Opinion: 'A flawed system to protect bank depositors'

Kerry McDonald argues weak local boards and a flawed system for dealing with failing banks could penalise local savers in a crisis. Photo montage by Lynn Grieveson.

Kerry McDonald, a former chair of the BNZ and former National Australia Bank director, argues the current system designed to protect depositors in New Zealand’s big four banks is fundamentally flawed. He cites weak local governance by both the banks' boards and the Reserve Bank, and an unfair system that penalises local savers in any crisis. Like the IMF, McDonald is calling for tougher Reserve Bank regulation and reform of protections for savers.

By Kerry McDonald

Banking involves identifying, understanding, mitigating and managing a large number of genuinely complex risks, usually in the face of high levels of uncertainty in numerous markets and measures, when even modest failures may have serious consequences and significant failures can destroy families, communities and businesses - and put nations at risk.

The recent failures of finance companies in the wake of the Global Financial Crisis is an excellent example of this. They reflected incompetent regulation and poor risk and incident planning and management. Very large amounts were lost, although some were protected and profited in the carnage from further poor Government policies. The warnings from this damaging event are now relevant to the banking sector and it is not a time to be complacent about the state of financial markets.

The recent Inquiry into the Australian banks and recent initiatives by APRA, the Australian bank regulator, also raise serious issues relevant to New Zealand.

The risks around running a bank are much harder and more complex than for other companies, but this does not appear to be reflected in many bank director appointments or boards.

Licensed bank directors in New Zealand must have the experience and expertise to understand the context and risks, be able to debate and agree relevant policies, challenge and guide management and hold it to account. The have to govern the bank's affairs under intense pressure when markets become unstable and difficult, and they have to be independent of any overseas parent.

But there is limited evidence of this capability on the boards of the New Zealand banks and boards which include weak links are always high risk.

Customers are not well placed to judge the capability of bank directors and boards and have no role in the process anyway. The regulators, the Reserve Bank and the Financial markets Authority) are better placed to form a view but don’t, only focusing on whether a director is a morally “fit and proper” person, not whether they have the necessary skills and experience which is a critical issue.

So who appoints directors and hold them to account?

The directors of the New Zealand banks owned by Australian banks are effectively appointed by the shareholding Australian banks, and the directors making these appointments are responsible to their Australian market shareholders and APRA. The Australian shareholding banks also have a high level of influence on the appointment of senior managers and on the policies and objectives of the NZ banks.

They approve the operating and strategic plans and the key performance objectives of their subsidiary banks, their risk appetites and management priorities and practices; and importantly, the priorities in the face of adversity. So, if the bank is at risk, are funds repatriated to protect the parent at the expense of New Zealand depositors, investors and customers, or not? Good question, especially given APRA’s current initiatives!

But New Zealand banking licences and laws require boards to be fully and solely accountable for the important decisions affecting the New Zealand banks, including the appointment of directors, the Chairman and executives, the risk strategy, key objectives and critical decisions in a crisis. Further, bank directors cannot opt, as most others can, to act in the best interest of the holding company, rather than the company – the New Zealand bank.

There are grounds for serious doubt about whether this important provision is complied with, particularly given the position of power of the parent Australian banks over the New Zealand banks and the relative weakness of the New Zealand bank boards.

And, there is no process in place by which the Reserve Banks monitors and supervises this issue, or indeed the equally important one of whether particular directors and board are genuinely capable and competent. A good balance sheet is one thing, but being able to govern and manage a bank in difficult times is entirely another. And if a board is weak management is also likely to be weak.

Interestingly the Reserve Bank’s own boards have often been weak on expert knowledge of banking and related matters, with unfortunate consequences.

Open Bank Resolution is flawed and unfair

There is a further critical issue. In a fit of madness the RBNZ and the Government implemented OBR – Open Bank Resolution. It means that is a NZ licensed bank is failing – becoming illiquid or insolvent, the bank can take as much of its depositors funds as it needs to plug the hole, which given the nature of banks may be a lot. Depositors have no say in this and the whole approach is a nonsense and seriously unfair to bank depositors, which is probably why it is not adequately disclosed to bank customers.

The customers of the bank do not manage it, set risk parameters, appoint managers, the CEO or directors and the Chairman. Nor do they set profit and risk targets. So the banks directors and managers can pursue their preferred policies, including high profit and high personal bonus policies when the banks depositors would be much more prudent and risk averse in the management of the bank.

The whole OBR concept is fundamentally flawed and grossly unfair to depositors. They are bottom of the pile in influencing the banks policies and activities and staff/director appointments; but first in line when poor policies lead to failure and to them contributing their hard earned/saved funds to keep the bank afloat. And it is not clear that the New Zealand boards are fully in control of their banks, or are fully capable of governing their banks, particularly in adversity, and protecting the interests of their New Zealand customers and depositors.

It’s also another excellent example of the Government penalising savers as easy targets. Why not borrowers too?

At the very least bank depositors should set up an action group so that they can influence the banks. There should also be disclosure signs on all banking premises. Something like this would do: “Your money deposited in this bank may be taken without your approval to allow this bank to keep trading”.

There are a number of important matters which need urgent attention by the Reserve Bank and Government, before markets impose their own solutions.

I have already raised my concerns directly with the Reserve Bank, as detailed in this letter sent to Deputy Governor Grant Spencer and Governor Graeme Wheeler in August last year.

A letter to the Reserve Bank

*Dear Grant,

I appreciated the opportunity to meet with you recently, but I am now confirming my concerns about New Zealand Registered Banks in writing as I believe they merit urgent attention.

They reflect my judgement after some 17 years as a director of a major New Zealand bank, mostly as a Chairman; and more than 10 years in governance roles with National Australia Bank, including 6 as an Advisor to the Board and a director. This included some difficult times and considerable involvement with regulators, including APRA.

My various bank roles started in 1991 and finally ended in January, 2016.

My main concern is with the capability of the directors and boards of the 5 main banks registered and operating in New Zealand.

In my judgement there is a lack of critical capability and experience to govern a bank in difficult times. There is a serious lack of high level banking experience, particularly with the more high level, complex issues and related risk management and critical incident experience. The boards give little sense of being a strong team, with the requisite leadership and capable of dealing astutely and effectively with serious challenges.

Importantly, there are too many weak links which can cause major problems when dealing with difficult and complex issues, particularly when under pressure.

They look more like boards for any occasion, rather than “fit for purpose” bank boards of independent banks – which is what they must be.

RBNZ is responsible for the oversight of the New Zealand banking system, for its stability, resilience and effectiveness. It checks that directors are “fit and proper “people for the role, but this does not include their capability to work as a director and whether a board is well-led and capable. Stress testing is useful, but not if the directors of a bank are not capable of operating effectively - and independent of the ownership Group (including Kiwi Bank)when the going gets tough.

I consider that this issue need your urgent attention.

A further issue is whether you are fully satisfied that the New Zealand subsidiary banks of Australian banks are operating within the terms of their banking licences, with the requisite degree of independence and autonomy. Managements tend to be largely or fully integrated trans-Tasman, which has benefits but also serious risks for the New Zealand banks. Moreover, the relationship has potentially serious implications for New Zealand bank customers. How do you manage/monitor this issue. Do directors understand their obligations and are they enforcing them, and acting with the necessary independence from the Australian or other parents

I am also concerned that there is a significant element of “moral hazard”/conflict of interest in this matter for the RBNZ, given that you have put OBR (Open Bank Resolution) in place, which increases the risks faced by bank customers - who have no say in the governance or prudential management of the New Zealand registered banks.

I also note another matter, not directly related. Member banks of international banking groups which have registered banks in New Zealand have been paying very large sums, often billions, to regulators in other jurisdictions, in the context of accusations of improper/illegal/fraudulent activities. Do you have sufficient oversight of these New Zealand registered banks to be sure that similar behaviour is not occurring here, given our very light regulatory oversight.

Yours sincerely

Kerry McDonald*