Reserve Bank responds to lessons of the GFC

The Reserve Bank is introducing a number of prudential policy changes, based on lessons from the global financial crisis (GFC), in order to further strengthen the New Zealand financial system.

This was the message of a speech delivered today by Reserve Bank Deputy Governor Grant Spencer, to the Financial Institutions of New Zealand 2012 Remuneration Forum in Auckland.

Mr Spencer identified three key prudential policy lessons from the GFC. The first was that financial institutions are more vulnerable than previously thought to “contagion effects” from financial shocks, due to the likelihood of liquidity contraction.

“In response, we have ‘upped the game’ on bank liquidity requirements, including the Core Funding Ratio (CFR). We are about to do the same with capital requirements under the new ‘Basel III’ framework,” he said.

Mr Spencer confirmed the Bank’s intention to increase the CFR from 70 to 75 percent in January 2013.

The second lesson was the importance of the credit cycle as a driver of financial system risk. In response, macro-prudential policies, aimed at limiting the build up of risk during credit booms, are being developed both here and internationally, Mr Spencer said.

“This is a new approach to prudential policy and as such we are developing, along with Treasury, an explicit macro-prudential governance framework to be agreed with the Minister of Finance as a basis for policy decisions going forward. We expect that the Reserve Bank will take the lead role in implementing macro-prudential policy, subject to consultation with government.” Mr Spencer said.

The third lesson was that governments must find ways of protecting the financial system from bank failures without recourse to taxpayer funded ‘bail-outs’.

“Our main response to this lesson is a resolution framework called Open Bank Resolution (OBR),” Mr Spencer said. OBR gives the government the option of quickly dealing with a bank failure, such that it remains open for transaction business, without requiring a government bail-out.

“Learning these lessons and improving our prudential policy framework will better equip us to withstand the effects of future financial shocks,” he said.