The Reserve Bank launched a stress test in March to determine the resilience of banks and the financial system to the risks posed by the COVID-19 pandemic. The COVID-19 stress test consisted of two parts. First, a desktop stress test where the Reserve Bank estimated the impact on profitability and capital for nine of New Zealand’s largest banks to the impact of two severe but plausible scenarios. Second, the Reserve Bank coordinated a process in which the five largest banks used their own models to estimate the effect on their banks for the same scenarios. The pessimistic baseline scenario can be characterised as a one-in-50 to one-in-75 year event with the unemployment rate rising to 13.4 percent and a 37 percent fall in property prices. In the very severe scenario, the unemployment rate reaches 17.7 percent and house prices fall 50 percent. It should be noted that these scenarios are hypothetical and are significantly more severe than the Reserve Banks’ baseline scenario.
Cyber-attacks could cost New Zealand’s financial sector more than $100 million a year on average according to a new Reserve Bank bulletin article, highlighting the need for industry resilience to counter these threats. Part of an expanding programme of work on risks to the financial system, Cyber incident cost estimates and the importance of building resilience examines the financial sector’s resilience to cyber threats and estimates the potential costs to the country’s financial system, using two internationally recognised methods. The authors Aria Zhang, Rosie Collins, and Cavan O'Connor-Close estimate an indicative average cost of cyber incidents of $104 million a year for the banking sector and $38 million annually for the insurance sector, or the equivalent of 2-3 percent of annual profits for the two industries. The modelling also indicates that in any given year there is a 5 percent chance the costs could exceed $2.3 billion a year. While quantifying these costs is difficult, the findings indicate the financial cost has the potential to be significant. The study did not capture any additional costs such as the possible loss of confidence in the financial system. The country’s cyber-security agency CERT NZ found more than 60 percent of cyberattacks on New Zealand organisations in 2018 targeted firms in the financial and insurance services sector. With the frequency and severity of cyber security incidents on the rise, the study highlights the importance of the financial sector remaining vigilant and managing cyber risks effectively. The Reserve Bank is strengthening its efforts to enhance the resilience of the financial system from cyber threats, including developing risk management guidance and promoting information-sharing in collaboration with industry and other public organisations.
This article provides an overview of the life insurance sector in New Zealand and highlights issues in the sector. It provides a range of indicators relating to New Zealand’s life insurance sector, and where possible, compares them to international peers. The purpose of this article is to support market discipline by sharing some of the data collected by the Reserve Bank in recent years. The insurance sector plays an important role in the financial system by spreading the costs of risk events through time, across the population and, via reinsurance, internationally. Life insurance coverage softens the financial impact of events such as death, disablement and major illness, allowing insured individuals and their families to maintain their living standards. It may also support mechanisms for long-term saving and provision for retirement, although the sale of new insurance policies that provide this facility has largely ceased in New Zealand. Life insurance policies currently available in New Zealand mainly provide coverage for personal risk, most commonly in the form of insurance that provides cover for a specified term. They are predominantly distributed through financial advisers and banks. New Zealanders have relatively low coverage compared to residents of other OECD countries. New Zealand life insurers are more profitable than their peers in many developed OECD countries, with return on equity higher than the median and a low claim ratio. They also have high costs relative to their international peers due to high commission rates and relatively high operating expenses. These characteristics may indicate poor value for money for some potential and existing policyholders as high expenses can drive up premiums. Additionally, high upfront commission rates and policy replacement activity, where policyholders replace an existing policy with a new one during the year, may undermine public confidence in the sector. Consequently, the level of insurance for personal risk may not cover actual financial vulnerability for some individuals in New Zealand, and some individuals may be priced out of the life insurance market altogether. Insurers hold solvency capital to withstand a range of possible adverse events such as natural catastrophes, insurance losses, credit events and market movements. The solvency ratio is a measure of capital strength and resilience. The aggregate solvency ratio for the life insurance sector has declined in recent years and is low relative to other countries. Some life insurers operate with low solvency margins over the regulatory minimum, raising questions about their ability to comfortably meet the minimum requirements in the event of an adverse shock. New Zealand life insurers make greater use of reinsurance than their international peers, partly due to differences in product mix. Life insurers primarily reinsure to reduce the volatility of profit and transfer risk to reinsurers. Recently, there has been a greater use of reinsurance as an alternative to holding solvency capital. The Reserve Bank began regulating and supervising insurers from 2011, after the Insurance (Prudential Supervision) Act 2010 (IPSA) came into force. The purposes of IPSA are to promote the maintenance of a sound and efficient insurance sector, and to promote public confidence in the sector. Alongside the forthcoming review of IPSA, the Reserve Bank will review solvency standards and consider the case for solvency buffers, with the aim of improving resilience in the sector. The Reserve Bank and the Financial Markets Authority (FMA) conducted a thematic review of the conduct and culture of the life insurance sector in 2018, and found “extensive weaknesses in life insurers’ systems and controls, with weak governance and management of conduct risks across the sector and a lack of focus on good customer outcomes”. The Government recently announced a new financial conduct regime in response to the issues identified in the review, and gaps in existing regulation. The proposal aims to address conduct issues and promote fair treatment of customers in the sector. Life insurers will be required to obtain a conduct licence from the FMA. The FMA will regulate the new regime and will have a full range of licensing and enforcements tools under the Financial Markets Conduct Act 2013. Steps have also been taken to enhance the regulation of financial advice in New Zealand. For example, the Financial Services Legislation Amendment Act 2019 will be supported by new regulations and a revised code of conduct for advisers.
A clear and effective strategy can play a significant role in helping monetary policy decision makers to achieve their objectives. This article outlines a framework for monetary policy strategy in New Zealand. It discusses the underlying principles of effective strategy in the context of a flexible inflation targeting regime and articulates the Reserve Bank of New Zealand’s monetary policy strategy during the inflation targeting period. On 1 April 2019, amendments to New Zealand’s monetary policy framework came into effect. Changes to the Reserve Bank of New Zealand Act 1989 added an employment objective to the Reserve Bank’s long-standing price stability objective, and created a formal Monetary Policy Committee with members internal and external to the Bank. Therefore, it is timely to take stock of the Bank’s current monetary policy strategy, which will provide a platform from which the Monetary Policy Committee’s strategy can be developed.
As of 2018, the Reserve Bank of New Zealand has a dual mandate for monetary policy focused on targeting price stability and supporting maximum sustainable employment. In this article, we discuss the Bank’s policy objectives in a broader historical context, illustrating how the aims and objectives of monetary policy have varied over time in response to pressing societal issues. The emphasis of this Bulletin article is on the objectives of monetary policy. Monetary objectives are one component of a wider set of legislated, economic objectives determined by government. Notwithstanding central bank independence, there has often been significant interplay between monetary objectives and the macro objectives set for fiscal policy. Monetary policy objectives have also fluctuated between two orientations. First, providing a stable unit of account and predictable monetary framework to facilitate private transactions. Second, proactively using monetary policy to shape the allocation of real resources to improve welfare. Inflation targeting represents a middle ground between these two orientations. In sections 2 and 3 of this article, we discuss the history of central bank objectives leading up to the development of dual mandates. The key message from these sections is that monetary policy objectives have evolved over time, reflecting different societal needs, evolving empirical experience and theoretical insights. In section 4, we outline why price stability and macroeconomic stabilisation are common objectives for monetary authorities and discuss the interplay between monetary objectives and theoretical insights over time. Section 5 concludes.
The Reserve Bank of New Zealand targets price stability and supports maximum sustainable employment using monetary policy. In late 2018, the Reserve Bank of New Zealand Act was amended to make a committee of decision makers responsible for monetary policy decisions, replacing the previous single decision-maker approach. A key goal of a monetary policy committee (MPC) is to make unbiased, and evidence-based monetary policy strategy decision which requires good committee design, high quality inputs and effective monetary policy deliberations. This article introduces a set of guiding principles and formal processes that support strategic decisions by facilitating an environment of robust deliberations. Our principles are: 1. clear objectives, 2. diversity, and 3. inclusion. Our formal processes for MPC deliberations are based on these principles.
This article provides an overview of the experience with unconventional monetary policies since the global financial crisis of 2007/8, and assesses the scope for unconventional monetary policy in New Zealand. While there is no need to introduce unconventional monetary policies in New Zealand at this time, it is prudent to learn from other countries experiences and examine how such polices might work in New Zealand if the need arises. We find there is potential to utilise unconventional monetary policies. However, given the specific characteristics of New Zealand capital markets there are limitations on the extent that unconventional polices can be applied, and the instruments that can be used. Furthermore, in a small open economy, such as New Zealand, the way that unconventional policies affect the economy may differ from the experiences of larger countries. Certain risks are associated with unconventional policies that would need to be managed. Consequently, it will be important that the Reserve Bank communicates on the objectives and nature of any unconventional policies that may be implemented. The Reserve Bank will continue to monitor other countries experiences with unconventional policies and undertake further research as New Zealands financial markets evolve.
Atif Mian is the John H. Laporte Jr. Class of 1967 Professor of Economics, Public Policy and Finance, and Director of the Julis-Rabinowitz Center for Public Policy and Finance at the Woodrow Wilson School of Public and International Affairs, at Princeton University. Professor Mian’s research has provided insight into the role of household debt and credit supply, both before and after the 2008 crisis. His book with Amir Sufi (University of Chicago), House of Debt (2014), explores the role of household debt in precipitating the crisis, its resolution and what needs to be done. Professor Mian visited the Reserve Bank in Wellington in December 2017. Ozer Karagedikli and Anella Munro, from the Economics Department of the Reserve Bank, interviewed him.
This article was originally published on 24 May: Banking conduct and culture - The Reserve Bank's role and efforts ahead.
This article is motivated by the recent rapid growth in technology- enabled innovation in financial services, referred to as ‘FinTech’. It explains and gives examples of developments in a number of broad categories of FinTech, and considers their implications for the Reserve Bank as prudential regulator. FinTech has the potential to enhance financial sector efficiency, but may also create new risks to financial sector stability. So far the overall impacts have been small, and for now the appropriate response by the Reserve Bank is limited to increased monitoring of emerging FinTech developments.
Over the past decade the financial services industry has been disrupted by a range of new technologies. This has included the launch of new, private, digital currencies such as Bitcoin. In this environment, central banks are considering how they can take advantage of these new technologies to help deliver their core functions. This article contributes to this discussion by evaluating the pros and cons of a public digital currency issued by a central bank across four functional areas: currency distribution, payments, monetary stability and financial stability. We distinguish between two kinds of digital currency conventional digital currencies, which rely on existing payments technology to operate, and crypto-currencies which rely on distributed ledged technology (similar to Bitcoin). We find the pros and cons of a central bank issuing a digital currency are mixed across each of the central bank functions, revealing the complexity in evaluating such a currency. In particular, we find the implications for monetary policy and financial stability could be significant, both positively and negatively.
Stress tests play an important role in the Reserve Bank’s supervision of the banking system. Firstly, stress tests improve understanding of the implications of current and emerging risks to financial stability. Secondly, stress tests help assess the resilience of participating banks to severe but plausible scenarios. Results provide one lens on capital adequacy rather than a final conclusion, reflecting the uncertainty around how stress scenarios would play out and the level of capital required to maintain market confidence. Finally, supervisory tests make a significant contribution to the development of risk management capability at participating banks.
Privately issued digital currency is value that circulates over the Internet. Digital currency provides an instantly clearing accessible method of transferring funds and conducting business on a global scale. It is a code or serial number representing value that is circulated online. Most often this represents a physical value stored offline. Other decentralized virtual currency systems such as Bitcoin circulate units with a value determined by the liquidity of market supply and demand. As smaller digital currency systems become more commercially accepted by retail users and merchants, these systems also tend to evolve into highly regulated enterprises. The most important part of any digital currency system is the point where digital units are swapped for national currency providing liquidity for consumers and merchants.
The market for credit plays an important role in New Zealand’s economy. Changes in credit market conditions can influence economic growth, as well as the stability and efficiency of the financial system. The Reserve Bank monitors credit conditions in a number of ways, including through a six-monthly survey of banks. The survey, called the Credit Conditions Survey, asks banks to report on observed and expected changes in demand for and the availability of bank lending. The Reserve Bank has begun publishing key credit conditions indicators from the survey. This article introduces the Credit Conditions Survey. It presents several key credit conditions indicators from the survey and shows how these relate to other indicators of credit availability. In general, the survey appears to produce meaningful indicators of changes in credit conditions. Survey responses also provide insights into future changes in the availability of credit.
The Reserve Bank uses stress tests to assess the soundness of the financial system. This article summarises results from a recent exercise involving the four largest New Zealand banks. The test modelled a severe macroeconomic downturn scenario and an operational risk event related to mortgage lending misconduct. Consistent with previous tests, results suggest that strong underlying profitability from repricing actions to maintain their net interest margins would allow these banks as a group to absorb significant losses through the stress scenario without breaching their minimum capital requirements. While the test demonstrates these banks’ resilience, there remains uncertainty as to how such scenarios would unfold in reality.
This year the Reserve Bank is releasing a coloured circulating fifty cent coin to mark Armistice Day, the effective end of the First World War. This follows a similar coin issued in 2015 to mark the Gallipoli campaign. Both coins feature new-technology minting processes, and both were especially commissioned to mark these events as the Reserve Bank of New Zealand’s contribution to the government First World War centenary celebrations. This article outlines the historical meaning of the armistice and gives a particular context for the Armistice Day coin. It also describes the special design of the coin, which is one of only two coloured circulating coins issued in New Zealand.
The financial sector has grown ever more interested in crypto-currencies and the innovative Distributed Ledger Technology (DLT) that underpins them. For central banks, in their role as providers of currency and critical payments infrastructure, a key area of interest is whether DLTs could be used to enhance existing payment processes. This article gives a high-level explanation of how different DLTs can change payments processes. The answer depends on what form the distributed ledger takes. We identify four binary elements that determine the different properties of distributed ledgers and use case studies to evaluate how these elements can improve on, or fall short of, existing payments infrastructure. We find that Blockchain – the most well-known DLT that underpins Bitcoin – brings benefits in terms of the speed of cross-border settlement and improves security by removing the single point of failure, but has drawbacks in terms of slowing the speed and increasing the cost of smaller domestic transactions, and being energy intensive. Some central banks have experimented with other forms of DLTs that try to capture some of the benefits of Blockchain while minimising the costs, but so far these DLTs have tended to mimic existing payment processes and have not demonstrated many additional benefits.
Labour is the largest input to the productive capacity of the economy. The amount of labour available to be employed – labour supply – is therefore important to understand when gauging inflationary pressure in the economy. However, labour market outcomes are complex. There are considerable differences in outcomes across age cohorts, gender and individuals more generally. In aggregate, New Zealand’s labour force participation has grown since 2000 to a recent all-time high. In this paper, we delve into the details of labour supply to understand what has been driving New Zealand’s historically unusual outcomes. Furthermore, we put the New Zealand experience into context by comparing post-2000 developments in labour supply across OECD economies.
The results of the IMF’s assessment were released in early May 2017. There were well over 100 recommendations, most of them directed at the Reserve Bank given its broad range of financial system responsibilities. The Reserve Bank is considering all the relevant findings and recommendations, and the extent to which implementation would further support the Reserve Bank’s statutory purpose of promoting and maintaining a sound and efficient financial system. Several specific FSAP recommendations dovetail with ongoing policy and supervisory initiatives such as the bank director attestation review, the review of bank capital requirements, the review of the statutory framework for the insurance sector and consultation on a debt-to-income instrument for the macro-prudential toolkit.
This article follows on from the narrative contained in Business cycle review: 2008 to present day (Williams, 2017). The first article described the evolution of the economy since 2008 and how monetary policy responded given the Bank’s assessment of economic conditions in real time. This article presents a broader view of the current (as yet incomplete) expansion, by looking at some of its defining features and comparing them to experience in previous expansions. In doing so, this article also presents some broad insights for monetary policy that have been reinforced in the current expansion.
