Increased regulatory scrutiny of banks’ compliance processes
This page contains information from the November 2019 Financial Stability Report.
Over the past year, a number of banks have disclosed breaches of their conditions of registration. Many of these have related to errors in the calculation of capital adequacy and liquidity ratios, and in some cases have gone undetected for a number of years. The sizes of the errors have varied, but none has yet caused a breach of minimum regulatory requirements. The prevalence and duration of calculation errors indicate weaknesses in the governance and control processes of the banks involved.
This trend is also concerning from a systemic risk perspective. While minimum capital and liquidity requirements have not been breached, the pattern of failure to calculate regulatory requirements correctly points to inadequacies in banks’ broader risk management frameworks. Weaknesses in risk management were also highlighted in the recent review of bank culture and conduct. This brings into question the long-term resilience and efficiency of the financial system.
The New Zealand regulatory framework relies on three pillars: regulatory discipline, market discipline, and self-discipline. The Reserve Bank is strengthening all these pillars. In particular, the Reserve Bank will be adopting a more intensive supervisory approach, which will involve greater verification of banks’ compliance with their conditions of registration.
Currently, a key component of the regulatory framework is the requirement for directors to attest that their bank is complying with all regulatory requirements. In 2017, the Reserve Bank conducted a review of the bank director attestation process and noted that many banks were attesting to compliance on the basis of negative assurance, i.e. they did not have evidence to suggest that they were not in compliance. Consequently, the Reserve Bank prompted banks to review their assurance processes, and to move from a negative assurance to a positive assurance framework. In this process, breaches have been identified. Some banks have also commissioned independent consultants to review their calculation processes.
The Reserve Bank will continue to monitor these reviews to ensure that the root cause of each error is found and that learnings are adopted widely within each bank. In some cases, the Reserve Bank expects the disclosure of compliance breaches to continue. As a precaution, the Reserve Bank has applied capital overlays to some banks, which will provide buffers against further errors. Larger buffers or enforcement action may be required if significant new errors emerge as the result of the banks’ assurance reviews.
The Reserve Bank will continue to engage with banks on their assurance processes and, if necessary, work with banks to strengthen their assurance processes and controls. Given the fundamental importance of accurate capital and liquidity calculations, the Reserve Bank expects directors to continue to focus on these as part of their attestation process.