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Cabinet Paper DEV-19-SUB-0346: Reserve Bank Act Review - Prudential Regulation of Deposit Takers and Deposit Protection
1 This paper seeks in-principle agreement to further prudential regulation and depositor protection arrangements as part of Phase 2 of the Reserve Bank Act Review.
2 The reforms outlined in this paper will strengthen New Zealand’s financial system safety net with respect to the role played by deposit taking institutions. Prudential regulation and supervision seeks to promote the stability of the financial system and the soundness of individual regulated entities (such as deposit takers).The prudential regime achieves these objectives through appropriately calibrated rules and requirements, proactive monitoring of the financial health of the individual entities, and an enforcement regime that promotes compliance. It is also critical that, in the event of a crisis, there are clear mechanisms to protect depositors and credible tools for managing the crisis and resolving any failures.
3 The June 2019 in-principle decision (DEV-19-MIN-0161) to harmonise the regulatory regime between banks and non-bank deposit takers has been developed in this paper. This new regime will be consolidated in the creation of a new ‘Deposit Takers Act’ (DTA). The regulatory regime is expected to capture at a minimum all lenders that offer transactional, savings and term deposit accounts to the public. Further consideration of how the regime will treat lenders who only issue longer-dated secured debt (e.g. finance companies) is needed.
4 I recommend that the Reserve Bank retain a high degree of flexibility in designing the prudential regime and applying it to individual deposit takers, in line with best practice for prudential regulators internationally. Standards will be the primary regulatory instrument under the new framework, which will modernise the regime and allow prudential rules to be disallowed by Parliament under the Legislation Act. Although I expect the new DTA to allow the Reserve Bank to regulate lending standards (such as restrictions on loan-to-value and debt-to-income ratios), there will be further consultation on the use of these powers next year.
5 I intend that the Review will result in a more flexible, graduated enforcement regime for dealing with institutions that have failed to comply with regulatory obligations. This will also allow the Reserve Bank to address emerging concerns in a timely and conclusive manner. To support a more intensive supervisory model, the Reserve Bank should be provided with increased supervisory resources and a power to undertake ‘on-site’ inspections.
6 I recommend that accountability requirements for directors of deposit takers should be strengthened. Positive duties will be imposed on directors, such as the need to ensure that a deposit taker is run in a prudent manner. I am also recommending that the accountability framework be extended beyond directors to certain senior employees, with obligations cutting across both the prudential and market conduct regulatory frameworks. This latter policy work will be progressed through a cross-agency process separate from the Phase 2 Review.
7 I recommend decisions that further progress the deposit insurance scheme. The scheme should have the objective of protecting depositors and, in so doing, contribute to financial stability. New Zealanders will be able to insure up to $50,000 at a single deposit taker. And the scheme should be funded by levies on deposit-takers, with a guaranteed and prearranged funding backstop provided by the Government (if a failure required more money than collected from members at that point). It is desirable to introduce the deposit insurance scheme alongside strengthened supervision and regulation, to mitigate the increase in moral hazard from deposit insurance.
8 Finally, I recommend changes to the crisis management framework in part to reflect lessons learned internationally from the Global Financial Crisis (GFC). As the resolution authority, the Reserve Bank will be provided with a greater range of crisis resolution powers, and clarity about its role and objectives in using these powers. I recommend increasing the range of tools for the orderly resolution of a failed deposit taker, including the addition of a statutory bail-in power (i.e. the ability to write down or convert unsecured liabilities to equity). New safeguards available to creditors will also be established.
9 Further decisions on prudential regulation, crisis management, and depositor protection will be sought from Cabinet next year including:
9.1 specification of the new positive obligations for directors of deposit takers, and related design features to strengthen the individual accountability regime
9.2 the treatment of finance companies who issue longer-dated secured debt within the new regulatory regime, including implications for the scope of deposit insurance
9.3 design features of the deposit insurance scheme required to progress legislation, and whether depositors (or the deposit insurance scheme in their place) should also have preferred access to the assets of a failed deposit taker, and
9.4 the role of the Minister of Finance in crisis management and options for resolution funding.
10 I recognise that the work required to develop the DTA is broad in scope and complex. It will be important to consult with industry on a host of complex issues with important consequences. The Review is aiming for further public consultation in early 2020 to support final Cabinet decisions around July 2020. These timeframes are ambitious, and could be subject to delays if industry engagement raises significant issues that require further consideration. A lengthy drafting and transition period is anticipated, meaning that it will be some years before the Bill is enacted in full.