I have never been to New Zealand, but judging by the
clarity of thought New Zealanders have brought to the subject of bank regulation, they must have a first-class educational system.
Donald Brush is governor of New Zealand's central bank. He explained, in a recent commentary in Financial Times, the new approach New Zealand has adopted for regulating its banks.
New Zealand's bank regulatory regime was similar to the system throughout much of the world -- confidential exams and numerous prudential rules. Two concerns caused a reexamination of the system.
First was the matter of cost. Brush cited studies in the U.S. showing that the cost to banks of complying with prudential regulations runs about 14% of all noninterest expenses.
Second was the issue of risk to the taxpayers. Though New Zealand had no guarantee of bank deposits, there was a concern that depositors might argue very persuasively that the public sector had a strong moral obligation to protect them in the event of a bank failure, due to the public sector's extensive inside knowledge of, and involvement in, the banking industry.
Brush said the authorities might have been willing to continue the status quo if they believed that the way they were conducting bank supervision reduced materially the risk of bank failures. But they concluded it did not.
First, their assessment of the condition of a bank was necessarily based on historical information. By the time a problem was spotted, it was too late to prevent it.
Second, most bank failures have resulted from fraud or very sharp changes in macroeconomic conditions. Bank supervision is relatively impotent to deal with either.
Third, as bank supervision by a public sector agency intensifies, monitoring of bank behavior by the private sector tends to become less vigilant, paradoxically increasing the risk of bank failures.
The solution the New Zealanders arrived at was to reduce significantly the government's role in the banking system through a number of important reforms:
Banks will be required to disclose publicly much more information about themselves (including concentrations of risk), with frequent audits required and directors required to attest to the accuracy of the information and the adequacy of the bank's internal controls.
Banks will be required to disclose any credit ratings they receive or the absence of ratings if they have none.
The central bank will monitor banks on the basis of publicly available information, though it will retain the right to seek clarification if the publicly disclosed information is unclear or appears inaccurate.
Most prudential rules will be eliminated, though the Basel risk-weighted minimum capital ratio will be retained to appease regulators in other countries.
The central bank will retain the fight to intervene in a bank by appointing a conservator, but only to prevent systemic problems.
Brush believes this approach will increase the incentives for bank directors, depositors, and others in the private sector to take responsibility for the soundness of their banks and will reduce the exposure of taxpayers.
The strongest banks in New Zealand are delighted with the new system, as banks will "no longer be made equal by the central bank's supervision and perceived guarantee."
Where were Donald Brush and his colleagues when the academics and politicians set about to socialize the U.S. banking system with FIRREA and FDICIA?
It seems the U.S. could learn some lessons from down under.
Mr. Isaac, former chairman of the Federal Deposit Insurance Corp., is chairman and CEO of Secura Group, a financial institutions consulting firm headquartered in Washington.