Motions

Hon Dr MICHAEL CULLEN (Minister of Finance) Link to this

I move, That, pursuant to section 161(2) of the Reserve Bank of New Zealand Act 1989, this House ratify the funding agreement entered into by the Minister of Finance and the Governor of the Reserve Bank of New Zealand pursuant to section 159 of that Act on 28 April 2008 and presented to the House on 20 May 2008. This is a relatively narrow motion and debate. It applies to a variation to the funding agreement to enable the Reserve Bank of New Zealand to exercise functions that it will acquire under legislation at present in front of the House that has very broad support within the House.

The Reserve Bank’s operating expenditure is funded from gross income under terms established by the Reserve Bank of New Zealand Act 1989—the Act—and a 5-year funding agreement. The Act requires the Minister of Finance and the governor to enter into a funding agreement for successive periods of 5 years. The current funding agreement was signed in April 2005 and expires at the end of June 2010. However, this agreement does not account for the bank’s new prudential responsibilities that it is going to acquire, and I am therefore asking the House to ratify today a variation to that agreement to enable the Reserve Bank to have the necessary funding for that role.

In December 2005 Cabinet agreed that the prudential regulation for the financial sector should be consolidated into a single regulator, and agreed in principle that this regulator should be the Reserve Bank. Subsequently, in June 2007, Cabinet agreed to changes to the institutional arrangements of the Reserve Bank and also that the costs of regulating non-bank deposit takers and the cost of regulating and supervising insurance companies should be met through a variation of the Reserve Bank’s funding agreement, to be ratified by Parliament. The Reserve Bank of New Zealand Amendment Bill (No 3), which is currently before the Finance and Expenditure Committee, gives the bank these new regulatory functions and powers. Additional funding is required by the bank in order to provide advice in respect of matters relating to the intended regulatory regime for non-bank deposit takers and insurers, and to develop the operational capability to assume new statutory responsibilities.

The key influences behind the revised variation in funding are as follows. In addition to licensing and undertaking prudential supervision of banks, the new policy outputs that will be required of the Reserve Bank are, firstly, that the bank will license non-bank deposit takers and be responsible for various obligations upon non-bank deposit takers to be included in regulations. Front-line supervision of non-bank deposit takers tends to be undertaken by trustees. Secondly, the bank will license and undertake prudential supervision of insurance companies.

In this funding agreement nominal expenditure is set at $43.3 million in 2008-09 and $46.9 million in 2009-10. This is an increase of $2.3 million and $3.9 million respectively for each of these years, above the funding levels specified for each of these years in the current funding agreement. The increase in costs arises from the staff required for increased policy advice responsibilities and for activities associated with greater oversight of the non-bank sector. The bank considers it will have the capacity to accommodate all the funding required for its expanding responsibilities under current funding levels for the year ending this month, and, as a result, the agreement is not varied for the 2007-08 financial year.

This funding agreement—the variation—contains no provision for the marginal costs of anti - money-laundering supervision by the bank. In the event that Cabinet agrees that the Reserve Bank is really the anti - money-laundering supervisor of the entities that it regulates, then it is likely the bank will seek additional funding for this new responsibility, at that time.

I should perhaps add that the bank has significantly increased its prudential supervisory capacities over the last 2 or 3 years. I think it was well recognised, under both the previous governor and the current governor, that those capacities had been run down to a somewhat unsatisfactory low level. With the new legislation to come into force, as I said, those prudential supervisory capacities will need to be expanded because these new requirements and responsibilities would not be able to be met out of current resources. I think what we have seen in the New Zealand financial markets over the last 2 years emphasises the importance of improving the supervision of non-bank deposit takers. Tens and tens of thousands of New Zealanders have lost money over the last 2 years, as a range of finance companies have gone under. Hopefully, increased supervision will reduce the risk, in the future, of that happening.

Dr the Hon LOCKWOOD SMITH (National—Rodney) Link to this

This Government motion is not a highly controversial matter, but the appropriate funding of the Reserve Bank is something that this Parliament should take seriously. It is ultimately this Parliament’s responsibility to ratify the agreement that the Minister of Finance has just mentioned. That agreement was provided for under the Reserve Bank of New Zealand Act whereby the bank is able to retain, each year, as agreed with the Minister of Finance, the amount of its gross earnings. This Parliament, quite properly, has the ultimate decision whether to ratify that agreement. So we do have the power to not ratify it, because, after all, expenditure of public moneys is something that is the preserve of this Parliament, not the Government. So it is an important responsibility that Parliament has to decide whether to ratify this increased expenditure.

What I think is important in a debate such as this is that these things are as transparent as possible, because obviously the Reserve Bank needs the funding to carry out its legislated functions, and no one in this Parliament would say the bank should not be able to retain that level of funding from its gross earnings. But I think what would be a little more helpful would be had the Minister explained a little more about why there has been such a big increase over recent years. Now, Dr Cullen mentioned that the actual dollar amounts that the variation to the funding agreement provides for is a relatively small number of dollars in 2008-09 and 2009-10; when I say “relatively small”, the increase I think in 2008-09 is about a 5.6 percent increase, and a 9 percent increase in 2009-10.

The $2 million or $3 million involved in that does not sound a huge amount of additional money to carry out the new roles that the Minister has just mentioned. For example, he mentioned that the licensing and prudential supervision of non-bank deposit takers would be a new function for the Reserve Bank, as is the licensing and prudential supervision of insurance companies. Obviously, that will require more funding, but to me what is interesting, as we look back over the current agreement that we are looking to amend tonight, is that in fact the Reserve Bank has been receiving quite significant increases in funding, anyhow. I draw the House’s attention to the 2006-07 financial year; according to the information I have, the agreed amount of money that the Reserve Bank was able to retain in the 2006-07 year was $34 million. The agreed amount that is put before this Parliament tonight to ratify for the 2009-10 year is $46.9 million. Now, that difference over a period of just 4 years is a 38 percent increase in the amount of gross income the Reserve Bank is able to retain.

One has to ask oneself whether a 38 percent increase is reasonable. Admittedly, the 2006-07 year, for some reason or other, was a year of lower retained income—the year before was $39 million. Be that as it may, as I understand it, in 2006-07 the agreed amount was $34 million. Do the new responsibilities around non-bank deposit takers and insurance companies justify that kind of increase—38 percent—in retained income in just 4 years? I think we deserve a little more explanation as to why there is quite such a big increase, because when it is not explained to the House more clearly why that level of increase has occurred, it invites suspicion.

Let me explain why it invites suspicion. In the last 12 months the Reserve Bank took a sort of swing into the area of currency trading, and at one stage there, I think, when the New Zealand - US exchange rate hit about US75c, from memory, or somewhere around there, the Reserve Bank suddenly launched into—naturally it would not have announced it previously—quite a significant foray into foreign exchange trading. Some people have said the bank used a peashooter against the currency traders, because international currency trading is a massive amount of money transacted each day, and the amount of retained earnings the Reserve Bank has to play that game is pretty limited; and, what is more, the Reserve Bank intervened at about US75c and the currency immediately proceeded to climb to over US80c.

Of course the Reserve Bank at that stage, on paper, would have lost significant money. The question that it would have been helpful to have an answer to, had Dr Cullen made it clear to Parliament tonight—maybe the next Government member could do this—is whether the Reserve Bank has lost any significant money on its currency trading escapades. To the uninitiated like me, because I am no expert in this field of currency trading, one could suggest that, OK, it intervened in the markets at about 75c, it lost on paper as the currency climbed to 80c—damn near US81c—but since then the New Zealand dollar against US currency has receded somewhat. What is it back to today?

TIM GROSER (National) Link to this

I will take just a brief call. Obviously, as my colleague has just explained, the Opposition will not be opposing this motion. It is crucial to this country that the prudential controls over our banking system, both narrowly defined—in this case we are moving in a broader direction—and more generally defined, are in good shape and that our officials in the Reserve Bank have the resources to do it.

We have raised some legitimate questions. We will have to, I presume, take it on trust, unless we get another intervention from the Government benches to indicate why such a significant increase in funding has been justified. I do not know whether an independent Treasury report has been commissioned on this, but I think the position the Opposition finds itself in is that we will just have to assume that this is a responsible bid for what is unquestionably an activity that the Opposition supports. We certainly know that the prudential soundness of our financial system lies at the very heart of the stability of—well, every country in the world.

The authorities here are trying to play what is essentially an eternal cat and mouse game that occurs with financial markets. As you no doubt know, Mr Deputy Speaker, the technical term for this is the process of financial disintermediation, whereby we establish a set of regulatory frameworks to manage risk and to manage the interventions of certain financial institutions. By definition we create an incentive on the part of other institutions not covered by the regulations to game the system, thus giving rise to this concept of disintermediation between the bank and the non-bank sector.

In a sense, it is a game that will be played for eternity. No matter what the authorities do in the future, they will by definition always create this incentive, and, again, another cycle will have to catch up, which is essentially what this funding is related to. It is related to extending the prudential controls, for the reasons that the Minister of Finance has very adequately described, towards certain non-bank deposit takers.

Mr Deputy Speaker you may remember a certain period of New Zealand’s economic history during which the controls over the banks were so tight that the principal source of non - State Advances Corporation funding was in solicitors’ funding for mortgages. So stringent were the capital adequacy reserve ratios and other mechanisms, that essentially the State drove the entire lending sector out into the non-bank sector. This continues in this pattern. We support the regulatory extension of the prudential controls.

In conclusion I will make a few fairly obvious points about why this measure is so important. The concept of a sound financial system is as central to the stability of a society as the rule of law is. Frankly, I put far more expectation on hyperinflation driving Mr Mugabe out of power than on any conceivable trade or political sanctions the international community might be considering in the future. The history of the world is littered with despots and Governments that believed they could ignore the implications of sound money, sound financing, and a sound financial sector.

I recall always that there is a tension here between over-regulation and under-regulation. There is huge literature, as you no doubt know, Mr Deputy Speaker, about the question of moral hazard for bankers, and I always thought that the best definition I ever heard was the definition given to one person who inquired too tightly as to where the limits of Bank for International Settlements intervention to support failed central banks would stop and start. He said: “I will not tell you, sir, how far we will go to bail you out. This is something I will discuss with your successor.”

So there is always necessarily a certain a degree of what I would call constructive ambiguity around these matters, in which regulatory authorities—be they, as in this case, the Reserve Bank of New Zealand, or, in the case internationally, the Bank for International Settlements—necessarily have to keep up their sleeve just how far they will go to avoid what is called moral hazard, or in other words, bailing out people, no matter what loss they have made. So it is crucial to that, and it is crucial to low inflation growth.

We know from the literature that in respect of developed countries, inflation up to and about 3 percent is the usual measure of it, not just in New Zealand, will be good for and is associated with higher real growth. Inflation above 3 percent is associated with lower growth. So much for those people who advocate weakening the inflation targets further in the naive belief that it would lead to sustainably higher employment and growth outputs. For reasons I will not bother with, the metrics are a little bit different in respect of developing countries where we can see the conjunction of somewhat higher rates of single digit inflation with higher real growth rates. But, basically, for developed countries, the sort of framework we have developed in New Zealand we have broad support for in this House, as it appears to be correlated with much sounder outcomes for the country as a whole. So we have some questions over the quantum. I am sure they will go unanswered tonight, but nevertheless the Opposition supports the underlying objectives of this motion.