Governor's statement
The Reserve Bank helps New Zealanders by promoting a stable economy, through its responsibilities for price stability, currency that holds its value, financial stability, and sound banking and payment systems.
In all of these functions during the last year we faced changes in our environment – with economic activity approaching a turning point; our banking system becoming more integrated with Australia; and some of our coinage requiring modernisation. These are significant changes affecting all New Zealanders.
I can draw attention to just a few significant developments in this Statement and encourage readers to familiarise themselves with our broader work programme outlined in this Annual Report and on our website. The website was upgraded during the year to improve layout, navigation and search capability and has recently received international accolades on its presentation and content.
Parliament in June ratified a new five-year Funding Agreement. Although this Agreement covers the period beyond this Annual Report, it means the Bank is equipped to address the new environment, helping us to meet increased demands on the policy framework; replace systems that are now at the end of their useful life; and implement effective strategies to manage risks.
Monetary Policy
During the year, inflation pressures remained stronger for longer than expected. Buoyant commodity prices, robust household spending and business investment, combined with a tightening of economic capacity, helped push CPI inflation from 2.4 per cent to 2.8 per cent. The Policy Targets Agreement requires us to maintain price stability, keeping Consumers Price Index (CPI) inflation between 1 and 3 per cent on average over the medium term, while avoiding unnecessary instability in output, interest rates and the exchange rate.
To achieve our price stability objective, we judged it necessary to continue the tightening we began in the last financial year, increasing the Official Cash Rate from 5.75 per cent to 6.75 per cent by March 2005. By the end of the June year, the economy was clearly slowing, although inflation pressures remained relatively strong. An issue for policy this year has been an increasing lag in the impact of monetary policy as a result of low world interest rates and reduced bank margins on mortgages. For the year ahead, the policy challenge will be the persistence of inflation pressures as economic activity continues to weaken. In particular, we are facing very strong oil prices, continued buoyant export commodity prices, and a persistently strong housing sector.
Given our dynamic economic environment, the Bank works constantly to improve its understanding of the economy. We have begun a programme of model development to improve our forecasts of economic activity and inflation; to better assess the effects of our policy actions; and to analyse risk in a more cohesive framework. We expect this work to lead to the redevelopment of the Bank’s main forecasting and policy system (FPS), as well as a more diversified approach to economic modelling.
Financial System Surveillance and Policy
During the past year, the Bank has undertaken a very large amount of work to promote the efficiency, soundness, and resilience of the financial system. We consider it best to undertake this work when the financial system is in a sound position, as it is currently.
Probably the most far-reaching of these initiatives have followed the announcement in January 2004 by the Minister of Finance and the Australian Treasurer that the two governments would seek greater mutual recognition and harmonisation in prudential regulation of the two banking systems.
Various analyses were undertaken during the year. Among the early conclusions were that there are some deficiencies in the regulation of non-bank financial institutions in New Zealand; that integration could be further enhanced through more formal coordination; but that moving to a joint trans-Tasman regulator for prudential regulation and supervision was not desirable at this time.
This was against the backdrop of the Government’s (trans-Tasman) Single Economic Market goal, and the fact that 85 per cent of the assets of the New Zealand banking system are owned by Australian parent banks. Despite these institutions being Australian-owned, New Zealand still needs the tools to manage the financial stability of its own system.
In early 2005, the Minister of Finance and the Australian Treasurer agreed to the formation of a Joint Trans-Tasman Council on Banking Supervision. The Council has reported to Ministers on legislative changes to help the Australian Prudential Regulatory Authority (APRA) and the Reserve Bank of New Zealand support each other in the performance of their regulatory responsibilities at least regulatory cost.
The Bank and APRA have continued to cooperate on developing an enhanced home-host framework, and agreed terms of engagement to implement the new Basel II Capital Accord.
We continued to bolster our ability to manage a bank in distress were such an event to occur. We produced a draft ‘outsourcing’ policy for systemically important banks, aimed at minimising the harm that could be done to New Zealand’s financial system if a bank, or a provider of services to a bank, were to fail. We aim to begin implementing the final policy in the next financial year, taking account of affected banks’ particular characteristics.
Another initiative has been our local incorporation policy. We rejected a proposal that systemically important banks could operate as ‘buttressed branches’ of their parent banks, rather than being required to incorporate in New Zealand. Only Westpac currently has a form that is not consistent with our local-incorporation policy and it has now announced it will incorporate locally
We have also sought to upskill ourselves in bank failure management in the event of bank failures.
Currency Operations
The coinage used by New Zealanders to transact payments will undergo significant change in 2006, following a decision announced in March 2005 to replace the 10, 20 and 50 cent coins with smaller, lighter coins made from plated steel, and to withdraw the 5 cent coin from circulation.
While the new coins will not be launched till July 2006, we have begun to build awareness of the new coins to ensure the change is least disruptive. This Annual Report is part of that process, with its visual theme built around the introduction of the coins.
The new coins will be easier for the general public to use, and will reduce coin transport and storage costs for businesses such as banks, security companies and shops. Downsizing the ‘silver’ coins and changing their composition to plated steel will generate savings for the Bank, and thus for the taxpayer, of about $2 million per annum.
People and Systems
The Bank relies heavily on its people and systems to carry out this diverse work programme, and we recognise the need to keep our skills and tools up to the task. A new email, electronic document and records management system was installed during the year, and significant work has been underway on the implementation of a new treasury system that is expected to go live in the second quarter of the 2005/06 financial year. The payments systems infrastructure has also been upgraded to provide a more secure and robust means of transaction processing between members.
The Bank this year recruited a small number of additional staff to augment resources for the significant projects it has underway. These projects have involved many of our staff and, at times, have presented significant challenges. Without the commitment and contribution of staff, the success of these projects would not have been possible.
I am grateful to Board members, who continue to provide valuable advice and support, especially Chair Dr Arthur Grimes, and Deputy Chair and Chair of the Board Audit Committee, Mrs Alison Paterson.
I thank staff for their dedication and energy in achieving the outcomes described in this Annual Report. I can assure stakeholders that the Bank’s staff take their responsibilities very seriously to ensure that New Zealanders can remain confident in the value of their currency, and can transact their business within a sound and efficient financial system, as required by the Reserve Bank Act.
Alan Bollard
Governor