MNI INTERVIEW: RBNZ's Prudential Body To Tackle Small Banks

The Reserve Bank of New Zealand’s newly established Financial Policy Committee (FPC) is expected to focus initially on unprofitable smaller banks and could adopt a tougher, European Central Bank-style approach to prudential management, potentially removing any implicit guarantees and encouraging amalgamations, a leading bank capital academic and World Bank advisor told MNI.

Martien Lubberink, associate professor of accounting and capital at Victoria University of Wellington, said several smaller banks in New Zealand struggle to generate a return on equity above their cost of capital, an issue the newly formed Bank of England-style FPC is likely to address. Some smaller institutions are generating around 6% returns compared with an 11% cost of capital, he noted, while the Australian-owned “big four” banks operating in New Zealand have an ROE of 11.4%.

“The profitability of the smaller banks is deeply behind,” he said, citing a Commerce Commission report two years ago that highlighted a serious lack of competition in the sector. (See MNI: RBNZ Set For Governance Shift After Banking Inquiry)

Lubberink said the long-term health of New Zealand’s banking sector depends on lifting returns on equity. Without it, smaller banks would struggle to invest in areas such as cybersecurity and financial innovation, further affecting their sustainability.

“So for the Reserve Bank, it has to make a couple of very important decisions about what to do with the smaller banks, because in the end, if they fail due to a major cyber risk or operational issues, you could have a systemic problem, or even something akin to a financial crisis, that would affect these banks more than the others,” he said.

“My suggestion would be to review which smaller banks should continue independently and which could be amalgamated into larger entities. Of course, this relies on ‘moral suasion,’ but also requires examining the current proportionality regime, which offers smaller banks a reprieve from some regulatory requirements.”

FPC ESTABLISHED

The RBNZ last week named Heidi Richards and Prasanna Gai as external members of the FPC, alongside internal members that include newly-appointed RBNZ Governor Anna Breman. Richards is a former senior prudential regulator and internationally-recognised leader in regulation, risk, and compliance, while Gai is professor of macroeconomics and head of the departments of economics, accounting and finance, and property at the University of Auckland.

The government’s approach so far has been to elevate and support Kiwi Bank to counter the market power of the big four banks, Lubberink said. However, he warned that this has increased Kiwi Bank’s risk appetite without a corresponding rise in capital.

New Zealand tends to avoid aggressive interventions, unlike the ECB, which has historically been less supportive of smaller institutions due to correlated risks in a crisis, he added. “During a crisis, all banks tend to move together. Supervising hundreds of small banks that could fail simultaneously is a major problem,” he said, pointing to New Zealand’s proportionality regime, which applies lighter rules to smaller banks.

Lubberink was confident Richards would bring significant value due to her cross-border banking regulatory experience. "She’s extremely well versed in supervision, particularly cross-border banking, including the relationships between Australian parent banks and subsidiaries here. Managing those dynamics requires years of experience, and she clearly has that."