Questions and answers - Proposed Deposit Takers Act

Why is the regulatory regime for banks and non-bank deposit takers being combined?

A single regime supports a more coherent approach across the banking and non-bank deposit taking (NBDT) sectors so that similar firms and activities are regulated with proportionality, where possible.

This will bring New Zealand’s framework into line with similar models in most other jurisdictions. 

What types of entity will be subject to prudential regulation and supervision?

Under the proposed DTA, prudential regulation and supervision will apply to firms that are in the business of borrowing and lending unless they are specifically excluded from the regime. This will include banks, credit unions, building societies, finance companies, and some wholesale funded lenders. The Reserve Bank will establish a policy on which deposit takers can call themselves banks.

Some wholesale funded lenders will not be required to be licensed under the new regime, for example those that solely borrow by raising funds on wholesale capital markets. However, the Reserve Bank will be able to collect information and set lending standards for prescribed categories of non-deposit taking lenders.

Designation and exemption powers will provide the Reserve Bank with significant flexibility in applying the framework, as is the case with other financial sector regulatory regimes.

How will small deposit takers be treated within the regulatory regime?

The prudential framework will have the required flexibility to accommodate the full range of deposit taking institutions, from very small non-bank deposit takers (NBDTs) to the largest banks. For example, the Reserve Bank will be able to calibrate regulatory settings for different classes of deposit taker. The framework will also provide discretion for the Reserve Bank to impose institution-specific requirements to reflect the underlying risk profile of that institution (supervisory adjustment). When exercising its powers under the DTA, the Reserve Bank will need to take account of certain principles that recognise (amongst other things) the importance of maintaining competition and preserving diversity in the deposit taking sector. 

The regime should not impose unnecessary barriers to entry to the deposit-taking sector and should allow for competition and innovation within the sector. A flexible and proportionate regulatory regime should provide a responsive regulatory environment for new business models, such as FinTech businesses, allowing these businesses to develop and grow while managing risks to financial stability appropriately. 

How will finance companies be regulated under the new regime?

Finance companies that borrow from retail investors will continue to be prudentially regulated and will be required to be licensed as deposit takers. Prudential standards, Reserve Bank supervision, and risk-based deposit levies will seek to mitigate any risks if finance companies seek to issue products eligible for depositor compensation.

How will the DTA’s purposes and decision-making principles guide the exercise of powers and duties under the DTA?

The purpose clauses will set out the way in which the Bank intends to protect and promote the stability of New Zealand’s financial system. The purpose statement will explain why the legislation is being enacted, while the substantive provisions in the Act will provide for what is required. In doing so, it will shape how the legislation is interpreted when there is uncertainty and the way in which the functions and powers provided for under the DTA are exercised.

A set of decision-making principles also provides an opportunity to bring in a range of other considerations for the exercise of the powers in the DTA.

Where does efficiency feature in the legislative hierarchy?

Efficiency-related principles — such as competition, proportionality, net benefits are outlined in the decision-making principles. This recognises that efficiency can mean several distinct concepts.

Outlining these concepts in the principles allows for efficiency to be described in specific and detailed ways. It also ensures that it is a key consideration for the Reserve Bank when it is exercising its powers and duties under the DTA.

Why will standards be the primary tool for imposing prudential requirements on deposit takers?

This model will recognise that prudential requirements are often of a legislative character by establishing legally binding obligations for all deposit takers, or classes of deposit takers in contrast to non-binding guidance a regulator may choose to issue, and provide a more robust statutory framework for setting prudential requirements. More specifically, it will replace Conditions of Registration (CoRs), which define most of the rules that registered banks must adhere to in order to operate in New Zealand, with standards, which are a form of delegated legislation. Standards will be set by the Reserve Bank and be classified as secondary legislation under the Legislation Act 2019, which means they will be subject to parliamentary oversight and potential disallowance via the Regulations Review Committee.

This approach maintains the Reserve Bank’s operational independence in setting prudential rules (in line with international best practice), while providing a greater degree of transparency and oversight than the current approach, which primarily uses CoRs.

What is the scope of areas in which the Reserve Bank can issue standards?

The approach agreed to by Cabinet will cover the range of matters currently provided for via Conditions of Registration (CoRs), but with more clarity where required — for example, the addition of liquidity requirements and lending standards, which are currently provided for under the broader heading of risk management systems and policies. The scope of standards is also intended to be broad enough to enable the Reserve Bank to set standards in relation to the full range of matters covered by the Basel Committee on Banking Supervision’s Core Principles, should it choose to do so.

The specified matters standards may relate to will be set out in the DTA and may be extended via regulations. This approach aims to provide a balance between clarity on the scope of the powers being delegated to the Reserve Bank and the flexibility for these powers to be adjusted in future to accommodate new developments.

How will the Reserve Bank be able to set prudential requirements that affect a regulated entity’s ability to lend?

The types of lending that lending standards may apply to — for example —  residential property, agricultural will be prescribed by regulations, leaving the types of borrowers and the types of macro prudential instruments used to be set by the Reserve Bank in the standards. Empowering the Reserve Bank to set lending standards that define specific tools is important in supporting the Reserve Bank’s operational independence in setting macro-prudential policy.

What is the role of the Minister of Finance in changing the scope of lending standards?

Cabinet has agreed that the DTA will include a requirement that the Minister of Finance can make regulations (following consultation with the Reserve Bank) defining the type of lending that lending standards may relate to. This reflects the legitimate interest of elected representatives in setting the permitted scope of this power given the potentially significant distributional effects it may have, and the potential tensions between the Reserve Bank setting lending restrictions to achieve its financial stability objective and wider governmental objectives.

What will be the process for licensing deposit takers?

All regulated entities will need to obtain a licence from the Reserve Bank to undertake the business of borrowing and lending. The DTA will set out the relevant criteria for licensing a potential applicant, as well as the specific process requirements. The Reserve Bank will have powers to establish licensing conditions, specific to licensed deposit takers. 

Licensing criteria will include fit and proper requirements for directors and senior managers of deposit takers. Fit and proper requirements are designed to help ensure that directors and senior management have the requisite skills, experience and integrity to perform their roles. The framework for fit and proper requirements and procedural protections in the DTA should be along the lines of that for insurers under the Insurance (Prudential Supervision) Act 2010, with some of the detail of the requirements specified in standards.

This approach will help ensure the Reserve Bank can flexibly manage the risks presented by particular entities. In addition, it will ensure there are effective due process requirements around licensing decisions and decisions to impose conditions (including appeal rights in certain cases).

How will the DTA improve deposit takers’ assurance to both the Reserve Bank and other external stakeholders that they are prudently managing risks?

The DTA will impose on directors of licensed deposit takers a positive and on-going duty to ensure there are adequate systems, processes and policies in place to ensure the entity complies with its obligations. There will be a pecuniary penalty for breaches of this duty by directors, subject to appropriate defences. In addition, directors will be able to take out personal insurance against the potential penalty for such breaches. Directors of licensed deposit takers may also be liable for a penalty if false or misleading information is given to the Reserve Bank or publicly disclosed by a deposit taker.

What changes will the DTA make to the Reserve Bank’s supervisory and enforcement functions?

New supervision and enforcement powers will strengthen the Reserve Bank’s ability to act before a financial institution is in trouble. This will provide more protections for consumers and increase the stability of the financial system.

Why is the DTA changing New Zealand’s legislative framework for bank crisis management?

Crisis management is a key part of the regulatory system’s financial safety net, along with prudential regulation and supervision, a central bank’s ability to supply liquidity to the system, and depositor protection. 

New Zealand’s legislative framework for bank crisis management, being largely based on statutory management, has not been meaningfully reviewed since the late 1980s. Under this framework, the Reserve Bank developed the Open Bank Resolution (OBR) policy to manage the failure of a large bank. The proposed reforms have been informed by international experience and subsequent post-global financial crisis (GFC) reforms. It is therefore timely to consider possible enhancements to New Zealand’s framework.

How will fiscal risk to public funds be managed?

The DTA will provide the Minister of Finance with the ability to direct the Reserve Bank on the management of risks to public funds in a resolution.

In other words, the Minister will be able to direct the Reserve Bank to take an action in the course of a resolution provided that it is for the purpose of managing risks to public funds. The intention is that the Minister’s direction power is a residual lever only, to enable the Minister to manage risks to public funds if necessary. It should not be used for day-to-day intervention in a resolution. 

Why are changes needed to the Public Finance Act 1989?

The DTA proposes to address a long-standing gap in the government’s financial crisis management framework by amending the Public Finance Act 1989 to authorise the Minister of Finance to approve expenditure in a financial crisis whether or not there is an appropriation in place. This authority will be similar to the existing authority to incur expenditure in a civil defence or health emergency. The authority will have several conditions attached to ensure that it does not raise expectations of taxpayer bailouts and will only be used as a last resort to maintain the stability of the financial system and the continuity of critical financial services when all other options were unlikely to succeed or not in the public interest.

What are the next steps for implementation of the Deposit Takers Act?

The Bill was introduced into the House on 22 September 2022, and is expected to receive Royal assent in mid-to-late 2023.

After the DTA has passed through the House, there will be a substantial work programme to implement the new prudential framework for deposit takers. It will take some years for the Reserve Bank to develop and consult on the secondary legislation that will implement the regulatory requirements for the new regime, and complete a licensing process for deposit takers to operate under the regime. The parts of the current Reserve Bank Act relating to the regulation and supervision of registered banks and the Non-bank Deposit Takers Act 2013 will remain in force until the remaining parts of the DTA have been fully implemented.

The Depositor Compensation Scheme provisions of the Act are intended to be in place late 2024, before the rest of the DTA.

What are the financial implications for the Reserve Bank of these changes?

The changes will have direct financial implications for the Reserve Bank as New Zealand's prudential regulator. This includes — for example —  increasing the operating expenditure of the Reserve Bank to support a broader set of responsibilities associated with a new depositor compensation function. In addition, a significant step shift in the resourcing and funding of the Reserve Bank is required to support a more intensive supervisory and enforcement model. There will also be transition costs tied to implementing the new legislative framework — for example — developing a new rulebook for deposit takers and managing any temporary or interim licensing regime.

To some extent, these expected costs have been anticipated in the 2020-25 Funding Agreement between the Minister of Finance and the Governor of the Reserve Bank signed in June 2020. The new agreement provides for an annual average level of operating expenditure of $115 million over the five-year period. This compares to the $80 million budget for the 2019/20 year.