Presentation to ISCR August 2014

1. Regulating globally - banking locally The impact of international regulation on the NZ banking market Presentation to ISCR August2014

2. What is NZBA? • Established in 1891, the New Zealand Bankers’ Association provides a forum for member banks to work together on non-competitive industry issues. • NZBA membership is open to any bank registered under the Reserve Bank of New Zealand Act 1989. • There are currently 14 members: • ANZ Bank New Zealand Limited • ASB Bank Limited • Bank of New Zealand • Bank of Tokyo-Mitsubishi UFJ Limited • Citibank N.A. • The Co-operative Bank Limited • JP Morgan Chase Bank N.A. • Heartland Bank Limited • Hongkong and Shanghai Banking Corporation Limited • Kiwibank Limited • Rabobank New Zealand Limited • SBS Bank (Southland Building Society) • TSB Bank Limited • Westpac New Zealand Limited

3. An industry approach NZBA is the banking industry’s voice. We actively contribute to a secure and successful banking system that benefits New Zealanders and the New Zealand economy. To achieve this goal we engage with a range of stakeholders including politicians, officials, regulators, opinion leaders, consumer representatives, the media and the general public.

4. Global Standard Setters High Level Assessment International Agreement Thematic Analysis International Standards Supervisory Principles

5. Global Audit Overview, Audit, Review Financial Sector Assessment Program (FSAP)

6. G20 Priorities G20 Priorities since 2008 include: • Strengthening bank capital and liquidity requirements and raising standards for risk management (Basel III); • Addressing risks posed by SIFIs and improving resolution regimes (including strengthening deposit insurance and core financial infrastructure); • Improving OTC derivatives markets; • Strengthening accounting standards; • Strengthening adherence to international supervisory and regulatory standards; • Reforming compensation practices to support financial stability; • Developing macro-prudential frameworks and tools; • Expanding and refining the regulatory perimeter.

7. BCBS – Capital Basel III Capital requirements • Minimum Capital Requirement 8 % of Risk Weighted Assets (RWA) –unchanged Capital Conservation Buffer Additional common equity requirement of at least 2.5% of RWA with constraints on distributions (dividends, bonuses) if overall capital ratio falls below 10.5 % of RWA; • Minimum Tier 1 Requirement 6% of RWA (up from 4%) • Common Equity Requirement Common Equity of at least 4.5 % of RWA (plus conservation buffer) – new • Quality of Capital Limits on acceptable hybrids for Tier 1 (subordination, discretionary, non-cumulative payments, no maturity), greater required deductions (deferred tax assets, equity investments, goodwill ) in calculating common equity. • Tier 3 capital instruments eliminated • Leverage Ratio Minimum non-risk weighted ratio of common equity to exposures of, initially, 3% (new) • Risk Weights Increased weights for some activities such as securitization and trading (announced Dec 2009), based on stressed VAR test (for 12 months of stress)

8. BCBS – Liquidity Liquidity Coverage Ratio (LCR) Requirement to hold more liquid assets eligible for use in repo transactions with the Central Bank. Net Stable Funding Ratio (NSFR) Requirement to have a minimum proportion of long term stable funding over a one year horizon, based on an assessment of the liquidity of its assets and its contingent liabilities.

9. BCBS-Deposit Insurance • BCBS-IADI Core Principles for Effective Deposit Insurance Systems “The deposit insurance Core Principles, which were developed by a joint working group between the Basel Committee and IADI, address a range of issues including deposit insurance coverage, funding and prompt reimbursement. They also focus on issues related to public awareness, resolution of failed institutions and cooperation with other safety net participants, including central banks and supervisors.”

10. FSB-Resolution Regimes The Key Attributes of Effective Resolution Regimes for Financial Institutions The Key Attributes set out 12 features considered essential for an effective resolution regime: • Scope: The regime should cover any financial institution that could be systemically significant. • Resolution authorities: should be independent and have clear mandates, roles, and responsibilities. • Toolkit: Resolution authorities should have broad resolution powers. • Set-off, netting, collateralization, segregation of client assets: These arrangements should be preserved, although the authorities should also be able to suspend their operation, subject to adequate safeguards. • Legal Safeguards: While resolution authorities may depart from the hierarchy of claims, they may have to offer compensation to creditors, and their decisions must be subject to judicial review. • Funding of firms in resolution: Authorities should minimize the use of public funds to resolve firms. • Framework for cross-border cooperation: Resolution authorities should be empowered and encouraged to achieve cooperative solutions with foreign resolution authorities. • Crisis Management Groups: Home and key host authorities should maintain CMGs that actively review and report on resolvability and on the recovery and resolution planning process for G-SIFIs. • Institution-specific cross-border cooperation agreements: should be in place among relevant authorities to manage the sharing of information and specify responsibilities in respect of all G-SIFIs. • Resolvability assessments: Resolution authorities should regularly undertake resolvability assessments for all G-SIFIs, and should be able to require changes to business practices, structure or organization. • Recovery and resolution planning: Jurisdictions must require planning for the recovery and resolution of firms that could be systemically significant. • Information sharing: Jurisdictions should eliminate impediments to the domestic and cross-border exchange of information among authorities, both in normal times and during a crisis.

11. FSB-Resolution Regimes

12. FSB Macro-prudential Tools The defining elements of macro-prudential policy are: • The objective (limiting systemic or system-wide financial risk), • The scope of analysis (the financial system as a whole and its interactions with the real economy), • Aset of powers and instruments and their governance (prudential tools and those specifically assigned to macro-prudential authorities). Macro-prudential polices aim to address two dimensions of system-wide risk: first, the evolution of system-wide risk over time – the “time dimension;” and second, the distribution of risk in the financial system at a given point in time – the “cross-sectional dimension.”

13. FSB- Macro-prudential Tools International level Basel III • Countercyclical capital buffer • Permanent capital conservation buffer National level • Additional sectoral risk weights • Quantity based prudential tools which can be adjusted counter-cyclically by imposing time-varying caps and limits on the demand of credit (Restrictions or caps on LVR’s, debt to income ratios, or loan to income ratios)

14. FSB - Macro-prudential Tools Further Work Last update to G20 noted whilst some progress made further work is needed to address the remaining challenges in successfully implementing macro-prudential policies and institutional frameworks, including: • Design and collection of better information and data to support systemic risk identification and modelling; • Design of techniques to identify and measure systemic risk that utilise this information and help inform the design of policies; • Design of an effective macro-prudential toolkit of powers and instruments, including the criteria for the choice and calibration of the instruments and methods to assess their effectiveness, as well as the respective merits of rules versus discretion; • Design of appropriate governance arrangements for the exercise of the macro-prudential policy powers.

15. What does all this mean for NZ? • NZ not a member of G20 • RBNZ Participates but not a member of BCBS or FSB • Eurocracy - GFC and international response means more complex rules (Basel I the first international capital standard in 1987 was 30 pages in length, the Basel II standard 347 pages, and the new Basel III standard 616 pages) • Increasing international pressure for global regulatory standards to help identify, manage and prevent systemic risks • FSAP reviews mean country performance (regulatory) is publicly measured against global standards • As a small open and indebted economy international views matter both from an institutional (IMF,BCBS FSB G20) and investor perspective • Less opportunity for NZ to diverge from international trends irrespective of whether they are meaningful for a domestic or even regional context

16. Bleeding Edge The Only Way? • Due to the above factors, departure from international norms cannot lead to a lower set of standards-irrespective of local context including lower risks - it can only ever lead to a higher or more conservative set of standards, or at best the same standards that are being implemented elsewhere • International pressure and our place in the world also lead to the same or higher standards being implemented earlier as another way to ensure NZ is not singled out as an outlier

17. Effects on the local market • Increased regulatory and compliance costs - cost of, and return on capital remains of utmost importance • Focus on DSIBs – but a number of local banks that matter regulation needs to be able to accommodate

18. Examples • Basel III Capital - in effect from 1 January 2013 rather than phased in from 1 January 2013 - but no leverage ratio • Basel III Liquidity - CFR in effect from 1 April 2010 – ahead of NSFR (in effect from 2018) with minor differences (due to low issuance of govt. securities) • OBR – banks prepositioning in place as at June 2013 (NZ only OECD country without deposit insurance scheme) • Macro-prudential Tools being applied: Conservation buffer, Sectoral risk weights (housing, rural), LVR restrictions

19. Upshot – Safe…

20. But at what cost? “First, the Reserve Bank was concerned at the compliance and efficiency costs associated with conventional approaches to banking supervision. This concern probably reflects the reality that banking supervisors tend to have strong incentives to promote a stable financial system, without always having appropriate regard to the compliance and efficiency costs to which supervision and prudential regulation can give rise.” Don Brash, Governor, Reserve Bank of New Zealand, 1996. “The Bank will continue to watch global developments and look to change standards where doing so is appropriate for the New Zealand financial system. In some areas, such as liquidity policy, domestic regulatory reform is occurring at a faster pace than global efforts. The Bank is also mindful that additional layers of regulation, while enhancing financial stability, may adversely impact the efficiency of the financial system and result in unintended consequences, including increased incentives for disintermediation. Future work will examine the nature of these trade-offs in the New Zealand context” Financial Stability Report, Reserve Bank of New Zealand, 2010