Proceedings of the Standing Senate Committee on
Banking, Trade and
Commerce
Issue 18 - Evidence - May 12, 1998 (p.m.)
OTTAWA, Tuesday, May 12, 1998
The Standing Senate Committee on Banking, Trade and Commerce met this day at 6:00 p.m. to consider the present state of the financial system in Canada (comparative study of financial regulatory regimes).
Senator Michael Kirby (Chairman) in the Chair.
[English]
The Chairman: Honourable senators, this evening we will meet, by videoconference, with witnesses from New Zealand.
I am Michael Kirby, the chairman of the committee. Thank you very much for taking time from your other occupations to be with us. Am I right that it is approximately ten o'clock in the morning your time?
Mr. Donald Brash, Governor, Reserve Bank of New Zealand: That is correct.
The Chairman: I will introduce my colleagues. They are: Senator Jack Austin from British Columbia, Senator Catherine Callbeck from Prince Edward Island, Senator Céline Hervieux-Payette from Quebec, Senator Donald Oliver from Nova Scotia, Senator David Tkachuk from Saskatchewan, and Senator Kelleher from Ontario. I am from Nova Scotia.
Our staff has sent you a list of the topics that we are interested in. Would you please introduce yourselves, and perhaps each of you would like to make an initial response to the material we sent you. Then we will get into a dialogue with you.
Mr. Brash: Thank you very much. We are delighted to be talking with you. We have learned a lot from Canada over the years.
With me is Mr. Peter Allport, Chairman of the Commerce Commission.
Mr. Peter Allport, Chairman, Commerce Commission, Government of New Zealand: Good evening, ladies and gentlemen.
Mr. Brash: My two colleagues from the Reserve Bank are Mr. Peter Leddingham, who is in charge of our Banking System Department, and Mr. Ian Harrison, who is a senior member of the staff in that department.
You have invited us to make some general comments about the approach to banking in New Zealand. How long would you like that statement to be? Are you looking for a 30-second introduction, or something longer than that?
The Chairman: Since we have had the benefit of reading a number of background papers about your work, Mr. Governor, it would be helpful if you just hit on some of the highlights as they relate to the issues before us. For example, there is a requirement that all major banks in Canada be Canadian-owned -- you have obviously not had that policy. You also have a different approach to regulation than we have. We also have a deposit insurance system, which you do not have.
In the broader context, it would be helpful to hear such things as how do you make a regulatory system as efficient as possible while ensuring that the system remains sound. As you know, we have adopted a system not quite like the U.S. As in the case of many things in Canada, we are a compromise between what I would call the rules-based system in the U.S. and the pure judgment-based system in the U.K. You have gone quite a different direction, and helping us understand, in part, why you went in that direction and what your experience with your new direction has been compared to the old system would inevitably start a dialogue between us.
Mr. Brash: I am very happy to do that. Before the mid-1980s, we really had only four recognized banks. Of those four, three were already foreign-owned. So, we have already had a long history of foreign ownership in the banking sector. The other bank, the fourth one, was in fact a government-owned commercial bank called the Bank of New Zealand; not the Central Bank but a commercial bank.
In the mid-1980s, when we liberalized the banking market and opened the gate to any party meeting certain qualitative standards, we saw a quite rapid increase in the number of banks. Many of those were foreign. Some of them were domestic institutions that had been quasi-banks and they converted to banks; the Post Office Savings Bank, for example. We had a series of so-called trustee savings banks, which had been modelled on the Scottish trustee savings bank model. They converted to a bank. Some building societies also converted to banks.
We had an increase in the number of banks at that point. But, again, we still had a heavily foreign-owned banking sector, although a considerable number of New Zealand-owned banks.
In 1991, we undertook a review of what we were doing in banking supervision. That review was motivated by three facts. One was the increasing foreign ownership in the sector -- and, really, we are looking at the question of what difference did that make in the way we conducted banking supervision. The second factor is that we had started with banking supervision of a fairly light-handed type. Over the five or six years since we began it in the mid-eighties, we have become progressively a lot more heavy-handed. We thought it appropriate to step back and ask ourselves whether that direction of change was desirable. The third and perhaps the most important single factor driving the review was some concern for the taxpayer risk in the system we were operating and, indeed, of course, most countries operate.
We were basing supervision on the gathering of large amounts of information on the banks individually. We kept that information confidential. We laid down a large number of rules and limits -- limits on life exposures, limits on a whole range of different things, foreign exchange positions, and so on. We were a bit concerned that if a bank were to fail in those circumstances, depositors might well say, "You, the supervisor, knew -- you had the information -- we, the depositors, did not. Furthermore, the banks were operating according to your rules. We want you to compensate us for the loss which we have incurred."
Some of us thought that that did not matter too much because we were such good supervisors that no banks had failed under our supervision. But then we looked at experience in other countries, including the United States, the United Kingdom, Scandinavia, Japan, Australia and, indeed, even New Zealand where we had some near collapses in the late eighties, and we began to wonder whether in fact our supervision was significantly reducing the risk of failure.
We spent a long time reviewing that question. We looked at studies around the world. We addressed the question of whether we needed a special regime for banks at all. We decided that we did. In the end, we decided that we could provide at least as satisfactory a regulatory regime and at least as secure a regime by a different approach. That is based on three main components.
The first component is that there be some rules, that the system not be self-regulatory. We retain a rule on a limit to how much a bank can extend to its own shareholder.
The second component is major emphasis on public disclosure; that is, very extensive and detailed disclosure on a quarterly basis. We do not pretend that most bank customers or bank depositors will read that information, but we believe that the obligation to make that information public will produce incentives on bank managers and bank directors, which will encourage them to behave prudently.
The third main component of the framework is a requirement that those quarterly statements are signed off by each director of a bank, on each quarter, both that the information being released is reliable and that the internal controls of that bank are appropriate to the nature of that bank's business and are being properly applied. Again, we think that that quite considerably increases the incentives on bank managers and bank directors to behave prudently.
Whether that has worked is the question that is of interest to the committee. It is difficult to be dogmatic about that because we have not had any bank which has failed this century. So it is pretty hard to deduce anything very dramatic because we have not had a failure since the new regime came into place. It is also true that, whereas we had a predominantly foreign-owned banking sector when the review began, we now have an almost completely foreign-owned banking sector. Most of the banks are owned by or are branches of large international banks with deep pockets. Again, the risk of failure, whatever our regime is here, is probably not very great.
We believe that we have increased the incentive for banks to behave prudently and, to that degree, at least marginally reduced the risk of bank failure. We have an intensively competitive banking sector and bank margins have declined quite appreciably over the last decade. We have a very innovative banking sector. From the point of view of the Central Bank, we have a banking sector that meets most of the needs which we feel a banking sector can deal with; namely, a competitive market, a stable banking system, an innovative banking system, and one which, even though the banks are foreign-owned, is clearly just as susceptible to monetary policy action by the Central Bank as it would be if the bank in question were domestically owned.
I would like to comment briefly on deposit insurance. We have never had deposit insurance in New Zealand. The banks themselves have been quite strongly opposed to it I suspect because in the early days, as I mentioned, we had only four banks that were very large banks. They felt that any deposit insurance system might simply cross-subsidize from them to weaker institutions. Thus, we have never had any pressure from either the banking sector or, indeed, the public to have a deposit insurance system.
The Chairman: Before turning to my colleagues, I would like to ask you two questions, which we will probably want to get into in more detail.
Dealing with the foreign ownership question, this country has been involved in a discussion, which has been on and off for 30 or 40 years, but more recently in the last ten years, about whether or not domestically owned major banks are required in order for the government and the governor to be adequately able to carry out his role in monetary policy. To what extent is your monetary policy role, as opposed to your regulatory role, as Governor of the bank constrained by virtue of the fact that all the major banks in the country are foreign-owned?
The other side of that coin is to what extent are you able to persuade foreign-owned banks, in the way that the Governor of the Bank of England seems to be able to persuade banks to do a variety of things, to behave in the way you might like them to behave, which goes beyond narrow business constraints necessarily? We have the problem of a number of communities that have only one bank, although there are six major chartered banks, and what do they do if that bank wants to close?
To what extent is your leverage in that kind of persuasiveness, which seems to be particularly prevalent in England when we talked to people there, constrained by virtue of the fact that the institutions are foreign- rather than domestic-owned?
Mr. Brash: From a monetary policy point of view, as I alluded to briefly earlier, the fact of their foreign ownership is not significant at all. As in Canada, perhaps to even a greater extent, we have a floating exchange rate. We do not interfere in the foreign exchange market at all, which means that effectively what happens in terms of domestic monetary policy is very much driven by what happens internally rather than liquidity flows across the border. I do not think there is any difficulty at all in running monetary policy, even though the banks are overwhelmingly foreign-owned.
Whether or not we have ability to persuade banks in the way that you suggest the Bank of England does is a more problematical question. We do not tend to approach policy in that way. I cannot think of circumstances where we would want to encourage a bank to do something which, on the face of it, was not in its own commercial interest.
I look across the Tasman Sea at the Australia banking system, which of course is in some respects not unlike your own in Canada, where they have four very large domestically owned banks. You alluded to the problem of what happens when banks close down rural branches and leave a small community without banking services. That is certainly happening in Australia, in a way which is causing some political tension, but, to the best of my knowledge, the Reserve Bank of Australia has not tried to lean on those banks to keep those branches open.
There are some real dangers in central banks trying to persuade banks to do things which are not in their commercial interest. Certainly, we have not felt the need to do that in recent times in New Zealand.
The Chairman: The members of this committee have historically been inclined to agree with that view. Our colleagues in the House of Commons have frequently not agreed with that point of view, on the grounds that what is usually couched as a community social responsibility of banks frequently seems to go way beyond business interests. We are inclined to be where you are on the second question.
Your comment on the foreign ownership issue and its impact on monetary policy was particularly helpful.
Senator Austin: Governor Brash, a few questions scattered across the horizon.
Is it history that accounts for the different attitude in New Zealand to that of Australia towards foreign ownership in the banking system? Do Australians have a different sense of their history? What is the reason that the two systems differ so largely?
Mr. Brash: I am not sure that I know the answer to that. I might ask assistance from my colleagues.
Certainly we have had foreign-owned banks in New Zealand for a long time -- since before the turn of the century.
Perhaps I will ask Mr. Leddingham to jump in here.
Mr. Peter Leddingham, Banking System Department, Reserve Bank of New Zealand: It builds on the answer you just gave, really, that we have long been accustomed to a high degree of foreign ownership in this country and, therefore, it has not been a great issue for anybody.
Mr. Brash: To add one illustration, when the government decided in the late 1980s to privatize the Post Office Savings Bank, which was an institution that served the banking needs of a large number of relatively low-income individuals, it was sold to the Australia-New Zealand Bank, which is an Australian-headquartered bank. Initially, there was quite a lot of resentment about that. I suspect it lasted no more than a matter of weeks. Most people now seem to be quite indifferent to that fact.
Senator Austin: In the structure of the foreign bank presence in New Zealand, are these branch banks foreign banks or do you require them to be locally incorporated?
Mr. Brash: No, we do not require them to be locally incorporated. Some of them are locally incorporated, and some of them are branches. Of the largest five banks, four are locally incorporated -- ANZ, BNZ, ASB and National Bank -- and one is a branch. In fact, the largest one is a branch; it is a branch called Westpac Trust.
The smallest banks would be predominantly branches. They tend to be niche banks, specializing in treasury operations or corporate banking. Deutsche Bank, Banque nationale de Paris, Banque de Tokyo Mitsubishi, those seem to be branches. But the large banks, as I say, four out of five are incorporated locally. There is no requirement to be incorporated.
Senator Austin: Therefore, it is not of significance to you whether they are branches or whether they are locally incorporated, as long as they meet your disclosure tests?
Mr. Brash: That is correct. Indeed, one of the advantages of having them operate here as branches is that they can utilize the balance sheet of the parent bank. The number of large corporates in New Zealand is not very great, but they are quite large, relative to the economy. For a locally incorporated bank to service those customers would be quite difficult while still retaining some degree of diversification of their balance sheet. If they can use the parent balance sheet, they can diversify that risk across the corporate borrowers rather more easily.
Senator Austin: Governor Brash, I want to ask you about the relationship between the Central Bank and the home regulators of your foreign banks. I presume that there is an easy and comfortable relationship, such that the lead supervisor, if you like, will give you whatever disclosure you are looking to have with respect to the parent or the bank itself, which has a branch in your system.
Am I correct?
Mr. Brash: I think it is an easy relationship, but, again, let me ask Mr. Leddingham to comment on that.
Mr. Leddingham: In our relationships with other regulators, our main counterpart regulators are in Australia and the U.K., and to some extent in the U.S.
We have had longstanding and very successful open relationships, particularly with the U.K. and Australian regulators, partly in fact obviously reflecting our current heritage. We have not felt the need to formalize those relationships by way of documented memorandum of understanding, although with the move to the new financial services authority in the U.K., we will be executing a formal document with that organization.
The relationships have been very open and transparent, and very successful and relatively frequent, too. The fact that we have all been both central banks and regulators has meant that there has been quite frequent contact between the organizations, not just on the regulatory front but on the policy front more generally.
Therefore, governors have met in a number of different environments on many occasions and have had many opportunities to exchange views, both formally and informally on regulatory matters.
Senator Austin: Let me come, then, to the question of applications by banks in countries where the regulatory experiences is perhaps less sophisticated or less transparent. For example, what would you do if a Thai bank or an Indonesian bank sought to set up a branch in your country? What would your standards be in that case?
Mr. Brash: We have basically taken the view that if we have some uneasiness about the parent bank or the regulatory regime under which that it operates we might, under those circumstances, require local incorporation. When I said earlier that we were quite comfortable with branch operations, I should have qualified that by saying that in some circumstances we might require a local incorporation.
Mr. Leddingham: I would like to add one further point to that. Our legislation requires us, in considering a registration application, to have regard to quite a number of matters, including, in particular, the standing of the institution. While we have open entry to the New Zealand banking system, the entry hurdles are not revealed. We do take issues of standing quite seriously and, indeed, we have said no to applicants. So we do not have totally open entry to our market.
Senator Austin: I am impressed by the degree of responsibility that bank directors take on in New Zealand and, I presume, the personal liability that runs with that responsibility, should there be errors.
Do you require bank directors in New Zealand to have New Zealand residence or nationality in any way? Do some of them have those local connections?
Is the standard of liability of the directors that of someone who has acted prudently in the circumstances, or is there an absolute standard of liability with respect to those directors? If the answer is absolute, how do you get anyone to be a director?
Mr. Brash: Let me comment on the first question. Because we allow branches, we are not really in a position to require local residence. Of course, many of them, by the nature of the case, will be offshore.
If the bank is incorporated locally, we require at least two directors to be independent of the parent bank. In other words, we want to ensure that the bank will clearly be functioning as a distinct corporate entity and not just as a de facto branch. Hence, in that situation it is normal for the two independent directors to be local, although we do not actually legally require that. However, they must be quite separate from the banking group for a locally incorporated bank.
Senator Austin: But they could have the same nationality as the owners of the locally incorporated bank? They could be resident in Australia as long as they are independent directors?
Mr. Brash: Yes, I think technically that is right. We have not ever had that situation emerge. To date, all the banks that are caught by this locally incorporated rule have local residence. I do not think we have ever been asked how we feel about non-local residents. The advantage of having local residents is that they have local-market knowledge. Certainly that has been the practice universally. We have not had any locally incorporated banks that do not have at least two, frequently more, New Zealand resident directors.
On the second question, you are absolutely right. It was a question that a number of banks raised with us when we were talking about our proposal: How will we get people willing to serve as bank directors; and do bank directors have to become effectively internal auditors? We took a lot of legal advice on that question.
Our understanding is that bank directors are reasonably safe, provided they can demonstrate that they have acted carefully, prudently, without negligence, and so on. Hence, they have to demonstrate that they have illustrated an appropriate process for checking data.
Senator Austin: This is what we call due diligence in our terms.
Mr. Brash: Yes.
Senator Austin: Just to clear up the facts of the locally incorporated banks. Although they are foreign-owned, how many of those would be retail banks and how many of those would be wholesale banks?
Mr. Brash: I think I am right in saying that almost all the locally incorporated banks are retail banks. One of the largest banks I mentioned earlier was a branch, and that is a retail bank also. Certainly of the top five banks, four are locally incorporated, one is a branch, and all are retail banks, among other things. Predominantly the branches tend to be the specialist players, the wholesale players, the treasury operators, and so on.
The only exception is Bankers Trust, which operates here as a subsidiary guaranteed by the parent. The other wholesale players are mainly branch operators.
Senator Austin: I would like to pursue the issue of your regulatory hand, as soft as it is. It is a requirement that there be quarterly disclosure. Are the criteria of the disclosure carried in statute form or in regulation form, or are they at the direction of the Central Bank?
Mr. Brash: The power to require disclosure is statutory power. Regulations are issued subject to that statute and are, from time to time, amended, after consultation with the banks.
You alluded to the regime being soft, and I can see why some people think that it is, but I do not think the banks themselves think that it is. For example, shortly after the regime was implemented in early 1996, one of the banks was forced to disclose that they had not only breached our limit on exposure to their shareholder, but had actually incurred a risk to their shareholder which exceeded their New Zealand shareholders' funds. Under the old regime, they would have said to us, "I'm sorry, we made a mistake. Terribly sorry. It won't happen again," and we would have growled at them. But because this bank was a subsidiary of a major European bank, they were probably fairly confident that we would not actually suspend their licence.
Under the new regime, they were forced to tell the whole world that they had broken the rule and had effectively shipped or potentially shipped all their shareholders' funds out of the country.
The media furore about that was quite considerable. Even more potent, I suspect, other banks were very angry. We had banks calling us, and they had banks calling them saying, "Look, what is my parent going to say when they discover that I had funds on deposit with you at that time and you had no shareholders' funds in the country?" I suspect that the directors of that offending bank were quite chastened by that experience, in a way which is really more potent than a letter from the Governor of the Central Bank.
Senator Austin: I withdraw any suggestion that your regulatory system is not one of considerable discipline, because that kind of public exposure is exactly what bankers fear to have. I understand how significantly it conditions behaviour.
You are a very good or even difficult witness because you anticipated some of my questions with your answer. I wanted to ask you how your disclosure system deals with hedging and derivatives on a quarterly basis. Do the banks have to report their currency exposure? To what extent do they have to show their exposure on risk models?
Mr. Brash: I would ask my colleague, Ian Harrison, to answer that question in one second, but let me make one other comment.
You referred to the things that bankers do not like. One of the rules that we abolished with the new system was a limit on counterparty risk exposure. We previously had a limit, as most other supervisors do. Some have a 25-per-cent limit of the bank's capital; some have a higher figure. We abolished that limit, but basically the quarterly disclosure requires banks to indicate how many counterparty exposures exceed 10 per cent of capital, how many exceed 20 per cent, how many exceed 30 per cent, and so on.
We are really relying upon the point that you make, that banks are very reluctant indeed to tell the world that they have a very concentrated risk portfolio. Indeed, that system is working very well.
Let me turn to my colleague, Ian Harrison, who worked with the banks to design a system for disclosing the off-balance-sheet risks that you refer to. We were very keen to have a system which was both meaningful to outside readers, but also not so cumbersome that banks would spend tens of thousand of dollars, possibly tens of millions of dollars, having to comply with it.
Mr. Ian Harrison, Banking System Department, Reserve Bank of New Zealand: We have a disclosure regime for market risk which is based on the borrowed standard model. We have twigged that in some respects. The most important thing is that they provide a single summary measure across the entire bank of the interest rate risk, which comes out as a single number, and similarly with foreign exchange risk and equity risk. Hence, the accountants can just make comparisons between banks and can see if that market risk figure is moving from quarter to quarter.
The disclosure is such that we allow banks some flexibility in the way they produce these numbers. We think they are reasonably robust within the limits which you would normally expect with market risk. There are a lot of ways of doing it, but they have all produced a number which will react to the big risks. Imbedded within that, banks will be accounting for their own balance sheet and off balance sheet exposures to interest rate and exchange rate risks.
Senator Austin: That is a very helpful and appreciated answer.
Finally, in this line of questions, has there developed in New Zealand an analysts' service or an advisory service for the public, people who buy bank-issued debt or deal with the bank on deposit certificates? Has the private-sector development built up where you have rating agencies who rate the credit of these various banks in New Zealand?
Mr. Brash: One of the reasons that New Zealand is not a very good laboratory for this disclosure-based regime is that the high degree of foreign ownership tends to mean that most people who deal with the banks say, "We do not need to worry about Bank X because they are owned by Lloyds Bank; we do not need to worry about Bank Y because they are a part of Citibank." There is less attention paid by the general public than would be true in a regime with higher domestic ownership.
One of the ways we have tried to make the information user-friendly is through bank ratings. We have said to banks, "You do not have to have a rating, but if you have a rating you have to disclose it; and if you do not have a rating, you must disclose the fact that you don't have one." All the banks, except two, are rated by either Standard and Poors or Moodies. And the general public, while they may not understand the details of on- and off-balance-sheet interest rate risk, understand the difference between triple A and single A. It is a very useful shorthand. We do, from time to time, see media reports tabulating the different ratings which banks have. Happily, most of our banks are rated pretty high.
Senator Oliver: I had originally four questions, and Senator Austin has covered most of the ground that I was going to cover. However, there are a few new areas that I would like to get your view on.
Financial service-providers around the world are going to their regulators and saying, "We now have a new regime that we must deal with," and that is electronic commerce and electronic banking. One of their big concerns, and one that they discussed with us when we were in the United States the week before last, is: How do you go about regulating things that are taking place on the Internet?
In view of your open system of self-regulation and of disclosure, I would love to hear from you what you are planning to do about financial institutions offshore. Who will be doing electronic commerce in your country?
Mr. Leddingham: Clearly this is an emerging area of some interest. It is one that we have certainly given some thought to, but, like most countries, we have yet to reach a final position on how we should view these things.
Our starting point would be that these developments are things that we are going to have to live with. Somehow the world is developing in this way. Regulators are not going to be able to stop these developments from happening, so somehow we have to find a way to live with them.
Our general thinking on the way in which we should approach that issue is very much in line with the way physical comments have developed over the years. Most New Zealanders know perfectly well that, if they go off to the Middle East somewhere and buy a carpet in a bazaar, it is a matter of "buyer beware." The consumer guarantee does not apply. They must take responsibility for checking that service-providers are reputable, have appropriate credentials, and so on.
We believe in general terms that the same kind of thinking can be applied to electronic commerce. We should indeed be taking a good deal of interest in what our local service-providers are up to and making sure that, if they are operating extensively in New Zealand, they should be meeting appropriate disclosure requirements, and so on.
As to cross-border activities, we are now past the point where we can practically police our border. We simply have to recognize that, and at that point take on what is essentially an educational role for the general public and perhaps with business more generally along the lines that I stated before: Make sure you are dealing with reputable parties, look to the self-policing mechanisms that do exist in an environment like the Internet, where disreputable providers can be identified quite easily. Let us hope that those kind of market mechanisms will successfully ensure that electronic commerce can proceed in a reputable fashion.
Mr. Brash: Mr. Allport would like to comment on that point also.
Mr. Allport: Just commenting on that from a general competition law point of view, we are faced with many of those issues in a broader competition context. I agreed with everything that has been said.
What we have done in the recent past is, if there has been electronic commerce which has infringed the laws of New Zealand and we cannot reach the perpetrator from a jurisdictional point of view, we have tended to go after the Internet service provider. Our basis for doing that is, perhaps, a little questionable and, so far, we have worked on the basis of applying pressure on them to ensure that the conduit they are providing is not a party to scam activity. I am talking here of blatant infringements. So far, that has been reasonably successful. However, I am sure that, as time passes, we will face more and more difficulties with these cross-border commerce issues.
Senator Oliver: One of the things that politicians and parliamentarians have always tried to do in relation to the public sector is to come up with a public policy system that protects those who want to use the banking system. Once you start talking about caveat emptor and laissez faire, we have to live with the consequences. It is a bit of a departure from our old way of providing bank regulation for our citizens.
Mr. Brash: That is true, though I take some comfort from the fact that, by the time you are banking on the Internet, you have a bit more sophistication than perhaps the people who have most needed our state protection in the past. That may not be a fair comment, but certainly the people we have seen in New Zealand as needing most protection are the ones less likely, at least in the near term, to be banking on the Internet.
Senator Oliver: One of the two things that you do, and which is so unique and so exciting for us in our study, is that you regulate by public disclosure and by self-regulation. Could you tell me how the basic consumers are reacting to a system like this? What have they been saying about it? How are small businesses and new creative services are being brought forward under your system of regulation? Are your consumers happy?
Mr. Brash: I would have to say that the supervision regime probably has not had a big effect on banking innovation. We have been having an increasing wave of innovation over the last 10 years, driven mainly by competition. As I said earlier, we have a very competitive banking sector, very high penetration of automatic teller machines, very high penetration of electronic funds transfers, I think the highest in the world at this point in terms of numbers of outlets and numbers of cards and so on, as well as a lot of telephone banking, Internet banking, domestically, and so on.
It has been a very innovative system in the recent years. However, I could not claim that that was primarily a result of our new approach to banking supervision.
I would have to acknowledge that a great many of the general public probably are quite unaware of the new approach to banking supervision. As I said earlier, that is partly because there is a perception that these banks are part of large banks and, therefore, the risk of one of their subsidiaries or branches failing in New Zealand is very low.
The main impact of the system has been on bank managers and bank directors. We have certainly been told some anecdotal stories where banks have been forced to look to their internal control systems in a way which we think is, to some extent at least, a direct result of the new system.
I had thought that we were going to have someone from one of our largest banks here this morning. The chief executive of that bank has told me that they have tightened up their internal controls quite substantially because he said, "My directors don't like signing these statements unless they can be quite certain of the process that has gone behind drawing them up." It has been useful, but more because of the change in behaviour of the banks themselves, thus, a change on the part of the public.
Senator Oliver: In Canada, as you know, our banks cannot sell insurance in their branches. When we were in London, the FSA told us that they would like to have securities, banking, insurance and all other financial services under this one umbrella, this FSA. Could you comment on the proposed English system and where you think it is going, and whether you think it is viable in view of what you have, which is different?
Mr. Brash: You are asking me about the structure of the FSA rather than the structure of the banking institution itself.
Senator Oliver: That is correct, because the FSA will be regulating all aspects of financial services from securities to insurance.
Mr. Brash: Again, I will ask Mr. Leddingham to comment on that.
We, ourselves, have not restricted banks from selling insurance in New Zealand. In fact, in the last few years, they have moved very aggressively into life insurance particularly and, to some extent into fire and general insurance as well. There is no restriction on that. As long as they are conducting financial services and including banking services, they are entitled to apply for bank registration.
Mr. Leddingham: I will make two comments. First, the organization of the New Zealand financial system is reasonably straightforward, compared with many other countries. While banks have indeed gotten into insurance, we have not yet seen in this market the emergence of conglomerates. In that sense, the issue has not yet become pressing for us.
The second point I would make is that the organization of regulation in New Zealand is quite simple. We have the Central Bank doing bank supervision; we have Mr. Allport and his team doing commerce commission-free trading and that sort of activity; and our other regulator is the Securities Commission which covers all other activities involving fund-raising from the public.
The Securities Commission is not a merit regulator. They base their operations primarily on public disclosure. Those disclosures are well reached by accounting standards. While securities firms and other deposit takers are not required to make quarterly disclosures, nevertheless, quite a degree of harmony exists across the regulatory structure. In other words, in the kind of things that we do as bank supervisors and the kind of things that the Securities Commission does in respect of deposit-taking activities, securities activities, we probably have a reasonably level playing field as compared with most other countries. There is not acute pressure on the regulatory structure for a level playing field. There is some pressure, but it is not as acute as it is in some other countries.
Senator Oliver: When we were in the United States, when a new or innovative situation arose, there was often a turf war between the regulators. Have you had any such turf wars in your country?
Mr. Leddingham: I would say "on the contrary". Electronic commerce is a good example that involves a number of different regulators. While we do not have a formal council of regulators or anything like that, we do have a very good network with our counterpart regulators. We will get together and discuss the issues with them. We have done that with things like store credit cards, since issues have started to emerge in that area. That was a classic area where it is not entirely clear whether it is the banks' supervisor or the securities regulator that should be looking after these activities. We believe strongly in maintaining good contacts and a good exchange of information with our counterpart domestic regulators in those kinds of areas, and I think that has been very successful.
Mr. Allport: In relation to what has just been said, it is true that the regulatory bodies in New Zealand work very closely together. In fact, we are physically located within a radius of probably 500 metres, so it is very easy to visit one another and discuss concerns and ask for advice. The level of collaboration and cooperation between the authorities is very high.
Mr. Brash: The Securities Commission is actually in the Reserve Bank building, which makes life very easy.
The Chairman: Before turning to Senator Kelleher, could I ask you, Mr. Governor, to clarify one point on which I am slightly confused?
In responding to Senator Austin you talked about instances where foreign banks opened branches and other instances where they incorporated subsidiaries. Are there legal requirements which compel a foreign bank operating in New Zealand to do certain things, such as being an incorporated subsidiary. Alternatively, is that simply a business decision on the part of the foreign bank? Can it operate with 200 branches or as a subsidiary?
Mr. Brash: They are totally free to make their choice, with the single exception I mentioned earlier which was prompted, I think, by a question about what would happen if a bank comes from a country where we are not confident about the quality of the supervisory regime or, indeed, where the bank itself may be not entirely self-evidently strong. In that case we would require incorporation, but that decision does not relate to the kind of activity which they are conducting.
The Chairman: You also said that the majority of foreign banks operating had come in as subsidiaries or had created subsidiaries. What is the business rationale for that? Why would they prefer to be a subsidiary rather than a collection of branches?
Mr. Brash: If I said the majority were subsidiaries, I was mistaken. Of the roughly 20 banks we have currently, there are about seven subsidiaries. That is not an exact figure; I will have to check it. It is a minority of the 20. If you are weighting that number by bank assets, it will be a majority of bank assets, but a minority of the number of banks. The reason, I suspect, owes as much to history as anything else.
Of the five largest banks, four are subsidiaries, and they have been incorporated here for a very long time.
The Chairman: The fifth is a multi-branch bank, in spite of the fact that they are just branches. Is that right?
Mr. Brash: Yes. You can be a branch bank and have as many branches as you wish.
The best example is the largest single bank in the country, Westpac Trust, which probably has 300 to 400 branches. It is, totally, a retail bank, a commercial bank, a corporate bank. It is a full-service bank. As I say, they are free to have as many branches as they like, and to open them or close them at their discretion.
The Chairman: To get back to the power of embarrassment issue on members of Boards of Directors, as well as the potential liability question, taking Westpac as an example with a significant number of branches but not incorporated as a subsidiary, its board of directors that would to sign off the statements, I assume, would be the board of the parent company in Australia, in which case it seems to me that the power of embarrassment and leverage factor may be somewhat less than if those people were actually living in New Zealand.
Mr. Brash: Factually, you are quite right. These people who sign off the statements are indeed the directors of the global bank, the bank based on Australia.
We have not noticed any perceptible decrease in their incentives to get that right. I think they would be very considerably embarrassed after signing off statements if they were to get it wrong.
Let me make one other point because it is relevant to this disclosure question. One of the issues we had to discuss was: What should a branch bank disclose? At one point, we actually thought the most sensible thing for it to disclose was not the information about the New Zealand operation, but about the global bank only because, clearly, if you are banking with the local branch of, let's say, Citibank or Hong Kong Bank, the local branch balance sheet may be trivial; you are really banking with the global bank and not the local branch.
Indeed, we toyed with the idea of limiting disclosure to the disclosure of the global bank rather than the domestic bank. In the end, and shortly following the collapse of BCCI you may recall some years ago, we decided to require disclosure of the local branch activity and as much of the global bank activity as the bank chose to disclose. We thought, again, the incentives there would be quite strong, that they would wish to disclose how powerful, how strong, how operationally stable they were, but it gives the person dealing with the local branch at least some understanding of the stability of the local branch.
Following the BCCI failure, we watched supervisors around the world grab pieces of banks that happened to be in their jurisdictions. In other words, they were not liquidating that bank on a pari passu basis. We thought it was, therefore, fair for people dealing with the branch to have some understanding of what the local branch balance sheet looked like.
Senator Kelleher: Gentlemen, thank you for this conference which we are all finding most interesting.
One point that struck me and that presents an interesting parallel is that you said you have five large banks and you have a multitude of some smaller ones. Would you believe that, in Canada, we have five large banks and then we have some very small ones. They are what we call Schedule II or foreign banks; there are about 46. However, most of them are in the wholesale, not the retail business, and they do not represent a very big portion of our total banking system.
We have a rule, or a tradition, here in Canada that the big shall not marry big. The banks think, given the global economy, that big is better. However, suddenly, our number-one bank and our number-three bank said to the Minister of Finance, who is the gentleman who has the power to say yea or nay, "We would like to merge, if you don't mind." Then the number-two bank and the number-four bank said to the Minister of Finance, who was still reeling from this first request, "By the way, we would like to merge too." Now we have four of our five big banks, which represent about 70 per cent of total domestic deposit accounts, saying that they want to merge. Instead of five big banks, we will have three big banks. Needless to say, we do not know what to do at this point. Is big better, as the banks tell us? Do we really need to create these big new banks in order to meet the global competition?
The concern has been expressed by the small business community and ordinary people that, once this happens, many branches will be closed and customers will not be served. Many people think that banks have little soul now and that they will have even less when these mergers occur.
What would you do if four of your big five came along and told you they were going to merge so that you would have two big banks instead of four? This is what we are faced with. The government has set up a special committee, a private-sector group known as the McKay committee to look at this. The Minister of Finance is scratching his head, and everybody is in a bit of an uproar. How would you respond to this, Mr. Governor?
Mr. Brash: I will give part of the answer and let Mr. Allport respond as well. It seems to us that there are really two public sector or public policy issues involved in that question. One is: Would the merger or would two mergers increase the degree of systemic risk in the banking system?; and the second question is: Would it significantly reduce competition in the banking sector?
We would look at the first question and the Commerce Commission would look at the second question. From our point of view, we would want to be sure that any merger would result in a strong and well-capitalized institution, unlikely, by its getting into difficulty, to bring the whole financial system into danger. We would look simply at the systematic risk question.
We would, undoubtedly, want to be satisfied on that point. It is an important issue. However, if the banks were both strong and likely to lead to a strong entity through their merger, we would not, by virtue of their size, object to that merger.
However, the Commerce Commission looks at the competition issues and they would look at it from a quite separate set of perspectives.
Mr. Allport: Senator, in those circumstances, we would investigate the merger proposal. We have a threshold under our Commerce Act concerning a dominant position in a marketplace, and either acquiring or strengthening a dominant position in a marketplace is prohibited under the Commerce Act.
We would consider the proposal under that umbrella, and either the proposals of the merger would come to us and seek a clearance under a section of our act, or they would just proceed with it if they did not think there was a major issue. If they proceeded with the merger, without seeking a clearance from us, we have the ability to investigate that, and if we thought it did lead to an acquisition of or strengthening of a dominant position, we would have the ability to challenge that through the courts.
Our threshold of dominance is a fairly high threshold. Just to give you a feel for that, under our business mergers and acquisition guidelines, if the proposal results in 60-per-cent market share or less, and the next largest competitor is 15 per cent or more, we would consider that a safe harbour and would have no concerns with it.
Those thresholds are pretty high by North American jurisdiction labels. One of the reasons perhaps for that is the small size of our economy. There is another provision under our act. If those areas of concern of dominance are reached, the parties could seek from us what is called an "authorization", which essentially assumes that what they are doing means they will acquire or strengthen a dominant position, and they will seek to get authorization from us to proceed with that. We would then look at that in a balancing situation of the benefits that may be derived from doing that versus any detriments to competition that may arise. In such a case, if the benefits exceeded the detriments, then we would authorize the merger to proceed.
Senator Kelleher: That is very enlightening, to say the least. When you mentioned the 60-per-cent threshold, you would not hear the gasps in New Zealand, but there were quite a few gasps here around the table.
I can say, Mr. Governor, in response to your response to me, none of the four banks that want to merge into two is unhealthy. They are all very healthy. There is no necessity for one to rescue the other or anything of that nature. They are all in very good financial shape.
The result of merging those four is that we would end up with the two new larger banks probably controlling about 75 per cent of the retail sector. Certainly, not one of them would have anywhere close to 60 per cent. It would be a fairly even split. I guess what you are saying is that our Minister of Finance should not worry at all. He should speak to you -- and I will give him that advice, of course -- because, under your regime, it would appear they would meet your existing criteria. We find that very interesting. I do not think that this situation is something that the Canadian people or the Canadian banking authorities are very happy about.
Mr. Allport: The question at issue may not necessarily be the overall market share that the parties to the transaction might have. It would get down, very clearly, to definitions of particular markets. That, of course, is the key to the application. Any competition lowers the definition of the market. The definition of the market would be unlikely to be the market for banking services. It may be reduced to much smaller components than that. It may be the provision of retail banking services or there may be, in fact, a series of market definitions in which the thresholds are not reached, but then there may be a relatively small market where that threshold would be reached and we would express some concern.
In those circumstances, we then have the ability to accept undertakings to divest, but it is only to divest shares or assets. The undertaking actually has to be the divestment of assets.
If, in the majority of situations there were not any concerns in the market but in one or two or a number of market segments there were concerns, the parties may offer to the commission to overcome that difficulty by giving undertakings to divest.
Mr. Brash: Just as a minor illustration of that, I was involved in asituation about 20 years ago when two investment banks sought to merge. One held the American Express card franchise in New Zealand; the other held the Diner's Club franchise in New Zealand. At that point, bank credit cards were not so widespread. At that point, the Commerce Commission authorized the merger, but on condition that one of the credit card franchises were sold.
Senator Kelleher: I should point out to you that we, too, have a Competition Act, as you might expect, and in addition to the consent being obtained from the Minister of Finance, we also have to obtain the consent as provided under the Competition Act. That department will have to give its consent as well. They are undertaking that study at this time.
From what little I hear and what little I know of our act, it probably more closely resembles the American regime, which is pretty tight. I may say they have had good reason to tighten it down there.
We will certainly pass your comments on to the Minister of Finance. We have your name, address and phone number, so you may be getting a call.
Senator Callbeck: Thank you very much, Mr. Governor and gentlemen.
Carrying on with the topic of mergers, what have been the results of mergers in New Zealand? What are the pluses and what are the minuses? For example, have shareholders' earnings increased? Has the range of services broadened? Have user fees or bank charges tended to go up?
I understand that when mergers have happened in the States the service charges of the merging banks have tended to increase.
What about closures? Mr. Governor, you spoke in your opening remarks about closures of banks in Australia. Is that due to mergers and is that happening in New Zealand?
Mr. Brash: I can give an answer to that, but I am not sure I can be very dogmatic. The reason I say that is that there is a rapid move away from delivery of banking services through the physical branch network in favour of electronic banking services, automatic teller machines, and so on. Throughout the country there has been a trend to close branches, quite separate from any additional closures which may have resulted from mergers.
Certainly, mergers have tended to result in branch closures in New Zealand. When you were asking the question, I jotted down four bank mergers that I can think of over the last five or six years. It is fair to say that all of them have resulted in quite significant numbers of branches being closed.
It is probably also true to say that most parts of the country -- there may be some exceptions -- are still very well serviced, indeed, by numbers of branches. Certainly, all the cities and towns continue to have a multitude of branches. It is only in the very, very small areas where there have been complaints that branch closures have severely disadvantaged the community. Having said that, as I say, I do not think that is so much driven by the fact of mergers so much as the other trends I mentioned such as increasing delivery by electronic means.
The other additional dimension there, I suppose, is that at least in New Zealand and possibly in Canada also, banks, until fairly recently, lived in a fairly protected environment, where they tended to provide some services at a loss and some services, of course, have made a very substantial profit. They are able to cross-subsidize between services without much difficulty. What we have seen in the market being opened up in the way that it has been, is an increasing tendency for banks to be forced to cover their costs in all services because they are being undercut in their profitable services. That also has been driving up the cost of the direct fees being charged for transactions in the banking services. We are seeing fee charges per cheque cashed and so on in a way which is, as I say, driven by this need to reduce the extent of cross-subsidization.
Senator Callbeck: In the smaller banks too, are your service charges tending to increase?
Mr. Brash: In general terms, yes. I am talking mainly now about the retail banks because those are the ones which are politically sensitive. It is fair to say that both the large and the small banks have tended to see their fees rise because they have had their basic lending business undercut by non-bank financial institutions.
Senator Tkachuk: Welcome and thank you for doing this. Our problems here in Canada are not just related to the concentration of the banking industry but as well of the financial service industry. You mentioned earlier that you allow banks to sell insurance. How are they organized? Are the insurance companies subsidiaries of the banks, or do they operate with holding companies with two separate corporations, a banking corporation and an insurance company? How do they report that to you?
Mr. Leddingham: We do not have any holding company arrangements of the sort where you have a banking subsidiary and an insurance subsidiary of a holding company. We do have holding companies in place of them between parent banks and the local subsidiaries, but they tend to be there for tax and organizational reasons rather than for more substantive reasons.
Typically, insurance operations that are sold by banks are operated either by subsidiaries of the bank or, in some cases, they are selling products from related parties or as a result of strategic alliances with other insurance providers.
Senator Tkachuk: Do you allow the banks to own security companies?
Mr. Brash: It is not really an issue because we have never had a Glass-Stiegel distinction between traditional commercial banking and securities activities in New Zealand. So banks are free to undertake securities business in the banks themselves.
Senator Tkachuk: Is your securities industry controlled basically by the banks, or are there fairly large independent security operations that operate independently of the banks?
Mr. Brash: There are quite a lot of operations run independently of the banks: frequently, branches or subsidiaries of international players, and the large North American and European investment banks. But they are outside the banking system to some degree.
Mr. Harrison: The great bulk of bond tracking, foreign exchange, and so on, is conducted by the banks.
Mr. Brash: But the investment banking business -- the underwriting and that kind of business -- would be done partly by banks and partly by non-banks; mainly by non-banks. The underwriting business, for example, is done mainly by non-banks, but it can be done by banks also.
Senator Tkachuk: At the beginning of our discussion, you talked about the studies that you undertook before you decided to move to the system that you finally moved to. Your studies were fairly worldwide. You obviously came to conclusions. I would like some further discussion of this.
Do rules-based systems or strong regulatory systems prevent bank failures? Do you believe they can prevent bank failures?
Mr. Brash: No, I am sure they cannot. That is fairly well established by looking around the international experience. Banks have failed all over the world, whether in the developing countries with poor supervisor systems, or in the developed world, where the systems have been, on the face of it, very good. While putting our amendments through Parliament two or three years back, we were just through the select committee stage of that process when Barrings failed. The select committee thought it appropriate to call us back before the committee to say, "Can you give us an assurance that your new system would prevent something like Barrings happening?" I said, "Unfortunately, I cannot give you that assurance. All I can say is that Barrings failed under the more conventional system." Of course, the Bank of England and the Monetary Authority of Singapore also operated under that system, when Barrings got into the most difficulty.
I do not think that any system can given an absolute assurance of preventing bank failure. When I look at the causes of bank failure since the Second World War, they have been essentially of two kinds. They have been bank employee fraud or they have been a result of very dramatic changes in asset prices -- land prices or share prices or whatever. It seems to me that the conventional approach to banking supervision has not proved itself to be very good at dealing with either of those situations. Fraud is very, very hard to pick up as an outside supervisor, and BCCI and Barrings are both good examples of that. Asset price changes are frequently not anticipated by even well informed people. When asset prices are going up, of course, loan loss provisions look prudent, bank capital looks adequate, everything looks hunky-dory, until asset prices fall by 50 per cent and, all of a sudden, things do not look quite so good.
Senator Tkachuk: Speaking of that, I want to turn to one more area, and that is the effect of what has happened in Asia on the banking system in New Zealand and the New Zealand economy. What effect has what we call here "the Asian flu" had on your economy in New Zealand? Has it affected the banking system? Are any of your banks exposed?
Mr. Brash: Not to a substantial degree. Bear in mind, as I said earlier, most of the banks here are part of much larger international banks. Some of those banks clearly have some exposure to Asia; in particular, some of the Australian banks have announced that they have some exposure to Asia. But to the best of our knowledge, that exposure is not particularly large, and certainly we do not have any impression that the local operations have a very large exposure.
The economic effects to the country as a whole, however, is of course quite substantial. Like Australia, we have substantial export exposure to the East Asian economies, and some particular industries are severely affected by that exposure. Forestry is one; tourism is another.
Senator Tkachuk: With your present regulatory regime and the reporting system that you have now, would the information that the banks had to give to you have included their exposure a number of years ago in Asia? Is that the kind of information that they would have been reporting, their foreign exposure, not only by the amount of money but also the actual countries that they were exposed to?
Mr. Brash: Certainly if it was material, that would be required to be disclosed, yes.
The Chairman: Mr. Governor, I am rather fascinated by your use of embarrassment as a regulatory tool. I wonder if I might just explore it with you a little bit. It seems to me that it works only to the extent that there is genuine negative publicity in cases where the information does not indicate a totally healthy patient. You commented earlier, for instance, that consumers are able to compare the bond rating agency's rating. I think what you said was that people knew the difference between a triple A and a single A but, on the other hand, most of the major banks are highly rated, so there is probably not a huge element of market difference on that score.
What kind of information is most effective in terms of having this potential embarrassment element? I put it in that context because it seems to me that you could get financial institutions to put out an awful lot of technical information which nobody, probably even including the financial press reporters, would understand. It seems to me that whatever you put out to have this leverage effect needs to be information which could be easily communicated by the media and understood by consumers. I suspect, if I am right, you have gone through a bit of an evolutionary process in determining what that set of data should be.
How did you do that, and what are the two, three or four most effective pieces of information?
Mr. Brash: We recognized from the beginning that the professional banking analyst would need a very substantial volume of information to make sense of the analysis. We, therefore, have a requirement that banks make this very substantial volume of material available.
At the same time, we recognize that that sheer volume of material would, in itself, be an obstacle for the great majority of the public in understanding about the banks. So we actually require disclosure at two quite separate levels. One is the detailed level, and the other is what we call our KIS statements, key information summary -- not keep it simple -- statements. Those are quite brief statements of two or three pages, which must be available in every bank branch on demand when a customer walks up the street.
Even within that relatively abbreviated information, I suspect that the sort of information which most people are looking at, or might look at, would be essentially the bank's rating and possibly the bank's capital adequacy ratio. Those two things are relatively well understood and I think would be meaningful to a significant minority of informed people.
The Chairman: Once these KIS statements are out, do the media then write the comparative pieces in the sense of saying, the Westpac numbers are such and such, followed by the numbers for A and Z Bank, et cetera? In other words, do the media make the comparison shopping easier for the consumer by publishing the data in a form that the consumer can then use it?
Mr. Brash: We wish they would do more of that. At this point, they are not doing much of that at all. In fact we have been discussing internally recently ways in which we might encourage a greater degree of media analysis.
As I said earlier, one of the real difficulties, and one of the reasons the laboratory is not a good test for this particular regime, is simply because the banks are so widely perceived to be part of these global banks, which are very large. That certainly diminishes the extent of the public interest in the information.
Mr. Leddingham is reminding me that we ourselves publish a comparative table on a quarterly basis, on our Web site. We have gone some way to making that information available on a comparable basis across banks to the general public.
Senator Oliver: I am wondering if some of the information that you force the companies to produce on a quarterly basis is considered by them to be sensitive and private. Do they disclose privacy information or certain corporate strategies of a particular bank that they would not otherwise have ever let their competitors know about? Have there been complaints to you about that kind of disclosure and, if so, what have you done about it? Are there some things that they can disclose not publicly, but privately, to you?
Mr. Brash: I will answer your last question first. We do not encourage banks to make available information to us that is not publicly available.
We do not require banks to disclose the identity of particular counterparties. While we do say that we want them to disclose the extent of their risk concentration, we do not require them to say that if the exposure is above 10 per cent or 20 per cent or 30 per cent of capital, then they must name the counterparty. They do not need to do that at all.
There was initially some resistance by banks to having to disclose, for example, risk concentration information and, indeed, also some opposition to disclosing the extent of the interest rate positions. But we said, "Sorry, we are not willing to accept that as an objection." The fact of the matter is that in a small market, most of the other banks know pretty well who is banking with whom, anyway. We do not believe that any information that is being disclosed through these various statements is telling informed players an awful lot.
I am not putting that very well. Some banks said, regarding the resistance to disclosing the extent of risk concentration, "People will guess that we are exposed to Fletcher Challenge, for example." We said, "Well, they may guess that, but that is too bad. If you really want to know who is banking Fletcher Challenge, it is not too difficult to find out anyway." We did not accept that objection as a reason for not disclosing the information that we thought was appropriate for an analysis of the bank's soundness.
Senator Oliver: In response to an earlier question from Senator Austin that dealt with offshore derivative activity, you said that you forced the companies to disclose even off-balance sheet activities. Was there any resistance there?
Mr. Harrison: The disclosure is a single number, which catches both on-balance sheet and off-balance sheet risk. You cannot tell from disclosure the exact source of that.
What is relevant in this context is your overall risk. Neither we nor the banks believe that the fact that we have a derivative tells you anything about the interest exchange rate. It is the need for all those disclosures.
Mr. Brash: Just to emphasize that point, some countries require banks to disclose the interest rate position in their trading book. As Mr. Harrison has said, the interest rate position, which banks are required to disclose under our regime, encompasses both their trading book and their banking book. So it is their entire net interest rate position, for example, or their entire net foreign exchange position, which we feel does not require them to breach any inappropriate client confidentialities.
Senator Austin: Governor, what you were saying about asset price inflation leads me to ask you this question: To what extent does your calculation of asset price inflation play a part in your monetary policy decisions?
Mr. Brash: Did you read the article on page 90 of this week's Economist?
Senator Austin: I have not yet.
Mr. Brash: There is a very interesting article on that question in The Economist this week.
Senator Austin: I complained to The Economist because they deliver 48 hours after they appear on the newsstands.
Mr. Brash: This is one of the most vexed questions on monetary policy in the world today. I do not think any central bank thinks it appropriate to design monetary policy principally around asset prices. On the other hand, I suspect that no central bank can totally ignore what is happening to asset prices, both because strong asset price inflation is likely, in time, to feed through into more general inflation, but also, of course, because very rapid asset price increase may well lead in due course to asset price deflation. Of course, that can have very severe effects on both the banking system and on the real economy.
I have a great deal of sympathy with Allan Greenspan, looking at the situation in the U.S. right now. Happily, we do not have any situation quite like that here, although we certainly did have a situation a few years back where escalation in residential property prices did cause monetary policy to be rather tighter than it might otherwise have been.
Senator Austin: Thank you for that, Mr. Governor. We have been pursuing the same question in the last three weeks with our Governor Thiessen. He is equally broad in his answer, and I can understand why that is, of course.
As you know, the Canadian Minister of Finance, Paul Martin, has been speaking at the G-7 to the issue of transparency in bank regulation in a more universal way than has been the case. He is asking various countries to consider what mechanism we might be able to adopt and what sanctions might be adopted with respect to a failure to produce a transparent banking system.
Do you believe that an international mechanism would be desirable? Or do you believe that the current system -- essentially the central banks -- can turn their attention to the issue and gain the leverage they need?
Mr. Leddingham: The governor may want to comment as well, but we clearly support the idea that banking supervision regimes should be transparent. That is not an issue.
What we have seen of the Canadian proposals does make us worry a little bit about the proliferation of a fearless seat of institutional arrangements, which may just add another layer to an international structure that is already quite complex. There are many organizations, ranging from the Basel committee, to the IMF, to a whole bunch of other entities and a number of regional groups, also increasingly getting involved in looking at these matters.
We are a little wary of adding more and more institutional layers to looking at how well supervision is being done.
Mr. Brash: That is absolutely right. I do not have a lot more to add to that. We have learned, or the world has learned, in the last 12 months of some of the severe consequences when banking systems weaken. We have seen, in the Asian area, some of those consequences very dramatically illustrated. I would have thought that those countries themselves now also have very strong incentives to take measures to strengthen their banking systems, irrespective of whatever national pressure is put on them.
Mr. Brash: Senator, I will make one additional comment, if I may. You referred to the Bank of Canada and Governor Thiessen and his comments. I had the privilege of visiting Ottawa in February last year, for a brief period, to talk with the Bank of Canada. Governor Thiessen said at that time that there are probably no two central banks in the world more similar than the Bank of Canada and the Reserve Bank of New Zealand. I think that is probably true. We certainly see monetary policy in very similar ways.
The Chairman: Mr. Governor, I have just one last question before we adjourn.
It seems to me that it is typically true that, when an individual has been responsible for leading a whole system through very significant change, as you have done for the last several years, often when you get four or five years into the change and get in a reflective mood and look backward, the person says, "Knowing what I now know, if I were starting all over again from scratch, I might do things differently." If you were to put on that reflective hat, are there two or three things that you would do differently, knowing what you know now?
Mr. Brash: Are you talking about what I would have done differently in the banking supervision framework or in the monetary policy framework?
The Chairman: I am talking about what you would have done differently in the banking supervision framework.
Mr. Brash: No, I think we are very well satisfied with the regime that we have. Before the new regime was fully in place, we moved to a real time gross settlement system for the banking payment system, being convinced that that was one very important measure needed to reduce systemic risk. We now have that fully operational.
My one remaining worry in this area is that the world has not fully resolved the question of international payment system risk, the so-called head-start risk, which we have all known about since 1974. None of us has quite clearly determined how to deal with it. That is the challenge which remains for all of us.
The Chairman: Mr. Governor, to you and your colleagues from the bank and to Mr. Allport, I want to thank you very much for taking the time to be with us today. This has been very helpful to us.
Our staff will be back in touch with you. We would like to find out precisely what your KIS statements look like, as well as your more technical statements. In the meantime, thank you very much for taking the time to be with us. It has been very helpful.
The committee adjourned.