Finance game at risk of Aussie rules

By BRIAN FALLOW economics editor

Reserve Bank concerns about the risk in New Zealand's key banks being Australian-owned could place a hurdle in the way of an Australian buyer of the National Bank.

Four of the big five New Zealand banks are Australian-owned and it is possible that the fifth, National Bank, will be sold by Britain-based Lloyds TSB to an Australian bank as well.

The increasing integration of the New Zealand and Australian banking systems poses particular challenges for the Reserve Bank in its role as the supervisor of the financial system.

One is that Australian law gives preference to depositors from that country if a bank fails. Partly for that reason, Reserve Bank policy is that "systemically important' New Zealand banks should be locally incorporated, not branches.

Another problem is that many "back office" functions such as payments clearing have been consolidated into the Australian parent bank's operations back home, raising questions about whether the New Zealand subsidiary could function as a standalone bank if, for example, the parent failed.

Governor Alan Bollard said yesterday: "Our position is that we would expect there to be no material transfers of National Bank business into branch form, and we would expect further discussions before any movement of technical capacity that reduced the bank's ability to continue to operate on a standalone basis under New Zealand statutory management."

He was speaking to a finance sector ombudsmen conference in Wellington. A Reserve Bank paper on its supervisory role presented to the conference said that in normal circumstances the location of the core functionality of a bank was of relatively little concern.

"However when stress emerges, the legal structure and physical location of different parts of the business may affect the ability of New Zealand authorities to contain the distress."

The Reserve Bank has been working with the trading banks for some time on hypothetical "stress testing' of their balance sheets and systems to cope with various shocks, such as a foot and mouth outbreak.

The adequacy of New Zealand's regulatory regime will come under scrutiny later this year during a routine inspection by International Monetary Fund officials.

The bank's paper made it clear it had no intention of backing away from the internationally unusual policy of relying on public disclosure requirements rather than detailed prescriptive rules and behind-closed-doors monitoring by central bank officials.

There is no deposit insurance and no Government guarantee of banks in New Zealand.

"In making this choice," the bank says, "we have been aware of the risk that regulatory protection of depositors can inadvertently and inappropriately become de facto protection of shareholders, undermining incentives for good risk management."

The public disclosure requirements mean any excessive risk-taking by banks would be quickly revealed to the market and banks would lose business as a result, it says.

If a bank failed, one option under consideration is recapitalising it using creditors' funds, the Reserve Bank says. In other words, some proportion of depositors' money would be turned into shares in the bank, in the hope that they would eventually get it back.