Story: Reserve Bank
Page 4 – Independence and supervision
Formal system of banking supervision
New Zealand started to deregulate the financial system in 1984, but the Reserve Bank did not introduce a formal system of banking supervision until 1987. In the interim some banks and other financial institutions made foolish lending decisions, often because their staff were not trained to work in a more competitive and risky environment. The Bank of New Zealand came close to collapse in 1989–90 and had to be rescued by the government. The earlier introduction of banking supervision might have prevented such errors.
The early 1990s saw a vigorous debate within the Reserve Bank over the supervision of banks. The banking supervision department favoured a relatively bureaucratic prudential regime, whereas the economic department thought the emphasis should be on requiring banks to disclose information to the public and financial markets. Reserve Bank governor Don Brash sided with the economists, but did not entirely abandon regulation because of pressure to conform to the minimum international standards in the Basel Accord (international recommendations on banking regulations).
In 1996 the Reserve Bank introduced an unusual variant of prudential supervision based on ‘disclosure and attestation’. Each bank was required to disclose key information about its health to the public and the directors had to attest to its accuracy. This was different from more intrusive regimes, often involving regular on-site inspections, which were the norm in most countries.
Critics said that the Reserve Bank was free-riding on Australian and British supervisors of banks operating in New Zealand, but Brash rejected this gibe. Largely at the initiative of the Reserve Bank, a system of real-time gross settlement was introduced in 1998. This mechanism reduced the risks to the banking system and its clients when inter-bank payments were being settled through accounts at the central bank.
Don Brash, the governor of the Reserve Bank between 1988 and 2002, told BBC radio in 1993 that he expected to be sacked if inflation rose above the 0–2% per annum target. When inflation did breach the target, however, Brash kept his job because inflation was still far below the levels common in the 1970s and 1980s.
Fears that the start of the year 2000 would bring chaos to computer systems, especially in the banking industry, proved unfounded. Yet the new millennium did bring challenges. Strong appreciation of the New Zealand dollar in the early 2000s led to renewed concern about the competitiveness of the New Zealand economy, and in 2004 the Reserve Bank was authorised to intervene in the foreign-exchange market to alleviate undue fluctuations in the exchange rate. Intervention was used very sparingly. Following a crisis in the finance company sector the Reserve Bank was given responsibility for supervising non-bank deposit takers in 2008.
Of much greater importance was the global financial crisis beginning in 2007. Fortunately, the Australian-owned banks, which dominated the New Zealand market, had not acted as recklessly as banks had in some other countries. Even so, it became difficult, at least for a while, for the Australian-owned banks and other New Zealand entities to borrow on international markets. As a precautionary measure, the government introduced a temporary guarantee of wholesale and retail bank deposits. The Reserve Bank released more money into the banking system, and, from mid-2008, slashed the official cash rate (which influences the interest rates of the trading banks), in order to underpin banking stability and maintain the level of economic activity. New Zealand was fortunate, during 2007–10, to avoid the worst of the crisis.
Don’t just float
Not all pundits applauded New Zealand's central bank reforms. In the 1990s prominent businessman Hugh Fletcher said that pursuing inflation control but leaving the exchange rate floating cost New Zealand businesses valuable revenue. Other businessmen disagreed. In 2011 Fletcher was on the Reserve Bank's board of directors.
In 1999 a Labour-led government was elected. It continued with largely the same monetary policies as the National governments of the 1990s. Brash stayed on as governor until 2002, when he left to become leader of the National Party, as he did not agree with the government’s economic policies. Alan Bollard, who replaced Brash as governor in 2002, published a lively account of the Reserve Bank’s efforts to manage the 2007–10 global financial crisis. Career central bankers are part banker, part civil servant and part economist.
Most of the action involving the Reserve Bank occurred in the 1980s and 1990s, when it was transformed from a rather dull and sleepy institution into a pioneer in the fields of central bank independence, inflation targeting and prudential supervision. In terms of independence and inflation targeting, New Zealand’s Reserve Bank became an inspiration for central-bank reform throughout the world. By the late 1990s, the pace of change had slowed, although in many respects the Reserve Bank continued to be a model central bank.