The Reserve Bank's risk management processes aim to protect the integrity of the entire financial system rather than individual entities, which should be allowed to fail to avoid moral hazard and inefficiency, the regulator says
The Reserve Bank's risk management processes aim to protect the integrity of the entire financial system rather than individual entities, which should be allowed to fail to avoid moral hazard and inefficiency, the regulator says.
The central bank is tasked with managing system-wide risk, and largely aims to deal with market failures where the cost of risks aren't borne by the institutions taking them, and where information in the market isn't asymmetrical, head of prudential supervision Toby Fiennes said in a speech to the NZ Society of Risk Management in Wellington.
The bank isn't generally concerned with risks to shareholders or an entity's profitability, rather it focuses on what risks might seriously damage the wider system. It estimates the cost of a severe financial crisis would be between 10 percent and 20 percent of gross domestic product.
"Any regime that seeks to avoid failure at all cost is very unlikely to be dynamically efficient," Fiennes said. "Even a large, interconnected entity cannot expect the Reserve Bank or government to support it if it fails, nor to make good any losses suffered."
In 2012 the central bank launched its controversial open bank resolution scheme, which it described as a living will, which would see failed bank write down the value of the most pressing unsecured liabilities almost immediately, so service could resume a day after an insolvency event or statutory management to allow customer transactions to keep flowing, without the need for taxpayer support.
The reason it attracted controversy was that customer deposits are at risk if shareholder funds get exhausted in the event of insolvency in much the same way as a standard liquidation.
Fiennes today said a regulatory regime that sought to avoid failure harms the soundness of the system by increasing moral hazard, which is where a party will take more risk as it won't bear all of the consequences, and reduce efficiency by encouraging firms to be overly cautious.
"We see our role as being to support that market-led risk management, and bolster it where we identify specific, material threats to the soundness and efficiency of the system," Fiennes said.
While the bank doesn't use the term 'too big to fail', it has a lower tolerance for risk among the larger banks which is "probably even lower than that of their own management" due to the potential spill over into the wider system, he said.
The Reserve Bank is undertaking a stock-take of its existing regulation with a view to simplify and remove redundant rules where it can, and is consulting on ways to improve regulation without imposing any unnecessary costs, he said.
(BusinessDesk)
