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Questions and Answers on prudential requirements for Non-Bank Deposit Takers

September 2007

What will be the role of the Reserve Bank of New Zealand?

As announced in June 2007, the Reserve Bank will become the single prudential regulator for New Zealand. This would widen the scope of the Reserve Bank’s prudential functions to include the prudential regulation of Registered Deposit Takers (RDTs) and the regulation and supervision of insurance companies.

This Q and A covers RDT regulation only, where policy decisions have already been taken by Cabinet: insurance regulation is included within the next phase of work on the Review of Financial Products and Providers, with a report back to Cabinet by 30 November 2007.

What is a Registered Deposit Taker (RDT)?

A “deposit-taker” will be defined in legislation as a person, other than a registered bank, which offers debt securities to the public, within the meaning of the Securities Act, and is in the business, directly or indirectly, of lending money or providing other financial services.

The definition would explicitly include building societies and credit unions.

This concept is broadly consistent with the definition of deposit-taker in many OECD countries and reflects the objective of targeting the regulatory requirements to entities that fund from ordinary, non-expert depositors. It would have the effect of including finance companies that fund from the public, building societies, credit unions, the PSIS and other such entities. The proposed concept has the intended effect of excluding finance companies and other entities that fund solely through non-public sources – eg those raising funds solely from related parties or from corporate or wholesale sources.

A Registered Deposit Taker (RDT) will be defined as a deposit taker that is licensed by the Reserve Bank

The Reserve Bank will have the power to exempt entities or classes of entity from the RDT requirements in circumstances where it makes no sense to capture these entities in the regime.

The Reserve Bank will also be empowered to designate entities as deposit takers for the purposes of these regulations, where these entities are deposit takers in substance but are not captured by the definition.

It will be unlawful to be a deposit taker, without being licensed by the Reserve Bank as a Registered Deposit Taker or a Registered Bank.

What is being proposed?

RDTs will be subject to the Securities Act requirements, as enhanced by the RFPP reforms, including the need to have a trust deed (and therefore be supervised by trustee corporations), a prospectus and investment statement. In addition to this, they will be subject to additional prudential requirements:

 

What are the objectives of regulating RDTs?

The proposed objectives for prudential regulation of the RDT sector are to promote a sound and efficient financial system by:

What do the objectives not include?

The objectives do not include:

What will licensing and regulation of RDTs involve?

Minimum requirements would apply to all RDTs at the time of licensing and on an ongoing basis. It is proposed that the licensing and other requirements will comprise:

What will be the functions of trustees under the new arrangements?

The trustees will continue to be the front-line supervisors for RDTs, much as they are now. Their functions will include:

Trustees will be subject to greater oversight by the Securities Commission under the new regulatory arrangements, and there will be a minimum set of requirements for the content of trust deeds.

Furthermore, in the case of prudential requirements that must be included in trust deeds (such as minimum capital, capital adequacy ratio, a related party exposure limit and liquidity requirements), it is proposed that the trustee would be responsible for enforcing compliance with requirements and will have additional obligations and powers imposed under the RDT legislation for that purpose. In order to achieve this outcome:

Why is a mandatory credit rating being proposed?

The requirement to obtain and disclose a credit rating from a rating agency approved by the Reserve Bank would bring a number of important benefits, both to depositors and to the financial system as a whole.

Ratings provide a relatively simple metric summarising, in one measure, the risk of an RDT defaulting on its financial obligations. A rating therefore reduces the need for investors to try to understand more complex and voluminous financial information on RDTs. Ratings would provide the most cost-effective means of enabling depositors to distinguish between higher and lower risk RDTs and thereby make better-informed investment decisions. This is particularly so if ratings are disclosed prominently in public offer documents and advertisements in ways that can be readily understood by non-expert investors, backed by greater initiatives to promote financial literacy among investors.

Ratings would also strengthen market disciplines on RDTs and reduce the need for a more intrusive form of regulation and supervision, both in terms of a reduced need for prudential restrictions on RDTs and less detailed financial public disclosure requirements. In turn, this would reduce the regulatory costs for the RDT sector relative to the situation where there are no required ratings.

Will ratings be understood by non-expert depositors?

Currently, there appears to be quite limited public understanding of credit ratings. However, as more RDTs acquire ratings, and as public awareness of ratings grows, the understanding and use of ratings by ordinary depositors are likely to increase. To facilitate this, a number of initiatives can be taken, both to promote more effective disclosure of ratings and to enhance public understanding of ratings, including:

Will ratings be costly for RDTs?

Requiring RDTs to obtain and disclose a rating will involve costs for RDTs – both in terms of the direct cost of the rating and the indirect cost of management time, systems and controls. However, the costs of mandatory ratings are expected to be modest for most RDTs relative to their revenue, assets and liabilities. The costs could be more significant for very small RDTs.

In the case of RDTs that can only achieve a low rating, a ratings requirement could increase their funding costs. This could lead to consolidation or rationalisation in the RDT sector, depending on market reaction to ratings. However, this need not be a negative development; it may be a desirable outcome of better-informed investor decision-making and efficient markets.

It has been agreed by Cabinet that small RDTs (those with total assets less than $10 million) will be exempt from credit rating requirements. These exempt entities will be required to prominently disclose that they have no rating; will be prohibited or restricted from disclosing ratings from non-approved agencies; and be required to comply with any additional prudential requirements imposed by regulation, such as minimum capital ratios or limits on exposures to related parties.

When will the new arrangements come into force?

It is intended that legislation to give effect to the new arrangements will be introduced in two stages.

The first bill, to be introduced in 2007, will contain required definitions (including for “deposit-taker”) and the provisions permitting regulations to be promulgated to prescribe requirements for credit ratings, minimum capital, capital adequacy, limits on exposures to related parties, and liquidity, and associated offences and penalties. It is hoped that the first bill will be enacted in 2008.

A second bill, to be introduced in 2008, will contain all remaining matters required to implement the RDT regime, including licensing and fit and proper requirements.

It is likely that a transition period will apply after the commencement date to provide existing RDTs with sufficient time to come into compliance with the new regulatory requirements.

Will stakeholders be consulted on the details of regulatory requirements?

Yes. Stakeholders will be consulted in the development of the proposed regulatory requirements. Consultation with some key stakeholders will occur in the preparation of legislation. Once legislation has been introduced into Parliament, it will be subject to the standard select committee process, therefore enabling any parties to express views on the proposed requirements. Any regulations prepared pursuant to the legislation will also be subject to the standard consultation process. The Reserve Bank intends to work closely with stakeholders on these matters.

How will credit unions be treated under the RDT regime?

Credit unions will be subject to the legislation applying to RDTs on the basis that:

The general power to provide exemptions from requirements under the RDT legislation provides adequate flexibility to deal with the special characteristics of credit unions. This means that there are no specific special treatments to be applied to credit unions which need to be built into the legislation.