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Briefing to the Incoming Minister 2011

Reserve Bank of New Zealand

Executive summary

The Reserve Bank of New Zealand is a "full service" central bank, with responsibility for monetary policy, the supervision and regulation of much of the financial system as well as the issue of New Zealand‟s currency. Having this range of functions helps to keep us well informed about the operation of the economic and financial system. This was particularly beneficial during the global financial crisis (GFC) with the Bank being able to react swiftly and innovatively to emerging issues.

The GFC has produced a range of lessons for central banks and we are continuing to incorporate them into our own policy thinking wherever possible. A key lesson from the GFC has been that financial crises can have a major and prolonged impact on the economy and, consequently, that regulatory policy should lean towards conservative settings. We have also learnt much about the operation of financial markets and their capacity to freeze during periods of stress. In the wake of the crisis, a number of countries were forced to reduce interest rates to zero and to adopt less orthodox forms of monetary policy such as quantitative easing (QE). While this was not necessary in New Zealand, we have attempted to learn from their experiences for reasons of future preparedness. The implementation of such policies can be challenging and their effectiveness remains contentious.


The New Zealand economy grew 1.5 percent in the year to June 2011 on the back of strong international commodity prices and a recovery in consumer and business sector confidence. We expect economic growth to reach around 3 percent over the coming year due to high export revenues and the reconstruction activity generated by the Canterbury earthquakes. However, a key issue is the extent to which recent global financial market turbulence, and signs of slowing trading partner growth undermine this outlook over the months ahead.

Headline inflation has remained elevated over the past year peaking at 5 percent, partly reflecting last year‟s GST increase. However, out latest assessment is that core inflation remains relatively well contained.

Provided global developments have only a mild impact on New Zealand, it is expected that the Official Cash Rate (OCR) will need to gradually increase over the next 18 months in order to ensure that inflation settles back within the 1-3 percent target band by early 2012. We will continue to update the outlook for inflation and monetary policy in our regular Monetary Policy Statements.

Global financial markets

Global financial markets have been intensely focused on high levels of public debt in many countries, especially in Europe, along with the capacity and willingness of policymakers to cut fiscal deficits and avoid default on their outstanding debt. While various measures have been proposed or adopted, the outlook remains volatile.

For New Zealand the consequences of these concerns have been manifest in two ways. First, worries about European banks‟ exposure to peripheral sovereign debt have contributed to a tightening in global debt markets in recent months, on which New Zealand‟s banks are heavily reliant. And secondly, a slowdown in global growth has the capacity to undermine the recovery in New Zealand‟s economy, which has been assisted by a strong terms of trade. In the event that access to global debt markets remains difficult for an extended period, the Reserve Bank has the capacity to provide additional liquidity to the banking system if required. More generally, the global experience underscores the desirability of ensuring that New Zealand‟s own fiscal position is managed on a sustainable path.

Canterbury earthquakes

The Canterbury earthquakes have resulted in exceptionally high levels of claims for insurers both in terms of quantity and cost. The continuity of new residential insurance in the wake of continued seismic instability is proving to be a significant issue for Canterbury and one which has the capacity to hinder rebuilding in the region.

The earthquakes are expected to prompt some structural changes within the insurance industry and we are seeing the beginnings of an adjustment in insurance premiums for both households and businesses throughout the country.

Domestic market operations

Domestic market operations support the effective implementation of monetary policy by helping to keep wholesale interest rates aligned with the OCR, promoting liquidity and managing the Crown‟s financial liquidity. Extraordinary liquidity facilities were required during the GFC when global debt markets became impaired. While these facilities have since been withdrawn the Bank maintains its capacity to use its balance sheet to provide additional support should this become necessary given the ongoing turbulence in financial markets.

Foreign reserves management

The Bank holds a portion of its foreign reserves on an unhedged basis. The low interest rate environment and a cautious approach to credit in the management of foreign reserves has reduced the returns on our unhedged reserves.

Furthermore, the returns on the reserves will remain volatile as the New Zealand dollar ebbs and flows with bouts of risk seeking / risk aversion on international markets.

The Bank is in the process of implementing a new foreign reserves asset allocation and management approach, which includes the establishment of independent benchmarks for the foreign reserves portfolio.

Regulation and supervision of banks

Despite the ongoing global financial market turbulence currently evident, New Zealand‟s banking system remains sound and our financial regulatory and supervisory framework continues to serve us well.

The Bank is taking the opportunity, nevertheless, to review all the policy instruments it has available to promote a more stable and resilient financial system. These „macro-prudential‟ instruments generally take the form of additional capital and liquidity buffers designed to provide the financial system with extra shock-absorbing capacity at times when this is desirable. We also intend to proceed with the implementation of Basel III capital and other requirements for banks.

The Bank has consulted banks on the changes that would be required to their IT systems to implement Open Bank Resolution (OBR) in a failure situation. The purpose of OBR is to avoid the „too big to fail‟ taxpayer bailouts and to place responsibility of failure effectively on shareholders and creditors while allowing the bank to continue to operate as a going concern. Banks are required to submit implementation plans to the Bank by the end of February 2012.

Regulation and supervision of other institutions

In September 2008 the Bank became the prudential regulator of non-bank deposit takers (NBDT). Currently these institutions are required to comply with prudential requirements relating to risk management, credit ratings, capital, liquidity, governance and related-party exposures. Trustees are the front line supervisors of NBDTs. A new NBDT Bill, introduced in August this year, will also impose a licensing requirement, an associated suitability assessment of directors and senior officers, and give powers to the Bank to gather information, issue directions, and remove and replace directors.

In September 2010 the Bank became the regulator and supervisor of licensed insurers. The Bank will be in a position to more closely monitor the financial position and solvency of insurers once the powers under the Act come into force in March 2012. In the meantime it is in the process of moving all insurers through to full licensing by September 2013.

In 2009 the Anti-Money Laundering and Countering Financing of Terrorism (AML/CFT) Act was passed. This made the Bank the AML/CFT supervisor for banks, NBDTs and life insurers. At present the Bank is assisting reporting entities to prepare for the advent of their new obligations.

Macro-financial policy

Over the past two years, the Bank has been undertaking research into macro-prudential tools and their possible role in New Zealand. We have identified several instruments that we believe could be helpful if and when we face periods of excessive credit growth here. While current weak credit growth means that there is little immediate need for such tools, our work has been clearly focused on future preparedness.


The Reserve Bank meets the currency needs of the public by ensuring the supply and integrity of bank notes and coins.

There are indications that the protection offered by the security features on New Zealand‟s current banknotes has diminished in recent years. The Bank is now in the early stages of a project to update the security features of New Zealand banknotes and to refresh their look. The earliest the new notes will be issued is 2014. It will have been 14 years since the current series of notes were issued.