Why Reserve Bank should hand over role of regulation
Debacle over CBL Insurance and previous Westpac Bank issues show supervision isn’t up to scratch
Reserve Bank deputy governor and head of financial stability Geoff Bascand is a contender for this year’s thick skin award. Peter Harris, managing director of the failed CBL Insurance, is also in the running for the dubious distinction.
On Monday, the Reserve Bank issued a media release headed “Reserve Bank welcomes uncontested liquidation of CBL Insurance”.
The release revealed the Reserve Bank was delighted CBL Insurance was placed into liquidation even though there was strong opposition from shareholders and other interested parties.
The release quoted Bascand as saying: “The Reserve Bank followed a careful and rigorous process leading up to the interim liquidation, appointing independent experts as investigators. This took time because of the need for fairness to the company, as well as the complexity of CBL Insurance’s overseas business. This was compounded by CBL Insurance’s poor quality data”.
The irony of this statement is Bascand and his team have oversight of insurance companies under the Insurance (Prudential Supervision) Act 2010.
Why did the Reserve Bank allow CBL Insurance to develop a complex overseas business, particularly when CBL had poor quality data?
Do Bascand and his team have the skills to oversee insurance companies and other complex financial institutions?
The day after his CBL Insurance comments, Bascand spoke at the UBS Australasia Conference in Sydney under the heading “Financial stability — risky, safe or just right?”. His speech gave the impression the Reserve Bank is more focused on the banking system, which has $527 billion of assets, rather than the insurance industry with about $70b of total assets.
Bascand told the conference the New Zealand financial sector is sound and well-regulated as it weathered the GFC better than most. That is true as far as the banks are concerned but what about the many finance companies that went bust?
What about Westpac’s capital requirement issue and the CBL Insurance debacle?
CBL Insurance, which is 100 per cent owned by the NZX-listed CBL Corporation, generated 61 per cent of its gross premiums from its French activities.
A High Court affidavit by the Reserve Bank’s Head of Prudential Supervision Toby Fiennes, who reports to Bascand, stated: “The Bank’s own internal review concluded in August 2017, based on information available at the time, that CBL Insurance had significantly under-reserved its French business to such an extent that its adjusted capital for solvency purposes (ie excluding inadmissible components) was most likely to be less than zero, and that there was a material likelihood that the wider CBL group had insufficient resources to meet the shortfall. There was also uncertainty about the CBL group’s ability to raise sufficient further capital.”
The regulator was also concerned that CBL Insurance had made payments of $55m to overseas companies in breach of its directions.
It is extraordinary the Reserve Bank didn’t reveal CBL’s French business was significantly underreserved in August 2017, or require CBL Corporation to release this information to the NZX and ASX.
The Bank’s secrecy was contrary to earlier Bascand statements that public disclosure is a cornerstone of its prudential regulation and supervision.
Between August 31, 2017 and February 2, 2018, when CBL trading was halted on the NZX, $82.9m worth of share trading went through the NZ bourse and A$52.3m through the ASX.
These trades were executed after the Reserve Bank knew the insurance company was in serious trouble.
How can a regulator, which boasts about its “careful and rigorous process”, withhold major price sensitive information from the investing public? The $135m-plus worth of shares traded between the end of August 2017 and early February 2018 are now worthless.
CBL shareholders are asking who regulates the regulators? Are regulators immune from scrutiny and sanctions?
CBL directors Harris and Alistair Hutchison also released a media statement this week under the heading “RBNZ favours overseas creditors and policyholders over locals. CBL directors forced to withdraw opposition to the CBL Insurance liquidation”.
According to the release: “Peter Harris said that despite significant efforts to guarantee a fully solvent outcome for CBL Insurance and full payment to its New Zealand creditors and policyholders, RBNZ have
scuttled that and is fixated on liquidation instead. The two large European creditors Elite Insurance and Alpha Insurance with their large creditor balances were the key value creditors and appeared to be more important to RBNZ than all other creditors and NZ policyholders who are now expected to lose money”.
Harris has thick skin to criticise the Reserve Bank, and talk about guarantees, when he was the driving force behind CBL and played a major role in the policies that led to its collapse. He owned 22.8 per cent of the listed company and was paid $2.6m for the December 2016 year, well above average for NZX companies of a similar size.
The CBL collapse, and last year’s problems with Westpac, raises questions about the Reserve Bank’s role as a regulator of banks and insurance companies.
Twelve months ago the Reserve Bank slammed Westpac for “its failure to comply with regulatory obligations relating to its status as an internal models bank”. This problem, which went back to 2008, was due to the same poor quality data that characterised CBL Insurance.
Westpac was required to increase its minimum capital levels with Bascand quoted as saying: “We believe the regulatory action is appropriate given the seriousness of Westpac’s non-compliance and the need to protect the integrity of the capital regime.”
Why did the Reserve Bank take so long to discover that Westpac was non-compliant? Does the Reserve Bank place enough emphasis on its regulatory and supervisory roles?
One of its issues is the Reserve Bank has a range of activities including monetary policy, financial market operations, macro-financial stability, prudential supervision, settlement services, and currency operations. In addition, the Bank paid a $145m dividend to the Crown for the June 2017 year and $430m for the latest year.
It is unusual for regulators to pay huge dividends and it highlights a potential conflict between money spent on prudential supervision and the Bank’s dividend objectives. The Financial Markets Authority, the country’s other major finance sector regulator, doesn’t pay a dividend.
The Reserve Bank’s role as a regulator has been raised in a 112-page consultation document issued earlier this month called “Safeguarding the future of our financial system. The role of the Reserve Bank and how it should be governed”. Chapter 5 is headed “Should prudential regulation and supervision be separated from the Reserve Bank?” The report illustrates the Bank spends only $15m, or 20 per cent, of total expenditure on supervision while the FMA has total expenditure of $35.5m.
There is a strong argument that the supervisory activities of the Reserve Bank, particularly over the insurance sector, should be transferred to the FMA or a new regulator.
A Bank of International Settlements’ report earlier this year showed 66 per cent of the 82 countries surveyed have banks regulated by the central bank while only 28 per cent of the 80 countries in the insurance survey have insurance companies regulated by the same authority.
The CBL Insurance debacle shows the Reserve Bank doesn’t have the skills or expertise to supervise insurance companies, particularly those with complex offshore operations. Westpac’s noncompliance demonstrates that the Bank doesn’t have the investigative depth to identify issues quickly.
Bascand painted a rosy picture in Sydney but the collapse of CBL Insurance, and the non-disclosure of its distressed position in mid-2017, shows the Reserve Bank has serious deficiencies in its prudential supervision operations.
Brian Gaynor is an executive
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director of Milford Asset Management, which holds Westpac shares on behalf of clients.