posting an average of 8.2 percent for the first seven months of the year. Our peso has been relatively resilient, trading below the P56/US$ level. In the external sector, the balance of payments (BOP) posted a surplus of US$783 million for the first quarter of 2005l this is a turnaround from the US$378 million deficit in the same quarter last year. Meanwhile, remittances from overseas Filipino workers sustained double-digit growths. inflows for the month of June 2005 posted a 32.1 percent growth (US$935 million) compared to same month last year. the cumulative level of remittances for the first semester reached US$4.9 billion, 21.5 percent higher than a year ago’s level. This is due to increased deployment of higher-paid skilled professionals and improved access to formal remittance channels. Accordingly, we continue to enjoy a comfortable reserve position with our gross international reserves (GIR) at us$17.7 billion in July 2005. Impetus for capital market reform A growing economy, such as ours, requires a steady flow of financing from both local and foreign sources. In sustaining this development, the economy needs a healthy financial system. A financial system that is built upon two strong pillars: a robust banking system and a fully-functioning capital market. Why is it necessary to develop our domestic capital market simultaneous with the restructuring of the banking system? A fully developed capital market can stimulate domestic savings and provide investment opportunities. compared to our Asian neighbors like Malaysia and Thailand, we have a smaller savings-to-GDP ratio at 21 percent. Domestic savings onshore are channeled to productive output crucial to economic development like infrastructure projects. A sound capital market also improves the financial environment with the offer of alternative financial instruments. At present, government papers dominate the local capital market with minimal alternative for other financial instruments. A marked difference with other countries where private debt issuance is far more significant. Also, the 1997 Asian financial crisis was a painful reminder of our vulnerability to external shocks due to our excessive dependence on the local banking system. BSP initiatives Cognizant of this challenge, Bangko Sentral has laid down a broad range of financial system reforms to complement and accelerate the development of the capital market. We initiated the groundwork through asset clean-up of banks to restore the credit supply to the economy. For the first semester of 2005, the non-performing loan (NPL) ratio of universal and commercial banks1 was back to a single-digit level at 9.2 percent. This is a reversal from a peak of 18.8 percent in October 2001 due to asset dispositions under the Special Purpose Vehicle (SPV) Law. Hopefully, we can restore asset quality to pre-crisis levels once the extension of the SPAV Law is accomplished. As the financial environment becomes increasingly global and liberalized, BSP saw the need to align the local banking practices with internationally accepted standards. We are upgrading the banking system’s capitalization and risk management standards to be fully compliant with Basel II by 2007l we are also institutionalizing corporate governance and financial transparency. By yearend, the banking industry will adopt the new international accounting standards (IAS/IFRS). The Monetary Board very recently approved the implementing guidelines. We are likewise improving the current regulatory framework through close coordination with other local and foreign financial regulators. I am happy to report that the Financial Sector Forum, our partnership with local financial regulators (SEC, IC and PDIC), is now fully operational with major projects currently underway. These projects include conglomerate mapping, information sharing, joint examination arrangements, rules harmonization and financial literacy. The domestic capital market remains shallow and underdeveloped. In response, the BSP has issued various circulars diversifying the financial products available in the capital market. traded papers like unsecured subordinated debts (as Tier 2 supplementary capital), long-term negotiable certificates of deposits or LTNCDs, documented repos, and securitization structures create market-oriented opportunities for banks and other players and deepen the capital market. The BSP has also been fully supportive of the establishment of the Fixed-Income Exchange (FIE) as an infrastructure for the secondary trading of fixed income and other debt securities. This envisages the trading, clearing, settlement and delivery of securities in a transparent and efficient manner. Recently, the BSP issued the implementing rules of Circular No. 392 to fully operationalize the rules on proper delivery of securities including the role of third party custodians. We are just awaiting the last missing step that is the interconnection of all key debt market participants to ROSS2] to create a truly seamless infrastructure for fixed income. Combined resources of which account for almost 90 percent of the total resources of the banking system. Registry of scriptless securities of the Bureau of Treasury. We have also started revitalizing the trust business to widen investor base with the gradual phase out of common trust fund (CTF) for a better product called unit investment trust fund (UITF). UITFs enhance the credibility of pooled funds to investors as the value of investments is mark-to-market, paving the way for long-term investment opportunities. Finally, we are encouraging the entry of more rating agencies to complement the establishment of an exchange traded papers. Rating agencies play an important role in guiding investors towards informed decision-making and in ensuring the proper disclosure of investment information. Future directions We have done much of the groundwork. What we need now is a decisive follow through. I must admit, we have encountered some resistance and minor set-backs along the way. But as Chinese industrialist Yin Ming Shan puts it, “Purest gold fears no fire”. This also speaks for our intentions to make the capital market work. Although we have made some milestones with the passage of the Securitization Law, the SPV Law and the elimination of documentary stamp tax in secondary trading, there are remaining measures in our legislative agenda that need to be pursued: the amendment of the BSP Charter, Corporate Recovery Act, Personal Equity and Retirement Account (PERA) Bill, Revised Investment Company Act (RICA), Credit Information System Act, revised Corporation Code of the Philippines, Iinsurance Code of the Philippines and Pre-Need Code of the Philippines. These pieces of legislation are central to capital market reform and IHAP’s support can strengthen our stand against the grueling legislative mill. In addition, a larger pool of institutional investors like insurance companies, mutual funds, UITFs and pension funds can also provide the required boost to the market. Our capital market also needs strong issuers to expand the variety and supply of instruments for investors. Using government papers as basis for pricing other long-term issues, I am encouraging private corporations whose leaders are present in the audience today, to issue quality papers and advance our advocacy on capital market development. Concluding remarks As a final note, I thank IHAP for this opportunity to share our advocacy on creating a well functioning capital market. Leadership is believing in causes and accepting the responsibility of motivating others to act on those causes with the same faith. Your enthusiasm and continuing support inspire us to pursue the remaining points in our overall financial reform package with renewed vigor. Thank you and more power!
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 12th Anniversary of the BSP, Manila, 4 July 2005.
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Amando M Tetangco, Jr: Continuity in a time of change Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 12th Anniversary of the BSP, Manila, 4 July 2005. * * * Introduction MB Member Valdepeñas, MBM Boncan, MBM Amatong, MBM Villafuerte, Outgoing MBMs Mr. Alindogan and Mr. Salazar, our esteemed former Central Bank Governors, our friends from the banking community and the business sector, distinguished guests, my family, our friends from media, my co-workers in the BSP, M.O., SPC and our regional offices and branches, ladies and gentlemen, good afternoon. Today we celebrate the twelfth year of the Bangko Sentral ng Pilipinas and I wish everyone a Happy Anniversary! This celebration is particularly significant for us. Governor Buenaventura, MBMs Quintos, Salazar and Alindogan are closing six years of outstanding work in central banking today. We salute them for their very important contributions to the relentless pursuit of the goals and objectives of this institution. I have been fortunate to participate in and personally witness the major changes made to advance monetary policy making and banking supervision during their watch. They, together with the MBMs who are staying behind, are one of a kind, a bold bunch of policymakers who were alien to the fear factor in introducing innovations to make the financial system and the BSP as an institution attuned to the new standards and requirements of a fast changing world. Governor Buenaventura cannot join us in today’s celebration, but the BSP is so close to his heart that he sent his taped message, so that even in spirit we shall all be complete. As he finishes his term, he leaves a legacy that, while towering, is at the same time edifying and inspiring for us to continue the tradition of excellence and hard work in the BSP. As we bid farewell to our outgoing MBMs, we also extend a warm welcome to our incoming Board members: Mrs. Amatong and Mrs. Villafuerte who are not new to the Monetary Board. We all look forward to working with them in the period ahead. This afternoon, I would like to share with you my thoughts about the two main pillars of central banking: monetary policy and banking supervision. I will also identify the challenges faced by a modern central bank and what they mean to the BSP in terms of our organization. Sustaining the shift in monetary policy regime The first pillar of price stability represents our contract with the Filipino people. When consumer prices are stable, we serve the cause of economic growth. Today, the issue of inflation strikes even closer to the hearts, or perhaps the guts of the public. Surveys by independent research organizations have, for example, consistently ranked high prices as the foremost concern of the lower income classes. A low and stable inflation preserves the purchasing power of the people’s incomes. There is more food on the table and more services to buy. In my earlier interviews with the media, I have stressed one important point that will be the hallmark of my stewardship. We will not try to reinvent the wheel. Instead, we shall strive to continually improve it and keep it running more efficiently. Our vision is to see that it brings us to where we want to go. We shall therefore continue to adhere to inflation targeting as our monetary framework. Inflation targeting emerged at that point where monetary targeting started to fade. Since the implementation of inflation targeting in January 2002, we have seen how rigorous economic 1/4 analysis, discipline in the conduct of monetary policy and greater transparency in the thinking of the monetary authorities have contributed to reduced gyrations in consumer prices. The dynamics of inflation expectations has been largely anchored in the market’s appreciation of the BSP’s explanation of the factors driving inflation and what the BSP intends to do to address them. This is the face of continuity. But you will agree with me that perhaps there is scope for change. We shall soup up the inflation targeting framework. We will not only reassess the various components of our forecasting models and the integrity of our databases, but we will also intensify our capacity to anticipate possible shocks in the system. The first is to make sure we have the right tools to deal with shocks; the second will give us the comfort that we will not be ossified by surprises. We have completed our early warning systems for various areas like currency, business cycles and the banking system, and we shall increasingly make use of them in our monthly review of the monetary policy stance. The results of our periodic environmental scanning exercises will be used in an attempt to more effectively incorporate political factors in assessing the risks to the inflation outlook. We are also reviewing our monetary tools that include the reserve requirement, open market operations and credit policy. If we may add, finally, the market can expect greater transparency in the conduct of monetary policy and this should reduce the gray areas in anchoring public expectation about inflation and enhance the functioning of the markets. Strengthening the financial system In the financial sector, the main challenges emerged from the overhang of the Asian financial crisis and the greater integration of the Philippines into the global financial system. In response, we have addressed these challenges precisely by strengthening the financial sector. Focus has been given to maintaining a sound and viable banking system and the development of the domestic capital market. Efforts in this area have begun to show positive results. Banks’ balance sheets are gradually recovering from the large burden of bad loans while the local bond market has received the initial shot from the reforms that include the now operational fixed income exchange. We shall sustain the Bangko Sentral’s reform strategy on cleaning up banks’ balance sheets, addressing remaining weaknesses in managing risks, and ensuring that our prudential regulatory standards are elevated to international benchmarks. We shall also continue to coordinate with other government agencies and the private sector in installing the remaining infrastructural requirements of a well-functioning capital market that would diversify our sources of funds and reduce our vulnerability to various shocks. But we need to enhance a few things even as we have started to launch them. We are moving into consolidated supervision and risk-based approach to bank examination that are aligned with international best practices. Such innovations are necessary to allow regulators to effectively manage challenges posed by conglomerate structures and cross-border issues. We are improving corporate governance and market discipline. A crucial element for effective oversight of the banking system is for the regulator to have stronger supervisory and regulatory authority and this can only be done with the support of Congress in amending the BSP Charter. Finally, we realize that the BSP can enhance its effectiveness by establishing teamwork with the other financial regulators. Thus was born the Financial Sector Forum (FSF) that has elevated the cooperation among the regulators to pioneering levels. The FSF will help harmonize supervisory and regulatory efforts, improve the exchange of information among regulators and promote better consumer protection. In the area of promoting the domestic capital market, the changes we would like to see are the fruits of the steps that have already been started in close collaboration with the private sector. We shall be pleased to see more robust trading of government and subsequently, private, debt securities at the Fixed Income Exchange, improved market confidence from the use of independent custodians, migration by the banks from the common trust fund to unit 2/4 investment trust fund, and lower borrowing cost with the installation of a credit information bureau, currently being discussed by Congress. We are excited to see the day when we are able to reduce our reliance on foreign borrowing because the domestic capital market is efficient enough to provide the critical mass to fund sustained economic growth. Promotion of microfinance and literacy program-the social dimension of BSP policy We shall also intensify the social dimensions of BSP policy. Foremost in this is our advocacy for microfinance. This program is the most effective tool for democratizing the access of the public to a portion of the nation’s wealth, for empowering the poor and the economicallychallenged group of small entrepreneurs and for scoring a dent on poverty alleviation. We shall also pursue economic and financial literacy program to reach out to our consumers, investors, overseas Filipino workers and their beneficiaries to help expand their options of where to put their money and ensure their economic future. BSP organization My fellow workers at the BSP, central banks have often been described as the most powerful institution in the economic sphere: the monetary policy decisions made by the monetary authorities “can lift markets overnight, bring people out of unemployment, keep growth on track and hold inflation in check.”1Yet what central banks can do is ostensibly limited by a host of factors notably increasing globalization. Globalization has integrated international capital markets and with this, deregulation and technological progress have rendered traditional control-based approaches virtually ineffective. As market forces drive globalization, it has also increased the propagation of shocks in the world economy. What then is the challenge for us? It is important for us at the Bangko Sentral ng Pilipinas to be able to row with the current and if necessary at some point, to row against it. What is imperative is that the BSP is appropriately structured and equipped. Our commitment to building a more effective central banking organization is captured by our new vision and mission statements and they should serve as our guide for the next steps. We owe a great deal to the work in the past to instituting best practices, enhancing the bank’s corporate image, and strengthening corporate governance within the BSP itself. I know that we can always count on you my fellow BSPers, for our committed and professional men and women have been the strength of our organization through the years. Moving forward, let us continue to give our best to this institution, which has always looked after our welfare. We see this in the better facilities, comprehensive adjustment in pay scale and expanded opportunities through improved training programs and scholarships. These are elements that we should review from time to time to ensure they remain adequate and appropriate. As a great inventor once said: “…if we did all the things we are capable of doing, we would literally astonish ourselves.”2 Meyer, Laurence H. (2002) “A Term at the Fed, An Insider’s View,” Harper Business. Thomas Alba Edison. 3/4 The way forward The BSP story of the last six years is ending today with a considerable amount of success. We are moving into the story of the next six years, complete with the template of new ideas and bold reforms. If we are to chart the roadmap in a “T” account, we will see that along the way, there are pluses and minuses, opportunities and challenges. The success of the last six years is punctuated by some unfinished agenda that needs to be pursued to achieve continuity in a period where change is the only constant. I recall what that celebrated columnist of the New York Times once suggested: it looks like some central banks find themselves with much less ability to move the economy than anyone expected.3 The reason is that some of them somehow cultivated the mystique of their invincibility that now turns out to be a handicap. In our case, while we deliver bold strokes to the market, we shall not throw caution to the wind. We shall be fully accountable for our efforts to keep prices stable and the banking system sound, but we shall also continue to inform the markets as necessary about the boundaries of what we can do. With this, the nation can be assured the BSP shall keep its end of the contract. Thank you and good afternoon. Krugman, Paul (2003), “The Great Unravelling,”, Allen Lane, -.72. 4/4
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 3rd Asian Accounting Firms (ASNAF) Conference, Makati City, 11 November 2005.
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Amando M Tetangco, Jr: Accounting reforms towards good corporate governance Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 3rd Asian Accounting Firms (ASNAF) Conference, Makati City, 11 November 2005. * * * Distinguished guests, ladies and gentlemen, good morning. I am deeply honored to be part of this gathering of accounting experts from the Asia Pacific Region. I understand there are also delegates from Europe, particularly France and Belgium. I wish to join ASNAF Chair Cherry Bernaldo in welcoming all of you to Manila. This is a rare opportunity to be with the movers in the profession who are at the forefront of the crusade of coping with the accounting evolution happening globally. To the men and women who continue to heed the call to serve in this noble undertaking, we salute you. The accounting profession has truly evolved into a vital catalyst of global convergence particularly with the adoption of the International Financial Reporting Standards (IFRS). The twin objectives of the new standards of promoting transparency and comparability in financial reporting transcends all regional boundaries and redounds to a greater cause of enhanced corporate governance and oversight. The Philippines believes in the cause of adopting uniform accounting standards across the globe. We have expressed an unyielding commitment to the international community that these standards will be implemented in the country for the year 2005 and the Bangko Sentral ng Pilipinas is spearheading its adoption in the financial industry. Let me share with you our valuable experiences in adopting the standards in the financial industry. Adoption of IFRS in the financial industry– the Philippine experience It is fitting to say that the new accounting standards are a phenomenon. The changes infiltrated the backbone of financial reporting, which affected the way transactions are recorded and reported. The old school’s concept of conservatism and materiality were overshadowed with new thoughts on fair valuation and substance over form. The new accounting standards modified our paradigm in evaluating the financial position and performance of institutions. In addition to the already difficult task of adopting the standards, the BSP also has to contend with the difference in perspective between the principles of IFRS and the regulatory bodies. A popular example of which is the concept of loan provisioning wherein the IFRS provides losses on financial assets based on an incurred loss concept while the regulators provide losses based on incurred and expected loss concepts. Another contentious provision of the standards is the fair value option, which has been the subject of criticisms from the regulatory community. The BSP has taken bold steps on these issues. At the onset, we emphasized that all financial institutions under BSP supervision should comply with the provisions of the new standards in all respects in preparing their audited financial statements. However, we remained steadfast in our position that financial institutions should provide for both incurred and expected losses. In this regard, they have to comply and reflect the BSP recommended valuation reserves in the prudential reports or in the reports submitted to BSP. On the other hand, considering the amendments of the iasb on the fair value option provisions, we allowed financial institutions to use the said classification, subject to certain regulatory conditions such as: • Having an appropriate risk management system prior to initial application of the fair value option for a particular activity or purpose and on an ongoing basis. • The fair value option may only be used for instruments for which fair values can be reliably estimated; and • Financial institutions should provide BSP with supplemental information as may be necessary, to enable BSP to assess the impact of the financial institution’s utilization of the fair value option. The adoption of the standards does not only call for alignment of existing regulations with the provisions but also necessitates the establishment of the infrastructure for prudential financial reporting. In this respect, we have revised the manual of accounts and developed a new reportorial requirement for banks. The advantage of going through this exercise is that we, as regulators, were given an opportunity to design the reportorial structure to create a common platform serving all our information requirements. The amount of information that we will be able to generate from the new reporting structure will enhance our off-site supervision capabilities. The Philippine transition to IFRS is a consultative process involving the regulators, industry players and external auditors. The different perspectives shared in this endeavor helped us in understanding the principles behind the standards and the impact of adoption on our interrelated functions. Disclosures and good governance One of the key features of the standards is the overwhelming amount of disclosure requirements. This has made financial reporting a complex process. However, looking at the upside of it, these disclosure requirements will empower the stakeholders in making relevant decisions. The BSP believes that this uncovering of more information, will help us realize our vision of full transparency, which is one of the pillars of good corporate governance. Disclosures along with the other reforms that we have implemented such as requiring the board of directors to create corporate governance and audit committees, imposing more stringent fit and proper standards for the qualification and disqualification of bank directors, and requiring at least two independent directors in the board, among others, are keys in strengthening the confidence of the public in the financial industry. We believe that gaining the public’s trust is the cornerstone of development. Trust is what binds the components of an economy together. It creates a level playing field for all market players, which fosters an environment conducive to investments. Trust bestowed upon a system goes beyond the basic economic infrastructure. It gives an unwavering assurance that through progress or crisis, the public would remain committed to pull the strings for development. Challenges The adoption of the standards only provides the gateway to achieving good governance. Several other hurdles will bask along the way as we strive to reach this goal. Each discipline in the accounting profession would have its share of issues to resolve and responsibilities to carry out that would be vital for corporate oversight. Auditors would play a more expansive role in this undertaking. They would give us an independent view on how the risk exposures and other activities of the business ultimately affect the financial statements. They would keep watch over compliance with the standards and maintaining fairness and accuracy in the reports. Accountants in the academe are handed with the noble task of passing on the learning from one generation to the next to keep the same passion seamlessly running through time. Corporate accountants would document the evidence of evolution in accounting through their books and financial reports. The regulators on the other hand, would anchor the industry on prudent grounds amidst the changing standards and practices. An even greater challenge is to channel this harmonious interplay of responsibilities to a regional effort of establishing a common set of regulations similar to the Sarbanes-Oxley Act in the United States or the EC 8th Directive in Europe. This vision may already be in the drawing boards in some of the countries represented here or better yet this may stir a united stance to echo a regional commitment on corporate governance. Conclusion We are in the middle of a monumental evolution of accounting standards and other best practices. Let us not focus on the difficulties and complexities of change, rather let us take this opportunity to correct the mistakes done in the past, strengthen our fortress for growth and seize the chance for global convergence. I would like to congratulate the organizers of this event for this worthwhile endeavor. Thank you and I wish you all a successful conference.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, during the 50th Anniversary Celebratory Luncheon of Rang-ay Rural Bank, Inc. (Rang-ay Bank), Sevilla, San Fernando City, La Union, 14 January 2006.
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Amando M Tetangco, Jr: Turning challenges into opportunities Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, during the 50th Anniversary Celebratory Luncheon of Rang-ay Rural Bank, Inc. (Rang-ay Bank), Sevilla, San Fernando City, La Union, 14 January 2006. * * * Governor Victor Ortega and Mayor Mary Jane Ortega, officers and staff of Rang-ay Bank led by Chairperson Eufrosina Nisce and Rang-ay President Ives Nisce, co-workers in the banking sector and colleagues from the government sector, distinguished guests, ladies and gentlemen: Naimbag nga malem ‘yo amin (Good afternoon)! I am indeed honored to be among the witnesses of this momentous occasion. Thank you for this privilege of being with you in celebrating your 50th anniversary. Today, we all are witnesses to the realization of your founders’ vision 50 years ago. And it is certainly one exhilarating experience. This feat has significant impact to the banking industry and most especially to the community that Rang-ay has been serving for half a century. Thus, I also take this opportunity, to express Bangko Sentral’s appreciation to the entire family of Rang-ay, particularly for being consistently in congruence with all our policy and regulatory reform initiatives all these years. Rang-ay at 50 Rang-ay Bank has undoubtedly lived up to its name. It has been bringing progress or should I say “karangyaan” to the community it serves from the first moment it opened its doors as a pioneer private bank in San Fernando, La Union on January 16, 1956. Today, you understandably have the right to be proud of your accomplishments. The last time we looked, you are still this region’s number one bank and among the top 25 rural banks nationwide in terms of both physical and financial resources. Your strong presence in Region 1 as well as in the nearby Cordillera Region is made possible by your network of ten branches (including that of a former affiliate - RB of Burgos). You continue to enjoy the trust and confidence of over 15,000 depositors 1 whose savings are now close to half a billion. Likewise, you have a relatively strong capitalization of 120 million. Rang-ay’s risk-based capital adequacy ratio (CAR) of 18.5 percent is also well above industry and regulatory standards. Your total loan portfolio is nearly half a billion which accounts to 65.5 percent of your total assets. Your lending activities have surely provided farmers and other entrepreneurial rural folks with wider latitude in accessing credit which translated to better lives for the rural community. With your wide array of deposit products and credit lending programs, you managed to sustain bottom line figures at very good levels. Rang-ay’s performance definitely did not go unnoticed as evidenced by the various accolades from financial and non-financial organizations 2 , the Bangko Sentral included. As such, one can say that rang-ay is poised to further improve its level of efficiency to ensure continuous market leadership during these challenging but equally rewarding times. To date, the Rang-ay Bank has 1 head office, 9 bank branches and 1 affiliate bank (Rural Bank of Burgos, which will be consolidated with Rang-ay, Inc. following the grant of the certificate of authority to operate by the BSP Rang-ay received 1 award from the BSP, 7 awards from other banks, 1 award from Rural Credit and Guarantee Corporation and 3 awards from a private non-government organization (NGO). Industry outlook Let me therefore take the next few minutes to outline the banking industry prospects in 2006 to help you firm up your strategic plans for this year and beyond. We are optimistic that the rural banking industry will sustain its positive performance this year and remain in the forefront of reforms as catalysts of a broad-based development in the countryside. For our part at the regulatory front, the BSP remains committed to the continuous implementation of our reform program to sustain financial stability and growth. Specifically, our objective is to have a more stable, more efficient and a more depositor and friendly banking system. We are still advocating clean up of banks’ balance sheets through the expedient and innovative disposition of non-performing assets. This is central to restoring the credit supply to the productive sectors of the economy. Our goal is to bring the banking industry’s NPA/NPL ratio to single-digit level. As of end-June 2005, the rural banking industry’s NPA/NPL ratios stood at 11.9 and 14.7 percent, respectively. This is still double the pre-crisis period since the sale of NPAs under the SPV Law only created a small dent on the inventory of acquired assets arising from soured loans. We, thus, welcome the approval by the House of Representatives of the extension of the SPV Law 3 _ by another two years. We are hopeful that the senate will approve the counterpart bill soonest so that banks can immediately resume the wholesale clean up of bad assets. We expect that this extension will result in the unloading of at least another 100 billion in bad assets so that NPL ratio will more or less be lowered to about 7 percent. We are also studying if Joint Venture Agreements (JVA) can give greater flexibility to banks to dispose of their bad assets apart from availment of incentives under the SPV Law. The unloading of foreclosed real estate properties through joint venture agreements 4 (JVAs) that will develop and enhance the marketability of banks’ acquired assets, particularly undeveloped properties, will not only clean up banks’ balance sheets but also potentially boost the housing market and even tourism. Beyond asset clean up, the BSP is following through with its regulatory reforms aimed at further strengthening corporate governance, risk management and capital adequacy in our banks through a more effective and efficient enforcement. Last year, we began the changeover to International Accounting Standards/Financial Reporting Standards. This would further strengthen the current transparency and disclosure requirements in financial reporting. The pivotal role of external auditors during this transition period is also being given higher importance. Recently, we have issued new regulations on internal audit designed to adopt a code of ethics and establish mechanisms for the reporting of financial improprieties, malpractices and acts of misconduct (corporate whistle-blowing). We are also sustaining our lobbying efforts in congress for the passage of the amendment to the BSP Charter and the enactment of the Credit Information System Act. The first will make the BSP a more effective monetary authority and banking regulator while the other will pave the way for the establishment of a truly comprehensive credit information system that is expected to lower the cost of borrowing, provide greater access to credit in general and reduce the dependency on collateral based lending. Beyond regulatory initiatives, the BSP is also equally committed in its advocacy to promote a sustainable microfinance program as a tool to alleviate poverty. The present poverty situation in the Philippines has given rural financing a new dimension, concretizing the significant role of rural banks in countryside development 5 Toward this end, we have Target is first quarter of 2006 A proposal is currently under study for approval of the Monetary Board. Upon approval, this will initially allow U/KBs to dispose their Real and Other Properties Owned or Acquired (ROPOA)s to various JVAs with real estate developers. At present, ROPOA still accounts to 46.0 percent of the banking system’s overall level of NPAs. At present, there are 4 microfinance-oriented rural banks and 158 rural banks engaged in some level of microfinance with a total loan portfolio of P2.3 billion catering to a total of 441,963 borrowers. recently allowed the selective 6 lifting of moratorium on bank branching to facilitate the expansion of financial services in underserved areas. Under Circular No. 505, we foresee, among others; the growth of bank microfinancing to benefit rural folks with greater access to formal banking services that in turn, mobilizes savings and investments. Moreover, we foresee an accelerated consolidation process in the banking industry in the next 3 years. This will be brought about by (1) a stronger regulatory framework that will hasten the exit of weak banks, hopefully on a voluntary and market-based basis; (2) the increasingly stronger competition by new foreign investors coming in, in existing banks; and (3) the rigorous technical demands posed by modern banking and finance standards. All these changes will dramatically transform the competitive environment. Down the road, we see a banking landscape characterized by a handful of main banks complemented by an abundance of smaller banks that serve various well defined market niches. Final note In closing, let me call on this generation of the family behind rang-ay bank to transform these reform initiatives into opportunities and further stretch your vision over the next years to come. With your wealth of experience, rang-ay can lead in turning the heavy flywheel of remaining reforms for the rural banking industry. I trust that rang-ay will harness its core expertise, geographic advantage and strong ties with the community in promoting a safe, sound and responsive banking system. Let us all work together in keeping the wheels of change turning. Agyamannak (thank you) and happy anniversary! Prohibition on bank branching remains in the cities of Makati, Mandaluyong, Manila, Paranaque, Pasay, Pasig and Quezon including the municipality of San Juan.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the annual reception for the banking community, BSP Complex, Manila, 17 January 2006.
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Amando M Tetangco, Jr: New year message 2006 with an overview of 2005 Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the annual reception for the banking community, BSP Complex, Manila, 17 January 2006. * * * Introduction Members of the banking community, special guests from the legislative branch and the judiciary, members of the Cabinet, fellow workers in government, guests from the media, friends, ladies and gentlemen, good evening. It t has been a tradition for the Monetary Board to host an annual reception for the banking community. As Chairman of the Monetary Board and Governor of the Bangko Sentral ng Pilipinas, I am only one of your seven hosts tonight. Let me therefore introduce your six other hosts --- My fellow members at the Monetary Board, by order of seniority of their appointment: 1. Dr. Vicente B. Valdepenas, Jr…. He is an economist, educator, former NEDA Director General and holds the distinction of being a member of the Monetary Board for three terms now; 2. Mr. Raul Boncan… A lawyer and former trade & industry Undersecretary, banker, professional manager, and businessman; 3. Mrs. Juanita Amatong…An economist, educator, and former Finance Secretary, the first woman to hold this important post; 4. Mrs. Nellie Favis-Villafuerte…A lawyer, prolific writer, and former Undersecretary of Trade and Industry; 5. Budget Secretary Romulo Neri…educator and former Director General of the National Economic and Development Authority and of the House of Representatives' Congressional Planning and Budget Office; and last but not the least; 6. Mr. Alfredo Antonio…a professional manager and banker, former CEO of the Development Bank of the Philippines and the Subic May Metropolitan Authority. Ladies and gentlemen, we are the members of the Monetary Board….and we welcome all of you to our traditional annual reception As you may have noticed, we also have non-banker guests this is our way of saying thank you to the other sectors of our society who work with the Bangko Sentral ng Pilipinas in the pursuit of its mandate to ensure stable prices and a sound banking system . An Overview of 2005 All of you present here tonight are our stakeholders and we are happy to report to you that…. Even in the face of a challenging year marked by record high oil prices, rising global interest rates, political tremors and credit rating downgrades, we ended 2005 on a clearly upbeat note among others: • Our economy continued to grow; • We contained inflation at single-digit levels even with runaway oil prices; • the cost of doing business remained benign with a steady downtrend in interest rates, based on 90-day t-bill rates; • The peso emerged as best performing currency in asia; • Capital adequacy ratio of banks remained well above the international benchmark; • The asset base of the banking sector sustained its growth; • Asset quality of banks continued to improve with single-digit non-performing loan ratio; • Our poverty alleviation program through microfinance was recognized as excellent by the united nations, making us one of only three asian nations given that distinction; • OFW remittances hit their highest level; • Foreign investment inflows continued to rise; • A higher-than-expected bop surplus was registered; • International reserves hit record-high levels; and • The revised value added tax and sin taxes, accompanied by stronger tax administration efforts are showing positive results. If both fiscal discipline and higher revenues can be sustained, there is good reason to expect a balanced budget by 2008 In other words, ladies and gentlemen, we are off to a good start in 2006 For this, we must also acknowledge the significant contributions of my predecessor…. Former Bangko Sentral Governor Rafael Buenaventura…. As well as the other members of the Monetary Board during his term friends, Governor Paeng could not be with us tonight but let us applaud him and his MB members as a way of saying thank you for their unwavering commitment to initiate necessary reforms in our financial sector. What’s in store in 2006 The new year gives us a fresh opportunity to do things better, not only for our respective institutions but also for our country Of course, you and I know we have a long way to go before we can truly say everything is… a-ok more than anyone, you know. Our economic fundamentals: our strong points…. As well as other areas requiring more attention In our case, it is critical for the Bangko Sentral ng Pilipinas to keep an eye on the risks to inflation and to make such risks clear to the markets and the general public our main focus is to ensure that we achieve our inflation target, keep the public’s inflation expectations anchored and manage the growth in domestic liquidity The Development Budget Coordinating committee is looking at a real GDP growth rate of 5.7 percent for 2006, with growth driven by services, industry, and agriculture which stands to benefit from better weather conditions. The main risk we see for domestic demand is high oil prices, which have already taken some of the buoyancy out of consumer spending last year rising oil prices also continue to be the key source of risk to inflation, although the strong peso and the easing of food prices should help balance inflationary risks . While inflation may range from 7.5 to 8.2 percent, we see a downward trajectory given expectations of an easing of oil prices from peak levels in 2005 and a short-lived impact of the revised vat on prices of goods and services . Market interest rates are also expected to benefit from ample liquidity, improving fiscal performance, and better prospects for our sovereign credit rating at the same time, our external position is likely to continue to benefit from dollar inflows from remittances and investments with healthy inflows, the peso is likely to remain generally stable in the course of the year . Challenges and strategies In the months ahead, the task for economic managers will be to strengthen the economy in the short term….and to preserve the momentum for economic reforms that will sustain growth in the long term. At the BSP, our job will be to be more steadfast in fighting inflation and reforming the financial sector . In the area of banking supervision, our focus will be on reducing the stock of non-performing loans with the help of congress in extending the SPV Law; enhancing the prudential regulatory environment of the banking system to align it with international standards and best practices; strengthening corporate governance standards and market discipline mechanisms; developing the domestic capital market further; enhancing the payments system; and improving the BSP’s supervision technology and capacity . In the pipeline are the issuances of the guidelines on the implementation of Basel II Accord, and the new financial reporting package in line with the adoption of international accounting standards. While there will be initial friction costs related to the transition, these will strengthen the banking system for the long haul . To speed up the development and deepening of the domestic capital market, the BSP will continue to work with other government agencies and the private sector for the completion of critical market infrastructure to further enhance system integrity and overall market confidence And in response to the need to further enhance financial information critical to investor decisions, BSP will also continue to work on the establishment of rating agencies, highlighting their role particularly in the conduct of banks’ risk management in addition, we continue to work with Congress on the creation of a centralized credit information bureau system to help private enterprises get better access to credit, reduce borrowing costs, and minimize the risk exposures of financial intermediaries. Similarly, we will continue to work with market players to widen the investor base for domestic financial instruments. All these reforms require the support and cooperation of the banking sector the BSP therefore takes heart in having in the banking community a responsive partner and support force in shaping the future of our financial system . A special advocacy for the Bangko Sentral ng Pilipinas is our National Coin Recirculation Program. In this regard, we are particularly pleased that tonight, the entire banking sector is expressing its support for this crucial advocacy that stands to benefit consumers, retailers, banks, and the BSP In particular, we are happy that the Bankers Association of the Philippines, the Chamber of Thrift Banks, the Rural Bankers Association of the Philippines, the Bank Marketing Association of the Philippines, and the Philippine Retailers Association have declared their full commitment to support our Coin Recirculation Program under a Memorandum of Agreement for this purpose . We are also pleased that Archbishop Gaudencio Rosales of the hugely successful Pondong Pinoy, our inspiration for our coin program, is here with us to sign a Memorandum of Agreement for the servicing of its coin deposits. Under the adopt-a-parish program of the Bankers Association of the Philippines, there are initially three participating banks: Bank of Philippine Islands, Metrobank, and Equitable-PCIBank Ladies and gentlemen, this is definitely a fine way to start the new year: committing to work together for the greater good. Indeed, the translation of the final outcome of our reform programs should be sustainable growth and development to the man on the streets, it is jobs and income to the nation, peace and prosperity these are goals we should all work for the cooperation of everyone is of utmost importance. With your continuing support, we are confident of achieving greater gains in reforming and energizing the economic and financial system, as well as in keeping the transmission mechanism of monetary policy in high gear . Finally, on behalf of the Monetary Board and our co-workers at the Bangko Sentral ng Pilipinas, I wish all of you a fruitful, meaningful and a hugely successful new year! Marami pong salamat thank you all.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, during the 57th Inaugural Meeting of the Management Association of the Philippines, Manila, 24 January 2006.
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Amando M Tetangco, Jr: The Philippine economy - the continuing challenge Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, during the 57th Inaugural Meeting of the Management Association of the Philippines, Manila, 24 January 2006. * * * Introduction During the BSP’s annual reception for the banking and business community last Tuesday, I had one principal appeal to our friends. To make the best of our circumstances, achieve progress in our own spheres, so that in the end, the whole nation will be better off. Distinguished officers and members of the Management Association of the Philippines led by 2005 President Mon Paterno and 2006 President Evelyn Singson, colleagues from the BSP and the government, distinguished guests, friends, ladies and gentlemen, good evening. MAP’s theme for this year, “Call to action: Country above self”, happens to be in accord with my Tuesday’s appeal. We are all convinced that the must-do list for the Philippines is long, some of the items are structural while some would require streamlining of policies. Any and all efforts to address this must-do list are therefore quite crucial. The next best thing to do is precisely this – take action in your respective spheres of influence. As captains of industries – described by media as movers and shakers of our economy – you can truly generate tremendous benefits for our country and our people. Ladies and gentlemen, what you have selected as guiding theme for this year is exactly the mindset we want Filipinos to have: Country above self. If you can widen the reach of this message to cover as many Filipinos as possible, then you would be a part of a chain that seeks to improve the nation. Now, let me share with you some positive news on the economic front which give us reason to be more confident about our future. 2005 a most challenging year By most accounts, 2005 was a very challenging year for the Philippines. We had to contend with high oil prices, rising global interest rates, lower farm output, and non-economic tremors. Yet our economy, as measured by GDP, continued to expand. Sure, it wasn’t at the pace we aimed for, but our economy proved its resilience once again. The expansion in economic activity was achieved amid an easing inflation environment. Inflation has continued to ease since the second half of 2005, supported mainly by the softening prices of food and oil, and to some extent the stronger peso. Headline inflation has fallen to 7.0 percent in the second half of 2005. The average inflation rate for last year was 7.6 percent. More importantly, core inflation, which takes out the impact of volatile food and energy prices on the CPI, has steadily trended downwards. The decline in core inflation suggests that the inflationary pressures of the past year were not of a permanent, demand-driven nature. This fact supports the limited and selectively tightening bias of monetary policy. Another source of optimism is the improving fiscal performance. Coming from a very difficult period of large and persistent fiscal overhang, the government embarked on and succeeded in its initial efforts towards fiscal consolidation, by way of intensified tax administration and vital new tax measures as well as expenditure control. The National Government budget deficit stood at P146.5 billion for 2005, well below the target for the period. This figure also represents the lowest budget shortfall since 2001. As revenue gains continue with the VAT implementation, we stand a good chance of seeing a balanced budget by 2008. The positive investor sentiment over the progress made on the fiscal front as well as healthy inflows from remittances have also strengthened the external position. Latest estimates show that the overall balance of payments (BOP) position for 2005 stood at a surplus of US$2.4 billion, which is a welcome turnaround from the previous year’s shortfall. The peso likewise ended stronger against the US dollar on the back of the positive market sentiment and strong inflows. The peso ended 2005 as the top performing currency in the Asian region. This surge in dollar inflows also allowed the BSP to build up its dollar reserves. At US$18.5 billion as at end-December 2005, the country’s gross international reserves (GIR) is significantly higher than the US$17 billion target for the year and is sufficient to cover about 4 months’ worth of imports of goods and services. Meanwhile, the country’s external debt also narrowed to US$55.5 billion by end-September 2005. This amount continued to be made up mostly of medium- and long-term liabilities, which ensures that our debt payments remain manageable and sustainable. At the same time, the Philippine banking system continued to show improving soundness. As of November 2005, commercial banks’ non-performing loans as a percentage to total loans registered a single digit level of 8.7 percent. Growth in bank lending, however, continues to be modest (2.1 percent Nov.), but we expect it to rebound this year given the substantial progress achieved so far with sustained asset clean up. Having said this, I have to admit, the Philippines is not yet totally out of the woods. There are risks that we have to face and manage in the years ahead. We are sure, however, to move forward if we persevere. For us at the bangko Sentral ng Pilipinas, we are aware of the risks attendant to our primary responsibility of keeping prices stable. The Monetary Board had to respond promptly and carefully to these inflationary risks to the inflation target. In the course of 2005, we raised our policy interest rates by a total of 75 basis points and increased reserve requirements by 200 basis points. These were modest responses compared to other jurisdictions where their capacity is nearing to the brim and the labor market is stretched to the limit. Yet they were decisive, considering the demand pressures were limited and the second round impact was yet to emerge. By the second half of 2005, inflation had started to ease. Improving fundamentals, optimism and 2006 What then do we see in 2006. We continue to face uncertainties, but I believe the country’s improving economic fundamentals should give us a reasonable degree of optimism about 2006. Economic activity, for one thing, is likely to continue at a reasonable pace, driven mainly by the services and industry sectors. Nonetheless, the rise in oil prices over the past year is likely to take its toll on domestic demand, particularly on consumption spending. For this reason, the development budget coordinating committee is looking at real GDP growth in 2006 that is likely to be closer to the lower end of its target at 5.7 percent. As for inflation, it is expected to be higher in 2006, given the continued upside risks. Oil prices, for example, are expected to remain high relative to their historical trend and the RVAT is likely to exert, at least a short-term, upward pressure on consumer prices. Taking into account the recent easing of oil prices, as well as the strengthening of the peso, inflation is expected to hover between 7.5 and 8.1 percent in 2006. Let me point out though that we do expect an easing of inflation in the second half of the year, as the impact of the RVAT diminishes. Meanwhile, improvements in fiscal performance, ample liquidity in the financial system, and moderate credit growth are expected to mitigate the impact of inflationary pressures on market interest rates. There is also good reason to expect a strong external position this year. Dollar inflows, primarily from OFW remittances and investments, are expected to continue to come in. With healthy inflows, the exchange rate is poised to remain broadly stable in the course of the year. The continuing challenges to monetary and banking policies While economic performance appears to be on track, we remain watchful of the potential risks and challenges to the economic outlook. These risks include the following: (1) volatility in world oil prices; (2) a build-up of excess liquidity in the financial system; (3) possible exchange rate volatility due to excess liquidity; and (4) adverse shifts in the public’s inflation expectations. In the face of these challenges, the public can count on the BSP to make sure that these risks do not endanger our path to economic progress. The BSP will stay committed to its mandate of promoting low and stable inflation. The BSP is also committed to strengthening the financial sector through continued structural reforms. Foremost of these measures is the clean-up of banks’ balance sheets of non-performing assets. The clean-up will help spur credit and investment activity and create the basis for more sustainable growth in the medium term. Other key financial reforms will be focused on: (1) improving the BSP’s supervision technology and capacity; (2) aligning prudential regulation of the banking system with international standards and best practices; (3) strengthening corporate governance standards and market discipline mechanisms; further developing the domestic capital market; and (5) enhancing the payments system. Efforts are also underway for the implementation of Basel II accord and adoption of international accounting standards by local banks. These initiatives are designed to bring local banking practices in line with internationally accepted standards. In the area of capital market development, the BSP will continue its active collaboration with other government agencies and the private sector for the completion of much-needed market infrastructure to enhance system integrity and overall market confidence. We will likewise pursue further enhancements in financial information to guide investor decisions. A key effort in this area is the establishment of credit rating agencies. We are also working closely with congress on the establishment of a centralized credit information system to help private enterprises secure better access to credit, reduce borrowing costs, as well as minimize the risk exposures of financial intermediaries. The BSP also actively seeks to widen the investor base of the local financial markets through a number of new investment products which would better reflect market prices. These will help encourage more institutional investors such as insurance companies, mutual funds and pension funds to participate in the capital market. Future reform measures will eventually lead to the introduction of exchange-based products that can further stimulate market activity and deepen liquidity. The continuing challenge Let me sum up by saying that the near-term economic outlook suggests more vibrant economic activity, but there are potential obstacles on the way to sustainable growth. The critical task ahead is for us to focus, not just on macroeconomic stabilization in the short-term, but also on preserving the momentum for economic reforms to ensure sustained growth in the years to come. Consistent with map’s marching order, we need to act outside of ourselves. Most of the items on the must-do list will take time before these come into fruition. Reforming an economy is an enormous task, one that the government, even in theory, cannot do by itself. Governments govern, or better still, guide. But it is the economic and business community that creates commodities and services, builds the economy and competes in the global market. I take heart in the fact that our business leaders in MAP remain a stalwart partner of the government in making economic progress possible. Personally, I am optimistic that our hard work and resourcefulness will allow us to overcome our remaining economic problems. As a people, they say Filipinos have a knack for turning adversity into opportunity. My caution is that we should not always welcome adversity to be able to turn it into opportunity. I believe that by responding to the challenges with a deeper sense of purpose, by adhering to “country above self” as a guiding principle, we can reach our full potential. By all means, we have what it takes to succeed. The outgoing officers and board members of the MAP, congratulations on a job well done, and to the new officers, I wish you all the best! Thank you very much. Mabuhay tayong lahat.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the General Membership Meeting and Induction of 2006-2007 Officers and Directors, Bank Marketing Association of the Philippines (BMAP), Makati City, 26 January 2006.
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Amando M Tetangco, Jr: Working together for a better nation Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the General Membership Meeting and Induction of 2006-2007 Officers and Directors, Bank Marketing Association of the Philippines (BMAP), Makati City, 26 January 2006. * * * Distinguished officers and members of the Bank Marketing Association of the Philippines (BMAP), colleagues and friends in the banking industry, special guests, ladies and gentlemen: good evening! Thank you for this privilege of once again witnessing your first general meeting for the year and the induction of your newly elected officers. It is comforting to note that your 2006 officials are mainly re-electionists, led by your President Mr. Roberto Banaag. Your membership made a wise decision as this move ensures, among others, continuity and consistency of your programs and advocacies. We expect this to consequently translate to BMAP’s sustained support of the priority reforms that we, at Bangko Sentral, continue to implement for a more stable and dynamic, more efficient, more depositor- and customer- friendly banking system. BSP reform initiatives The BSP indeed has taken bold and decisive moves. We believe we have already mounted the appropriate regulatory framework for the prudent conduct of banking business in these challenging times through the reforms initiated by my esteemed predecessor. The next thing to do is to make this work. Foremost on our must-do-list is the alignment of existing regulations with international standards and the promulgation of policies more responsive to the growing competitiveness and sophistication of the financial services industry. We are now following through on the enhancements of regulations to strengthen corporate governance, risk management, and capital adequacy in our banks, which would be complemented with effective and efficient enforcement. In line with these commitments, the Monetary Board (MB) recently approved the issuance of three major regulations covering: • The new financial reporting package (FRP); • The guidelines on supervision by risk; and • The guidelines on information technology (IT) risk management The new FRP effectively amends the Manual of Accounts MOA) and revises the reportorial requirements for banks to align these with the provisions of the Philippine Financial Reporting Standards (PFRS) / Philippine Accounting Standards PAS). To the extent possible, we have integrated in the new FRP the requirements of the PFRS/PAS and the Basel 2 capital adequacy framework. The new FRP will also facilitate an enhanced off-site surveillance for the BSP on its supervised entities. On the other hand, embodied in the guidelines on supervision by risks are BSP’s expectations on how banks and other financial institutions should manage their risks. These are also designed to provide guidance on how the risk-focused supervision will be applied to these risks. Likewise, the guidelines on I.T. risk management are intended to communicate BSP’s expectation of banks in the area of I.T. risk management process. These would effectively identify, measure, monitor and control banks’ technology risk exposure. To ensure healthy competition and promote growth, we have also liberalized certain aspects of banking. We have lifted the moratorium on bank branching. We have opened up outsourcing possibilities and allowed an increasingly wide array of treasury, consumer and wealth management products. Many more meaningful changes in the banking industry can be expected this year and in the coming years as we further move to fully adopt international best practices. For instance, you will be seeing more binding standards on connected party transactions come into force after a 2-year transition period. There will also be more standards and better enforcement of risk disclosure and client suitability to better protect customers. Moreover, the BSP is coming out with a stricter “fit and proper rule” to ensure that officials tasked to manage banks and other financial institutions possess the required integrity and competence. These regulatory enhancements will naturally affect the conduct of banking in our land. Banking prospects in 2006 We envision a banking landscape dominated by a handful of major banks complemented by many smaller banks that serve various well-defined market niches. We expect an accelerated consolidation process in the banking industry in the next 3 years that will be principally driven by: 1. a stronger regulatory framework that will hasten the exit of weak banks (hopefully on voluntary basis); 2. the increasingly stronger competition by existing foreign banks and new foreign investors coming in into existing banks; and 3. the rigorous technical demands posed by modern banking and finance standards. We also see parallel exciting developments in the capital market. The BSP will continue its active collaboration with other government agencies and the private sector for the completion of muchneeded market infrastructure to enhance system integrity and overall market confidence. In the end, our vision is that all these changes in the capital market will provide: • A richer array of investment opportunities for the public, • Greater funding flexibility for public as well as for the private sectors; • Greater scope for interest rate risk management, and • More reliable signaling mechanism for pricing financial assets BSP’s own transformation process We are complementing the industry’s transformation process with our own. In fact, we are in the process of fully adopting a consolidated and risk-based supervision approach. International best practice on banking supervision has adopted this approach primarily because of its more forward-looking orientation rather than the after-the-fact view of traditional supervision. Accordingly, the focus of our attention now is on the most significant risks within a particular financial institution and within the industry as a whole. Consistent with this new approach, we are reorganizing the BSP supervision and examination sector. We expect to generate benefits particularly in terms of operational efficiency, cost efficiencies, as well as greater value-added to BSP supervised entities through better-focused post-examination recommendations. We are also continuing our lobbying efforts in congress for the amendment of the BSP charter. This will make the BSP a more effective monetary authority and banking regulator. We are likewise strongly advocating for the enactment of the Credit Information System (CIS) Act, which will pave the way for the establishment of a truly comprehensive credit information system. This is expected to lower the cost of credit, provide greater access to credit in general, and reduce the dependency on collateral-based lending. Toward a seamless supervision of the BSP’s supervised and regulated entities, we are also further strengthening our ties with our co-regulators, both here and abroad. I am happy to report that we are making real progress on various initiatives being undertaken under the umbrella of the financial sector forum (FSF). Discussions during the sixth FSF meeting centered on programs aimed at deepening consumer literacy and further strengthening of coordinating arrangements between and among the member agencies (SEC, BSP, OIC and PDIC). The Financial Sector Forum, through its Consumer Protection and Education Committee (CPEC), shall mount a consumer protection and education campaign plan. This plan aims to equip consumers with adequate, timely and relevant information about financial products and services, not only for their protection but also for maintaining the stability of the financial sector. This is a specific area where the expert assistance of BMAP will be most welcome. Actually, we are counting on BMAP to respond to this campaign with the same vigor and dedication as it did to our call for the crafting of a consumer code in the Philippines. The BSP attributes to BMAP’s strong political will the expedient launching of the “Service code for consumer banking in the Philippines” in October 2005. (Only 14 months after BSP challenged the industry to make one for the Philippines). The FSF, through its Reporting, Information Exchange and Dissemination Committee (RIED), has also moved to supplement its current Memorandum of Agreement (MOA) covering bilateral information exchange among FSF members. The amendments will allow the establishment of an overall framework for the exchange of relevant reports and/or data which in turn shall facilitate the development of comprehensive statistics on the financial system. To address cross-border supervisory issues, we have already established contacts with our foreign counterparts in ten (10) countries where Philippine banks also operate. Two of them, the China Banking Regulatory Commission and the Nederlandsche Bank, have already made commitments for the exchange of information on areas of common interest as supervisory authorities. Meanwhile, we are confident that we shall be able to see the fruits of our negotiations for the adoption of a minimum set of ground rules for the exchange of similar information with the remaining eight foreign supervisors 1 . A call for support BMAP, together with the other captains of the banking industry, has undoubtedly made significant contributions towards the realization of many of our reform initiatives. However, we still have a plateful of them to complete. We believe that BMAP remains strategically positioned to continue to enlist the support of industry primemovers in these endeavors. You have the power to promote synergy amid a mixture of divergent plans to achieve our shared vision for the banking industry and for our country. We look forward to another year of closely working with you. Once again, congratulations to your officers! Thank you very much. Mabuhay tayong lahat. Namely: Monetary Authority of Singapore, Hong Kong Monetary Authority, Germany’s Federal Financial Supervisory Authority (FFSA), Taiwan’s Financial Supervisory Commission, UK’s Financial Services Authority, Japan’s Financial Services Agency, and the US Federal Reserve Bank
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 4th National Convention, Chinese ¿ Filipino Business Club Inc, Manila, 9 February 2006.
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Amando M Tetangco, Jr: The Philippine economy: developments and prospects Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the 4th National Convention, Chinese – Filipino Business Club Inc, Manila, 9 February 2006. * * * The officers and members of the Chinese-Filipino Business Club, Inc. led by President Rufino Ko Pio, special guests, ladies and gentlemen, good afternoon. Thank you for inviting me to join you at your 4th National Convention. I am truly glad for this opportunity to be with you. Chinese-Filipino businessmen represent a very important segment of the Philippine economy. You have a unique place in our economy as you personify the convergence of the best from two cultures: the highly admired Chinese work ethic combined with Filipino ingenuity. This formidable combination has given wings to a strong entrepreneurial spirit that has helped strengthen the backbone of the Philippine economy. I am pleased therefore to give you an overview of how our economy performed in 2005, the developments that can affect your business and how we at the Bangko Sentral ng Pilipinas see the prospects for the Philippine economy. Later, we can have a discussion on economic issues of particular interest to you. Recent economic developments I will now give you a brief overview of recent economic developments. We had to deal with many challenges in 2005. Among others: we had to grapple with the impact of record high oil prices; slower growth in exports; the El Nino weather phenomenon which stunted the growth of agricultural output; credit ratings downgrade; and domestic political concerns. And yet, in the face of all these, our economy proved its resilience and fundamental strength. Our domestic economy, as measured by gross domestic product, continued to expand and managed to grow by 5.1%. As businessmen, you know that achieving such growth, in a year marked with challenges, did not happen by chance; it resulted from the continuous implementation of a comprehensive economic reform program involving both the government and the private sector. Part of this reform program is fiscal consolidation, which is now generating benefits for the country. The combined effects of government’s cost cutting programs, improved tax collection efforts, and higher revenues from sin taxes and the EVAT, brought down the government’s fiscal deficit in 2005 to P146.5 billion, substantially lower than the programmed deficit of P180 billion. This has led government to say that it is now possible for us to have a balanced budget by 2008. When this happens, our government will no longer be compelled to borrow money to finance its regular operations. This is an important step in our effort to reduce the share of debt payments to the national budget; this will allow us to spend more for infrastructure that supports economic growth and basic services that improve the quality of life of Filipinos. It is also noteworthy that we were able to keep inflation at single-digit levels in spite of record high oil prices and sustained economic growth. From 8.4 percent at the beginning of 2005, headline inflation fell to 6.6 percent by year-end, due mainly to declining food prices, the easing of oil prices from record levels, as well as the appreciation of the peso against the US dollar. The country’s external position also strengthened in the past year. Overall balance of payments position for 2005 stood at a surplus of US$2.4 billion, a turnaround from the previous year’s large deficit. This was made possible by overseas Filipino workers whose remittances in 2005 reached nearly $11 billion, the highest on record; higher investment inflows also contributed to this surplus. By December 2005, these dramatic surges in remittances and investments allowed the Bangko Sentral ng Pilipinas to build up its international reserves to its highest yearend level so far: at $18.5 billion. In January 2006, our international reserves breached $20 billion for the first time ever, with the addition of proceeds from loans obtained by the National Government and BSP’s investment income from abroad. Meanwhile, the country’s external debt as of end-September 2005 dropped from the year-ago level, with medium- to long-term debt accounting for almost 90 percent of the total. This indicates better manageability and sustainability of our external debt. Another positive development is the continuous improvement in the soundness of our banking system. As a whole, our banking sector is well-capitalized, with capital adequacy ratio well above the international standard. At the same time, asset quality of banks continued to improve with nonperforming loans of universal and commercial banks at 8.74 percent as of November 2005. This is the lowest level in more than seven years. Altogether, these positive economic trends have boosted confidence in the economy, as reflected in an increasingly stronger peso. In fact, our peso emerged as the top performing currency in Asia in 2005. Outlook for 2006 In the light of our better-than-expected economic performance in 2005, we are confident we will be able to achieve our targets this year. Among others, we expect our economy to continue to expand at a reasonable pace, led by services, industry, and agriculture sectors. Nevertheless, since oil prices continue to be a concern, GDP growth rate, according to the DBCC, may range between 5.7% and 6.3%. Inflation is seen to rise slightly early this year, as a result of high oil prices and the vat rate adjustment. However, the continued stability of the peso should help cushion its impact. In the second half of 2006, we expect inflation to follow a decelerating trend as cost-push pressures subside. Meanwhile, market interest rates are likely to remain stable during the year, due to improving fiscal position of the government, ample liquidity in the financial system and projected modest growth in bank lending. On the external front, dollar inflows from OFW remittances and foreign investments are expected to remain strong in 2006 as deployment of more workers escalate and as more high-salaried workers get jobs overseas. This should boost our external position and further build up our gross international reserves. It also underpins our expectations of a generally stable peso in 2006. Policy directions For the BSP, our principal thrust over the near term will be oriented towards responding to inflationary risks and delivering price stability over the policy horizon. The BSP will also intensify its efforts to strengthen the financial system, further enhance the effectiveness of its supervision and regulation of banks, and help promote the development of the domestic capital market. We will continue to foster an environment that will facilitate further disposal of banks’ non-performing assets. For those of you in the market for real estate, I recommend you take a look at the nonperforming assets of banks that are up for sale. The rates are attractive for buyers as banks now conform with the risk-based provisioning required by the Bangko Sentral. Our policy is to require banks that take on more risks, to have correspondingly higher capitalization. The asset cleanup of banks should spur credit and investments, thereby creating the basis for more sustainable growth in the medium term. Other key financial reforms will focus on aligning prudential regulation of the banking system with international standards and best practices, strengthening corporate governance standards as well as market discipline mechanisms, and further enhancements on our payments system. In the area of capital market development, the BSP will continue its active collaboration with other government agencies and the private sector for the completion of necessary infrastructure that would enhance system integrity and overall market confidence. The operation of the fixed income exchange and the implementation of the third-party custodian scheme are part of the initiatives to accelerate the development of the domestic capital market. This is a priority program as a deep, dynamic and liquid domestic capital market will provide a valuable alternative source of funds with less foreign exchange risk. We will also continue to lobby for the passage of key legislation aimed at developing the local capital market and strengthening our regulatory authority. In addition, we are working closely with Congress on the creation of a centralized credit information bureau system and the establishment of credit rating agencies. These should enhance the quality of financial information available to investors, enhance private sector access to credit, and minimize exposure to risks of financial intermediaries. The Bangko Sentral will also continue to promote microfinance, as its flagship program for poverty alleviation. The collateral-free loans, ranging from P5,000 to P150,000 have been effective in providing our entrepreneurial poor, or what we call the e-poor, with much needed capital to start a microenterprise. So far, banks have provided microfinance to more than 750,000 borrowers. Some of you may be surprised to know that the average repayment rate of our e-poor on their microfinance loans is 98%! This is so much better than the repayment record of banks from their major borrowers. In fact, microfinance is now a source of profits for many banks. I hope your organization can also provide support for our microfinance program. For instance, you can teach our entrepreneurial poor the basic principles of running a profitable business, in other words share some of the secrets of your success. By doing so, we will be able to liberate more of our countrymen from poverty. I am pleased to inform all of you that the microfinance program of the Philippines has already developed a good success record. In fact, no less than the United Nations gave an award to the Philippines for its institutional approach to microfinance, which makes it responsive to its e-poor clients and ensures its long-term sustainability. I hope this inspires you to join us in promoting microfinance to alleviate poverty in our country. Concluding remarks Ladies and gentlemen of the Chinese-Filipino Business Club, there is no doubt, we have made solid economic gains; even foreign media have taken notice. For instance, the International Herald Tribune noted that investors are now looking to the Philippines, often shunned in the past for being "The sick man of Asia." And while there is still much that we need to fix in our economy, we can do this better and faster if the government and the private sector will cooperate and work more closely together in making our economy efficient and more globally competitive. The success of policymakers’ efforts to sustain economic growth ultimately depends on the support of the private sector; you and I know, government cannot do everything on its own. In this regard, I commend the tireless efforts of industry groups such as the Chinese- Filipino business club for its role in keeping the economy healthy and buzzing with activity. Moreover, I congratulate your organization for its spirit of volunteerism in supporting community projects. May your tribe increase. It is my hope that you will become even more proactive in ensuring the long-term growth of our economy. Finally, I wish the leadership and members of the CFBCI good health, wealth and good fortune, at all times. Marami pong salamat.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Testimonial Luncheon of the AB Capital and Investment Corporation, Makati City, 1 March 2006.
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Amando M Tetangco, Jr: Towards a shared vision for capital market reforms Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Testimonial Luncheon of the AB Capital and Investment Corporation, Makati City, 1 March 2006. * * * Distinguished directors, officers and staff of the AB Capital and Investment Corporation led by Chairman and Chief Executive Officer Ramon R. Del rosario, Jr.; President and Chief Operating Officer Francis M. Varela; former President Filomeno G. Francisco; ladies and gentlemen: Good afternoon! Congratulations on your 25th year anniversary! It is indeed an honor for me to join all of you today as you celebrate this momentous occasion. For more than two decades, AB Capital and Investment Corporation has positioned itself as a prominent player in the capital market industry. Specifically, you have carved your place in corporate finance, fixed-income securities dealership, stock brokerage and fund management. You also hold a creditable track record in equity and debt securities underwriting, having acted as issue manager and/or lead underwriter for several of the country’s most prestigious and most successful debt and equity offerings. It’s no wonder you have earned various local and international distinctions for your financial savvy backed by a solid financial standing, as well as for your significant contributions to capital market development. I am positive that you owe much of this success to the competence and foresight of your leaders and the dedication and zeal of your workforce. In the pursuit of your institutional aspirations, you also have significantly contributed to our shared goal of promoting stability and efficiency in the Philippine financial system for a sustainable economic growth. In return, let me take this opportunity to share with you our continuing reform initiatives which could be useful guideposts in fine-tuning your chosen path. The economy at a glance To put things in perspective, let me start with an overview of the economy. In 2005, the economy proved its resilience and fundamental strength, despite the prevailing difficult macroeconomic conditions. The country’s economic performance is benefiting directly from improving fiscal discipline and sound monetary policies. For 2006, we expect to keep the momentum going. We realize, of course, that sustaining economic growth over the long term would depend, to a large extent, on the resilience of the financial system which forms the backbone of the economy. Thus, we are taking parallel actions on key fronts. The promotion of a sound and stable financial system is the centerpiece of this agenda. Within this framework, the development of the Philippine capital market is being given high priority alongside the continuous reform of the banking system. Capital market initiatives Already underway is a series of reforms in the Philippine capital market intended to: create a sound market infrastructure, enhance transparency and market discipline mechanisms, promote greater investor protection, and strengthen the legal and regulatory framework. Toward this end, the following are some of our key contributions: Delivery of securities In July 2003, the BSP issued regulations mandating the proper delivery of securities by dealer banks and non-banks to the investor. This is meant to promote transparency and discourage proliferation of manipulative practices. Accreditation of third party custodians The BSP subsequently issued regulations on the pre-qualification criteria for banks and NBFIs that will operate as securities custodians and defined the functions and responsibilities of each. It is important that we develop the custodian as an important agent in the capital market that can facilitate the lending and borrowing of securities. Market infrastructures The BSP also supported private sector-led initiatives to establish a fixed income exchange (fie) intended to improve the current market infrastructure. The fie centralizes trading of securities for enhanced transparency and efficient price discovery. At present, transparent pricing has been achieved for the interdealer market, as quotations are available on a per security basis, and executions are at the best bid and offer. In the future, we hope to see efficient price discovery for the common investor in the public market phase, as price and trading data will be made available on a timely basis. Expansion of the menu of financial products The domestic capital market remains shallow and underdeveloped. In response, the BSP has issued various circulars diversifying the menu of financial products available in the capital market. Traded papers like unsecured subordinated debts (as tier 2 supplementary capital), long-term negotiable certificates of deposits or LTNCDs, documented repos, and securitization structures create marketoriented opportunities for banks and other players and deepen the capital market. Recently, we have issued circular 503, amending the guidelines on risk-based capital framework to include Hybrid Tier I instruments as part of qualifying capital. Hybrid capital instruments that have equity-like features enable them to absorb losses similar to common equity. However, these instruments must be perpetual and redeemable by the issuer subject to prior BSP approval. Moreover, we have also started revitalizing the trust business to widen investor base with the gradual phase out of Common Trust Fund (CTF) for a better product called Unit Investment Trust Fund (UITF). Uitfs enhance the credibility of pooled funds to investors as the value of investments is mark-tomarket, paving the way for long-term investment opportunities. Credit rating agencies We are encouraging the entry of more rating agencies. Rating agencies play an important role in guiding investors towards informed decision-making and in ensuring the proper disclosure of investment information. Accordingly, we have issued circulars which set the criteria for accreditation of domestic and international credit rating agencies. To date, the BSP has authorized one domestic credit rating agency to issue ratings for bank supervisory purposes. Likewise, we have recognized one internationally accepted credit rating agency with a representative office in the Philippines to undertake local or national credit ratings. Legal and regulatory framework We are also advocating the passage of key legislative measures that will spur the development of the capital market and strengthen the regulatory framework. A key priority is the approval of the extension of the Special Purpose Vehicle (sPV) law for another two years to complete the cleanup of Non-Performing assets (NPAs) in the banking system and restore credit supply to the economy. Following a succession of asset dispositions under SPV I, Bnks’ NPL/NPA ratios declined to singledigit levels. As of end-December 2005, NPL/NPA ratio of the commercial banking system stood at 8.5 percent and 8.6 percent, respectively. 1 We will also continue to lobby for the enactment of the credit information system act that will establish a central credit information system for improved discipline in the credit process. Credit bureaus will be able to serve as a reliable source of information to allow lenders to accurately evaluate risks and select between creditworthy and poor-quality borrowers. Another vital legislation is the Revised Investment Company Act (RICA) that will establish a comprehensive regulatory framework to enable investment companies to play a key role in capital formation. Moreover, this bill is aimed at protecting the interests of the investing public by preventing the misuse of customer funds. Other legislative measures that we would like to see enacted in the near term are the Personal Equity Retirement Account (PERA), the Pre-Need Code and the Corporate Recovery Act. With these reforms in various stages of implementation and others more that are in the pipeline, we can expect better prospects for the growth of the Philippine capital market. Undoubtedly, the continuing support of all financial industry players will ensure for us greater success in this endeavor. As a final note, I call on you to assist us in fostering an environment conducive to a vibrant domestic capital market. You are, undoubtedly, one of the major players in the capital market today. We will be relying on your experience in helping provide order and depth in the market. Although the road ahead is considerably tough, I am confident that AB Capital - armed with vision, a strong resolve and with sound leadership at the helm - will be more than prepared to meet the challenge. Let us all do our share in responding to the call for building a deep, dynamic and liquid capital market a precondition for achieving sustainable economic growth. Once again, happy anniversary and I wish you all more success in the years to come! Comparatively lower than the 12.7 percent NPL ratio and 11.4 percent NPA ratio as of end-December 2004.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Induction of Officers of the Philippines Electronics and Telecommunications Federation, Inc. (PETEF) and the Information Technology Association of the Philippines (ITAP), Makati, 13 March 2006.
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Amando M Tetangco Jr: Outlook on the country's economic condition and the role of information technology to uplift economic growth Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Induction of Officers of the Philippines Electronics and Telecommunications Federation, Inc. (PETEF) and the Information Technology Association of the Philippines (ITAP), Makati, 13 March 2006. * * * Good evening, ladies and gentlemen. I am honored and pleased to be a part of tonight’s event - the joint membership meeting and induction of the officers of the Philippine Electronics and Telecommunications Federation, Inc. (PETEF) and the Information Technology Association of the Philippines (ITAP). Congratulations to all of you. Special thanks should go to Miss Cynthia Mammon, ITAP’s indefatiguable Director and Chair for Events, whose persistence in finding a suitable schedule for us has caused my being here tonight possible. Your two organizations, under the leadership of your presidents, Mr. Renato Garcia for PETEF and Ms. Dittas Formosa for ITAP, together, play a pivotal role in the fulfillment of the government’s thrust to harness the benefits of the phenomenal improvements in Information and Communications Technology or ICT. Information has always played a vital role in our history. Society has used information to gain a more accurate picture of any situation it is in, make better decisions for the future, and improve the quality of life in general. But never before has information been more accessible than it is now. To illustrate, let me quote Bill Clinton, the 42nd President of the United States speaking at the announcement of their Next Generation Initiative in 1996. Mr. Clinton said, “When I took office, only high energy physicists had ever heard of what is called the world wide web… Now even my cat has its own page!”. That, was only a little over 10 years ago. Since then computers have progressively become smaller, more powerful, and more affordable. We are now linked by cell phones, fiber optic cables, the internet, and and satellites. One can access information about almost anything (even about Bill Clinton’s cat) with just the flick of a button. Increased accessibility of information as we are now experiencing, however, is not the end. Information and the manner in which it is disseminated must be employed for useful, productive purposes and attuned to economic development. Objective For tonight, I would like to begin by situating us in terms of the monetary, external and banking sectors of the economy. Then I would like to make a few suggestions for areas where I believe ICT can be most useful in the context of these sectors of the economy. Business outlook Based on the most recent business and consumer surveys of the BSP, both the business sector and the households continue to be positive on the economy and anticipate better times ahead for us. The sustained appreciation of the peso, lower interest rates and the improved fiscal position as well as the favorable employment conditions here and abroad are reasons cited by the business sector for its confidence and Filipino household for their heightened willingness to consume more. On the inflation front - the February inflation rate of 7.6 percent, although higher than the January figure, is within the BSP’s forecast range for the month. Thus, the rate is still consistent with our projected path for inflation, which shows a decelerating trend beginning the second half of 2006. This and the prevailing conditions in the economy have provided a room for the BSP to keep its policy rates steady during last week’s policy rate setting meeting. Now moving on to an area, which I know everyone has a keen interest in – the peso. Our outlook for that continues to also be positive, given that the underlying sentiment prevailing in the market remains constructive, arising from the sustained healthy economic fundamentals and the successful implementation of key economic reforms. These improvements in the external sector have allowed us to build up the country’s gross international reserves to over USD 20 billion for the first two months of the year, which is sufficient to cover 4.3 months of imports of goods and payments of services. On the banking sector – we continue to push towards the clean up of banks’ balance sheets. The latest NPL ratio of banks remains at single digit level, 8.4 percent. In addition, we continue to pursue the extension of the SPV Law that will enable banks to further off-load non-performing assets to the market. Role of Information Technology to uplift economic growth. Given this upbeat scenario, what role do I see for ICT in fostering economic growth? E-reportorial requirements Let me begin with the banking sector. Since the enactment of the e-commerce law in 1999, the BSP has taken to task the promotion of electronic transations. We began by simplifying bank reporting and providing guidelines for the electronic transmission of the same to the BSP. We have systems in place for the electronic transmission of reports to us not only by the big commercial banks but the thrift and rural banks as well. In order to better appreciate the reports and data gathered from the banks and utilize these to supervise them in a more proactive way, the BSP embarked on a data warehousing project. To fully automate the project, the BSP is procuring an integrated financial reporting portal system that will allow BSP-supervised banks to send/upload reports to BSP and retrieve/download processed reports from BSP using mutually acceptable secured channels of communication. Reaching out to the rural areas An area that your association may be of help to us in this regard is encouraging through your education campaigns and drives the smaller thrift and rural banks to be more e-savvy. There are over 700 rural banks scattered all over the country but only about half have email facilities and about the same number have in-house developed systems. You may want to consider e-enabling the regional areas as there is already a heavy concentration of applications in the mega-metro manila area and other major cities. For the BSP’s part we developed the “Integrated Regional Information System” (IRIS) which allows the branches of banks in the countryside to conduct electronic transactions with BSP such as cash deposit, withdrawal, FX purchase, peso exchange, and rediscounting of loans and payments. IRIS has been implemented in three BSP regional offices and 5 regional units, and is expected to be fully deployed in the remaining BSP branches by the 3rd quarter of 2006. IT risk management With the increasing applications of technology to banking services comes increased exposure of banks to technology-related risks, including operational, reputational, and strategic risks. To help mitigate these, the BSP recently put out guidelines for technology risk management. The BSP established these guidelines to ensure that the knowledge and skills necessary to understand and effectively measure, monitor and control these risks are in place. Anti-money laundering efforts In addition to risk management, you may also partner with financial institutions in the anti-money laundering efforts of the government. Under the Anti Money Laundering Act, as amended (AMLA), covered institutions, i.e., financial institutions that are supervised by the BSP, the SEC and the Insurance Commission, are required to electronically report to the AMLC all “covered and suspicious transactions”. While the AMLC has established its own Monitoring and Analysis Systems (TMAS) to receive, analyze and store all prescribed e-reports to the AMLC, banks still hold all the other necessary information on their clients beyond the reporting requirements of AMLC. Covered financial institutions may be looking for partners to assist them in developing systems that will create an environment which would institutionalize red flag indicators for suspicious transactions, and thus facilitate not only their reporting to AMLC, but also their own internal surveillance requirements. These are just some of the recent undertakings in the banking and financial sector where you may find that your collective expertise as associations could be employed. Business opportunities: e-marketing I mentioned at the beginning of my talk that the BSP’s recent surveys show optimism from both the consumer and business sides of the economy. Your associations should be able to build on that. I sincerely believe that the optimism in these sectors, and in the marketplace in general, is getting more deeply entrenched. And you should harness that. A particular advocacy of the BSP is micro-finance. Recently, because of the good repayment experience of banks from micro-finance lending, banks have increased exposure to this segment of borrowers. The extension of loans for micro-finance has ceased to be the monopoly of thrift and rural banks, as the big commercial banks are now finding out that lending to micro-finance and SME’s is very profitable. You have a great role to play here. You can connect the artisans and cottage industries to the market place. An example of this successful use of the ICT as cited by the United Nations is a Filipino website, Global Echo, which sells not only quilts and blankets woven by women in the rural areas, but also teaches other developing countries to use the internet to become more self-sufficient and eliminate middlemen in reaching their markets. There are many other similar applications where you could partner with financial institutions. Conclusion As I have painted a positive picture of the economy to you, I challenge you here tonight to maximize the benefits of Informtion and Communication Technology, by e-enabling a greater part of our nation, reaching out not only to the obvious and traditional markets but enlarging your scope. Your associations, more than any other, know that the government cannot do everything. We need partners that can assist us not only directly through the areas that I have outlined before, but also indirectly through the crafting of enabling laws that would foster an environment that would encourage ICT to flourish positively. Let me end with a quote from noted author, Sir Arthur Clarke, “Any sufficiently advanced technology is indistinguishable from magic.” Ladies and gentlemen, I am excited to see that time when we would have fully seized the benefits of information technology, for then it would be truly “magical”. Once again, my warm congratulations to the officers of PETEF and ITAP. Magandang gabi po sa inyo at mabuhay tayong lahat.
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Speech by Mr Amando M Tetangco Jr, Governor of the Central Bank of the Philippines, at the Oath-taking of the officers and directors of the Economic Journalists Association of the Philippines, Makati City, 17 March 2006.
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Amando M Tetangco Jr: Transparency and communication in central banking Speech by Mr Amando M Tetangco Jr, Governor of the Central Bank of the Philippines, at the Oath-taking of the officers and directors of the Economic Journalists Association of the Philippines, Makati City, 17 March 2006. * * * President Vicente Lopez of the Economic Journalists Association of the Philippines, distinguished officers and members of EJAP board, special guests, friends, good evening. It is always a pleasure to attend gatherings of the media. It is where you hear the stories behind the stories that finally make it to the newspapers and broadcast stations. It is where you gain clarity as to why certain stories are angled in a particular manner. At the same time, attending media gatherings is also quite challenging. As they say, communications is a two-way street. Thus, if you receive, thou shalt also give. Personally, I have also provided insights behind certain news reports…in some cases, off the record or simply not for attribution. The objective is to ensure that a story is placed in the proper context or perspective so as not to mislead…or misinform. Mutual respect is essential to maintain a professional relationship. We at the Bangko Sentral ng Pilipinas are fortunate that our relationship with the media in general and… in particular, with the members of the BSP Press Corps, past and present, have been cordial and professional. I believe the professional manner by which journalists have been covering and reporting on the Bangko Sentral is partly responsible for the consistent positive ratings we get in surveys of government agencies. We thank you for this. I have been told…several times….that it is not easy to report on the Bangko Sentral because the language or the jargon we normally use have to be interpreted and laymanized, so to speak, to be understood by the general public. A journalist who was not a business writer, but ended up covering BSP for a day, described the press statement he got…that it might as well have been in German or Greek! He couldn’t make heads or tails of it….and therefore could not appreciate the significance of the announcement. Fortunately, for both of us, he was humble enough to admit he could not understand it…and therefore received an explanation. As a result, he came up with a story that was accurate and easy to understand. At this point, I want to assure all of you that we have been doing our best in making our statements better and easier to understand and I have to acknowledge that the news stories I read in the newspapers the next day are generally better written, and easier to understand. We also appreciate that there is always an attempt to contextualize and provide a perspective on the impact to readers. The challenge for government agencies like ours is to constantly find better ways of communicating and reaching out to you. You are our link to the public and it is our responsibility to make sure there is proper understanding of our policies, programs, and pronouncements. This is the reason why we have been making ourselves accessible to you. If you have noticed, we have been conducting more regular briefings, responding promptly to requests for interviews, answering your calls and text messages, and at times, even providing written responses to your questions. But beyond these, we are going to institutionalize a series of briefings on Central Banking 101 and how our policies influence and affect the other sectors our economy and ultimately our people. We are also ready to prepare special briefings on particular topics you may request, including the new accounting standards, Basel II, inflation targeting and understanding the dynamics of foreign exchange. We can make this program available not only to members of the BSP Press Corps but also to other members of EJAP who wish to be updated. I hope we will have good attendance and participation in these briefings. A wise Central Bank Governor once said, “Good politics is good economics, and good economics is good politics”. Let me add a third element that serves as the key to bridging politics and economics: good information. I understand the EJAP is now twenty years old. Over this time, the economic consciousness of our people has been raised because of the media in general…and you, the economic journalists in particular. The members of the EJAP can rightfully claim that you are instrumental in encouraging economic policy discussions that have led to the crafting of good policies and programs. Now, we could go into a debate of what is good economic policy discussion or simply noise…. But that I shall leave for a more philosophical conversation at another time…. I feel very strongly about the role that you, as economic journalists, play in communicating our policies. As I said earlier, good information translates to good economics. This is certainly the right forum for me to talk about a topic of growing importance to central banks – “Transparency and Communication”. Transparency broadly relates to the openness of a central bank in making explicit its monetary policy decisions and explaining the reasoning behind them. From a strategic perspective, it also encompasses clear communication of the longer-run objectives and strategy of monetary policy. Through your insightful reporting, you actually help us operationalize our communication policy at the BSP. In the past, there has been a general view that central banks tended to operate with considerable secrecy and mystery. However, over the past decade or so, most central banks have moved towards increased transparency and greater communication in the conduct of monetary policy. A brief look at the developments in financial markets and the conduct of central banking in recent decades will show that this trend developed partly out of necessity. What are these developments? First, it has become increasingly clear over the last few decades that central banks need to have a considerable degree of independence to ensure consistency in the implementation of monetary policy over time. But along with a high degree of independence, central banks are required to be transparent to establish accountability. In effect, without transparency, nobody knows what an unelected bunch of central bankers do or commit to do. There is no basis for assessing their performance and accountability. As a parenthetical remark, let me say here, this principle of independence requiring transparency, leading to accountability, further leading to performance and commitment works well even in other areas, including the area of politics. Second, financial markets have increasingly become globally interconnected such that monetary policy, whether good or bad, can be rapidly transmitted and thereby, impact on the behavior of market participants. It then becomes imperative for central banks to effectively communicate their actions to allow financial markets to figure out policy decisions. This is good for business and macroeconomic planning and promotes general stability. Finally, inflation targeting, our monetary policy framework, is forward-looking, and the only way to establish accountability is to be transparent about the commitment to promote price stability. Central banks, however, did not embrace transparency (and necessarily communication) only because they were forced to do so. Increased transparency and greater communication have their benefits. It is in a central bank’s own interest to be transparent in its monetary policy actions. Clearly communicating the level of price stability and the strategies to achieve it…. Help to anchor the inflation expectations of the business sector and the public in general. What is the practice of the BSP in terms of transparency and external communication? In the past four years of the inflation targeting framework, the BSP has adopted various disclosure and reporting mechanisms which you are familiar with. These mechanisms are intended to help the public understand what the BSP is doing and the reasons for its monetary policy actions. For instance, we have the: 1) press statement after the meeting of the monetary board on BSP’s monetary policy stance; 2) highlights of the Monetary Board discussion which is published in our website after a lag of six weeks; and 3) quarterly Inflation Report and the related media briefing. As a bonus, you also get a monthly dose of our inflation forecast relative to our annual target. We also hold public discussions to increase public understanding and ownership of the monetary policy process. The public information campaign in various locations around the country has helped increase the public’s familiarity with inflation targeting and monetary policy in general. The BSP’s communication approach has been aimed at the very broadest audience possible, with the policy stance articulated in layman’s terms as much as possible. This approach has generated positive feedback from various quarters and served BSP in good stead. The role of economic journalists In assessing our performance in the communications front, I believe we are making good progress and headed in the right direction. We are well aware that earning the people’s trust in the credibility of the BSP remains an ongoing challenge. We know that the familiarity of the general public with the BSP and its functions still needs to be further enhanced. In this regard, economic journalists have a very important role to play. Along with other forms of media, you have the responsibility of informing the public about the BSP’s monetary and banking policies. In the process you contribute to constructive public dialogue on such policies and not simply noise. The central purpose of journalism is to provide citizens with accurate and reliable information that they need to function in a free society. To achieve this, we conduct regular briefings for you and other members of the press on economic concepts and issues. We hope that you will continue to help us convey to the public the BSP’s policies and decisions in a clear, accurate and balanced manner. Malaki po ang inyong naitutulong sa pagpapalaganap ng mga layunin namin sa bangko sentral. naniniwala po ako, na dahil sa inyong tulong, mas mabilis na nagiging malinaw sa ating mga mamayan ang mga polisiya ng bangko sentral. The translation into the real sector of monetary policy through the various transmission mechanisms then would be swifter and more expeditious. Conclusion In conclusion, we at the BSP recognize that central banking and in particular, inflation targeting, is a public trust, much like a newspaper such as the Business World.” We have to continue in our mandate of ensuring price stability and a stable financial system “Without fear or favor” just like a Daily Tribune. Transparency and communication is a crucial part of the job of everyone charged with the management of the economy. That is why, Malaya kaming nag-issue ng bulletin that mirror the news of the times and evolving standard today. And while being a constant inquirer, we expect economic journalists such as yourselves to be balanced in your reporting. For our part, we will continue to strive to advance in our communication strategy as there remains plenty of room for improvement. In the end, as we are guided by The Star, “The truth shall prevail”. Finally, I congratulate the EJAP for its continuing program to improve the craft of its members. As I said earlier, we at the Bangko Sentral ng Pilipinas stand ready to help you achieve this objective through regular briefings on relevant and timely economic topics. Again my congratulations to the new set of officers and the active members of the Economic Journalists Association of the Philippines. May your tribe increase. Maraming salamat sa inyong lahat.
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Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Annual National Convention of the Chamber of Thrift Banks, Baguio City, 17 March 2006.
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Amando M Tetangco, Jr: Assessment of the thrift banking system Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines, at the Annual National Convention of the Chamber of Thrift Banks, Baguio City, 17 March 2006. * * * Good morning! I send my warmest greetings and congratulations to the membership of the Chamber of Thrift Banks (CTB) on the occasion of your National Convention, the high point of the annual celebration of the Thrift Banking Week. You have chosen the theme of responding to the challenges ahead. As both banking supervisor and monetary authority, we welcome your cooperative and constructive approach to the many issues confronting the banking system. Indeed, we continue to face many challenges ahead even as we have also made considerable progress. Assessment of the thrift banking system As I survey the thrift banking system today, I believe it has proven its resilience in the face of all the many challenges. In 2005, total resources of the industry grew by a very respectable 13.3 percent. Deposit level also continued to post double-digit growth of 16.8 percent, indicating strong confidence in the industry. Meanwhile, the industry remained adequately capitalized with capital adequacy ratio (CAR) averaging at 16.8 percent as of end-June 2005. This is well above the prescribed minimum ratio of 10 percent and more than double the international benchmark of 8 percent. Non-performing loans (NPL) ratio favorably declined to 8.9 percent as of end-December 2005 from 11.0 percent last year and from a peak of 13.4 percent at end-September 2002. Likewise, NPA ratio went down to 12.5 percent from 15.9 percent last year. The industry’s strengthening balance sheet also reflected a steady increase in the loss provisioning for bad assets. The industry posted a better NPA coverage ratio of 23.4 percent at end-December 2005 from 17.2 percent the previous year. However, this is still much lower than the 42.1 percent total NPA coverage ratio in universal/commercial banks. The whole banking industry should actually be striving for at least 50 percent coverage. And the best way to do that is to rapidly get rid of your remaining non-performing assets that continue to impose a drag on your performance. Indeed, your profitability remained marginal with return on equity and return on assets ratios at just 0.2 percent and 0.03 percent, respectively. As an industry, thrift banks continued to be the least profitable. BSP reform agenda The BSP is determined to pursue a banking reform agenda to shield the banking system against critical threats that may undermine its stability and integrity. Specifically, we are intensifying the reform process aimed at addressing core aspects of banking operations and enhancing the regulatory framework for the effective conduct of banking supervision. First of all, we must bear in mind that high NPAs are a fundamental threat to the safety and soundness of the banking system. We must therefore act decisively to remove this threat. So far, we have been successful in trimming down the stock of NPAs in the banking system especially through asset disposition under the Special Purpose Vehicle Law (SPV) Law. Consequently, both NPL and NPA ratios of the banking system are currently at record lows. The imminent approval of a two-year extension of the SPV Law by congress will boost the momentum for further disposal of banks’ NPAs. I hope the industry will now more aggressively utilize this opportunity. This is the last chance. In a related development, the Monetary Board (MB) also recently approved the guidelines that would allow banks to enter into Joint Venture Agreements (JVA) with property developers to provide an additional channel for banks to reduce their NPA holdings by helping convert bad assets into readily marketable or income producing assets. However, to prevent abuses, certain safeguards were adopted. In the first place, all JVAs under the program are subject to prior MB approval. Only pre-existing non-performing assets are eligible under the program to guard against potential moral hazard. Banks are also prohibited from providing funds to the joint venture either as a loan or capital contribution. However, banks may extend financing to JV partners or to buyers on arms length commercial basis. Lastly, banks are not allowed to recognize income out of the properties they contributed to the joint venture regardless of the agreed valuation of said properties in the JVA. They are only allowed to recognize income upon receipt of the proceeds from the sale of the developed properties. Proper accounting is also required. Moving on, we also continue to seek closer alignment of existing regulations with international standards to make regulatory policies more responsive to the growing competitiveness and sophistication of the financial services industry. In particular, we are focusing on strengthening corporate governance, risk management, and capital adequacy in our banks. This will be complemented with effective and efficient enforcement. In pursuit of this objective, we have recently issued major regulations covering: • The new Financial Reporting Package (FRP); • The guidelines on supervision by risk; • The guidelines on information technology (IT) risk management; and • The amendments to the fit and proper rule • The prompt corrective action framework. The new FRP effectively amends the Manual of Accounts (MOA) and revises the reportorial requirements for banks, in accordance with the provisions of the new Philippine Financial Reporting Standards (PFRS)/Philippine Accounting Standards (PAS). To the extent possible, we have also integrated into the new FRP the requirements of the Basel 2 Capital Adequacy Framework. The new FRP will greatly promote an enhanced level of financial transparency and also facilitate an enhanced off-site surveillance of banks and other financial institutions under our jurisdiction. Banks are constantly exposed to various risks because of the increasingly complex financial setting. Rather than constrain product innovation and operational flexibility, we would rather espouse the adoption of appropriate internal risk management mechanisms to ensure that banks and other financial institutions continue to operate in a safe and sound manner. It is for this purpose that we have set out the guidelines on supervision by risks under Circular No. 510. Mainly, these guidelines specify BSP’s expectations on how banks and other financial institutions should manage their risks. These are also designed to provide guidance on how the risk-focused supervision will be applied to these risks. Meanwhile, the guidelines on I.T. risk management are intended to communicate to the banking industry BSP’s expectations on how technology-related risks should be viewed in the context of bank risk management. We all know how pervasive information technology has become in our banking business. These guidelines will aid in effectively identifying, measuring, monitoring and controlling banks’ technology risk exposure. Building on previous initiatives to raise corporate governance standards, we recently came out with a stricter “fit and proper rule” encompassing all directors and senior officers of banks. This is to ensure that officials tasked to manage banks and other financial institutions possess the integrity and competence required for the job. Very recently, the monetary board approved the Prompt Corrective Action (or PCA) framework. This basically communicates to the industry how the BSP will deal with potential problems in bank operations at a very early stage hopefully to forestall more serious problems from arising that would necessitate more drastic and painful measures. The key triggers for the initiation of PCA include substandard capital adequacy ratios and poor Camels performance. Whenever PCA is initiated, banks will be required to put forward an action plan to immediately correct the situation. The action plan will be in a memorandum of understanding to be executed between the bank board of directors and the BSP. To promote healthy competition in the banking system and allow your greater flexibility to respond to market opportunities, we have also allowed the partial lifting of the moratorium on bank branching primarily to facilitate the expansion of financial services in underserved areas. Likewise, we have opened up outsourcing possibilities and allowed an increasingly wide array of treasury, consumer and wealth management products. All told, you can expect many more meaningful changes in the banking industry this year and in the coming years as we gear up for the full adoption of international best practices. I hope you will not see the recent changes as just more rules to cramp your style. On the contrary, by shifting to more strategic regulation of corporate governance, risk management, and capital adequacy, we hope to give banks much greater flexibility to pursue businesses that are consistent with their skill, risk appetite, and capital position. Banks that are well-managed and well-capitalized will be fully liberated to pursue their corporate objectives in this evolving environment. In contrast, banks that are poorly run and undercapitalized will find themselves severely under pressure both from the market and the regulator. We are also continuing our advocacy efforts in Congress for the passage of key legislative measures. Among others, we are seeking approval of the amendments to the BSP Charter which will make the BSP a more effective monetary authority and banking regulator. Another vital piece of legislation is the Credit Information System Act which will pave the way for the establishment of a truly comprehensive credit information system in the country. This is expected to lower the cost of credit, provide greater access to credit in general, and reduce the dependency on collateral-based lending. Taking the long view, what is the significance behind all these developments in the banking system? How are they going to affect the thrift banking industry? Essentially, these developments would alter the overall banking landscape. The change will be influenced mainly by the accelerated consolidation process in the banking system that is expected to take place within the next 3 years as a result of a combination of regulatory enhancements and the exacting standards posed by an increasingly complex financial environment. The enhanced competition would naturally favor the stronger, more capable banks and financial institutions. On the other hand, the smaller banks would do well to harness their core expertise in order to better serve their respective market niches. The highly global and complex banking scenario leaves no room for complacency for all banking industry players. To survive, thrift banks must enhance their financial strength, conform to sound corporate governance practices and boost their competitive advantage by honing excellence in specific target markets. Concluding remarks I would like to end my keynote speech by calling on all member institutions of the chamber to remain supportive of our policies and reform initiatives. The reform agenda that I have outlined to you today is a work in progress. In the past, you have taken a proactive role in the pursuit of genuine reforms in the thrift banking system. Now is the time to reaffirm that commitment. There is a lot of work ahead of us, but with vision to guide us and with steadfast action, we can be assured of success in achieving our shared goal of building a stronger, more competitive banking system. Thank you very much and more power to all of you!
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Remarks by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the launch of GlobeQUEST TouchPoint, Makati City, 4 August 2006.
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Amando M Tetangco, Jr: Innovative and efficient delivery channels for banking services in the Philippines Remarks by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the launch of GlobeQUEST TouchPoint, Makati City, 4 August 2006. * * * Mr. Gerry Ablaza, Mr. Gil Genio, the officers and staff of Globe Telecom and Innove Communications, fellow bankers, special guests, good evening. As head of the Bangko Sentral ng Pilipinas, the institution that oversees the banking sector, I am truly glad…efforts to develop innovative and efficient delivery systems for banking services continue in many fronts. Tonight, we witness the unveiling of Globequest Touch Point which, I understand, is a completely integrated electronic or e-banking package. In other words, it is an end-to-end technology solution: from hardware to software, to I.T. experts, to data center services, down to network infrastructure. For all intents and purposes, it is equivalent to outsourcing an e-banking system. This is an exciting proposition that has a lot of growth potential, moving forward. Today, we have 872 banks, of which only 55 or 6.3% have electronic banking services approved by the Bangko Sentral ng Pilipinas. Please note that these 872 banks have more than 7,600 branches. What they need therefore are efficient and secure communication systems and infrastructure. The economies of scale that I.T. companies such as Innove offer, therefore, will be particularly valuable to smaller banking institutions that may not have the technological expertise and enough resources to build their own e-banking facilities. Ladies and gentlemen, it was the advent of automated teller machines or ATMs that allowed banking services and transactions to continue beyond traditional banking hours. Now, ATMs no longer have this monopoly; new and better electronic banking options allow us to do transactions outside the confines of banks premises and beyond regular banking hours. Today, we have Internet banking, mobile banking or phone banking. Remote access through the Internet and mobile devices has allowed banks to provide additional channels to deliver more services to their clients. Mobile banking through the use of cellular phones is now popular as text messaging has become a means to remit funds, pay bills and loans, and make deposits. Accessing a bank’s web portal through mobile devices is also expected to become a common occurrence as advances in technology further improve the capability of mobile devices to rival even current personal computers. It is interesting to note that there are also non-bank institutions 1 that deploy ATMs to serve the needs of the depositing public in remote areas of our country. Thus, today, banking services are within reach of segments of the population that previously had no access due to geographic and cost constraints. All these have resulted in greater convenience to the public who can now choose to bank anytime, anywhere. In the same vein, banks have also benefited from these technological advances, as efficiencies improve and operational costs are reduced. Indeed, the Philippine banking industry continues to undergo rapid and extensive transformation, due largely to improvements and innovations in communications and information technology. Nevertheless, even as we mention its upside, we recognize that these technological innovations carry risks, which must closely be monitored, managed and balanced against the benefits. Examples of private sector ATM deployers are Nationlink and EnCASH. In response to this need, BSP has undertaken the following: created specialized supervision units such as that for information technology; issued Circulars to guide the development of electronic banking as well as to ensure consumer protection and awareness; and adopted international best practices to keep us at par with the rest of the world. The increasing interdependencies of banking, telecommunications, and information technology, pose a challenge for BSP to continuously adapt to a rapidly evolving technological and business environment. Nevertheless, with the support and cooperation of all stakeholders, such as Globe and Innove….I am confident our vision of a globally competitive financial industry will be realized, eventually. Finally, let me conclude by congratulating globe telecom and Innove Communications on the launch of Globequest Touchpoint. This is indeed a vital empowering solution toward providing the public with anytime, anywhere access to banking services. I hope you will continue to generate even better and more cost-efficient technology solutions. Maraming salamat po at magandang gabi sa inyong lahat!
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Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Quarterly Risk Management Forum, Makati City, 6 December 2006.
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Amando M Tetangco, Jr: Central Bank of the Philippines’ initiatives to strengthen risk management practices in banks Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Quarterly Risk Management Forum, Makati City, 6 December 2006. * * * Good afternoon, and thank you for inviting me to speak in this quarter’s risk management forum organized by the Gov. Jose B. Fernandez, Jr. Center for Banking and Finance (JBF Center), in cooperation with the Professional Risk Managers’ International Association (PRMIA). My remarks this afternoon will focus on BSP’s initiatives to strengthen risk management practices in banks under our supervision. Since banks still dominate the financial landscape in our country, the BSP as the banking supervisor has to be at the forefront of the development of better risk management practices in the country. Although this is a very challenging role to play given the pace of development in the field of risk management, I do believe that the BSP is up to the challenge and has been proactive judging by the number of initiatives we have put in place starting in the mid-90s. It is my pleasure to share with you our experience on the implementation of these initiatives, but before that let me highlight the risk profile of the Philippine banking system, which dictated the direction and pace of these regulatory actions. Risk profile of the Philippine banking system As of end-June 2006, total on-balance sheet assets of the banking industry amounted to P4.5 trillion, of which about 89 percent are accounted for by the dominant commercial banking segment. Additionally, off-balance sheet notional accounts – consisting of derivatives, trust and trade-related contingent exposures – amounted to P2.3 trillion. In terms of risk-weighted assets or RWA – which is a supervisory measure of banks’ risk exposures to credit risk and market risk only – commercial banks’ exposures are made up of 90 percent credit risk and 10 percent market risk. With the addition of operational risk in the risk-based capital adequacy framework of the BSP on 1 July 2007, our simulations show that commercial banks’ RWA will be made up of 77 percent credit risk, 8 percent market risk, and 15 percent operational risk. As primary buffer against these risk exposures, Tier 1 capitalization of the banking system, which includes hybrid Tier 1 capital stood at P433 billion as of end-March 2006. Our banks have also issued P79 billion in Tier 2 capital as allowed under our regulations consistent with international practices. CAR (capital adequacy ratio) stood at 19.4 percent as of end-March 20061 while loss provisions, which serve as cushion for expected losses have been significantly boosted from just 1.44 percent of total assets in end-December 1997, to 2.72 percent as of end-June 2006. BSP’s risk management initiatives Now, let me guide you through the important historical highlights of BSP’s risk management initiatives. In 1995, the BSP recognized the greater risk exposure in the system brought about by derivatives activities. To mitigate this, the BSP issued Circular No. 102 prescribing the minimum standards for risk management of derivatives. This was probably the first BSP regulation that specifically focused on banks’ market risk taking activities and risk management practices. Prior to this, risk management regulations were largely confined to basic credit risk management and to internal control issues. In 1997, the thrust of bank supervision started to shift its focus towards a more forward-looking view of risk management and whether a bank has the infrastructure to manage its own risks, instead of just mainly performing financial audit and compliance review. The objective was to address weaknesses in management and internal controls before financial performance suffers rather than being satisfied with identifying what went wrong after the fact. The BSP’s effort to focus on risk management is ultimately intended to give banks greater flexibility to respond to changing opportunities and challenges in the face of global competition under a more deregulated environment and at a time of rapid technological advances. Traditional bank supervision tended to micromanage banks to avoid risks that seem too high. The new approach to supervision is now more focused on the assessment of the quality of risk-management practices and generally allows banks to take on greater risks so long as the banks demonstrate the ability to identify, measure, manage and price for those risks. This more liberal approach to supervision, which allows banks more opportunities for success, entails that the BSP emphasize the responsibility of the banks’ board of directors and senior management to ensure the soundness and stability of their respective banks. The regulators’ role is primarily to evaluate the quality of oversight and management provided by these critical actors – that is, the quality of corporate governance. Strengthening banks’ corporate governance has thus been the theme of a number of BSP regulations. In June 1997, Circular No. 130 requiring the board of directors of banks to, among others, adopt and maintain adequate risk management policy was issued. A few months after, or in October 1997, the BSP also issued Circular No. 145 requiring banks to develop and implement a compliance system and to appoint/designate a compliance officer to oversee its implementation. In September 2001, the BSP issued Circular No. 296 which implemented the fit and proper standards for directors and officers of banks and non-banks as mandated by the General Banking Law (GBL) of 2000. The same Circular also prescribed a mandatory orientation program on corporate governance for banks’ board of directors. Moreover, the BSP issued in October 2003 Circular No. 410 which provided the accreditation guidelines for banks’ external auditors. In 2004, the BSP continued to issue a number of guidelines that aimed to further enhance governance practices in banks. Earlier that year, the BSP issued the guidelines for the management of banks’ large exposures (Circular No. 414). This was followed by the strengthening of rules on connected party transactions or DOSRI by expanding both the coverage of transactions and the definition of related interests (Circular No. 423). The BSP also issued Circular No. 429 that year which aimed to further strengthen banks’ compliance function. The BSP also issued that year the guidelines for the development and implementation of banks’ internal credit risk rating systems (Circular No. 439) in anticipation of Basel II. The guidelines strongly emphasize the oversight function of the board of directors over these systems. Before 2004 ended, BSP issued Circular No. 456 amending the provisions on the specific duties and responsibilities of the board of directors in the Manual of Regulations for Banks. The said Circular created three board-of-director-level committees, namely; audit committee, corporate governance committee, and risk management committee. This year, the BSP pushed forward with its shift to risk-based supervision by issuing the guidelines on the supervision by risk, setting forth the expectations of the BSP with respect to the conduct of risk management by financial institutions under its jurisdiction. This was followed closely by the issuance of the guidelines on technology risk management, which is aimed at ensuring effective management of technology-related risks by financial institutions. Just recently, the BSP issued broad guidelines on market risk management and liquidity risk management, which set forth BSP’s expectations on the management of these risks by banks. BSP’s risk-based capital initiatives While the BSP has been trying to enhance banks’ risk management practices, it is also simultaneously working on improving the risk-based capital adequacy framework as empowered under the GBL of 2000. We responded swiftly once the legal framework was put in place. In March 2001, the BSP adopted Basel I-type framework through Circular No. 280. This Circular provided the guidelines for the computation of risk-based capital for credit risk. The BSP’s risk-based capital adequacy framework was further enhanced with the issuance of Circular No. 360 in December 2002. Circular No. 360 incorporated market risk into the framework. In 2005, the focus was on preparing the implementing regulations for the eventual implementation of Basel II in the Philippines. At the time, preparatory works on Basel II implementation were already at an advanced stage globally. The discussions during international fora had already become complex and rather extended. For our part, the approach to implementation has been more calculated. Certain elements of the Basel II approaches such as those pertaining to risk weights for corporates and NPLs, were gradually incorporated in existing regulations to pave the way for a smoother implementation of the whole new framework in 2007. Meanwhile, in response to heightened appetite and growing exposure of banks to structured products and in preparation for the envisaged take-off of the domestic securitization market following the approval of the Securitization Act of 2004, the BSP pre-emptively issued in 2005 the risk-based capital treatment of banks’ exposures to structured products and securitization structures. In support of major policy objectives of enhancing credit access and expediting the clean-up of bad assets from the system, the BSP likewise advanced lower credit risk weightings for high grade corporate debt exposures and micro and SME exposures, but also increased the risk weighting on non-performing loans. This year, the BSP has issued the much-awaited Basel II implementing guidelines for the Philippines. The BSP’s Task Force on the Implementation of Basel II has just concluded their series of briefings both within and outside of the BSP in preparation for the parallel run that will be conducted starting end this year until mid next year. Unlike the existing BSP risk-based capital adequacy framework, the new Basel II-based framework does not only focus on the computation of the appropriate level of capital given a certain level of risk exposure, but it also highlights the need for more market disclosures by banks on their risk management exposures and practices. This is fully consistent with Basel II Pillar 3 recommendations, as well as the new International Financial Reporting Standards or IFRS which we fully adopted since 2005. The rationale is that the market itself contains disciplinary mechanisms that can reinforce the efforts of supervisors by rewarding banks that manage risk effectively and penalizing those whose risk management is inept or imprudent through their patronage or non-patronage. Basel II and risk management As we move into implementation of Basel II, industry reaction is both revealing and interesting. On one hand, the commotion it is causing with banks doubling their efforts in improving their risk management systems to meet the requirements of the advanced approaches is a very positive development as far as the BSP is concerned. On the other hand, it is rather disappointing that it takes regulatory pressure for many banks to finally start investing in a sound risk management system. I understand that there are certain problems that now face banks as they aim to improve their own risk management systems. . A survey of emerging market central banks conducted by the BIS reveals the three main difficulties faced not just by you, but by banks in emerging markets in general, in implementing more sophisticated risk assessment techniques. These are: 1. Data problems. Modern techniques of risk assessment in Basle II involve estimation of probabilities of default on the lenders’ portfolio, as well as of loss-given-default. Foreign banks get around by relying on data from their home country operations, but these data may not be applicable in the emerging markets they operate in. Many emerging markets are however taking steps to improve data availability. For example, Malaysia and Thailand have respectively established centralized credit registry for households and corporations and a credit information bureau. 2. Lack of suitable techniques for designing and calibrating models to evaluate alternative scenarios. 3. Large human resources and infrastructure (IT and other) costs of implementing advanced techniques for risk assessment. But improvements in risk management have inherent value to banks by avoiding major costs, including potentially catastrophic costs that can break a bank. Thus they should be pursued with or without regulatory requirements. Those of you who are sports fans can relate to this. As you know, success in many sports today relies on a solid defense that is always there whether the breaks are with you or not. Sophisticated risk management systems should be put in place because the bank sees the need to, and not just to impress, or perhaps intimidate the supervisors. The latter I guarantee is highly unlikely to happen because our supervisory personnel have also been doing their homework. Indeed, we have not just strengthened the regulatory framework. No less important, the BSP has invested heavily in the last few years in enhancing our supervisory capacity in line with the new demands. These efforts have ranged from individual skills enhancement through world class in-house structured training program to acquisition of relevant international certification, to creation of highly trained special teams, and currently a wholesale re-engineering and reorganization of the whole supervision and examination set-up. I assure you, we will be up to the task. We practice what we preach. Wrong motivations for improving banks’ risk management systems may obscure the ultimate aim for such actions – i.e., to make banks’ shareholders and other stakeholders, NOT the regulators, happy by safeguarding and enhancing the value of their investments. On our part, BSP’s interest in promoting better risk management is motivated more by macro considerations – that is, a safe and sound banking system is crucial to economic growth and to the stability of financial markets. Concluding remarks Let me now sum up. If you notice, the BSP initiatives I have mentioned are geared towards simultaneously promoting sound risk management practices in banks, and strengthening the riskbased capital adequacy framework. This is because both robust risk management and strong capital positions are critical in ensuring that individual banks operate in a safe and sound manner, which in turn enhances the stability of the financial system. In addition, strong capital helps banks absorb unexpected shocks and reduces moral hazard associated with the regulatory safety nets. Finally, let me reiterate BSP’s commitment to the identification, assessment, and promotion of sound risk management practices in the financial system, which it considers as central elements of good supervisory practice. But of course the BSP can only do this with the invaluable help of our allies from the academe and the industry, such as the JBF Center and PRMIA. Before I end, let me just quote Captain James Kirk of the Star Trek Enterprise: “Risk is our business. That’s what this starship is all about. That’s why we’re aboard her.” Indeed, the same can be said of banking. Thank you very much and good day to all of you.
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Remarks by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Thanksgiving Dinner hosted by the AIG Philam Savings Bank, Inc., Makati City, 23 November 2006.
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Amando M Tetangco, Jr: Strengthening partnerships for a more resilient banking system Remarks by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Thanksgiving Dinner hosted by the AIG Philam Savings Bank, Inc., Makati City, 23 November 2006. * * * Thank you Ched. Former Central Bank Governor and now Philamlife President and CEO Jose Cuisia, Jr., Mr. Ridha Wirakusumah of AIG Asia, other officers and staff of the Philamlife-AIG family, fellow bankers, special guests. Good evening! I am glad I am here to witness what you call the gala premier to celebrate the merger of Philam Savings Bank and AIG Credit Card Company Philippines which gives birth to AIG Philam Savings Bank. To us in the banking sector, this strategic move by the Philamlife Group and AIG to consolidate their consumer finance businesses will further strengthen the bank’s financial position and boost its competitive edge. Ultimately, this should translate to a more efficient and reliable delivery of financial products and services to the public. To central bankers like me who are responsible for keeping the banking sector sound, healthy, and responsive to the needs of the economy, this is welcome news indeed. My former boss, former Central Bank Governor Joey Cuisia, will attest to this. In fact, it has been the policy of the Bangko Sentral ng Pilipinas to encourage mergers and consolidation….so that we will have stronger and more globally competitive banks. Thus, those keeping track of developments in the banking community will realize that the AIG Philam Savings Bank is the latest outcome in a series of mergers that have been taking place as our banks gear up for increasing competition. In this period of global convergence where competition is the norm and banks are measured against rigorous standards, one strategy that enhances the likelihood of survival and sustained viability is to go the way of mergers and consolidation. In this regard, we foresee a scenario of fewer but more financially powerful universal and commercial banks that are better able to compete in a world of more open borders. However, this is not to say that there will be no place in the evolving financial environment for smaller banks such as thrift and rural banks. In fact, smaller specialist banks cover important niche markets that have unique needs; for instance, consumer trade and microfinance come to mind. Under this scenario, the smaller banks complement the services of the bigger banks, thus ensuring the availability of financial services to the entire market spectrum. In the case of thrift banks, their areas of specialization lean toward consumer lending, housing loans, small business loans, agri-business loans. This is a vital role that the thrift banking industry, AIG Philam Savings Bank included, should fully serve. In particular, AIG Philam Savings Bank’s considerable experience in consumer banking and its commitment to deliver quality service to a broader clientele will certainly add value to the development of local financial services. I am certainly looking forward to AIG Philam Savings Bank taking a more active role in financial literacy to fully realize the growth potential of your market. Indeed, providing consumers with adequate, timely and relevant information about financial products and services is a necessary prerequisite to ensuring the growth of your market. Alongside our aim to promote a more efficient and competitive banking system is our initiative to implement major structural reforms for enhanced transparency and accountability, improved risk management, and stronger capital position of banks and other financial institutions. I am happy to report to you that such reforms continue to take root within the banking industry. Over the years, we have stepped up the reform process in the banking system to keep pace with market changes and international best practices in the areas of corporate governance, risk management and capital adequacy. In the months ahead, we can look forward to even more challenging and exciting developments as we move closer to full compliance with Basel II, the global capital standards for banks. Preparation is crucial; by now, for instance, banks should have established a sound risk management system. Given the financial strength and leadership of its parent companies, I am positive AIG Philam Savings Bank will be up to the challenge and emerge as a major thrift bank player whose brand of service will raise the bar for bank customers. On this optimistic note, I thank the Philamlife Group and AIG for its abiding faith in the future of our economy in particular and our country in general, and for joining the Bangko Sentral ng Pilipinas in its drive to strengthen the banking system. Finally, on behalf of the Bangko Sentral ng Pilipinas, I extend our best wishes to all the officers and staff of AIG Philam Savings Bank. May you serve your customers well, adhering at all times to the good governance tenets of transparency, fairness and accountability. Good luck and congratulations! Mabuhay!
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Opening statement by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Foreign Correspondents Association of the Philippines (FOCAP) Forum, Manila, 4 December 2006.
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Amando M Tetangco, Jr: Focus on the Central Bank of the Philippines’ core mandate of promoting price and financial stability Opening statement by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Foreign Correspondents Association of the Philippines (FOCAP) Forum, Manila, 4 December 2006. * * * I am pleased to address you in this forum organized by the Foreign Correspondents Association of the Philippines. Your continued interest in the Philippine economy has greatly helped in shaping the quality of information provided to the international community. Fora such as this offers us an excellent opportunity to engage various stakeholders in policy dialogue. My short remarks today will focus on the BSP’s core mandate of promoting price stability and financial stability and how the institution has responded to the challenges facing it. As Fed Chairman Bernanke aptly puts it “monetary policy is most effective when it is coherent, consistent, and predictable, while at all times leaving full scope for flexibility and the use of judgment as conditions may require”. This highlights the fundamental role of transparency and communication in inflation targeting. The more that the public understands the logic of our policy framework and decisions, the more we are able to better manage inflation expectations and the more their behavior will facilitate the achievement of the price stability objective. An encouraging development is that inflation has been on a decelerating trend beginning the second quarter of this year, much earlier than expected. What is BSP’s view on the inflation outlook? In our Third Quarter Inflation Report, released in October, we noted that our short run prognosis points to subdued supply pressures and uneven demand conditions. Subsequently, on November 2, the monetary board decided to maintain the BSP’s key policy rates. At the same time, the tiering scheme on banks’ placements with the BSP under the RP/RRP and special deposits accounts windows was restored. This measure is intended to encourage banks to seek alternatives to placing their excess funds with the BSP such as lending to the public. Looking ahead, the BSP is fully aware that it still has to contend with the obvious danger to inflation posed by oil prices and the potential surge in liquidity growth from strong foreign exchange inflows. As risks to inflation are judged to remain tilted on the upside, the BSP will continue to keep a close watch on incipient inflationary pressures, especially those emanating from the demand side, and will stand ready to undertake the necessary monetary action. Addressing supply-side risks also remains a key policy priority. Toward this end, the BSP actively pursues stronger representation with relevant government agencies in support of supply-side intervention measures that seek to maintain stability of basic food supplies. Targeting inflation does not mean being indifferent to exchange rate movements. The exchange rate plays an important role in the transmission of monetary policy because of its direct impact on prices of traded goods and its indirect impact on aggregate demand. While the BSP leaves the determination of the value of the peso to market forces, there is scope for occasional BSP action to dampen excessive volatility in the exchange rate that could potentially undermine the price stability objective. On the external front, we expect that the balance of payments (BOP) will remain strong. Current projections indicate a surplus that will be sustained by continued inflows from OFW remittances and strong exports of goods and services. Improving investor sentiment is also expected to boost the capital and financial accounts. Turning now to the Philippine banking system, the system remains fundamentally stable and sound. This owes in large part to efforts to enhance financial intermediation and improve risk management by banks. We also continue to improve upon the core aspects of banking operations and enhance the regulatory framework for the effective conduct of banking supervision. Specifically, our focus is on realigning local regulations with international standards, particularly those pertaining to corporate governance, financial reporting and capital adequacy. We are gearing up for Basel II, which calls for the adoption of risk-based capital for banks. As a first step towards Basel II, higher risk-weightings on NPLs have been introduced. The upshot of this is that banks are now compelled to adopt more formal procedures for quantifying risk and collecting information. The realignment has affected the BSP as well. We have moved from a compliance-based supervision to a risk-based approach to supervision. The BSP also continues to advance its reform initiatives to develop the capital market infrastructure. Some important measures have been taken to create a better market infrastructure, enhance transparency and instill market discipline. The full implementation of the third-party custodian system that ensures proper delivery, accounting and monitoring of all securities sold was also actively pursued. We are also actively supporting various legislative initiatives that are intended to foster financial market development. Notable among these is the proposed creation of a centralized credit information bureau system to improve the quality of financial information available to investors, enhance private sector access to credit, and minimize exposure to risks of financial intermediaries. I deliberately planned to keep my remarks short to have a longer Q & A session. I look forward therefore to a productive, open, and stimulating discussion.
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Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Corporate Planning Society of the Philippines' 2006 4th Gen. Membership Meeting & Christmas Party, Manila, 28 November 2006
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Amando M Tetangco, Jr: Highlights of economic performance in the Philippines over the past year and key challenges ahead Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Corporate Planning Society of the Philippines' 2006 4th General Membership Meeting and Christmas Party, Manila, 28 November 2006. * * * Ladies and gentlemen of the Corporate Planning Society of the Philippines, fellow workers in government, special guests. Good afternoon and welcome to the Bangko Sentral ng Pilipinas. I am delighted that the Bangko Sentral is hosting your association's 4th general membership meeting. This provides us the opportunity to directly share with you our insights on vital inputs you need to firm up your plans for the coming years; after this, we can have a free-wheeling discussion so that we can also hear from you, learn about your concerns, and clarify certain issues. This is our way of supporting the cause of strategic planning in our country, the critical and essential function of creating a road map to achieve institutional goals that….taken together….sustain a nation's growth and development. First, I will discuss the highlights of our economic performance over the past year and our expectations, moving forward. I will also touch on the key challenges ahead and how this will influence the policy direction of the Bangko Sentral. The economy in perspective Well, as you are aware, our key economic indicators have been telling us that 2006 is bound to be one of our best years….as positive results have been broad-based. In fact, analysts have been describing 2006 as a defining moment for our economy, as it has turned around negative perceptions…. and raised investor confidence in our country. Overall, our economy continues to grow, buoyed by the vibrant performance of key sectors notably manufacturing, trade and finance as well as the resurgence of agriculture, fishery and forestry. In fact, real Gross Domestic Product (GDP) accelerated to 5.5 percent during the first half of 2006 from 4.8 percent in the previous year. Significantly, we were able to keep inflation at single-digit levels….even as our economy grew and absorbed record high domestic oil prices. In fact, we have been seeing a steady decline in inflation from a high of 7.6% in March this year to 5.4% last October, the lowest level since June 2004. Please note that this is within the Bangko Sentral's forecast range of between 5 to 5.7%. As the institution mandated to stabilize prices, the Bangko Sentral is satisfied with this trend. Essentially, the continued softening of fuel prices and the strengthening of the peso supported the further deceleration in inflation in October. Latest forecasts of the Bangko Sentral continues to indicate a generally declining path for inflation, with average inflation for 2007 expected to fall within the 4-5 percent target, barring unforeseen adverse shocks of course. As a result, the Monetary Board, in its last policy meeting on November 2, kept the Bangko Sentral's benchmark policy rates unchanged, but reinstated a tiering of interest rates on bank placements with the BSP to encourage further bank lending. Treasury bill (T-bill) rates also declined across the board in early November, due primarily to the improved fiscal position of the National Government, manageable outlook for inflation and ample liquidity. On the external front, the overall balance of payments position for the first six months of 2006 recorded a surplus of $2.04 billion, an improvement from the US$1.98 billion surplus recorded in the same period in 2005. The improvement resulted from higher inflows in current transfers, particularly from remittances of overseas Filipino workers (OFWs), higher exports and investment inflows. During the first nine months this year, OFW remittances reached US$9.1 billion, up 14.4 percent from the same period last year as more Filipinos found work overseas and banks became more aggressive in offering remittance services to OFWs. Based on this trend, we expect total OFW remittances in 2006 to set a new record and approximate $12 billion. I am also pleased to inform you that our country's gross international reserves (GIR) reached a new record-high level of US$22.3 billion in October this year. Given the sustained uptrend in our international reserves, we have in fact pre-paid some of our foreign loans. Likewise, these developments on the external front continue to sustain the appreciation of the peso versus the US dollar. I am sure you are all aware that the peso hit P49.60 to one US dollar yesterday, its highest level since 2002, as market sentiment continues to be positive. Better-than-expected fiscal performance is a key factor in this regard, as government spending remains restrained even with higher revenues generated from the Revised and the Expanded Value Added Taxes. To summarize, ladies and gentlemen, we have better macroeconomic fundamentals as inflation continues to decelerate, the peso remains strong against the US dollar, and our fiscal position continues to improve, with actual surpluses posted in four months so far this year. As the Government adheres to the implementation of its economic reform program, we should see more positive developments, moving forward. The financial sector reform agenda Similarly, our financial reform agenda has been generating positive results. In particular, the resources of the Philippine banking system reached record high levels as banks continued to register modest growth in deposits and capital accounts. This is significant… as banks account for more than 95% of the assets of the Philippine financial system. In as much as our economy depends practically on the banking sector for its financial needs, it is imperative that banks are kept sound, healthy and responsive to the needs of its customers. For your information, the Bangko Sentral supervises 41 operating universal and commercial banks with 4,277 branches, 84 thrift banks with 1,209 branches, and 754 rural and cooperative banks with 1,305 branches. These figures are as of June 30, 2006. With the series of mergers and consolidations that are taking place as banks seek to comply with more stringent capitalization requirements under Basel 2 and international accounting standards, we should see fewer, but stronger banks in the coming years. The BSP remains steadfast in its efforts to help clean up banks' balance sheets to stimulate lending activity. So far, we have seen the non-performing loan (NPL) ratio of universal and commercial banks drop from a high of 17.4% in 2001….to 8.5% in December 2005…. and further to 7.43% last September. Aggregate capitalization of the banking sector using the new and more stringent risk-based framework indicates that the banking industry's capital adequacy ratio (CAR) continues to exceed the statutory level set by the BSP at 10 % and the global standard of 8% set by the Bank for International Settlements. Parallel to this positive development, outstanding loans of commercial and universal banks increased by 6.1% year-on-year in September to P1.597 trillion, the highest growth rate since May 2005. While these may be modest compared to levels reached in the previous years and by international standards, the numbers nevertheless indicate the overall soundness of the Philippine banking system on account of continuing reforms in recent years. These include, among others, adherence to international best practices and the good governance tenets of fairness, accountability, transparency and social responsibility. Capital market reform to broaden the funding sources of the economy, as well as to ease the vulnerability of banks to economic downturns, remains a priority for Bangko Sentral. In collaboration with other government agencies and the private sector, the Bangko Sentral worked for the completion of needed infrastructure that would enhance financial system integrity and overall market confidence. The operation of the fixed income exchange (FIE) and the implementation of the third-party custodian scheme are part of these initiatives to provide viable and sustainable alternative sources of funds. The challenges ahead In the years ahead, the Bangko Sentral ng Pilipinas will remain focused on its mandate of ensuring price stability by adhering to its inflation target; ensuring that the banking sector remains sound and able to meet the financial requirements of the economy; and ensuring the stability of the Philippine payments system to minimize or prevent systemic risks. To pursue its price stability mandate, the Monetary Board, the policy-making body of the Bangko Sentral, will continue to rely on the following basic instruments: policy rates which are set every six weeks and influence the interest rates at which banks transact with their clients; reserve requirements or the share of depositors' money that banks must set aside to meet withdrawals; open market operations which allow the Bangko Sentral to influence the level of money circulating in the economy through the purchase or sale of government securities; and rediscounting which encourages banks to finance priority economic activities such as exports and microfinance. The Bangko Sentral uses inflation targeting as a framework to maintain price stability. Under this strategy, the BSP calibrates its policy actions to achieve the rate of inflation agreed upon with other economic agencies of government. Adopted in 2002, this approach has served us in good stead. The challenge for us is to keep our forecasting tools on the money so that our policy rate decisions will generate the desired outcome when its full impact is absorbed by the economy 18 to 24 months down the road. Yes, ladies and gentlemen; this is the lag time we have to contend with in measuring the effectiveness of our policy response to ensure stable prices. As the sole issuer of Philippine currency, the Bangko Sentral must also ensure that there is just enough money in circulation to meet the requirements of the country. The amount of money in circulation must not be too low that it could lead to higher interest rates and slower economic growth. On the other hand, money supply must not be too high that it will be inflationary and reduce the purchasing power of the peso. This is a complex and challenging balancing act. As mentioned before, it is imperative that the banking sector remains sound and healthy as it provides the funding requirements of the economy, using essentially money entrusted to it by the people. In fact, funding for more than 70% of the resources of the banking system come from deposits which, as of June 2006, had reached P3.2 trillion. Ensuring the stability of our payments and settlements system is equally important. As the bank of banks, the Bangko Sentral serves as an effective clearing house for high value inter-bank transactions as it holds cash balances of the banks. For this purpose, the Bangko Sentral operates a real-time gross settlement system which we call the Philippine Payments and Settlements System or PHILPASS which processes about 2,000 transactions with a total value of about 300 billion pesos….daily. This is therefore a vital service as it minimizes settlement risks for high value transactions that may adversely affect the stability of the financial system. I hope that you will continue to support Bangko Sentral's policies and programs; in the same manner, you can depend on our support….if there is convergence on what our respective institutions want to accomplish. Indeed, with appropriate programs of cooperation and complementation, the government and the private sectors can unleash the synergy which could sustain growth and development of our economy; jobs and income for the man on the street; as well as peace and prosperity for our country. Let us therefore work together to sustain our growth momentum and continue to implement our reform agenda. Remember, in the face of increasing global competition and millions of Filipinos who remain mired in poverty, we either innovate….or stagnate. Let us choose to innovate… together. Maraming salamat sa inyong lahat.
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Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the 15th Philippine Statistics Quiz (PSQ) National Finals, Central Bank of the Philippines, Manila, 5 December 2006.
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Amando M Tetangco, Jr: The vital role of statistics in national development Keynote address by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the 15th Philippine Statistics Quiz (PSQ) National Finals, Central Bank of the Philippines, Manila, 5 December 2006. * * * Dr. Isidoro P. David, President of the Philippine Statistical Association; Dr. Romulo A. Virola, Secretary-General of the National Statistical Coordination Board; Honorable Carmelita N. Ericta, Administrator of the National Statistics Office; our distinguished judges and guests; regional finalists and their teachers and parents; fellow workers in the government; ladies and gentlemen, good afternoon. We, at the Bangko Sentral ng Pilipinas, warmly welcome this opportunity to once again host the Philippine Statistics Quiz National Finals. The BSP has always been supportive of these kinds of activities that give due recognition to the vital role of statistics in national development. As the country’s central monetary authority and as the supervisor and regulator of the banking system, we formulate policies on the basis of statistical information that we produce, collect and compile, as well as monitor, assess and review. Statistics are important not only for the stories they tell but also because they provide the basis for sound, sensible policies going forward. Timely, relevant and reliable information provide sound guideposts that enable us to make informed choices and, ultimately, form an educated stand on issues that affect our nation’s future. With statistics permeating the different facets of life, the BSP, together with other statistical agencies, is confronted with the challenge of going beyond the production of statistics and moving toward upgrading the level of statistical literacy in the country. It is in this light that we commend the Philippine Statistics Quiz (PSQ) Steering Committee for its efforts to promote and enhance awareness of the value of statistics in the school environment. This initiative of the PSQ is laudable as it helps demystify statistics as a science. Statistics has long been perceived by many as a complex and even perhaps mysterious field of study. Fora, such as this, however, can display how fascinating and practical this subject can be, as students tackle problems that show the interconnection between statistics and the real world. The BSP welcomes every opportunity to help nurture young minds with a view to strengthening the human resource base of our nation. I challenge our young college freshmen here to develop their love and enthusiasm for statistics, for with this goes the development of their critical thinking. On this note, the BSP unites with the Philippine statistical community and the academe in honoring this year’s finalists and in congratulating the winners and their mentors. Thank you very much.
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Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Annual Reception for the Banking Community, at the Central Bank of the Philippines, Manila, 16 January 2007.
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Amando M Tetangco, Jr: The BSP and the banking community – a partnership for a better year in 2007 Speech by Mr Amando M Tetangco, Jr, Governor of the Central Bank of the Philippines (Bangko Sentral ng Pilipinas), at the Annual Reception for the Banking Community, at the Central Bank of the Philippines, Manila, 16 January 2007. * * * Distinguished members of the banking community, special guests, friends, ladies and gentlemen. On behalf of the Monetary Board, I welcome all of you to our Annual Reception for the Banking Community. We at the Bangko Sentral ng Pilipinas always look forward to this yearly event because it gives us, central bankers, the opportunity to interact with you at the social level and - more importantly because we have you as a captive audience as we deliver the banking sectors’ report card for the past year, as well as our roadmap to the future. To put these in perspective, I will review our economic performance in 2006, share our views on how the economy will perform in 2007, and what these imply for the monetary and banking policies of the Bangko Sentral ng Pilipinas. Ladies and gentlemen. In plain language, 2006 was a good year for the economy. We saw GDP continue a pattern of broad-based expansion, with the services sector, to which banks belong, recording the strongest performance. Fiscal reforms and government’s prudent management of its resources continue to yield strong dividends, with revenue growth outpacing spending. At the same time, monetary and banking policies generated positive results: slower inflation, declining interest rates, a stronger peso, and gross international reserves at an all-time high on the back of strong inflows from export receipts, OFW remittances, and foreign investments. It is noteworthy that even with supply shocks from record-high domestic oil prices and the value-added tax reforms, we managed to grow the economy without fueling inflation. It is equally noteworthy that in 2006, the consolidated assets of the Philippine banking sector reached a record high level, even as asset quality continued to improve with the implementation of the SPV Law. In fact, as of November 2006 and for the first time since the 1997 Asian crisis, the benchmark non-performing loan ratio of commercial banks dropped to less than seven per cent; similar trends are being observed in thrift and rural banks. Let us therefore give the banking sector a well-deserved round of applause. Moreover, the capital adequacy ratio of the banking system stands strong at about 16% in 2006, even as the banking system increased provisioning levels and made the transition to the demanding new international accounting standards. I also wish to commend the banking sector for its growing support for microfinance, our special advocacy for alleviating poverty in our country. Latest data indicate that there are more than 200 banks providing microfinance services to 630,000 micro-borrowers with total loan portfolio of P3.7 billion. The average is P11,600 per borrower, more than double the 2006 figure of about P5,000 for each borrower. Let us thank these banks for their support through another round of applause! Market reforms continued to take root in 2006 including the development of market infrastructure. Among others, we saw the full implementation of the third-party custodian system and the fixed income exchange. Another is the interconnection of the Bangko Sentral’s real-time gross settlement system or Philippine Payments and Settlements System with the Philippine Dealing System and the Bureau of Treasury in line with the Delivery-versus-Payment settlement of government securities. The BSP capped the year with the prepayment of $1.4 billion in loans, including all its obligations to the International Monetary Fund (IMF). This ended 4 ½ decades of continuous borrowing from the Fund. This sends a clear signal to the international community that the structural reform process and macroeconomic prudence in the Philippines have firmly taken root and that Philippine authorities can independently craft and pursue a credible and strong policy framework and reform program for sustaining the country’s economic growth. The year 2006 also saw the BSP implementing the following enhancements in our monetary and banking policies: • Refinements in our inflation targeting framework to align it with practices in other inflation targeting countries. • Streamlined access to our rediscounting facilities, one of our instruments for conducting monetary policy. In particular, we launched electronic rediscounting facility to ensure wider and faster delivery of credit to SMEs in the countryside. • Continued alignment of domestic prudential standards with international benchmarks and best practices, particularly in upgrading the quality of corporate governance and disclosure as well as risk management. • Issuance of guidelines on banks’ internal credit rating systems, technology risk management, as well as market and liquidity risks management. • The adoption of the prompt corrective action framework which provides a time bound setting to deal with problem banks. • Adopted measures to improve access of SMEs to financing through lower reserve requirements and relaxed - but still prudent - regulations on bank branching, risk weights, single borrower’s limit, connected lending and documentation. Indeed, the continuing partnership between the BSP and the banking sector has produced very positive results in 2006. Economic and monetary policy outlook Moving forward, let me share with you our views on the likely economic prospects for 2007. With resilient personal consumption, strong exports performance and robust services and industry output, GDP growth is expected to rise to 5.7-6.5 percent for 2007. If our fiscal position continues to improve, we can look forward to stronger, more sustained long-term growth. Inflation is seen to continue to slow down in 2007, with the government target of 4-5 percent likely to be achieved, in the absence of new shocks. Nevertheless, there are certain risks to inflation that need to be carefully monitored and assessed, including oil prices, possible impact of El Nino on agricultural output, wage adjustments, and possible liquidity expansion. The BSP will continue to keep a vigilant eye on these risks so that it could move pre-emptively against threats to price stability. On the external front, dollar inflows from OFW remittances and foreign investments are expected to remain strong. This should continue to boost our external payments position and enable us to further build up our international reserves. These conditions, in turn, underpin our expectations of a strong peso in 2007. In fact, we are now our reviewing foreign exchange regulations, with further liberalization as our goal. Going forward, we will continue to support various legislative initiatives to foster the development of our financial markets, including the creation of a centralized credit information bureau system to improve the quality of financial information available to investors, enhance private sector access to credit, and minimize exposure to risks of financial intermediaries. We are hopeful that the bill will be approved by the Bicameral Committee and signed into law by the President as soon as possible. The BSP will also continue to support additional legislative initiatives to hasten the development of the Philippine capital market, including the amendments to the BSP charter, Corporate Recovery Act, Revised Company Investment Act, and the Personal Equity Retirement Act. In the banking sector, we expect further expansion of bank resources, improvement in banks asset quality through NPL disposal, and improved capitalization. We should also see a stronger banking system resulting from more mergers and acquisitions. This should make banks better financial intermediaries and risks managers. Ladies and gentlemen. Improved macroeconomic conditions, accumulating banking reforms, and robust improvements in banks’ profitability, set the stage for an even stronger performance of the Philippine banking system in 2007. Finally, I wish to thank all the bank associations and all our partners in the retail and the business sector, including our media friends, for their support in making our joint program “Tulong Barya Para sa Eskwela” a resounding success! Clearly, the combined donations/savings of around P12.5 million which we generated sends a clear signal that coins are indeed valuable; that “ang barya, mahalaga.” This should convince our schoolchildren to start saving up with their coins. Let us therefore give everyone who participated in “Barya Para sa Eskwela” a well-deserved round of applause. Salamat po sa inyo. We look forward to your continuing support for the nationwide implementation of our economic and financial literacy program in cooperation with the Department of Education which should transform each child into regular savers. Concluding remarks Friends. 2006 was a good year for the economy and the banking sector. We are therefore primed for an even better and stronger performance in 2007. While mindful of the challenges ahead, we at the Bangko Sentral ng Pilipinas are determined to move forward in partnership with the banking community. And so, ladies and gentlemen, may I offer a toast to a strong and successful partnership between the Bangko Sentral ng Pilipinas and the banking sector. May we become a truly potent enabling force in moving the country forward and providing a better life for all Filipinos. Cheers!!! Thank you everyone and enjoy the rest of the evening.
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