Academic journal article The Reserve Bank of New Zealand Bulletin

A Short History of Prudential Regulation and Supervision at the Reserve Bank

Academic journal article The Reserve Bank of New Zealand Bulletin

A Short History of Prudential Regulation and Supervision at the Reserve Bank

Article excerpt

1 Introduction

The Reserve Bank carries out a number of financial system-related functions (see appendix 1). The scope of these functions has evolved following the passage of the Reserve Bank of New Zealand Amendment Act in 1986. The Amendment Act established prudential regulation and supervision as an explicit function for the first time in the Reserve Bank's history, for the purpose of maintaining financial stability. The 1986 Act also tasked the Reserve Bank with a 'lender of last resort role'. Over time other financial system-related functions have been added:

* the oversight and designation of payment and settlement systems between 2003 and 2008;

* the regulation of non-bank deposit-takers (NBDTs) in 2008;

* the supervision and enforcement of anti-money laundering and countering terrorist financing (AMLCFT) provisions for banks, NBDTs and life insurers in 2009;

* the regulation and supervision of insurers in 2010; and,

* a formal framework for macro-prudential policy (vis-a-vis banks) in 2013.

This article puts the Reserve Bank's financial system-related responsibilities in a historical context. (2) We identify a number of distinctive 'prudential regimes' to illustrate this development. The regimes differ across time both in terms of the scope of functions, and the relative balance between the three prudential pillars that support financial system outcomes: self, market and regulatory discipline (figure 1).

The pillars are a useful organising framework to understand the emphasis placed on regulated entities, market participants and the prudential regulator respectively that together contribute to financial stability. Briefly:

* self-discipline: concerns an institution's own processes and risk management frameworks, the responsibility for which lies primarily with its senior management and directors.

* market discipline: the way in which market participants influence a financial institution's behaviour by monitoring its risk profile and financial position. (3)

* regulatory discipline: this refers to the role of mandated rules and requirements set by the Reserve Bank. Some of these rules help support the other two pillars (e.g. by reinforcing good governance practices within financial institutions or through requiring disclosure of a financial institution's financial position). Other regulatory rules address the inherent limitations of self and market discipline because, left alone, financial institutions do not take into account the costs they impose on society from their actions (this is termed 'market failure'). This is illustrated most clearly in behaviour that may result in financial stress and ultimately failure of an entity, which can have a very disruptive impact on both the wider financial system and the macro-economy.

We begin the historical narrative with a brief description of the 'preprudential era'--the period between 1933 and 1987 before the Reserve Bank took on an explicit prudential supervision mandate. Section three examines the initial prudential regime set up under the 1986 Amendment Act which established a very light-handed approach. In section four we highlight the debate that occurred within the Reserve Bank following the shift to a more 'orthodox' regulatory regime established under the new 1989 Reserve Bank Act. The outcome of this debate culminated in the introduction of a new disclosure regime in 1996. Section five documents a gradual re-emphasis placed on regulatory rules and requirements prior to the global financial crisis (GFC). The last section discusses the growth in the scope and nature of the Reserve Bank's regulatory functions following the tumult of the GFC.

2 The pre-prudential era

Prior to the Reserve Bank Amendment Act 1986, the Reserve Bank was responsible for 'regulating' trading banks, trustee banks and the Post Office Savings Bank (POSB). However, there was no direct prudential supervision perse, in the sense of the term as it is understood today. …

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