If monetary policy is the Reserve Bank’s smash hit, its prudential regulation of financial markets is its B-side track.

Yet the bank’s role as prudential regulator deserves scrutiny. As we saw with last week’s lightning strike on CBL Insurance, the bank’s governor has enormous powers. These include the sole power to determine – and enforce – the prudential requirements for all registered banks by controlling the conditions of registration and applicable prudential standards.

Indeed, while the Reserve Bank has a board, the board has no role when it comes to prudential regulatory powers. Like the bank’s monetary policy responsibilities, its prudential regulatory powers are directly vested in the governor.

Consequently, the governor is not accountable to the board in the way any other chief executive would be and the board has no power to override regulatory decisions.

This is a remarkable concentration of both policymaking and regulatory decision-making power in a single individual.

None of this would matter if the Reserve Bank’s exercise of regulatory power were consistently exemplary. But, as The New Zealand Initiative will disclose in a report to be published next month, there are reasons to believe the bank’s conduct is far from exemplary.

That is not to say it has left New Zealand’s financial markets vulnerable to systemic risk. Rather, the concerns arise with the standards of behaviour of those responsible for the bank’s regulatory decision-making, and with the quality of analysis informing its policymaking.


Lacks checks and balances
These concerns should come as no surprise. The governance framework for the bank’s regulatory function lacks many of the usual checks and balances.

First, the single-member decision-maker model lacks the safeguards of a second (or third) pair of eyes that come with multimember decision-making bodies.

Second, the board’s limited role means there are restrictions on its ability to hold the governor to account.

Third, the bank is not subject to the same level of departmental or parliamentary review as other regulators.

Recognising some of these oddities, former finance minister Steven Joyce last year asked the Treasury to commission a report reviewing the bank’s governance from former state services commissioner Iain Rennie.

Then, after the 2017 general election, the new minister of finance, Grant Robertson, announced a two-stage review of the Reserve Bank of New Zealand Act and appointed an independent expert advisory panel to assist with the review.

The first part of the review focuses on monetary policy and is well under way. Scoping for phase two – focusing on regulatory powers – will be completed this month.

As background material for this part of the review, the Treasury released Mr Rennie’s report. It recommends a move away from the single decision-maker model in favour of a complex "committee-based" approach.


Three committees
Three committees would be formed, each with external participants, to exercise the bank’s decision-making powers. One committee would deal with monetary policy; the other two with micro- and macro-prudential regulation. The board's role would be modified to a monitoring one.

While it is possible to make a case for a committee-based approach for monetary policy, Mr Rennie’s recommendation of separate committees operating at a level below the board to deal with prudential regulatory decision-making is questionable.

To start with, it is inconsistent with the approach taken for other independent regulatory agencies with board governance models, including the Financial Markets Authority. It would also add an unnecessary layer of complexity.

More importantly, it is not justified by any evidence or analysis in the report. And it is likely to make the Reserve Bank board role less attractive to future board applicants.

The Rennie report also suggests there is a “tension” between the board’s “advice role” and its role assessing the bank’s performance. But if there is such a tension, it is not an unusual one. It is an inherent feature of the board governance model, where a board both tests and approves the strategies developed by management and evaluates management’s performance.

The Rennie report is correct, though, in describing the board role as an unusual one – but not for the reasons stated.

What's odd is that the decision-making powers of the "chief executive" – the governor – do not derive from the board as they do, for example, for the chief executive of the FMA (or for CEOs in the corporate world).

Rather than “clarifying” the board role, the proposals in the Rennie report would further eviscerate the board. And they would perpetuate the gap between the role of the board and the principles of governance applied in most other regulatory agencies.

As a report commissioned by a prior government, the Rennie report is unlikely to dictate any changes to the bank’s governance. The newly appointed independent expert advisory panel will doubtless form its own views.

For the sake of New Zealand’s financial markets, let’s hope it does. That way the B-side track may become a hit, too.