## cr17110

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**Canonical URL:** [cr17110](https://www.imf.org/-/media/files/publications/cr/2017/cr17110.pdf)

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### EXECUTIVE SUMMARY
- Since 2011, New Zealand has enjoyed an expansion driven largely by construction, supported by strong net migration and low interest rates.
- Growth and inflation outlook:
  - Growth is expected to remain at above 3 percent in 2017.
  - In the medium term, growth is projected to moderate as net migration normalizes, earthquake reconstruction spending declines, and interest rates rise.
  - Inflation is expected to gravitate toward the mid-point of the 1–3 percent target range of the RBNZ.
  - External shocks are the main source of downside risks.
- Key macrofinancial vulnerabilities:
  - Imbalances in the housing market.
  - Banks’ concentrated exposures to the dairy sector.
  - High reliance on wholesale offshore funding.
  - New Zealand’s vulnerability to natural catastrophes affecting insurers.
- Key recommended near-term (ST), medium-term (MT), and implementation (I) actions summarized in the report include increasing RBNZ supervisory resources, strengthening cooperation with Australian authorities, issuing enforceable supervisory standards, considering DTI measures, increasing capital buffers for systemic banks, and reconsidering depositor protection.

### MACROFINANCIAL SETTING AND RISKS
- Financial sector structure and exposures:
  - Banks represent about 75 percent of total financial assets.
  - Foreign funding accounts for almost 20 percent of banks’ liabilities.
  - Four subsidiaries of the largest Australian banks had a share in the banking sector’s total assets of 86 percent at end-2016 (elsewhere noted as 83 percent as at June 2016).
  - Nonbank financial institutions (NBFI) have more than halved in size since 2007.
  - Nonbank lending institutions (NBLI) composition and ownership: savings institutions (credit unions and building societies), deposit-taking institutions funding via deposits or debentures, and non-deposit taking finance companies; most are domestically-owned.
- Housing and property:
  - Mortgage exposure: banking sector exposure to residential mortgages reached over 50 percent of total claims at end-2015.
  - Weighted average time before a mortgage has to be repriced: around 12 months (average months to rate reset: around 11 months).
  - Housing pressures concentrated in Auckland where 1/3 of the population lives.
- Agricultural exposure:
  - Agriculture credit exposure: 15 percent of total exposures in 2015; the dairy industry accounts for more than two-thirds of that exposure.
  - Break-even payout reference: $5.25 per KgMS.
  - At end of the 2013–2014 season, 10 percent of farms accounted for around one-third of total sectoral debt.
  - RBNZ introduced a new capital requirement for farm lending in June 2011.

### KEY ECONOMIC AND FINANCIAL STATISTICS (selected exact values)
- Population, millions (Dec 2015): 4.6
- Quota (in SDR millions): 1,252.1
- Nominal GDP per capita, USD (2016): 37,056
- GINI Coefficient (2012): 33 percent
- Real GDP Growth, Production (in percent) 2012–2022: 2.5 2.2 3.4 2.5 3.1 3.1 3.0 2.6 2.6 2.6 2.5
- Unemployment (in percent of labor force) 2012–2022: 6.4 5.8 5.4 5.4 5.1 5.0 4.8 4.8 4.8 4.8 4.9
- Consumer Prices (percentage change) 2012–2022: 1.1 1.1 1.2 0.3 0.6 1.5 2.0 2.0 2.0 2.0 2.0
- General Government Revenue (in percent of GDP) 2012–2022: 34.0 33.9 33.9 34.9 34.8 34.2 34.0 34.0 34.1 34.1 34.0
- General Government Expenditure (in percent of GDP) 2012–2022: 35.9 34.9 34.2 34.2 34.2 33.7 32.6 32.0 31.5 31.2 31.2
- Fiscal Balance 2012–2022: -1.9 -1.0 -0.3 0.7 0.6 0.5 1.4 2.0 2.6 2.9 2.8
- Public Debt (Gross) 2012–2022: 31.3 30.0 29.5 29.6 29.5 27.4 23.7 21.2 18.7 15.5 12.4
- Reserve Bank of New Zealand Policy Rate (percent, average) 2012–2022: 2.5 2.5 3.1 3.2 2.1 1.8 2.3 2.7 3.0 3.0 3.0
- Credit to the Private Sector (percentage change) 2012–2022: 3.7 5.1 4.5 8.4 7.5 6.1 5.5 4.8 4.7 4.8 4.8
- Current Account (in percent of GDP) 2012–2022: -3.9 -3.2 -3.2 -3.4 -2.7 -2.5 -3.1 -3.3 -3.4 -3.5 -3.5
- Gross Official Reserves (in months of prospective imports): 4.1 3.7 3.6 3.8 4.2
- Net External Debt 2012–2022: -78.2 -71.5 -68.8 -66.0 -65.7 -65.3 -65.6 -66.1 -66.6 -67.2 -67.6
- Real Effective Exchange Rate: 108 111 115 109 109

### FINANCIAL INTERMEDIATION AND NONBANK SECTOR (selected exact values)
- Banks assets (percent of GDP): 173.9 (2006) and 197.5 (Sept 2016).
- Managed funds and trusts (including KiwiSaver and other superannuation): 41.9 (2006) and 54.5 (Sept 2016).
- KiwiSaver and other superannuation: 13.0 (2006) and 24.8 (Sept 2016).
- Retail and cash management trusts: 12.3 (2006) and 17.1 (Sept 2016).
- Nonbank lending institutions: 15.7 (2006) and 5.4 (Sept 2016).
- Private insurance: 13.7 (2006) and 12.5 (as of 2015).
- Listed stock market capitalization: 42 percent of GDP in 2015.
- Total bonds outstanding in the local market: 50 percent of GDP.

### FINANCIAL SOUNDNESS INDICATORS (selected exact values)
- 90-day bank bill rate (percent end-year) 2010–2016Q3: 3.0 2.8 2.7 2.7 3.4 3.2 2.5
- Regulatory capital to risk-weighted assets (in percent) 2010–2016Q3: 12.8 13.3 13.1 12.5 12.4 13.5 13.1
- Tier I capital to risk-weighted assets (in percent) 2010–2016Q3: 9.8 10.6 11.5 11.4 11.4 12.1 11.9
- Capital to assets 2010–2016Q3: 7.4 7.9 8.2 8.7 8.4 8.2 8.0
- Non-performing loans to total loans (in percent) 2010–2016Q3: 2.1 1.7 1.4 1.0 0.8 0.5 0.5
- Non-performing loans (in millions of NZ$) 2010–2016Q3: 6,255 5,239 4,312 3,380 2,790 2,000 2,087
- Liquid assets to total assets 2010–2016Q3: 16.5 16.9 16.2 16.2 15.7 15.0 14.0
- 1-month maturity mismatch (in percent) 2010–2016Q3: 7.3 9.3 7.9 7.0 6.9 6.3 5.2
- Core funding ratio 2010–2016Q3: 81.2 82.8 85.6 85.5 86.3 85.8 86.3
- Off-shore wholesale funding to total liabilities (proxy): 27.4 24.3 21.6 20.3 20.1 19.6 19.8
- Asset composition (2010–2016Q3) — Housing share of assets: 55.6 55.8 55.7 56.3 56.3 56.4 57.1
- Return on assets (in percent) 2010–2016Q3: 0.8 1.2 0.9 1.1 1.1 1.0 0.9
- Net interest margin 2010–2016Q3: 2.2 2.3 2.2 2.2 2.4 2.3 2.1

### FINANCIAL STABILITY AND RESILIENCE: STRESS TESTS, SCENARIOS, AND RESULTS
- Four major macrofinancial risks identified in Risk Assessment Matrix (RAM):
  - (i) a strong correction in the real estate market;
  - (ii) depressed dairy prices;
  - (iii) deterioration in global economic conditions; and
  - (iv) tight conditions in global financial markets.
- Adverse scenario calibration (selected exact figures and projections):
  - Characterized by a 2.4 standard deviation move in two-year cumulative real GDP growth rate by 2018 (1990–2016).
  - New Zealand GDP growth contracts by - 1.4 percent in 2017 relative to baseline projection of 2.5 percent.
  - Real GDP reaches a peak deviation from baseline at -7.1 percent in 2018–19.
  - Unemployment peaks at over 10 percent by end-2018.
  - Persistent disinflation over 12 quarters.
  - Residential prices peak-to-trough decline: 40 percent.
  - CRE peak-to-trough decline: 30 percent.
  - Real equity price index falls by 30 percent by end-2018.
  - Bank credit falls by 20 percent relative to baseline levels by 2021.
  - Dairy-specific calibration: sustained 20 percent fall in dairy prices relative to June 2016 (a 60 percent fall from the June 2014 peak) with a 20 percent peak-to-trough drop in land prices for the dairy scenario.
- Solvency stress-test main results (aggregate outcomes):
  - Baseline: aggregate CET1 around 10.5 percent by 2021; aggregate Tier 1 leverage around 7.2 percent under baseline assumptions.
  - Under adverse scenario: aggregate CET1 ratio at 7.7 percent at the low point; all banks meet minimum requirements; four banks would breach their total capital CCB in 2018.
  - IMF weighted-average cumulative bad debt expense over 5-year horizon: around 4.0 percent relative to starting loans.
  - IMF projected loss rates by portfolio (relative to starting loans): housing loans: 1.4 percent; real estate and SMEs: 5.4 percent; rural portfolio: 7.0 percent; personal loans: 12.3 percent.
  - RBNZ projected loss rates by portfolio (relative to starting assets): housing loans: 2.1 percent; CRE: 6.0 percent; rural portfolio: 9.0 percent; personal loans: 10.0 percent.
- Sensitivity test highlights:
  - Prolonged compression of net interest margins by 150 bps would erode capital buffers by around 400 bps.
  - Prolonged compression of margins by around 100 bps over 3 years hits net profits of some banks materially.
  - Severe collapse of real estate prices by 50 percent would push mortgage LGD ratios to about 30 percent.
  - Simulated default of the three largest counterparties for each of the 5 largest banks still leaves banks meeting regulatory capital ratios.
- Liquidity stress-testing (top-down quasi-LCR and CFR results):
  - Weighted average CFR August 2016: 85 percent.
  - Under Basel III assumptions, 30-day weighted average LCR ratio August 2016: 113 percent.
  - Under “New Zealand retail” scenario, aggregate LCR ratio fell to 73 percent with 6 banks falling under the threshold.
  - Under “New Zealand wholesale” scenario, aggregate LCR ratio improved to 78 percent; aggregate liquidity is larger at 2.8 percent of total assets as this scenario hits major banks harder.
  - Conclusion: banks would have sufficient liquid buffers to withstand 1-week and 30-day liquidity stress scenarios, but results do not stress effectiveness of cross-currency swaps.
- Contagion and network analysis findings:
  - Under baseline calibration no bank default leads to consecutive defaults; loss of 3 largest cross-bank exposures can cascade to one locally-incorporated bank; loss of 3 largest corporate/nonbank exposures can cascade to defaults of four banks.
  - If LGD on defaulted exposures increases to 90 percent, a single bank default can cascade to additional bank defaults (up to 5 institutions in some simulations).
  - Market-contagion analysis indicates inward cross-border spillovers from distressed G-SIBs to New Zealand banks are significant; Australian banks’ consolidated distress transmits to New Zealand via equity-return/funding-spread correlations.

### CONTAGION, CROSS-BORDER COOPERATION, AND TRANS-TASMAN RELATIONS
- Home-host relationships with Australia exceed international practice; APRA’s intensive home supervision supports New Zealand operations.
- Recommendations:
  - RBNZ should take a more proactive role in collaborative supervision and joint on-site work.
  - Scope of the Memorandum of Cooperation on Trans-Tasman Bank Distress Management (MOC) could be extended to include insurance companies and FMIs.
  - Further work on a trans-Tasman framework for assessing systemic importance and coordinated responses recommended.

### MACROPRUDENTIAL FRAMEWORK AND SUPERVISION: RECOMMENDATIONS
- Macroprudential toolkit:
  - Consider adding a debt-to-income (DTI) cap and measures such as debt servicing to total income (DSI), implement if LVR changes insufficient.
  - Maintain and increase transparency and accountability without jeopardizing RBNZ independence.
  - Increase capital buffer requirements for domestic systemic banks (to reflect concentration in four major banks).
- RBNZ supervisory approach and enforcement:
  - Move to increase weight on regulatory discipline within the three-pillar framework (self, market, regulatory).
  - Issue enforceable supervisory standards on key risks, governance, risk management, and controls.
  - Review enforcement regime to promote preventive action, including eliminating ministerial consent for directions in non-fiscal/systemic cases and making compliance with RBNZ policy documents evidence of prudent practice.
  - Initiate targeted on-site programs to test the foundations of the three-pillar approach and verify directors’ attestations.
  - Clarify responsibilities between the Treasury and RBNZ; reinforce RBNZ role and autonomy.
  - Increase supervisory resources for banks, insurance companies, and FMIs.
- FMIs and securities market regulation:
  - Adopt proposed FMI legislation to provide legal basis for oversight of systemically important FMIs, adopt PFMI in secondary legislation, change FMI self-assessment frequency from three to two years.
  - Review regulatory perimeter to include wholesale asset managers and custodians; enhance conduct regulation in insurance sector.
- Financial integrity:
  - Ensure designated nonfinancial businesses and professions (company service providers, lawyers, accountants) are fully subject to AML/CFT requirements.

### CRISIS MANAGEMENT, RESOLUTION, DEPOSIT PROTECTION
- Open Bank Resolution (OBR):
  - OBR aims to avoid use of public funds by freezing and haircutting deposits while continuing operations; applies to banks with over NZD 1 billion of deposits.
  - OBR credibility limited by absence of deposit insurance, some legal powers, and complexities for large failing institutions.
- Deposit insurance and alternatives:
  - Introducing deposit insurance identified as the best option to enhance credibility of safety net.
  - As a second-best, introduce a legally established de minimis exemption from freezing and haircutting deposits in OBR.
  - RBNZ public consultation suggested a de minimis exemption of NZD 500; IMF recommends a higher amount in legislation. Authorities’ analysis suggests NZD 10,000 per depositor would exempt the full amount of 80 percent of the number of bank deposits while leaving the bulk by value at risk.
- Resolution architecture and legal/statutory changes:
  - RBNZ should be sole resolution authority with clear mandates and responsibilities; Minister of Finance approval required only for resolutions with fiscal or systemic implications.
  - Revise RBNZ Act to insert resolution objectives (including protection of depositors and the public interest), require accountability reporting, and clarify sole resolution authority and ministerial consent conditions.
- Crisis preparedness:
  - Strengthen domestic crisis management: agree ex ante roles and processes, preposition mobilization/logistics/communications plans, and test via simulation exercises.
- Trans-Tasman preparedness:
  - No ex-ante consensus on single- or multiple-point-of-entry resolution strategies; further trans-Tasman coordination advised.

### FINANCIAL MARKET INFRASTRUCTURES (FMIs) AND DERIVATIVES CLEARING (selected exact values)
- Derivative transactions increasingly cleared by foreign CCPs (e.g., LCH.Clearnet Ltd, ASX Clear Futures).
- Table 4 selected 2015 values:
  - ESAS: Size of daily settlement value 30 billion NZD (12 percent).
  - NZClear: 7 billion NZD (3 percent).
  - NZCDC (securities): 85 million NZD; NZCDC (derivatives): 900,000 NZD (<0.5 percent).
  - SBI: 3.6 billion NZD (1.4 percent).
  - HVCS: 24 billion NZD (9.8 percent).
- Interconnectedness: ESAS critical to other FMIs; NZClear critical to NZCDC, SBI, HVCS, CLS.

### INSURANCE SECTOR: STRUCTURE, SUPERVISION, AND ICP FINDINGS
- Market structure:
  - 96 licensed insurers (end-2015).
  - Branches of foreign insurers: 35.
  - Australian-owned operations (branches and subsidiaries combined): 66 percent of market by premium and 75 percent by assets.
  - ACC and EQC provide extensive public risk-sharing: ACC for personal injury; EQC for first-loss cover for residential property losses from earthquakes and specified natural hazards.
- ICP assessment (summary findings and recommendations):
  - Solvency and capital adequacy:
    - Solvency standard considers insurer risk profile but lacks multiple solvency control levels; recommended to have two solvency control levels per ICPs 17.3 and 17.4.
    - Recommendation to apply solvency standard to all statutory funds and to develop internal guidance for actions at each solvency control level.
    - RBNZ should collect more granular asset breakdowns and improve disclosure on investments, ALM, and risk concentrations.
  - Supervision and enforcement:
    - RBNZ adopts a principles-based, low-intensity supervisory philosophy with emphasis on board accountability and self-discipline.
    - Adequacy of resources at RBNZ and FMA needs reconsideration.
    - RBNZ encouraged to develop ERM guidelines, require ORSA-like assessments, and enhance enforceability of risk management requirements.
  - Intermediaries and conduct:
    - Government and FMA should strengthen or remove registration-only regime for intermediaries, introduce minimum competence and disclosure requirements for advisers and brokers, and consider insurance-specific regulation where appropriate.
  - Public policy:
    - No insurance policyholder protection scheme; policy framework emphasizes consumer informed decisions and avoiding moral hazard.
  - Crisis and cross-border:
    - RBNZ should prioritize crisis management policy and require insurers to maintain contingency plans given high catastrophe risk.

### SUPERVISORY RESOURCES, APPROACH, AND LEGAL FRAMEWORK
- RBNZ supervisory approach:
  - Three pillars: market discipline (disclosure), self-discipline (directors’ attestations), regulatory discipline (rules/guidelines, off-site monitoring).
  - Approach described as non-intrusive / low-intensity; lacks routine on-site inspections for most prudential areas.
- Legal and enforcement constraints:
  - Section 113(1)(e) of the RBNZ Act requires Ministerial consent for bank-specific directions, raising a high threshold and impeding preventive enforcement.
  - Recommendation to amend section 78 to make compliance with RBNZ supervisory policy evidence of prudent banking and to remove ministerial consent requirement for non-fiscal/systemic directions.
- Resource constraints and priorities:
  - RBNZ staff "highly competent" but numbers insufficient.
  - Priority actions requiring additional resources: issuing enforceable supervisory standards, initiating targeted on-site programs, improving supervisory data collection, expanding FMI oversight, and strengthening crisis preparedness.

### SELECTED IMPLEMENTATION STATUS (2004 FSAP RECOMMENDATIONS — selected items)
- Disclosure-based regime: Pillar 3 implemented early 2008; some Pillar 3 add-ons not implemented; regulatory stocktake considering a quarterly ‘dashboard’.
- Importance of independent directors: Implemented; corporate governance requirements introduced in June 2010 (effective 2012).
- Crisis management and bank resolution: Partially implemented; OBR Pre-positioning Requirements Policy since June 2013; statutory framework amended in 2003 and 2006; MOC on Trans-Tasman Bank Distress Management signed in 2010.
- Nonbank supervision: Partially implemented; RBNZ assumed responsibility for regulation of nonbank deposit-takers after 2008 Amendment Act; Insurance (Prudential Supervision) Act 2010 established RBNZ prudential supervision of insurers.
- Securities markets regulation: Partially implemented; FMA established 2011; Financial Markets Conduct Act 2013 progressively brought into force from April 2014 with transition to 1 December 2016.

### KEY RECOMMENDATIONS (selected, preserving exact phrasings and time-frames where provided)
- Increase RBNZ resources for supervision and regulation of banks, insurance companies, and FMIs (ST).
- Strengthen cooperation and collaboration arrangements with Australian authorities (ST).
- Clarify responsibilities of the Treasury and RBNZ on financial sector issues to reinforce the role of RBNZ as prudential regulator and supervisor (ST).
- Issue enforceable standards on key risks, governance, risk management, and controls (ST).
- Review and extend the enforcement regime to promote preventive action and enhance sanctions powers (MT).
- Initiate on-site programs to test the three-pillar approach and increase supervisory engagement (ST).
- Refine FMA supervision and expand regulatory perimeter to include custodians and oversight of wholesale asset managers (I, ST).
- Adopt and implement proposed FMI legislation and adopt PFMI in secondary legislation; change FMI self-assessment frequency from three to two years (I, ST).
- Ensure designated nonfinancial businesses and professions are subject to AML/CFT requirements (MT).
- Expand data collection and modeling to develop structural models for credit risk in CRE and corporate portfolios (MT).
- Strengthen macroprudential arrangements, increase transparency, maintain accountability without jeopardizing independence (C).
- Introduce DTI measures in the macroprudential toolkit and implement if LVR changes are insufficient (I).
- Increase capital buffer requirements for domestic systemic banks (I).
- Strengthen crisis readiness: prepositioning, mobilization, logistics, communications, and simulation exercises (MT).
- Reconsider deposit insurance or introduce a limited depositor preference for the de minimis exemption in OBR (MT).
- Revise RBNZ Act to clarify resolution objectives and authority and require ministerial consent only for fiscal or systemic implications (MT).

*Source: IMF Financial Sector Assessment Program — New Zealand, Executive Summary and selected chapters (cr17110).*

### EXECUTIVE SUMMARY ___________________________________________________________________________ 6

### EXECUTIVE SUMMARY

### MACROFINANCIAL SETTING AND RISKS
- Since 2011, New Zealand has enjoyed an expansion that has recently gained momentum. Construction has been a major driver, with strong net migration and low interest rates amplifying the momentum.
- Growth and inflation outlook:
  - Growth is expected to remain at above 3 percent in 2017.
  - In the medium term, growth is projected to moderate as net migration normalizes, earthquake reconstruction spending declines, and interest rates rise.
  - Inflation is expected to gravitate toward the mid-point of the 1–3 percent target range of the RBNZ.
  - External shocks are the main source of downside risks.
- Financial sector structure and exposures:
  - Banks represent about 75 percent of total financial assets.
  - Foreign funding accounts for almost 20 percent of banks’ liabilities.
  - The banking system is concentrated: four subsidiaries of the largest Australian banks had a share in the banking sector’s total assets of 86 percent at end-2016.
  - Nonbank financial institutions (NBFI) have more than halved in size since 2007.
  - Nonbank lending institutions (NBLI) are savings institutions (credit unions and building societies), deposit-taking that fund activities via deposits or debentures issued to the public, and non-deposit taking finance companies; most are domestically-owned.
- Insurance sector characteristics and risks:
  - There are 96 licensed insurers.
  - 76 percent of premium income is from branches or subsidiaries of foreign insurers.
  - The largest insurer, an Australian group, accounts for almost half of total non-life premium income.
  - Key public risk-sharing arrangements: the Accident Compensation Commission (ACC) provides extensive coverage for personal injury insurance; the Earthquake Commission (EQC) provides first loss cover for losses from earthquakes and other specified natural hazards for insured residential properties.
- Key macrofinancial vulnerabilities:
  - Imbalances in the housing market.
  - Banks’ concentrated exposures to the dairy sector.
  - High reliance on wholesale offshore funding.
  - New Zealand’s vulnerability to natural catastrophes affecting insurers.

### FINANCIAL STABILITY AND RESILIENCE
- Stress test and contagion findings:
  - The banking system is resilient to severe shocks: solvency and liquidity stress tests and sensitivity analyses indicate the banking system can withstand adverse and severe shocks.
  - There is limited impact of solvency and liquidity contagion from direct exposures to banks and nonbank financial institutions, common holdings of securities, and market contagion.
  - Results of stress tests should be interpreted with caution and used as a supervisory tool.
- Systemic concentration and spillover potential:
  - The financial system is dominated by four major banks with similar business models heavily weighted toward housing loans.
  - Direct exposures among these banks are relatively limited, but potential for spillovers is elevated.
- Housing sector and credit dynamics:
  - Credit has resumed strong growth during the last few years, putting pressure on funding and increasing concerns with the housing sector.
  - Authorities have applied exposure limits to loans with high loan-to-value ratios (LVR), which have strengthened banks’ portfolio profiles but had limited effects given rising housing prices.

### MACROPRUDENTIAL FRAMEWORK AND SUPERVISION
- Strengthening macroprudential toolkit:
  - Adding a debt-to-income (DTI) cap to the macroprudential toolkit would enhance systemic resilience by limiting risks from growing household indebtedness.
  - Implementing DTI measures if changes to the LVR do not reduce housing-sector risks.
  - Increase capital buffer requirements to reflect the concentration of the financial sector in four banks.
- RBNZ supervisory approach:
  - The RBNZ’s three-pillar framework (self, market, and regulatory discipline) should increase the weight of regulatory discipline by adopting a more intensive approach to supervision.
  - Recommended supervisory actions:
    - Issue enforceable supervisory standards on key risks, governance, risk management, and controls to make supervisory expectations more transparent.
    - Review the enforcement regime to promote preventive action, including eliminating ministerial consent for directions and making compliance with RBNZ policy documents evidence of prudent practice.
    - Initiate on-site programs targeted on areas of high risk to test the foundations of the three-pillar approach and directors’ attestations.
  - Clarify responsibilities of the Treasury and RBNZ on financial sector issues and reinforce the role and autonomy of the RBNZ as prudential regulator and supervisor.
  - Increase supervisory resources for banks, insurance companies, and FMIs to support RBNZ staff in improving supervisory effectiveness and early preventive action.
- Financial Market Infrastructures (FMIs) and securities market regulation:
  - Proposed FMI legislation will provide the legal basis for oversight of systemically important FMIs and a graduated range of enforcement, crisis management, and regulatory powers.
  - Authorities are encouraged to adopt international principles for FMIs (PFMI) in secondary legislation and change the frequency of FMI self-assessments from three to two years.
  - The securities market regulatory reform significantly improved the framework through the establishment of the FMA as conduct regulator and new licensing for certain product providers.
  - Suggested enhancements:
    - Review the regulatory perimeter to include wholesale asset managers and custodians.
    - Enhance conduct regulation in the insurance sector.
- Financial integrity:
  - Ensure designated nonfinancial businesses and professions are subject to AML/CFT requirements, particularly company service providers, lawyers, and accountants.

### CRISIS MANAGEMENT AND RESOLUTION
- Open Bank Resolution (OBR) and depositor protection:
  - The OBR framework aims to avoid use of public funds when resolving systemically important banks and is a step in the right direction.
  - To enhance credibility and strengthen the financial safety net:
    - Introducing deposit insurance would be the best option.
    - Absent support for deposit insurance, a second option is to legally establish a de minimis exemption from freezing and haircutting deposits in OBR, set at an appropriate level.
- Resolution architecture and decision-making:
  - RBNZ should be the sole resolution authority with clear mandates and responsibilities.
  - Minister of Finance (MoF) approval should be required only for resolutions with fiscal or systemic implications.
  - Revise the RBNZ Act to:
    - Provide greater clarity and certainty in resolution, including inserting objectives in resolution such as protection of depositors and the public interest.
    - Require accountability reporting against these objectives.
    - Clarify that the RBNZ is the sole resolution authority and require ministerial consent only for resolutions with fiscal or systemic implications.
- Crisis preparedness:
  - Strengthen domestic crisis management arrangements by agreeing ex ante on roles, responsibilities, and processes; prepositioning mobilization, logistics, and communications plans; and testing through simulation exercises.
- Trans-Tasman cooperation:
  - Home-host relationships between Australia and New Zealand exceed international practice.
  - The RBNZ could take a more proactive role in collaborative supervision.
  - The scope of the Memorandum of Cooperation on Trans-Tasman Bank Distress Management (MOC) could be extended to include insurance companies and FMIs.
  - Further work on a trans-Tasman framework for assessing systemic importance and coordinated responses is recommended.

### KEY RECOMMENDATIONS (selected from Table 1: 2016 New Zealand FSAP: Key Recommendations)
- Increase RBNZ resources for supervision and regulation of banks, insurance companies, and FMIs (ST).
- Strengthen cooperation and collaboration arrangements with Australian authorities (ST).
- Clarify responsibilities of the Treasury and RBNZ on financial sector issues to reinforce the role of RBNZ as prudential regulator and supervisor (ST).
- Issue enforceable standards on key risks, governance, risk management, and controls (ST).
- Review and extend the enforcement regime to promote preventive action and enhance sanctions powers (MT).
- Initiate on-site programs to test the three-pillar approach and increase supervisory engagement (ST).
- Refine FMA supervision and expand regulatory perimeter to include custodians and oversight of wholesale asset managers (I, ST).
- Adopt and implement proposed FMI legislation and adopt PFMI in secondary legislation; change FMI self-assessment frequency from three to two years (I, ST).
- Ensure designated nonfinancial businesses and professions are subject to AML/CFT requirements (MT).
- Expand data collection and modeling to develop structural models for credit risk in CRE and corporate portfolios (MT).
- Strengthen macroprudential arrangements, increase transparency, maintain accountability without jeopardizing independence (C).
- Introduce DTI measures in the macroprudential toolkit and implement if LVR changes are insufficient (I).
- Increase capital buffer requirements for domestic systemic banks (I).
- Strengthen crisis readiness: prepositioning, mobilization, logistics, communications, and simulation exercises (MT).
- Reconsider deposit insurance or introduce a limited depositor preference for the de minimis exemption in OBR (MT).
- Revise RBNZ Act to clarify resolution objectives and authority and require ministerial consent only for fiscal or systemic implications (MT).

*Source: IMF Financial Sector Assessment Program — New Zealand, Executive Summary.*

### 4.      The capital market of New Zealand is small but has been growing in recent years, with

### cr17110 - 4.      The capital market of New Zealand is small but has been growing in recent years, with

### Market structure and recent developments
- The listed stock market capitalization was 42 percent of GDP in 2015.
- The total amount of bonds outstanding in the local market was 50 percent of GDP.
- The bond market is dominated by central government issues and financial institutions.
- Since 2004, the share of primary listings’ holdings by domestic institutional investors increased 9 percentage points to around 40 percent in 2014.
- The number of transactions in secondary markets increased since 2010—almost threefold on the main stock market index in New Zealand (NZX 50).
- Drivers of recent growth: creation of the KiwiSaver scheme, partial privatization of state-owned enterprises, and low global and domestic interest rates.
- KiwiSaver opened in 2007.

### Key economic and financial statistics (selected values from Table 2 and text)
- Population, millions (Dec 2015): 4.6
- Quota (in SDR millions): 1,252.1
- Main Exports: Dairy, meat, forest products
- Key Export Markets: China, Australia, E.U., U.S.
- Nominal GDP per capita, USD (2016): 37,056
- GINI Coefficient (2012): 33 percent
- Real GDP Growth, Production (in percent) 2012–2022: 2.5 2.2 3.4 2.5 3.1 3.1 3.0 2.6 2.6 2.6 2.5
- Unemployment (in percent of labor force) 2012–2022: 6.4 5.8 5.4 5.4 5.1 5.0 4.8 4.8 4.8 4.8 4.9
- Consumer Prices (percentage change) 2012–2022: 1.1 1.1 1.2 0.3 0.6 1.5 2.0 2.0 2.0 2.0 2.0
- General Government Revenue (in percent of GDP) 2012–2022: 34.0 33.9 33.9 34.9 34.8 34.2 34.0 34.0 34.1 34.1 34.0
- General Government Expenditure (in percent of GDP) 2012–2022: 35.9 34.9 34.2 34.2 34.2 33.7 32.6 32.0 31.5 31.2 31.2
- Fiscal Balance 2012–2022: -1.9 -1.0 -0.3 0.7 0.6 0.5 1.4 2.0 2.6 2.9 2.8
- Public Debt (Gross) 2012–2022: 31.3 30.0 29.5 29.6 29.5 27.4 23.7 21.2 18.7 15.5 12.4
- Reserve Bank of New Zealand Policy Rate (percent, average) 2012–2022: 2.5 2.5 3.1 3.2 2.1 1.8 2.3 2.7 3.0 3.0 3.0
- Credit to the Private Sector (percentage change) 2012–2022: 3.7 5.1 4.5 8.4 7.5 6.1 5.5 4.8 4.7 4.8 4.8
- Current Account (in percent of GDP) 2012–2022: -3.9 -3.2 -3.2 -3.4 -2.7 -2.5 -3.1 -3.3 -3.4 -3.5 -3.5
- FDI (in percent of GDP) 2012–2022: -0.1 -0.7 0.7 0.1 -0.4 0.7 0.6 0.6 0.6 0.6 0.6
- Gross Official Reserves (in months of prospective imports): 4.1 3.7 3.6 3.8 4.2
- Net External Debt 2012–2022: -78.2 -71.5 -68.8 -66.0 -65.7 -65.3 -65.6 -66.1 -66.6 -67.2 -67.6
- Real Effective Exchange Rate: 108 111 115 109 109

### Financial intermediation and nonbank sector
- Financial intermediation takes place primarily through the banking sector, which mostly focuses on domestic lending.
- Banks assets (Evolution of the financial system, in percent of GDP): Banks 173.9 (2006) and 197.5 (Sept 2016).
- Managed funds and trusts (including KiwiSaver and other superannuation) grew from 41.9 (2006) to 54.5 (Sept 2016).
- KiwiSaver and other superannuation: 13.0 (2006) and 24.8 (Sept 2016).
- Retail and cash management trusts: 12.3 (2006) and 17.1 (Sept 2016).
- Nonbank lending institutions: 15.7 (2006) and 5.4 (Sept 2016).
- Private insurance* 13.7 (2006) and 12.5 (as of 2015).
- Stock market capitalization in selected countries graphic notes: New Zealand shows relatively low stock market capitalization compared to many peers.
- Managed funds are the largest nonbank financial institutions.

### Financial soundness indicators (selected values from Table 3)
- 90-day bank bill rate (percent end-year) 2010–2016Q3: 3.0 2.8 2.7 2.7 3.4 3.2 2.5
- 90-day bank bill rate, real: 0.7 -1.2 1.6 1.5 2.2 2.9 2.2
- Stock market index (percent change, end-year): 2.4 -1.0 24.2 16.5 17.5 13.6 8.8
- Regulatory capital to risk-weighted assets (in percent) 2010–2016Q3: 12.8 13.3 13.1 12.5 12.4 13.5 13.1
- Tier I capital to risk-weighted assets (in percent) 2010–2016Q3: 9.8 10.6 11.5 11.4 11.4 12.1 11.9
- Capital to assets 2010–2016Q3: 7.4 7.9 8.2 8.7 8.4 8.2 8.0
- Non-performing loans to total loans (in percent) 2010–2016Q3: 2.1 1.7 1.4 1.0 0.8 0.5 0.5
- Non-performing loans net of provisions to capital 2010–2016Q3: 18.7 13.7 9.8 6.9 5.4 3.9 4.2
- Non-performing loans (in millions of NZ$) 2010–2016Q3: 6,255 5,239 4,312 3,380 2,790 2,000 2,087
- Liquid assets to total assets 2010–2016Q3: 16.5 16.9 16.2 16.2 15.7 15.0 14.0
- 1-month maturity mismatch (in percent) 2010–2016Q3: 7.3 9.3 7.9 7.0 6.9 6.3 5.2
- Core funding ratio 2010–2016Q3: 81.2 82.8 85.6 85.5 86.3 85.8 86.3
- Customer deposits to total loans: -69.6 70.6 72.6 73.4 73.7 71.8
- Off-shore wholesale funding to total liabilities (proxied by share of foreign-currency-denominated liabilities to total liabilities): 27.4 24.3 21.6 20.3 20.1 19.6 19.8
- Asset composition (agricultural, business, households) 2010–2016Q3: Agricultural 15.8 15.5 15.7 15.5 15.5 15.6 15.3; Business 24.2 24.3 24.3 24.0 24.0 23.8 23.7; Households 60.0 60.1 60.0 60.5 60.5 60.5 61.0
- Of which: Housing 55.6 55.8 55.7 56.3 56.3 56.4 57.1
- Return on assets (in percent) 2010–2016Q3: 0.8 1.2 0.9 1.1 1.1 1.0 0.9
- Return on equity (in percent) 2010–2016Q3: 11.2 16.1 11.4 13.9 14.1 12.0 11.9
- Net interest margin 2010–2016Q3: 2.2 2.3 2.2 2.2 2.4 2.3 2.1

### Financial Market Infrastructures (FMIs) and derivatives clearing
- Derivative transactions of New Zealand banks are increasingly cleared by foreign central counterparties (CCPs) as a consequence of the G20 mandate to clear standardized over-the-counter derivatives through CCPs.
- Table 4 selected values for 2015:
  - Exchange Settlement Account System (ESAS): Size of daily settlement value 30 billion NZD (12 percent).
  - NZClear: 7 billion NZD (3 percent).
  - NZCDC (New Zealand Clearing and Depository Corporation): Securities: 85 million NZD; derivatives: 900,000 NZD (<0.5 percent).
  - Settlement Before Interchange (SBI): 3.6 billion NZD (1.4 percent).
  - High Value Clearing System (HVCS): 24 billion NZD (9.8 percent).
- Interconnectedness notes: ESAS is critical to other FMIs; NZClear critical to NZCDC, SBI, HVCS, CLS; several FMIs are critical for monetary policy operations and collateral management.
- The landscape shows systemically important FMIs inside New Zealand and important links to systemically important FMIs outside New Zealand (examples noted include foreign CCPs such as LCH.Clearnet Ltd and ASX Clear Futures, and other infrastructures like CLS, DTCC, Singapore).

### Key vulnerabilities and risks (section 6)
- Concentrated exposures to real estate and agriculture sectors, dependence on wholesale funding, and similar business models of the four Australian subsidiaries are the main vulnerabilities.
- Mortgage exposure: banking sector exposure to residential mortgages reached over 50 percent of total claims at end-2015.
  - The weighted average time before a mortgage has to be repriced is around 12 months because most borrowers are still under floating or on short-term fixed rates.
  - Rising housing prices have elevated debt-to-income ratios of new house buyers; the rise has been most rapid in Auckland (where 1/3 of the population lives).
  - The property boom has also been driven by increased investor activity.
- Agricultural exposure: agriculture credit exposure stood at 15 percent of total exposures in 2015; the dairy industry accounts for more than two-thirds of that exposure.
  - Low global milk prices put significant financial pressure on dairy farms; half of the sector experienced a second consecutive season of operating losses in 2015–2016.
  - Prices have recently recovered and, according to the most recent forecasts (as reported), the effective payout for the dairy industry will increase above the break-even price in the next season.
  - Additional risk: at the end of the 2013–2014 season, 10 percent of farms accounted for around one-third of the total sectoral debt.
  - To address farm-lending credit risk, in June 2011 the RBNZ put in place a new capital requirement for farm lending.
- Concentration and commonality of business models: the financial system is highly concentrated on a few Australian-owned players, with similar business models and vulnerabilities; strong correlation in financial soundness among subsidiaries and with their parents.
- Wholesale funding and liquidity risks:
  - The banking sector depends to some extent on wholesale funding, including foreign-currency funding sourced from offshore markets, exposing it to maturity mismatch and rollover risk.
  - Introduction of the core funding ratio (CFR) in 2010 mitigated rollover liquidity risk.
  - Over 50 percent of banks’ assets are long-term housing financing, so maturity mismatch remains a concern.
  - Banks have reduced reliance on non-NZD funding to below 20 percent of total liabilities (a reduction of around 10 percentage points from the pre-crisis peak).
  - This reduction mitigates FX exposure and increases the availability of foreign-currency swap counterparties, pushing down hedging costs, but banks may remain vulnerable to hedging risks under stress.
  - Because New Zealand banks looking for offshore funding use mostly the primary market, funding liquidity on global markets is relatively more important than market liquidity; heightened volatility in global financial markets may contribute to a pick-up in wholesale funding spreads.

*Italic: Source: IMF staff report content as provided in the supplied PDF extract.*

### 7.      The analysis of resilience is linked to the four major macrofinancial risks that might

### 7.      The analysis of resilience is linked to the four major macrofinancial risks that might

### Risk Assessment Matrix (RAM) — four major macrofinancial risks
- Identified risks that might challenge solvency or liquidity of the banking system:
  - (i) a strong correction in the real estate market;
  - (ii) depressed dairy prices;
  - (iii) deterioration in global economic conditions; and
  - (iv) tight conditions in global financial markets.
- Overall assessment: The stress tests results indicate that New Zealand banks are generally resilient to these risks.

- Persistently lower dairy prices
  - Overall Level of Concern: High
  - Likelihood of severe realization in 1–3 years: Medium
  - Expected impact on financial stability:
    - Recent reduction in global supply helped reduce imbalance, but markets remain volatile and supply might readjust more gradually than expected.
    - The estimated payout would be well below the break-even payout of $5.25 per KgMS, resulting in a third consecutive season of negative cash flow for many farms.
    - Low milk prices would put the dairy sector under material stress, with debt relative to trend income increasing over 350 percent.
    - This could result in a sharp increase in nonperforming loans.

- A significant China downturn leading to a global growth slowdown and further declines in commodity prices
  - Overall Level of Concern: Medium
  - Likelihood of severe realization in 1–3 years: Medium
  - Expected impact on financial stability:
    - China downturn would weaken New Zealand export demand directly and indirectly via Australia.
    - Global growth slowdown would lead to broad-based falls in export demand, low commodity prices, and confidence effects.
    - Adverse effects: weaker bank earnings, reduced borrower creditworthiness (including via falling property prices), greater defaults, write-offs, and loan impairment charges.
    - Effects could be amplified by large currency fluctuations and disruptions in capital flows.
    - Australian-owned New Zealand banks would be particularly exposed, with potential spillovers from Australian parents.

- Dislocations in offshore wholesale funding markets
  - Overall Level of Concern: Medium
  - Likelihood of severe realization in 1–3 years: High
  - Expected impact on financial stability:
    - Triggers include disorderly/accelerated U.S. monetary normalization, low market liquidity, or funding pressures for Australian-owned New Zealand banks prompted by regulatory changes.
    - Cost of long-term wholesale funding would increase with heightened market volatility.
    - Higher funding costs could erode net interest margins and reduce profits via lower securities valuations.
    - Banks’ ability to borrow cross-border would be hampered, exacerbating funding and liquidity risk.
    - New Zealand banks' reliance on wholesale funding remains large, with just over half of this funding sourced offshore.

- A large correction in property markets (residential and CRE)
  - Overall Level of Concern: Medium
  - Likelihood of severe realization in 1–3 years: Medium
  - Expected impact on financial stability:
    - Auckland house prices remain elevated relative to fundamentals; price pressures spreading nationwide, stretching household balance sheets.
    - CRE prices increasing with prices relative to rents returning to pre-crisis peaks; supply factors point to risk of oversupply in medium-term.
    - Generalized and substantial fall in property prices would increase credit impairment losses on real estate-secured portfolios.
    - If correction triggers recession, rising unemployment and lower corporate profits could lead to higher impairments across other asset classes.
    - Credit risk exacerbated by high household debt-to-income ratios.

*NEW ZEALAND — INTERNATIONAL MONETARY FUND 19*

### Solvency Stress Tests — methodology and scenario
- Tests performed:
  - 5-year solvency test with interlinkages between funding costs and stressed capital ratios.
  - Liquidity stress tests, sensitivity tests, and a contagion module (network analysis and market-based contagion).
  - Supervisory reverse stress tests by four major banks informed sensitivity analysis.

- Scenarios used (Figure 7):
  - Baseline: 2016 October IMF WEO macroeconomic projections.
  - Adverse: captures RAM risks; simulates a balance sheet recession triggered by deteriorating global conditions, tighter and more volatile financing conditions, a credit cycle downturn in China, and persistently lower commodity prices.
  - Adverse scenario specifics:
    - Global downturn impacts Australia and New Zealand with spillovers.
    - Sharp correction in New Zealand property and equity markets triggers private domestic demand-driven contraction.
    - Funding shock: bank-specific stressed spreads over benchmark rate for wholesale debt issuance plus a ‘systemic’ funding shock component linking bank-specific funding costs to stressed capital position of the rest of the banking system.
  - To assess dairy vulnerability: scenario features a sustained 20 percent fall in dairy prices relative to June 2016 and a protracted recovery, representing a 60 percent fall from the peak observed in June 2014, with a 20 percent peak-to-trough drop in land prices.

- Stress-test mechanics:
  - Iterative projection of bank funding costs:
    - Stage 1: initial bank-specific funding costs informed by reference rate projections, bank-specific stressed spreads benchmarked against GFC bond behavior, and bank liability structures as of June 2016; used to project stressed Tier 1 ratios.
    - Stage 2: revised funding costs driven by macro variables, bank-specific variables (including stressed Tier 1 ratios from stage 1), global variables, and a contagion risk factor from rest of New Zealand banks unexplained by systematic factors (capturing systemic funding risk).

### Solvency Stress Tests — main results
- Aggregate outcomes:
  - Under baseline: capital of all banks above minimum requirements and the CCB with aggregate CET1 around 10.5 percent by 2021.
  - Aggregate Tier 1 leverage ratio settles around 7.2 percent under baseline assumptions (RBNZ projected this for stress-testing purposes though the leverage ratio is not implemented).
  - Under adverse scenario:
    - All banks meet minimum requirements with aggregate CET1 ratio at 7.7 percent at the low point of the stress.
    - Four banks would breach their total capital CCB in 2018.
    - Shortfall in aggregate capital ratios mainly driven by stressed RWAs, credit losses, and funding costs.
    - Banks able to retain capital through profitability despite erosion in margins.

- Comparability:
  - IMF results broadly comparable to RBNZ’s results using common scenarios and RBNZ’s in-house credit risk models (Appendix IV).

*NEW ZEALAND — INTERNATIONAL MONETARY FUND 21–22*

### Sensitivity Tests — additional vulnerability analysis
- Purpose: explore bank vulnerabilities to wider shifts in risk factors; informed by reverse stress tests.
- Key sensitivity findings (Figure 9):
  - Pressures on effective margins have significant direct impact on capital ratios.
  - Sharp hike in risk-free rates (pushing down asset valuations) has more limited impact on capital ratios.
  - A severe collapse of real estate prices by 50 percent would push mortgage LGD ratios to about 30 percent; most impact from recent vintages despite improved LVRs around 65 percent.
  - Simulated default of the largest counterparties:
    - Default of the three largest counterparties of each of the 5 largest banks (including other banks, other financial institutions, and corporates) would still leave banks able to meet regulatory capital ratios.
    - Only bank exposures to supranationals were excluded from this analysis.
  - Prolonged compression of net interest margins by 150 bps would erode capital buffers by around 400 bps.
  - Capital ratios are resilient to sharp increases in policy rates.

- Cautionary note:
  - Stress tests replicate historical events or express extreme “tail events” from historical loss distributions; the nature of crises often involves unanticipated shocks where past offers limited guidance.
  - Suggestion: RBNZ could expand data collection and modelling to develop structural models for credit risk in CRE and corporate portfolios.

*NEW ZEALAND — INTERNATIONAL MONETARY FUND 23*

### Liquidity Stress Tests — framework and outcomes
- Tests conducted jointly by RBNZ and IMF using common assumptions.
- Context:
  - All locally incorporated banks required to comply with RBNZ liquidity policy; Basel III liquidity requirements not implemented in New Zealand.
  - RBNZ adopted quantitative liquidity requirements in April 2010.
  - One-month mismatch ratio broadly aligned with Basel III LCR; CFR has similar structure to Basel III NSFR.

- Top-down liquidity stress tests:
  - Used Basel III liquidity standards and current RBNZ regulatory framework.
  - Range of Basel III quasi-LCR tests over 2 horizons and 3 scenarios:
    - Standard 2013 LCR prescribed haircuts, rollover and run-off rates.
    - Two additional New Zealand–tailored scenarios more severe than Basel III: 30-day quasi-LCR test and 5-day quasi-LCR test on three stress scenarios (“LCR scenario,” “New Zealand retail” scenario, and “New Zealand wholesale” scenario).
  - RBNZ’s liquidity survey used to populate LCR tool; mapping to HQLA and liability categories conducted on a best-effort basis.

- Key liquidity metrics and results:
  - Core funding requirement (CFR):
    - Originally set at 65 percent in 2010; requirement increased such that banks are now required to have at least 75 percent of their loan portfolio financed using core funding.
    - Weighted average CFR for the banking system was 85 percent in August 2016.
  - Liquid buffers and LCR:
    - Under Basel III assumptions, 30-day weighted average LCR ratio was 113 percent in August 2016.
    - Under “New Zealand retail” scenario, aggregate LCR ratio fell to 73 percent with 6 banks falling under the threshold.
    - Under “New Zealand wholesale” scenario, aggregate LCR ratio improved to 78 percent; aggregate liquidity is larger at 2.8 percent of total assets as this scenario hits major banks harder.
  - Conclusion: Despite significant reliance on wholesale funding, banks’ funding structure appears resilient partly due to strengthened regulatory and supervisory standards since last FSAP; banks would have sufficient liquid buffers to withstand 1-week and 30-day liquidity stress scenarios.

- Limitation: Tests do not stress the effectiveness of cross-currency swaps used to hedge wholesale funding issued in foreign currency.

*NEW ZEALAND — INTERNATIONAL MONETARY FUND 24–25*

### Contagion analysis (overview)
- Contagion module components:
  - Network analysis using bilateral exposure data to assess propagation of credit and funding risk given the exposure network.
  - Contagion analysis based on market-based data to evaluate contagion through financial markets from transactional exposures, common holding of securities, and investors’ correlated strategies.
- Purpose: enhance systemic risk consideration in stress-testing exercises and capture propagation channels beyond direct credit losses.

*NEW ZEALAND — INTERNATIONAL MONETARY FUND 21*

*Italic: Source: cr17110 - 7.      The analysis of resilience is linked to the four major macrofinancial risks that might (cr17110 PDF).*

### 17.      A contagion module assessed the potential for distress in a financial firm to create

### 17.      A contagion module assessed the potential for distress in a financial firm to create

### Contagion module and scenarios
- Transmission channels considered: bilateral exposures (network analysis) and market contagion (market-implied asset returns and funding-cost spillovers).
- Network analysis basis: Espinosa, M. and Sole, J. (2010) “Cross-Border Financial Surveillance: A Network Perspective”, IMF Working Paper 10/15.
- Network data source: RBNZ’s large exposure data template covering the 10 largest bank and nonbank financial institution exposures, the 10 largest other exposures, and any exposure larger than 10 percent of CET1 capital; coverage includes all 15 locally incorporated banks.
- New Zealand-specific liquidity stress scenarios (changes relative to Basel LCR):
  - “New Zealand retail” scenario:
    - run-off rates for stable (unstable) deposits: 10 percent (15 percent) rather than 5 percent (10 percent) under Basel LCR.
    - run-off rate for undrawn but committed credit and liquidity facilities for retail and SMEs (corporates) rises from 5 percent (20 percent) to 10 percent (40 percent).
  - “New Zealand wholesale” scenario:
    - run-off rate for uninsured corporate deposits increases from 40 percent to 100 percent.
    - operational deposits generated by clearing and custody are drawn down at a 75 percent rate rather than 25 percent.
    - secured funding backed by Level 2B assets runs at a rate of 100 percent over the Basel 50 percent mark.
- Quasi-LCR metrics considered: 30d Quasi-LCR Test and 5d Quasi-LCR Test.

### Liquidity stress test findings
- Sample: all fifteen New Zealand locally incorporated banks.
- High-level outcomes:
  - The majority of banks would comply with the transitional 80 percent 30d LCR threshold under Basel III, but the size-weighted average quasi-LCR falls below this mark under the retail and the wholesale scenarios.
  - Results improve under the 5d quasi-LCR test: no bank falls below the 80 percent threshold.
  - Under the wholesale scenario for the 5d test there is a small liquidity shortfall of 1.3 percent of assets.
  - All banks comply with the RBNZ’s liquidity requirements: the 1-week and 1-month mismatch ratios and the core funding ratio.

### Network analysis: credit and funding shock simulations
- Simulations included:
  - credit shock: one credit counterparty defaults at a time.
  - funding shock: default of a funding counterparty inducing a liquidity shortfall.
  - potential fire-sale of assets linked to LCR prescribed haircuts for liquid assets (fire-sales calibrated exogenously).
- Contagion via interbank exposures:
  - Under baseline calibration there are no banks whose default would lead to consecutive defaults of other institutions.
  - A loss of the 3 largest cross-bank exposures leads to a cascade default of one locally-incorporated bank.
  - A loss of three largest corporate and exposures to other nonbank financial institutions results in cascade defaults of four banks.
  - If LGD on defaulted exposures increases to 90 percent:
    - the simulated default of one bank leads to a cascade default of 1 more bank.
    - 5 institutions default following the loss of their 3 largest exposures.
- Sensitivities:
  - Results are sensitive to changes in LGD assumptions.
  - Results are robust to changes of the discount on asset sales and of the share of non-replaceable funding.
- Model limitations noted:
  - Fire-sale assets calibrated using LCR prescribed haircuts; deeper price discounts on non-liquid assets and spiral effects are not explicitly modeled.
  - Contagion effects from bear-market sentiment to banks with similar business models to the bank in distress are excluded.

### Market contagion and cross-border spillovers
- Market-contagion analysis complements network analysis by measuring spillovers unrelated to direct credit exposures (common exposures or similar business models).
- Analysis performed for Australian banks (lack of market data for New Zealand subsidiaries).
- Key findings:
  - For large Australian banks, instability can spread from their global counterparts due to active presence in offshore debt markets and derivative markets.
  - Distress at the consolidated level is expected to trickle down to subsidiaries because of tight correlation between Australian banks’ equity returns and New Zealand banks’ funding spreads.
  - Lower aggregate equity returns at the consolidated level are associated with widening funding spreads for New Zealand banks in wholesale markets.
- CoVaR framework usage:
  - Distress defined as a firm reaching its Value at Risk (VaR).
  - Two financial systems defined for contagion measurement:
    - (i) a global banking system covering the 30 G-SIBs as of November 2015 (calculations performed over 28 G-SIBs due to data limitations).
    - (ii) an Australian banking system including the four largest Australian banks.
  - Conditioning state variables guided by their role in affecting global returns in financial markets.
- Cross-border spillover finding:
  - Inward cross-border spillovers from distressed G-SIBs to New Zealand banks are significant.
  - Australian banks have become increasingly exposed to European banks.
  - Transmission of distress is more severe to tail equity returns than to market-implied asset returns during stressed times (due to fire sales effects and contagion in funding costs); the reverse holds during calm periods (flight-to-quality effects).

### Macroprudential framework, housing risks, and policy recommendations
- Institutional framework:
  - Clear mandate for financial stability operationally clarified by a Memorandum of Understanding (MoU) signed between the RBNZ and the MoF.
  - MoU created a narrow framework, limiting actions to banks and including just four instruments in the toolkit.
  - To amend the toolkit the RBNZ needs agreement of the MoF; procedures are not transparent to the public.
  - Recommendation: RBNZ’s advice and the opinions of the MoF on the need for adjustment should be publicly disclosed within an appropriate timeframe.
  - Recommendation: review the macroprudential toolkit more regularly than the current five years (e.g., biannually).
  - Recommendation: ensure decision-making processes are free from financial industry and political pressures while preserving accountability and independence.
- Housing sector measures and remaining vulnerabilities:
  - Timeline of RBNZ actions:
    - mid-2013: rules requiring banks to reduce the volume of high-LVR lending to below 10 percent of new commitments.
    - end-2015: tightened LVR restriction to Auckland investors.
    - October 2016: extended investor restrictions nationwide and imposed tighter limits on investor loans and owner-occupier lending.
  - Despite LVR measures, imbalances remain:
    - long-term declining rental yields and a rising price-to-income ratio suggest overvaluation.
    - household debt-to-income has edged up further; record high household indebtedness persists.
  - Recommendation: consider adding Debt-to-Income (DTI) limits (or measures such as debt servicing to total income (DSI)) to the macroprudential toolkit to complement LVR restrictions.
  - Rationale: DTI/DSI can better target risks from high household indebtedness and reduce distortions arising from reliance on a single tool; first-time home buyers are disproportionately affected by LVR restrictions.
  - Further recommendation: continue efforts to reduce distortionary tax benefits and facilitate housing supply.
- Systemic concentration and capital buffers:
  - Financial sector concentration generates structural vulnerabilities.
  - Direct exposures among the four largest banks are relatively limited, but spillover potential is elevated due to:
    - reliance on overseas funding.
    - potential for deleveraging or fire sales by one large bank to depress asset values and economic activity system-wide.
  - Recommendation: RBNZ should increase capital buffers to reflect the prevalence of SIFIs in the financial system as part of the current review of capital requirements.
- Supervision and regulatory powers:
  - RBNZ’s supervisory approach: non-intrusive, three pillars (market discipline via public disclosure; self-discipline via corporate governance and directors’ attestations; regulatory discipline via simple conservative framework, off-site monitoring, disciplinary actions).
  - APRA cooperation: enhanced formal and informal cooperation; APRA conducts a more intrusive supervisory approach towards New Zealand operations of Australian banks and insurers.
  - Recent improvements: adoption of Basel II and III capital standards for banks, prudential liquidity policy ahead of Basel III, additional supervisory guidance, increased regulatory reporting, RBNZ now the prudential supervisor for insurance (legislation enacted in 2010).
  - Shortcomings and recommendations:
    - RBNZ does not conduct on-site inspections to verify compliance and effectiveness of management, systems, and data.
    - Need to improve supervisory data collection from insurers.
    - The RBNZ’s effectiveness would be strengthened with broader powers to impose binding standards in all areas of prudential regulation (current powers limited to solvency and fit-and-proper requirements).
    - Licensing framework for overseas insurers (branches) could be strengthened to ensure assessment of equivalence of foreign regulatory regimes.
    - Supervisory engagement should move towards communicating supervisory expectations and requiring action, particularly with large institutions.
- Operational note:
  - Outsourcing policy requires large banks to have the legal and practical ability to control and execute core outsourced functions.

*Source: IMF staff analysis in chapter/section titled “A contagion module assessed the potential for distress in a financial firm to create” from the provided IMF document.*

### 30.      While RBNZ staff are highly competent, insufficient resources are an impediment to

### cr17110 - 30.      While RBNZ staff are highly competent, insufficient resources are an impediment to

### Resource constraints and supervisory capacity
- RBNZ staff are described as "highly competent" and "professional," but "numbers are insufficient."
- Strengthening the regulatory discipline pillar requires increased resources, including technical capacity to:
  - develop prudential requirements and guidelines;
  - deepen the analysis that supports the supervisory ratings;
  - develop a supervision policy balancing risk and efficiency costs of supervision.
- The FMA needs to build more insurance expertise to promote adequate conduct supervision of the sector.

### Gaps versus international standards and implications for the three-pillar approach
- The RBNZ's "non-intrusive" or low-intensity approach contrasts with the Basel Core Principles (BCP) and Insurance Core Principles (ICP) and can impair market and self-discipline.
- Key hindrances to effectiveness and convergence with BCP/ICP:
  - absence of supervisory testing to determine compliance and effectiveness of risk management;
  - limited supervisory guidelines and regulations that could serve as benchmarks for the three pillars.
- Priority actions to close significant gaps:
  - Issuing enforceable supervisory standards on key risks, tailored to reflect institution complexity and system risk profile, to provide transparency and support preventive enforcement. Regulation of governance, risk management and controls and undertaking risk assessment in these areas need strengthening.
  - Reviewing the enforcement regime to promote preventive action. Compliance with RBNZ guidelines should serve as evidence of prudent banking and insurance. Remove the legal need for the consent of the MoF to issue directions in banking cases not involving a systemic impact.
  - Initiating on-site programs to test the foundation of the three-pillar approach and directors’ attestations. On-site activity should be targeted to high-risk areas, issues identified through off-site analysis, new risks and products, and to test accuracy of regulatory reports. Off-site thematic reviews (e.g., PRESS and iPRESS) are used to profile banks’ risk management.
  - Clarifying responsibilities of the Treasury and RBNZ for financial sector issues to reinforce RBNZ’s role as prudential regulator and supervisor and enable swift supervisory response (Appendix V).

### Cross-border cooperation with APRA
- RBNZ has a close home-host relationship with APRA; Australian parental support (e.g., following the Canterbury earthquakes) has been a source of strength.
- APRA's intensive home-supervision partly mitigates RBNZ's low-intensity approach.
- RBNZ encouraged to be more active in joint on-site visits, focusing on objectives of home and host supervisors to prepare for coordination in stress.
- Interdependence exposes New Zealand to shocks originating in Australia, with particular exposure in life insurance because of:
  - significant Australian presence in branch form;
  - exemption given to branches from many RBNZ prudential requirements;
  - direct dependence on Australian insolvency law and practice in case of failure.

### Capital markets and asset management supervision
- Major overhaul of capital markets regulatory framework since the last FSAP; supervision of asset management started recently.
- Creation of the FMA as conduct regulator and licensing regime for managers of Managed Investment Schemes (MIS).
- Retail offers of MIS are now regulated and subject to governance, disclosure and eligibility requirements; FMA completed initial licensing of MIS managers and is refining a risk-based approach.
- Financial Markets Supervisors (Supervisors), private entities licensed by the FMA, now perform statutory supervisory activities for MIS offered to retail investors (monitoring asset valuation policies, custody, leverage and liquidity risk management).
- FMA should keep risks and responses under constant review, ensure oversight where technical expertise and macro perspective are required, and ensure quality of Supervisors' work.
- Gaps in perimeter:
  - Provision of custody services does not require a license and falls outside direct supervision by the FMA; government could require licensing and supervision.
  - Wholesale asset management activities are not covered by the FMC Act; insufficient data to assess risks.

### Financial Market Infrastructures (FMIs)
- FMIs are heavily dependent on the four largest banks; potential failure of one main bank would put severe stress on all FMIs and the market.
- RBNZ and FMA jointly responsible for FMI regulation and oversight but "currently lack sufficient legal powers" because the regime is voluntary and authorities lack an appropriate toolkit.
- Proposed reforms will align New Zealand with international standards and provide legal powers for oversight of systemically important FMIs, a gradual range of enforcement powers, and crisis management and regulatory powers.
- Implementation of the new regime will need more oversight resources than currently planned.
- Network analysis findings:
  - Largest overlap of members between ESAS, SBI, and HVCS; NZ Clear and NZCDC largely form their own clusters.
  - Banking groups are most heavily centered in the ESAS/SBI/HVCS cluster and highly connected to NZ Clear; nonbank financial groups are connected to NZ Clear and NZCDC.
  - Three Australian banks have membership in all FMIs; the four Australian banks represent 80 percent of total settlement volume.
  - Membership is dominated by Australian banks, followed by New Zealand banks; settlement volume measured in NZD shows banking groups as dominant.
- Supervisory recommendations:
  - Adopt international principles for FMIs in secondary legislation, formalize supervisory practices, and increase staff resources.
  - Increase resources to avoid 'ad hoc' supervision and enable supervisory standard assessments and analysis of broader financial stability themes (cyber resilience, crisis management arrangements, risks from use of overseas FMIs).
  - FMA encouraged to publicly disclose role and responsibilities regarding oversight of domestic and foreign FMIs.

### Financial integrity and AML/CFT
- Since the 2004 FSAP, New Zealand's AML/CFT regime was assessed by FATF and strengthened; authorities amended the AML/CFT Act and assessed ML/TF risks.
- Professional services/gatekeepers and legal persons with complex ownership structures identified as highly vulnerable to ML; drug crimes, fraud, tax evasion and foreign predicate crimes generate the most significant illicit proceeds.
- Authorities taking steps to align legal framework with the FATF 2012 standard by mid-2017, updating ML/TF risk assessments, and preparing for the next FATF assessment scheduled for 2019.
- Remaining shortcomings:
  - Several designated non-financial businesses and professions are not fully subject to AML/CFT requirements.
  - Lawyers and accountants (who perform customer due diligence obligations on behalf of more than 40 percent of financial institutions) should be subject to AML/CFT measures and supervision in line with the standard — Government has recently introduced legislation to address the issue.
  - Need for timely access to up-to-date beneficial ownership information of legal persons and arrangements.

### Correspondent banking and remittances
- New Zealand banks have closed accounts of Money Transfer Operators (MTOs); authorities are active in enhancing remittance corridors.
- Average transfer costs are trending up; data suggest MTO market has become more concentrated, with remittance volume to Small Pacific States broadly stable in recent years.
- RBNZ issued a 2015 statement clarifying AML obligations and advocating a measured risk management approach by banks.
- Government agencies provide technical assistance to Small Pacific States on ML/CFT, payments infrastructure, and remittance solutions.

### Crisis management, resolution, and safety net
- Unique considerations: minimally resourced supervision, emphasis on self-discipline and market discipline, strong interdependence with Australia, and long-standing decision not to introduce deposit insurance.
- Council of Financial Regulators (CoFR) comprises FMA, RBNZ, the Treasury, and MBIE and is an advisory and coordinating body.
- Domestic crisis management weaknesses and required actions:
  - Strengthen domestic contingency planning and clarify decision-making and exercise of resolution powers; ensure detailed logistics and communication plans are pre-positioned.
  - Complete procedural guidance for use of resolution tools and develop rosters of potential statutory managers and mobilizable staff from government, agencies and private sector.
  - Revise RBNZ Act and Insurance (Prudential Supervision) Act 2010 (IPSA) to require post-reporting by RBNZ on performance against resolution objectives to enhance accountability.
  - Revise RBNZ Act to have same power as IPSA to apply for appointment of a liquidator.
  - Introduce a special resolution regime paralleling IPSA for nonbank deposit-takers.
  - Make RBNZ the sole resolution authority with clear mandates and accountabilities, requiring MoF approval only for resolutions with fiscal or systemic implications; Treasury role should focus on guarantee/public funds decisions and advice to the Minister.
- OBR (Open Bank Resolution) arrangements:
  - Since June 2013, large banks required to comply with RBNZ’s OBR Pre-positioning Requirements Policy.
  - OBR aims to provide a credible alternative to use of public funds by freezing a portion of balances and taking control to continue operations while seeking resolution; applies to all banks with over NZD 1 billion of deposits.
  - OBR does not actually resolve a failing bank; many complexities exist for OBR credibility given supervisory approach, absence of deposit insurance, absence of some legal powers, and challenges in dealing with large failing institutions.
- Deposit insurance and alternatives:
  - Introduction of deposit insurance is identified as the first-best element to complete the safety net.
  - As a second-best option, introduce limited deposit preference to provide a legal foundation for a de minimis exemption from freezing and haircutting deposits in OBR.
  - RBNZ public consultation suggested a de minimis exemption of NZD 500; IMF recommends a higher amount established in legislation to provide some benefits of deposit insurance.
  - Authorities’ analysis suggests NZD 10,000 per depositor would exempt the full amount of 80 percent of the number of bank deposits, while still leaving the bulk by value of deposits at risk.19
  - Issuance of additional capital instruments with write-down and convertibility features could be considered to provide further bail-inable liabilities, but caution is urged because the majority of these instruments have been purchased by individual investors who may not fully appreciate the risks.
- Trans-Tasman coordination:
  - Further work on the trans-Tasman framework for assessing systemic importance and coordinated responses is needed.
  - No ex-ante consensus on single- or multiple-point-of-entry resolution strategies; participating authorities have national mandates that may constrain advance agreement on crisis measures.
  - Recommend expanding (and renaming) the Trans-Tasman MOC to include insurance and FMIs.

*Source: IMF staff.*

### Appendix I. New Zealand: Implementation Status of

### Appendix I. New Zealand: Implementation Status of 2004 FSAP Recommendations

### Disclosure-based regime
- Status: Partially implemented
- Actions taken:
  - The RBNZ implemented Pillar 3 (along with the rest of Basel II) in early 2008 by updating and expanding the existing capital adequacy disclosure in their disclosure regime, in a slimmed-down version judged sufficient for the New Zealand market.
  - Several add-ons to Pillar 3 in recent years have mostly not been implemented by the RBNZ (example: banks’ remuneration policies and practices) because they were not considered material for New Zealand banks or particularly meritorious.
  - Some changes were made in early 2013 to reflect Basel III updates (covering the new classification of capital instruments, more detail on their terms, and the new types of capital ratio including the CET1 ratio and the buffer ratio).
  - The regulatory stocktake exercise by RBNZ is considering options to improve the disclosure regime; the main proposed change is to introduce a simple and accessible quarterly ‘dashboard’ presenting key financial information on all locally incorporated banks in a standard format in one place on the RBNZ website.

### Importance of independent directors
- Status: Implemented
- Actions taken and recommendations:
  - Fit-and-proper criteria should continue to apply in a comprehensive manner.
  - The RBNZ introduced new corporate governance requirements for New Zealand incorporated registered banks in June 2010 (requirements came into effect in 2012), designed to strengthen the independence of locally incorporated foreign-owned banks vis-à-vis their parents.
  - Post-GFC, the RBNZ has significantly increased its engagement with independent directors.

### Surveillance
- Status: Partially implemented
- Recommendations:
  - For banks, monitor more regularly liquidity and large exposure early warning indicators; consider commissioning third-party reports and establish a small specialist team to make focused, on-site visits on particular aspects of credit and operational risk.
- Actions taken:
  - The RBNZ elected not to establish a small, specialist in-house team to make focused on-site visits on particular aspects of credit and operational risk.
  - In 2010 the RBNZ introduced a prudential liquidity policy (BS13) to address funding liquidity risks (including the relative reliance of New Zealand banks on short-term wholesale market funding).
  - The RBNZ started collecting private (regulatory) data on a monthly basis on any ‘large exposures’ that are in arrears (since late 2008).
  - A new regulatory report, applying to all registered banks, will require banks to list their largest credit exposures, irrespective of their credit ratings.

### Crisis management and bank resolution
- Status: Partially implemented
- Recommendations:
  - Review possible approaches to bank resolution, and the operational and legal consequences that might arise, with a view to establishing internal operational guidelines.
- Actions and legal changes:
  - The Reserve Bank Amendment Act of 2003 introduced changes to RBNZ powers to respond to a bank in distress or a failure situation, including removing the need for the RBNZ to consult with a bank before giving directions or removing/replacing/appointing directors (powers still require consent of the MoF).
  - The 2003 Amendment Act changed the appointment of a statutory manager to be for a specified period rather than indefinitely.
  - In early 2005 a trans-Tasman Council on Banking Supervision was formed to enhance coordination of home-host regulatory issues between New Zealand and Australia.
  - A 2006 Amendment Act formally implemented government responses to Council recommendations, requiring RBNZ to implement powers so as to avoid detrimental impacts on financial system outcomes in Australia, to the extent reasonably practicable; a reciprocal provision was included in Australian legislation.
  - Any statutory manager appointed to oversee a troubled financial institution is required to consult with APRA.
  - A Memorandum of Cooperation on Trans-Tasman Bank Distress Management was signed in 2010 to assist coordinated response to financial distress in banks with significant operations in Australia and New Zealand; the Memorandum does not pre-commit to, or rule out, any particular resolution options.
  - The GFC prompted accelerated development and implementation of a mechanism to resolve a bank in distress while minimising system impact. OBR, in principle, allows a distressed bank to be closed overnight and placed into statutory management (at the decision of the Minister following recommendation from the RBNZ).

### Nonbank supervision
- Status: Partially implemented
- Recommendations:
  - Review practices and resource needs for government agencies involved in oversight, especially the offices of the Registrar and the Government Actuary, with a view toward enhancing public access to timely and comprehensive data.
- Actions and structural changes:
  - The regulatory landscape for nonbank financial institutions (NBFIs) has altered considerably since the last FSAP, involving prudential and market conduct dimensions.
  - In 2006 a working group (RFPP) was established to review financial products and providers to develop a consistent framework for regulation of nonbank lenders.
  - The RFPP led to RBNZ assuming responsibility for the regulation of nonbank deposit-takers (supervision rests with trustees licensed by the FMA) following a 2008 Amendment Act.
  - The Insurance (Prudential Supervision) Act 2010 completed the shift to a single prudential regulator model.
  - The RBNZ does not regulate nonbank non-deposit taking lenders.
  - The FMA was established in 2011 to consolidate financial markets securities regulatory functions; the role of the Government Actuary was disestablished in April 2011 and its functions, powers and responsibilities were incorporated within the FMA in May 2011.
  - The Insurance and Superannuation Unit was disestablished in April 2011 and staff transferred to the FMA.
- Market infrastructure and registers:
  - A new online register—the Disclose Register—was put in place to provide market information about investment products and as a vehicle for issuers to upload documents, data and information.
  - The FMC Act established two registers (offers of financial products and managed investment schemes); the Disclose Register contains both.
  - The Companies Office and the Registrar of Financial Service Providers are the administrators of the Disclose Register.
  - By midnight on 30 November 2016, most existing offers and schemes must be registered on the Disclose Register; a transition period applied until then.
  - The Financial Service Providers Register (FSPR), created in 2008, is a searchable online register of people, businesses, and organisations that offer financial services in New Zealand; registration does not constitute official approval or indicate licensing.

### Securities markets regulation
- Status: Partially implemented
- Recommendations:
  - Enhance the regulatory framework by including minimum standards of conduct for collective investment scheme operators, improving reporting mechanisms, strengthening standards and penalties relating to market abuse, and strengthening oversight of market intermediaries that are not exchange members.
- Actions and legal/institutional changes:
  - Significant changes since the last FSAP: the 2006 RFPP led to establishment of the FMA in 2011 and new standards for market conduct culminating in the Financial Markets Conduct Act 2013 (FMC Act).
  - The FMA was established to consolidate financial markets securities regulatory functions and to administer a new consolidated regulatory framework for securities.
  - The FMC Act provides a regulatory framework for financial conduct covering offering, promotion, issuance and sale of financial products, on-going responsibilities of those who offer/issue/manage/supervise/deal in/trade financial products, and regulates provision of certain financial services including licensing for providers of CIS to retail investors.
  - The FMC Act was progressively brought into force from April 2014; although in effect on 1 December 2014, most regulated entities had until 1 December 2016 to transition from the old to the new regime.

### Stress testing: Institutional perimeter and data (Appendix II / Appendix III excerpts)
- Institutional perimeter (TD by Authorities vs TD by FSAP Team):
  - Authorities included: Four major banks: ANZ Bank New Zealand Ltd; ASB Bank Ltd; Bank of New Zealand; Westpac New Zealand Ltd.
  - FSAP Team included: Five major banks: ANZ Bank New Zealand Ltd; ASB Bank Ltd; Bank of New Zealand; Westpac New Zealand Ltd.; and Kiwibank Ltd.
  - Criteria for perimeter: firms’ balance sheet, firms’ share in the lending market, and firms’ role in the New Zealand payment system.
  - Market share reported:
    - Authorities: About 85 percent of total banking sector assets.
    - FSAP Team: About 90 percent of total banking sector assets.
- Data and effective dates:
  - Effective date: June 2016. Effective date for market risk: June, 2016.
  - Data sources listed for FSAP Team include: supervisory data, publicly available data (bank disclosures, Bloomberg, Thomson Reuters, Dealogic, Markit, Haver Analytics, Moody’s KMV, Bankscope, SNL, International Financial Statistics (IFS), IMF Global Assumptions (GAS), and IMF WEO).
  - Scope of consolidation: Consolidated group basis.
- Stress testing process and methodologies:
  - RBNZ conducts its own TD macroprudential stress test based on the WEO/RBNZ forecast (baseline) and IMF’s Global Macrofinancial Model with inputs from the RBNZ (adverse). RBNZ uses structural models for real estate exposures (TUI model) and the dairy stress portfolio (model for defaults on dairy lending). Results aggregation includes adjustments based on expert judgment including losses for other portfolios.
  - The FSAP team conducts its own TD macroprudential stress test based on the WEO/RBNZ forecast (baseline) and the IMF’s Global Macrofinancial Model with inputs from the RBNZ (adverse).
  - FSAP modeling specifics:
    - For expected losses, a separate credit risk model is calibrated for 5 economic sectors (drawing on RBNZ supervisory data) and core industry sectors (drawing on market-based data).
    - For unexpected losses in IRB portfolios, PDs are estimated from stressed loan loss provision ratios linked to IRB models and allowing for RBNZ regulatory overlays on farming lending and mortgage exposures.
    - For STA exposures and specialized lending subject to the slotting approach, stressed NPL ratios, stressed coverage ratios, and a stressed transition matrix for performing exposures are projected.
    - For robustness, the TD stress test includes projections using RBNZ’s structural TUI model on borrowers’ balance sheets and a detailed stress test of banks’ mortgage book by LTV vintage using a Merton-based option-value approach.
    - For market risk, stress to major sovereign issuers is modeled.
    - The FSAP team developed and calibrated a comprehensive battery of econometric and structural models for the 2017 New Zealand FSAP: Over 100 credit risk models are estimated for PDs based on bank-level regressions, panel-based regressions, and multivariate vector autoregressive models (VAR) with principal component analysis (PCA). Over 25 models are estimated to project solvency and funding cost interactions and contagion from peer banks.
    - Lending rates are linked to shocks to deposit rates and wholesale funding spreads, projected in line with the macro scenario, bank-specific solvency ratios and funding stress in peer banks.
    - Shocks to NIMs are modeled as a function of RBNZ’s Official Cash Rate, money market shocks, and the slope of the yield curve, with pass-through effects estimated empirically and linked to the interest repricing schedule for each bank as of June 2016.
    - Bank-specific wholesale spreads are linked to behavior of ytm spreads of active bonds at the peak of the GFC under the adverse scenario and over the last two years under the baseline scenario.
- Tail shocks and adverse scenario (TD by Authorities / FSAP Team descriptions):
  - Calibration and characterization:
    - The adverse scenario is calibrated using the IMF’s Global Macrofinancial Model and auxiliary models estimated by the RBNZ drawing on historical crisis-episodes in New Zealand, Australia, and the United Kingdom.
    - This scenario is characterized by deteriorating global conditions from a sharper than expected global growth slowdown, tighter and more volatile conditions, a credit cycle downturn in China, and persistently lower commodity prices. The global downturn impacts directly on Australia and New Zealand, with additional spillovers through financial linkages with Australia, autonomous confidence effects, and a sharp correction in the New Zealand real estate market and equity market.
    - The scenario constitutes a 2.4 standard deviation move in two-year cumulative real GDP growth rate by 2018, calculated over 1990–2016.
  - Key numerical projections and shocks (preserve exact figures as presented):
    - New Zealand GDP growth contracts by - 1.4 percent in 2017 relative to a baseline projection of 2.5 percent growth rate.
    - Real GDP reaches a peak deviation from baseline levels at -7.1 percent in 2018–19.
    - Unemployment peaks at over 10 percent by end-2018.
    - There is persistent disinflation over 12 quarters.
    - Residential prices peak-to-trough decline of 40 percent.
    - CRE peak-to-trough decline of 30 percent.
    - Real equity price index falls by 30 percent by end-2018.
    - Money market rates peak in 2017.
    - Bank credit falls by 20 percent relative to baseline levels by 2021.
    - The scenario includes an additional idiosyncratic and system-wide funding risk shock triggered by dislocation of money markets and linked to banks’ capital ratios under stress and contagion from other New Zealand banks.
- Sensitivity analysis elements:
  - Shocks to NZL residential house prices impacting stressed LGDs.
  - Shocks to the NZD swap curve.
  - Shocks to net interest margins.
  - Additional calibration informed by 2016Q3 banks’ reverse stress test exercise.

*IMF staff compilation from "Appendix I. New Zealand: Implementation Status of 2004 FSAP Recommendations" and associated Appendices in the provided content.*

### 4. Risks and buffers

### 4. Risks and buffers

### Positions / risk factors assessed
- Credit risk
  - Mortgage loans credit risk losses projected using the TUI model, a structural approach to the understanding and measurement of residential mortgage lending risk.
  - Rural portfolio credit risk losses projected using the dairy portfolio model that incorporates cross-sectional data and considers behavioral assumptions of the drivers of default.
  - Other sectoral categories in the credit book include: SME/corporate lending, CRE lending, consumer lending, sovereign/bank lending (“liquid bonds”).
- Operational and market risk
  - Driven by mark-to-market losses of the liquid asset portfolio. Losses are reversed as bonds mature.
- Profits
  - Margin compression as banks push down lending margins to alleviate customer distress.
  - Inability to pass higher funding spreads on to fixed term mortgage customers.
- Regulatory impact
  - Phase-out of Tier 1 and Tier 2 instruments according to transitional rules.

### Credit risk (detailed)
- Exposure types
  - IRB and Standardized exposure: retail exposures, corporate exposures, sovereign/public sector exposures, exposures to financial institutions.
  - Covered bonds and securitization exposures are included.
  - Off-balance sheet exposures using baseline and stressed Credit Conversion Factors (CCFs) are included.
- Sovereign risk
  - Mark-to-market valuation of securities (from shocks to interest rates and credit spreads) in trading book and AFS/FVO linked to macro scenario.
- Market risk other than sovereign risk
  - Market stress from shocks to changes in interest rates and credit spreads.
- Profit and income projections
  - Interest income declines for the amount of lost income from defaulted loans.
  - Interest income from non-defaulting loans estimated according to satellite models.
  - Interest expenses increase due to rising funding costs linked to the macroeconomic scenario with empirically estimated pass-through, stressed capital ratios and contagion from peer banks.
  - Net fee and commission income and other income evolve with macroeconomic conditions and banks’ balance sheets.
  - No change in business models (no rebalancing of portfolio).

### Behavioral adjustments / Dynamic balance sheets
- Balance sheets evolve over the stress horizon according to the scenario.
- Credit supply effects are disallowed to calibrate credit risk projections.
- Balance sheets evolve with key macroeconomic aggregates adjusting for credit demand effects.
- EAD under stress from off-balance sheet exposures increases about 5-10 percent on average, reflecting higher use of undrawn credit and liquidity facilities.
- Conservative assumption: all facilities are assumed to be contractually irrevocable (“committed”) to extend funds in the future.
- Maturing assets are replaced by exposures of the same type and risk.
- Dividends:
  - Linked to banks’ net profits.
  - Under positive profits, the dividend payout floor is set at 30 percent subject to dividend restrictions if banks breach their capital conservation buffer. Otherwise, no dividend payout is assumed.
- Effective tax rate evolves with the macro scenario.
- Loss recognition: Losses are recognized in the same year that loan is impaired.
- If banks’ capital ratio falls below regulatory minimum during the stress test horizon, no prompt corrective action is assumed.
- Regulatory impact: The effects of the phase-out of no-longer-eligible additional Tier 1 and Tier 2 capital are included. No conversion of additional Tier 1 capital is assumed during the stress horizon.

### Calibration of risk parameters
- Parameter definitions
  - PiT credit loss rates for expected losses and TTC PDs and LGDs for regulatory capital requirements (RWAs).
  - PiT, PDs and LGDs for expected losses. PiT TTC-adjusted PDs and TTC LGDs for regulatory capital requirements (RWAs).
  - PDs are blended PDs (i.e., include both defaulted and non-defaulted counterparties) by asset class.
  - LGDs are calculated post credit risk mitigation by asset class.
- Parameter calibration
  - For IRB exposures, shifts to RWAs are informed by banks’ BU stress test results, historical experience during the GFC and expert judgment.
  - For IRB exposures, shifts to PDs are informed by shocks to credit risk losses and banks’ estimated PDs calculated in historical stressed episodes.
  - Shocks to LGDs are projected using a Merton-based approach for mortgage exposures, shocks to unemployment for retail unsecured exposures, and shocks to GDP for corporate exposures.
  - PDs and LGDs evolve with the macroeconomic and financial variables of the scenario.
  - For STA exposures and specialized lending subject to the slotting approach, inflows into NPL categories are based on a panel regression, including risk migration for performing exposures, and stressed coverage ratios.

### Regulatory standards and capital definitions
- Capital definition according to Basel III / RBNZ rulebook, including CET1, Tier 1, and total CAR.
- The CET1 ratio is computed using Basel III end-point definition.
- Capital components that are no longer eligible for additional Tier 1 and Tier 2 capital components follow a front-loaded Basel III transitional path according to RBNZ’s regulatory capital framework with complete phase-out by January 1, 2018.
- CET1/Tier 1/CAR ratio hurdle rate at 4.5/6.0/8.0 percent of RWAs for regulatory minimum capital breach with an additional 2.5 percent hurdle rate for capital conservation buffer breach.
- Leverage ratio (3 percent hurdle rate met with Tier 1 capital) using the Basel III definition, notwithstanding the fact that the NZ liquidity regulatory framework does not include a leverage metric.

### Reporting format for results (solvency)
- Evolution of CET1, Tier 1, CAR for the aggregate banking system.
- Distribution of individual CET1, Tier 1, CAR in the banking system.
- Contribution of key drivers to aggregate net profits and aggregate CET1 capital ratios.
- Number of banks and share of total assets below hurdle rates.
- Capital shortfall in terms of nominal GDP.

### Liquidity Stress Testing Matrix — Institutional perimeter and data
- Institutions: Selection criteria: RBNZ liquidity returns under BS13.
- Market share: All fifteen locally incorporated banking institutions.
- Data and base date: The one-week and one-month maturity mismatch is based on supervisory data as of August 31 2016, under the RBNZ liquidity policy framework (BS13).
- The one-week and one-month quasi-LCR test is based on supervisory data as of August 31 2016.
- Definition of HQLA is stricter than under APRA’s Basel III LCR implementation under APRA’s Prudential Standard APS 210 Liquidity given the lack of a fee-paying contingent credit line facility in New Zealand.

### Liquidity channels of risk propagation and methodology
- Basel III measures of liquidity risk—the quasi-LCR conducted on three calibrated scenarios.
- A cash-flow analysis based on RBNZ’s mismatch ratio.
- A general maturity mismatch analysis by maturity bucket based on RBNZ’s CFR.

### Liquidity risks and buffers
- Risks: Funding liquidity risk, rollover risk, and market liquidity risk.
- Buffers: HQLA securities assessed at market values net of haircut on a security-by-security basis.

### Tail shocks (size and scenario design)
- A range of adverse scenarios:
  - LCR Scenario under standard assumptions calibrated by BCBS.
  - An LCR “New Zealand retail stress” scenario that replicates the peak stress observed in relevant comparator jurisdictions during the GFC.
  - An LCR “New Zealand wholesale stress” scenario characterized by:
    - (i) a freeze of wholesale funding on the interbank market, secured funding market via repo and covered bonds, and the commercial paper market (with run-off rate for operational deposits of 75 percent and for not-fully covered corporate deposits of 100 percent),
    - (ii) liquidity risk from shocks to secured funding backed by RMBS to 50 percent and shocks to undrawn but committed credit and liquidity facilities with run-off rates of 50 percent for supervised banks and other financial institutions.
  - Implied cash flow assumptions include haircuts of up to 60 percent for securities and bank loans that can be mobilized in repos, no issuance of new unsecured funding and freeze of securitization markets, call-back rates of up to 100 percent, and cash outflows of up to 75 percent.

### Liquidity regulatory standards
- Counterbalancing capacity above net cash outflows under stress scenario.
- Basel III transitional arrangement for the LCR ratio at 80 percent.
- CFR above RBNZ’s regulatory 75 percent threshold.

### Reporting format for results (liquidity)
- Changes in average liquidity position and counterbalancing capacity for each scenario.
- Distribution of banks’ liquidity position under each scenario.
- Number of banks with counterbalancing capacity below net cash outflows.
- Banks’ post-shock net liquidity position.
- Liquidity shortfall in terms of banking system total liabilities.

### Appendix IV — RBNZ and IMF stress test comparison: key findings
- Comparability
  - The RBNZ stress test results are broadly comparable to the IMF stress test results using the commonly agreed scenario and RBNZ’s in-house credit risk models in combination with expert judgment.
  - Under the RBNZ test, results computed for the aggregate balance sheet of the big four banks. Under the adverse scenario, aggregate Tier 1 capital is projected at around 8.4 percent at the low point, and total capital ratios reaching about halfway through the conservation buffer at the worse point.
  - IMF aggregate results are broadly comparable with stress tests conducted on individual balance sheets covering the five largest banks.
- Credit risk losses
  - IMF test: weighted-average cumulative bad debt expense over the 5-year horizon of around 4.0 percent relative to starting loans.
  - RBNZ test: 3.6 percent of starting assets.
  - IMF projected loss rates by portfolio (relative to starting loans):
    - housing loans: 1.4 percent of bad debt expense,
    - real estate and SMEs: 5.4 percent,
    - rural portfolio: 7.0 percent,
    - personal loans: 12.3 percent.
  - RBNZ projected loss rates by portfolio (relative to starting assets):
    - housing loans: 2.1 percent,
    - CRE: 6.0 percent,
    - rural portfolio: 9.0 percent,
    - personal loans: 10.0 percent.
- Market risk losses
  - IMF stress test: trading securities and AFS securities suffer marked-to-market losses; accumulated asset valuation loss of around 10 percent given composition of banks’ securities portfolio as of June 2016. Hedges assumed are to not operate under stressed market conditions.
  - RBNZ test: liquid assets treated as HTM securities and hit by an accumulated loss rate of 0.3 percent.
- Interest rate / funding risk
  - Interest risk losses are material as bank funding costs increase under stressed money market conditions and banks’ ability to pass funding shocks through to lenders is constrained, being capped at 50 percent in the IMF test.
  - Sharp rise in funding costs driven by shock to the reference rate, credit risk concerns over bank debt as capital buffers are eroded under stress, and system-wide contagion from weaker banks.
  - Impact mitigated by thin maturity gaps in the banking book and sound interest rate repricing schedules.
  - Overall, net interest margins compress by around 60 bps at the low point of the stress from 2.2 percent in June 2016.
- Reverse stress tests (four large banks)
  - Reverse stress tests reveal capital ratios are robust to a severe macroeconomic downturn but could be exposed if there was also a compression of margins and a spike in operational risk.
  - Net profits reported by some banks are hit by a compression of margins of around 100 bps over the 3-year scenario.
  - Capital buffers are eroded by an increase in operational risk losses reaching an average 11 percent of credit losses, and leading to rising regulatory capital requirements.
- Operational note
  - For residential mortgage loans, the average number of months to rate reset stands at around 11 months.

*Source: cr17110 - 4. Risks and buffers (IMF).*

### Introduction

### Introduction

### Purpose and Scope of the Assessment
- Primary goal: focus authorities on areas needing attention in implementation of the BCP by the RBNZ.
- Framework assessed: Basel Core Principles for Effective Banking Supervision issued by the BCBS in 2012.
- Context: assessment is part of the FSAP undertaken by the IMF in 2016 and based on the regulatory and supervisory framework in place at the time of the visit.
- Scope: RBNZ supervision of the registered banks only; other financial industries supervised by the RBNZ are not covered.
- Not intended to represent analysis of:
  - the state of the banking sector,
  - the macroprudential policy framework, or
  - the crisis management framework (these are addressed in dedicated technical notes of the FSAP).

### RBNZ Supervisory Approach
- Three pillars:
  - Market discipline, based on public disclosure.
  - Self-discipline, based on bank directors’ attestations of public information.
  - Regulatory discipline, based on a simple and conservative regulatory framework, off-site monitoring, and disciplinary actions.
- Relies on synergies with APRA home-country supervision of Australian banks’ operations in New Zealand.
- In practice, the RBNZ approach conflicts with BCP requirements that expect granular regulatory guidance and on-site independent verification work by the supervisor.
- RBNZ aims to strengthen supervision while retaining its current approach.
- Purpose of assessment: evaluate effectiveness of New Zealand’s banking supervisory systems and practices against the Core Principles, which are neutral regarding different approaches so long as the overriding goals of each Principle are achieved.

### Institutional Setting and Market Structure
- RBNZ responsibilities include:
  - prudential regulation and supervision of registered banks and insurers,
  - regulation of NBDTs,
  - oversight of the payment system (and settlement systems jointly with the FMA),
  - AML/CFT supervision for banks, NBDTs and life insurers,
  - lender of last resort and crisis management powers.
- Some crisis management powers and the power to make regulations are exercised together with the MoF and the Governor-General acting on recommendation from the RBNZ.
- In 2013 the RBNZ introduced a framework for macroprudential policy vis-à-vis the banking sector under its existing objectives and powers.
- Market concentration and structure:
  - Four large Australian subsidiaries dominated the market with a share of total banking sector assets of 83 percent as at June 2016.
  - The four subsidiaries are significant to their parents (about 15 percent of group earnings and total assets on average).
  - One large state-owned bank and the rest are small banks, both foreign- and domestic-owned.
- Cooperation with APRA:
  - Enhanced formal and informal cooperation arrangements with APRA reflect codependence of the two banking systems and aim to provide synergies supporting the RBNZ in fulfilling prudential responsibilities.
- Mission engagement:
  - The mission held extensive meetings with RBNZ officials, Treasury, FMA, APRA, the industry, and relevant third parties.
  - Visits to Wellington and Auckland in New Zealand, and Sydney and Melbourne in Australia.
  - Acknowledgement of high quality of cooperation and comprehensive self-assessment provided by RBNZ staff.

### Banking Sector Characteristics and Resilience
- GFC impact:
  - The GFC had a mild negative impact on the New Zealand banking sector.
  - A significant number of finance companies experienced difficulties over 2006–2010 and were put into receivership.
  - Failures were caused mainly by problems with asset quality, connected lending, and credit management (many prior to liquidity pressures in the GFC).
  - Parent banks of large subsidiaries were able to support their New Zealand operations and were subject to effective home-country supervision.
  - Unexpected funding-liquidity risks were contained by unprecedented emergency liquidity facilities and support provided by the RBNZ.
- Sector profile:
  - Banking sector focuses on lending to the domestic private sector and providing traditional products.
  - Sector appears well capitalized, with sufficient liquid assets, high asset quality, and stable profitability over the last 10 years.
  - Dependence on wholesale funding, including foreign currency funding: foreign funding accounts for 19 percent of banks’ liabilities.
  - As of October 2015:
    - over 80 percent of banks’ liabilities (including deposits and minus equity) had a maturity of below one year,
    - 65 percent was on demand or with maturity of less than 3 months.

### Preconditions for Effective Banking Supervision
- General strengths:
  - New Zealand is a small open economy underpinned by strong policy frameworks.
  - Commitment to open-market policies facilitating trade and investment.
  - Transparent and efficient regulations applied evenly in most cases.
- Institutional responsibilities:
  - Treasury: responsible for maintaining a stable and sustainable macroeconomic environment; fiscal policy is one of its main tools.
  - RBNZ: responsible for ensuring price stability as defined by the Policy Targets Agreement signed between the MoF and the Governor; operationally independent regarding monetary policy formulation.
  - RBNZ Act enables the Governor-General, on advice of the MoF, to direct the RBNZ to formulate and implement monetary policy for any economic objective other than ensuring price stability for a period not exceeding 12 months.
- Macroprudential framework:
  - RBNZ has independent decision-making power vis-à-vis macroprudential policies empowered by the RBNZ Act.
  - A MoU signed in May 2013 outlines governance arrangements for use of macroprudential tools.
  - During 2008–2009 crisis the RBNZ established the Macrofinancial Committee to focus explicitly on macrofinancial stability issues.
  - New Zealand has actively used macroprudential tools to address systemic risks.
- Public infrastructure and rule of law:
  - New Zealand ranks in the 97–100th percentile of all countries for the World Bank key indicators of governance (Voice and Accountability, Political Stability and Lack of Violence, Government Effectiveness, Regulatory Quality, Rule of Law, Control of Corruption).
  - Noted features:
    - an adaptable and responsive legislature,
    - quality laws relating to business organization, insolvency, property registration and transfer, and consumer protection,
    - an independent judiciary of high standing,
    - institutions to administer and enforce market conduct and competition law (FMA and the Commerce Commission),
    - strong independent professions (legal, accounting and actuarial) and adherence to international and professional standards (IFRS, actuarial standards, etc.),
    - support for freedom of contract, property rights and protection from arbitrary government action,
    - well-developed corporate and commercial law.
- Crisis management and resolution:
  - Legal framework for resolution of banks is established in the RBNZ Act.
  - Upon identifying an institution as failing or likely to fail, the RBNZ recommends to the MoF initiation of resolution through appointment of a statutory manager.
  - OBR has been developed as a tool, not tested yet, to provide a credible alternative to a bailout for a systemically important institution.
  - Greater clarity required on the decision-making process for dealing with a crisis and the exercise of resolution powers.
  - RBNZ has a statutory lender-of-last-resort role.
- Liquidity and funding measures:
  - In 2010 RBNZ introduced a prudential liquidity policy to encourage banks to self-insure against funding-liquidity risks.
  - Australian parents could previously provide contingent funding to New Zealand subsidiaries up to 50 percent of the parent’s Tier 1 capital.
  - APRA has tightened related party exposure requirements, reducing non-equity exposures to 5 percent of Tier 1 parent capital.
  - New Zealand banks required to set up contingent funding arrangements secured by instruments exempt from resolution actions in New Zealand, such as covered bonds introduced in 2010.
- Deposit insurance:
  - No ex ante depositor protection insurance in New Zealand (reflects government policy and RBNZ view that emphasis should be on reducing moral hazard).
  - A temporary opt-in retail deposit scheme was introduced in 2008 for registered banks and NBDTs, initially for two years, subsequently extended until December 2011.
  - Government plans to consider merits of an explicit depositor protection scheme in conjunction with crisis governance in due course.
- Market discipline and public safety nets:
  - Regulatory and commercial environment supports market discipline in industries operating under free-market conditions.
  - RBNZ committed to bank disclosure; no restrictions on ability to move deposits and other investments between banks.
  - Assessment notes that market discipline in New Zealand banking is less idiosyncratic than assumed by RBNZ’s supervisory approach.
  - Large maturity mismatches and systemic risks mean public safety nets are commonly required; market discipline often must be complemented or replaced by effective regulatory discipline.

### Main Findings
- Progress since last FSAP:
  - RBNZ has increased attention to strengthening regulatory discipline and following international standards in substance.
  - Examples:
    - Adoption of the new Basel capital framework.
    - Issued supervisory guidance and increased regulatory reporting.
    - In 2016, RBNZ began final stage of multi-year upgrade of supervisory non-public statistical and prudential reporting from banks.
    - Supervisory policies published are mostly related to “conditions of registration” and thus enforceable.
    - Off-site thematic reviews performed to profile banks’ risk management in areas of concern, such as dairy and real estate.
    - An off-site process (PRESS) rates banks based on risk profile and systemic impact.
    - An AML/CFT supervision process has been implemented.
- Limitations of current approach:
  - Effectiveness limited by heavy weight on market discipline relative to regulatory discipline and intensive supervision.
  - Defining feature: absence of independent testing of prudential returns and risk management practices for prudential purposes.
  - RBNZ avoids detailed on-site inspections (either by own staff or external experts) due to concern about weakening bankers’ incentives to ensure robust controls.
  - Need to re-evaluate whether lack of a more intensive approach, including increased on-site program, may undermine market and self-discipline.
  - Current approach hinders supervisors developing expertise on bank operations, hampering analysis and policy development.
- Resource constraints:
  - RBNZ staff quality and competence were highly regarded, but insufficient resources impede achieving compliance in-substance with the BCP.
  - Staff operate under resource constraints; mere reallocation would not be enough even if low-intensity approach retained.
  - Strengthening regulatory discipline will require reassessment of resources and technical capacity.
  - To enhance the supervisory process, an increase in staffing is required at least to:
    - develop an on-site program that tests the foundation of the three-pillar approach,
    - deepen analysis supporting PRESS ratings,
    - issue supervisory guidelines that promote preventive actions.
- Self-discipline concerns:
  - Self-discipline pillar relies on directors’ attestations that the bank has adequate risk management systems.
  - RBNZ has issued limited guidance on what constitutes adequate risk management.
  - This vacuum likely filled by foreign banks using home-country supervisors’ standards; domestic-owned banks may follow different standards.
  - RBNZ familiarity with Australian standards but would need to review standards on-site for next tier foreign-owned banks and domestic-owned banks.
  - Not issuing standards may create an uneven playing field as directors attest to different standards, diminishing the value of disclosures.
- Enforcement:
  - An effective self-discipline regime needs supporting regulatory framework and swift enforcement when banks violate rules.
  - RBNZ has broad enforcement powers, but lack of regulatory benchmarks and high legal threshold for issuing directions (orders) make swift enforcement less likely.

*Source: Introduction, IMF assessment of implementation of the BCP by the RBNZ (cr17110 - Introduction).*

### section 113(1)(e) of the RBNZ Act when a bank is conducting business in a non-prudent manner the

### cr17110 - section 113(1)(e) of the RBNZ Act when a bank is conducting business in a non-prudent manner the

### Legal framework and enforcement constraints
- Under section 113 of the RBNZ Act, with the consent of the MoF, the RBNZ may issue directions requiring banks to take corrective action, remove or replace directors, auditors, or management and cease any unsafe business activity.
- Directions may be imposed to correct violations, but also to address actions "not considered prudent" by the RBNZ.
- The threshold to issue a direction is high and the lack of supervisory guidance on what constitutes prudent banking (other than the broad description in the Act) impedes preventive enforcement.
- Demonstrating imprudent behavior (for example, inadequate risk management or insufficiently developed risk appetite statements) is made difficult by the lack of supervisory standards. As a result, the RBNZ’s enforcement is currently based primarily on breaches that have already occurred and is not preventive.
- The only exception is in the case of AML/CFT supervision, where an on-site program is in place.

### Key recommended actions (as developed in the report)
- Improve compliance with the BCP and enhance effectiveness of the RBNZ three-pillar approach through the following measures:
  - (i) amending section 78 of the RBNZ Act to make compliance with RBNZ-issued supervisory policy evidence of prudent banking;
  - (ii) issuing supervisory policy documents as warranted (for example on credit risk);
  - (iii) carrying out targeted on-site programs (directly or through external experts) to verify regulatory reports, risk management, and the quality of credit exposures;
  - (iv) enhancing proactive cooperation within the trans-Tasman agreements to support cross-border synergies in supervision;
  - (v) considering options to facilitate the taking of enforcement action based on supervisory judgment;
  - (vi) improving analysis to support PRESS ratings by retaining work papers to document determinations on adequacy of risk mitigants.

### Supervisory mandate, “will to act,” and operational independence
- A positive assessment of the supervisor’s ability to act (resources, authority, organization, constructive working relationships, and actions taken) is not sufficient; it must be complemented by the "will" to act to take preventive and corrective actions.
- Developing the “will to act” requires:
  - a clear and unambiguous supervisory mandate;
  - operational independence coupled with supervisory accountability and transparency;
  - skilled staff; and
  - an arm’s-length relationship with the industry to avoid “regulatory capture.”
- The Principle by Principle assessment reflects the supervisor’s “ability to act” and the conditions needed for their “will to act.” Political will is also required but cannot be measured externally.

### Responsibilities, objectives, powers, independence, and cooperation (CPs 1–3, and 13)
- Statutory objectives of the RBNZ are broadly defined as “promoting the maintenance of a sound and efficient financial system; or avoiding significant damage to the financial system that could result from the failure of a registered bank.”
- Broad definitions (e.g., “sound and efficient financial system,” “significant damage,” “systemic implications”) have allowed the RBNZ to develop a hands-off supervisory philosophy departing from conventional, more resource-intensive practices.
- The RBNZ is defining its risk appetite framework to translate statutory objectives into practical outcomes and clarify supervisory conduct.
- Coordination with government is defined in law and supported by a MoU, but boundaries between responsibilities (RBNZ, Treasury, MoF) may need further clarification in practice.
- The MoF’s letter of expectations for the RBNZ Board, of April 22, 2016, will help clarify how the objectives of soundness and efficiency are promoted and balanced.

### Resources and staffing
- RBNZ staff are highly qualified, but numbers are clearly insufficient to conduct effective supervision, even if on-site work were conducted by external experts under RBNZ prudential mandates and guidance.
- Insufficient resources impede a more intrusive supervisory approach, targeted reviews, early action, crisis preparedness, and broader financial stability analysis.
- The RBNZ should reassess the adequacy of resources assigned to its banking supervisory function.

### Cooperation with APRA and trans-Tasman synergies
- RBNZ has a unique, close home-host relationship with APRA, underpinned by legislation, bilateral MoUs, and the Trans-Tasman Banking Council (TTBC), set up in 2005.
- Arrangements for cooperation could be used proactively to achieve joint interests and cost-effective supervision, including proactive engagement during APRA on-site visits.
- Building sound cross-border relationships takes time and will prepare supervisors for effective coordination in times of stress.
- The need for a more coordinated approach by the two supervisors was a widely-held view among stakeholders.

### Methods of ongoing supervision (CPs 8–10, and 12)
- New Zealand’s banking structure (largest four banks are subsidiaries of Australian banks) has influenced a supervisory approach that relies on home-country oversight and allows RBNZ higher risk tolerance and less prescriptiveness.
- Ongoing supervision is based on three pillars: market, self, and regulatory discipline.
  - Market discipline: public disclosure and publication of financial information.
  - Self-discipline: corporate governance and directors’ attestations that risk management systems “are in place to monitor and control adequately all material risks of the banking group.”
  - Regulatory discipline: supervisory rules/guidelines on capital (Basel II and III), liquidity, outsourcing, related party lending, and corporate governance.
- The RBNZ follows a non-intrusive approach: guidelines avoid hard limits; detailed on-site inspections are not conducted; supervisory conclusions rely on off-site reviews, risk appetite statements, financial information, reports submitted to bank management, and prudential meetings.
- Guidance issued by the RBNZ does not sufficiently communicate expectations for management systems to monitor and control material risks; directors’ attestations may be based on differing benchmarks and expectations.
- Lack of first-hand independent verification of prudential returns and assessment of banks’ risk management practices prevents a thorough understanding of banks.

### PRESS risk assessment tool
- PRESS incorporates 10 risk areas and adds a systemic impact factor to arrive at an aggregate numerical rating reflecting bank risk profile and systemic impact.
- Macroeconomic factors and stress testing results (conducted by RBNZ or individual banks) add a forward-looking aspect.
- Ratings are primarily results-oriented; analysis supporting the ratings is not well documented and is based primarily on banks’ internal risk reporting.
- Recommendation: improve analysis to support PRESS ratings by retaining work papers to document determinations on adequacy of risk mitigants.

### Consolidated supervision
- The RBNZ does not conduct effective consolidated supervision; supervision is based on the registered bank’s banking group as defined in conditions of registration, allowing subconsolidated supervision focused on the registered bank and its subsidiaries.
- The wider banking group or conglomerate would not be supervised under current practice.
- Corporate structures of New Zealand banking groups are generally simple; no material foreign operations of New Zealand incorporated banks at time of assessment.
- The four banking groups with more complex structures are large Australian banking groups supervised by APRA.
- Attention to consolidated supervision is focused on assessing “parent support” as a PRESS risk factor; RBNZ can change its approach if bank risk profiles change.

### Ownership, licensing, and structure (CPs 4–7)
- Registration by RBNZ defines a bank, not the business carried on; this previously created lack of clarity as other entities engaged in bank-like activities such as accepting deposits.
- Since 2013, all NBDTs are licensed by the RBNZ; their supervision is entrusted to private sector trustee companies based on RBNZ sectoral regulations.
- Transfer of significant ownership is infrequent due to concentrated ownership and small number of institutions; major acquisitions were not significant at time of assessment.

*Source: cr17110 - section 113(1)(e) of the RBNZ Act when a bank is conducting business in a non-prudent manner the (IMF).*

### section 78) makes use of supervisory judgment more difficult. Additionally, even bank-specific

### cr17110 - section 78) makes use of supervisory judgment more difficult. Additionally, even bank-specific

### Supervisory judgment and enforcement
- Section 78 and section 113(1)(e) of the RBNZ Act: issuance of bank-specific directions requires the prior consent of the Minister of Finance (MoF), which may reduce timeliness of enforcement and make use of supervisory judgment more difficult.
- Enforcement (directions) process is largely untested and may result in the RBNZ being reactive with corrective action.
- Use of supervisory judgment is enhanced when the supervisor has issued enforceable guidelines on risk management processes.
- Recommendation (Principle 11): Make compliance with BS Policy documents evidence of prudent practice (s78) and eliminate Ministerial consent for directions under section 113(1)(e).

### Corporate governance (CP14 / BS14)
- Companies Act of 1993 establishes corporate governance requirements; RBNZ issued prudential requirements (Document BS14) providing additional guidance.
- BS14 incorporates fit-and-proper principles from the Basel Committee’s 2010 paper: Principles for enhancing corporate governance and addresses Board composition and inclusion of independent directors.
- Only areas directly linked to conditions of registration are enforceable.
- RBNZ monitoring through off-site reviews; scope not sufficiently detailed to meet the BCP standard.
- Supervisory activities do not include determining board engagement level, oversight of senior management, review of governance structures, management selection, remuneration decisions, Board communication of corporate culture, or establishment of a strong control environment.
- Recommendation (Principle 14): Update BS14 to include expanded guidelines on risk appetite statements, required Board policies, and codes of conduct; enhance ability to ensure ongoing suitability of directors/management.

### Prudential requirements, regulatory framework, accounting, and disclosure (CPs 15–29)
- RBNZ does not impose direct requirements on banks to have comprehensive risk management policies and processes, except in capital adequacy and liquidity.
- RBNZ relies on directors’ attestation with every financial statement disclosure that: “the bank had systems in place to monitor and control adequately the material risks of the banking group, including credit risk, interest risk, currency risk, equity risk, liquidity risk, operational risk, and other business risk, and that those systems are being properly applied.”
- Accuracy of disclosure is tested off-site through report analysis and on-site interviews with bank management.

### Liquidity policy (BS13)
- BS13 requires banks to comply with quantitative and qualitative standards.
- Establishes quantitative measures based on balance sheet ratios and cash flows to arrive at one-week and one-month percentages of liquidity outflow to total funding.
- Computes a one-year core funding ratio, required to be not less than 75 percent.
- Results of liquidity requirements yield broadly similar results as application of Basel III according to RBNZ estimates.

### Connected (related) party exposures (BS8)
- BS8 establishes limits and market-terms requirements for related party transactions.
- Aggregate limit on all related party exposures: 125 percent of Tier-one capital.
- Aggregate nonbank related party exposures limit: 15 percent (by condition of registration).
- Aggregate limit on net exposures (under robust bilateral netting agreements) set according to the bank’s rating, with a maximum of 75 percent of Tier 1 capital.
- Policy does not require prior Board approval for related party transactions or write-offs; definitions do not cover all types of related party required by Principle 20.
- Compliance monitored off-site; information aggregated and not adequate to monitor related party lending risk.
- Recommendation (Principle 20): Expand requirements to include prior Board approval and reporting on write-offs; expand information collected (terms, names, repayment status); expand definition of related party to include related parties of the bank’s directors and other parties as defined in CP20 footnotes.

### Capital framework and implementation (BS2A / BS2B)
- RBNZ seeks to follow Basel guidance where appropriate (BS2 A and B).
- Implemented Basel II Internal Models Based Approach (BS2B): four banks are accredited to use the IRB approach.
- Implemented Standardized approaches (BS2A).
- RBNZ takes a simple and conservative approach to capital adequacy.
- Main divergence: leverage ratio has not been considered at this stage and is kept under review.
- Other departures (Pillar 2, Pillar 3, SIFI surcharges) are policy choices tailored to national circumstances.
- Capital framework currently under review.
- Recommendation (Principle 16): Continue assessment and review of capital framework.

### Accounting, external audit, and supervisory reliance
- Financial statements prepared in accordance with New Zealand equivalents to internationally recognized accounting standards (NZ IFRSs) and audited by qualified external auditors under equivalent ISAs.
- RBNZ relies on external auditors and director attestations to determine prudentially whether banks use valuation practices consistent with IFRSs.
- RBNZ routinely meets with external auditors of the 10 largest locally incorporated banks; meetings do not cover valuation practices or other supervisory responsibilities entrusted to external auditors.
- Recommendation (Principle 27): Engage external auditors in focused dialogue on valuation practices and other prudential concerns delegated to auditors.

### Supervisory approach, techniques, and reporting (selected BCP findings)
- Primary off-site methodology: PRESS, functioning as an early warning system tracking trends and possible impacts.
- Supervisory approach relies on market discipline, directors’ attestations, off-site monitoring, interviews, enforcement when deficiencies are uncovered, and limited issuance of supervisory policies.
- Analysis is not documented; does not include detailed evaluation of risk mitigants; PRESS results not specifically discussed with banks.
- RBNZ does not rely on on-site inspections as a supervisory tool; attestations by directors are not verified by on-site reviews.
- RBNZ does not independently verify prudential returns; verification currently consists of cross-checking different reporting outcomes for consistency.
- Recommendation (Principles 8–10): Increase analysis of risk mitigants, retain work papers, share analysis results with banks; carry out on-site inspections (targeted and risk-based) to verify data and implementation; develop processes for strong first-hand independent verification of prudential returns.

### Risk management, credit risk, provisioning, concentration, and operational risk (CPs 15–19, 21–25)
- RBNZ has not issued enforceable benchmarks for comprehensive risk management; high-level approach relying on off-site reports and meetings.
- No issued requirements or definitions on nonperforming loans, forbearance, renewals, cured loans, or loan classifications based on risk; no prudential guidelines on loan loss provisioning.
- RBNZ does not establish large exposure limits nor issue guidance on concentration risk; in 2016 an additional regulatory collection of large exposure data was initiated.
- RBNZ has not issued guidance on interest rate risk in the banking book; relies on reviewing banks’ internal reporting.
- Operational risk reviewed via banks’ management reports; no detailed guidelines or on-site testing to verify adequacy.
- Recommendation (Principles 15, 17, 18, 19, 21, 22, 23, 25): Major change required to supervisory approach including issuing supervisory regulations/enforceable policies as benchmarks; adopt a more intrusive approach with on-site inspections; increase forward-looking capacity with stress testing; allocate additional resources and training.
- Specific recommendation for credit risk and provisioning: issue detailed guidelines on loan classification, extended loans, forbearance, nonperforming and cured loans, and provisioning; perform on-site reviews to verify credit portfolio quality and internal reports.

### Internal control, audit, disclosure, AML/CFT (CP26–29)
- RBNZ does not comply with most requirements of CP26 and does not intend to; determining adequacy of internal control frameworks is left to banks.
- Independent verification of internal controls identified as critical and indispensable to exercise effective regulatory discipline.
- RBNZ committed to high-quality public disclosure; encouraged to continue assessing whether public disclosure meets user needs and to complement disclosure with information on remuneration.
- AML/CFT regime implemented in 2013; supervisory approach in this area departs from the generally hands-off prudential approach and still needs to mature.
- Next FATF assessment in 2019 will be an important landmark to reassess progress.
- Recommendation (Principles 26–28): Increase independent verification of internal controls; enhance engagement with external auditors on valuation and prudential matters; continue to strengthen disclosure practices including remuneration information.

### Summary compliance and key numeric limits and dates (as stated in the source)
- One-year core funding ratio: required to be not less than 75 percent.
- Aggregate limit on all related party exposures: 125 percent of Tier-one capital.
- Aggregate limit on nonbank related party exposures: 15 percent of Tier 1 capital.
- Aggregate limit on net exposures under robust bilateral netting agreements: maximum of 75 percent of Tier 1 capital.
- Four banks are accredited to use the IRB approach under BS2B.
- Additional regulatory collection of large exposure data initiated in 2016.
- AML/CFT regime implemented in 2013; next FATF assessment in 2019.

### Recommended actions (high level)
- Clarify RBNZ’s operational objective for banking supervision to remove legislative ambiguities.
- Reassess and increase resources for banking supervision.
- Narrow scope for government interference by clarifying Ministerial roles (e.g., section 68B) and remove requirement for Ministerial consent for bank-specific directions.
- Increase use of enforceable supervisory requirements as benchmarks to facilitate preventive supervisory and enforcement action.
- Expand on-site inspection program, targeted and risk-based, to verify data, credit portfolios, Board implementation of policies, and internal controls.
- Enhance coordination and proactive cooperation with APRA on trans-Tasman supervisory matters.
- Issue detailed guidelines on credit risk, provisioning, concentration limits, related party transactions, and other key risk areas.
- Engage external auditors in focused discussions on valuation practices and areas of prudential concern.

*Source: IMF Detailed Assessment Report (New Zealand)—excerpts as provided in the supplied content.*

### Appendix VI. Report on the Observance of Standards and Codes:

### Appendix VI. Report on the Observance of Standards and Codes: Insurance Core Principles—Summary Assessment

### Introduction
- Assessment of insurance regulation and supervision in New Zealand carried out as part of the 2016 New Zealand FSAP.
- Benchmarked against the ICPs issued by the International Association of Insurance Supervisors (IAIS) in October 2011, as revised in November 2015.
- Excludes personal accident and earthquake schemes provided by government entities:
  - The EQC, established under the Earthquake Commission Act 1993, provides natural disaster coverage in relation to residential property and associated land up to specified limits.
  - The ACC, established under the Accident Compensation Act 1972, provides no-fault personal injury coverage for all New Zealand residents and visitors.
- EQC and ACC excluded from scope of regulatory assessment due to similarity to social insurance schemes, but included in market statistics because they form an integral part of financial protection in New Zealand.
- Assessment based solely on laws, regulations and supervisory practices in place as of August 2016; key reform proposals summarized as additional comments.
- Assessment team included Mimi Ho and Ian Tower (external experts); assessment conducted from August 16 to September 7, 2016.

### Information and Methodology Used for Assessment
- Based on laws, regulations, supervisory requirements and practices in force in August 2016.
- Authorities provided a comprehensive self-assessment supported by examples of actual supervisory practices and assessments.

### Overview of the Institutional Setting and Market Structure
- RBNZ adopts a principles-based, low-intensity supervisory philosophy; commenced prudential supervision in 2010 following IPSA.
- Supervisory emphasis on board accountability and consumer responsibility in selecting financial products and providers.
- RBNZ has issued standards and guidelines and has generally refrained from in-depth on-site supervision to encourage self-discipline by insurers’ boards and management.
- Responsibility for insurance market conduct supervision lies with the FMA; FMA oversight embedded in general oversight of financial advisers and financial products; established in 2011, taking over functions of former Securities Commission and the Government Actuary.
- New sales of life insurance are for protection only, without savings elements; most life insurers have established fund management subsidiaries and provide insurance and fund management from separate entities.
- KiwiSaver is a tax efficient (non-insurance) work-based retirement savings product that has attracted savings that might otherwise have gone into insurance.
- No compulsory class of non-life insurance because of role of ACC; ACC and EQC premiums/levies account for 45 percent of total non-life premiums.
- Industry concentration:
  - Total number of licensed insurers: 96 at end-2015.
  - Branches of foreign insurers: 35.
  - Australian-owned operations (branches and subsidiaries combined) represent 66 percent of market by premium and 75 percent by assets.
- RBNZ has extensive cooperative arrangements with Australian authorities as the home supervisor.
- Non-life sector exposed to earthquake and other natural disasters; Canterbury earthquakes in 2010–2011 led to government bail-out of one insurer and failure of another.
- Most Canterbury claims fell to private insurance market; EQC covers residential properties only up to limits.

### Preconditions for Effective Insurance Supervision
- Well-established and transparent macroeconomic and financial sector policy framework:
  - RBNZ primary responsibilities include macroprudential policy, oversight/designation of payments systems, and monetary policy.
  - Treasury responsible for execution of government economic policy.
  - FMA responsible for oversight of organized financial markets and conduct of business across the financial sector.
- Well-developed public infrastructure: business organisation, insolvency, property registration and transfer, and consumer protection laws well-established; judiciary independent; accounting and auditing frameworks follow international standards.
- Corporate governance frameworks present in Companies Act 1993, FMC Act, FMA principles/guidelines, and NZX corporate governance principles.
- Disclosure requirements under company law and listing rules; general requirement for audited financial statements to be publicly available; reduced requirements available for entities without public accountability.
- No insurance policyholder protection scheme; policy framework emphasizes consumer informed decisions, avoidance of moral hazard, and reducing public perception of an implicit government guarantee.
- Insurers and intermediaries required to be members of a dispute resolution scheme unless undertaking only wholesale business.
- Deep and liquid financial markets relative to country size but small by international standards and limited to shorter maturities:
  - Government securities issued only out to ten years.
  - Lack of long-term risk-free benchmark rates constrains longer term private issuance.
  - Limited inflation-indexed products.
  - No restrictions on foreign investment.
- Insurers invest largely in NZD-denominated assets and mostly in debt securities; equity and bond markets small and instrument range limited.
- Many insurers use head office or parent company to source and manage foreign investments.

### Main Findings (ICP-by-ICP summary and key issues)

- General
  - RBNZ and FMA established a “twin peaks” approach: RBNZ responsible for prudential regulation; FMA responsible for conduct.
  - Legislative changes in recent years strengthened the regulatory framework.
  - Authorities’ statutory objectives support protection of insurance policyholders; RBNZ statutory objectives focus on soundness of insurance sector, including promoting public confidence.
  - Both RBNZ and FMA have extensive powers but limited powers to establish rules themselves or impose administrative sanctions (with important exceptions for RBNZ).

1. Objectives, Powers, and Responsibilities of the Supervisor
- Objectives of regulators clearly set out in law and support policyholder protection, notwithstanding RBNZ’s focus on sector soundness.
- RBNZ and FMA powers extensive but limited regarding establishment of rules and administrative sanctions.

2. Supervisor (governance and resourcing)
- Governance structures and decision-making processes clearly defined for RBNZ and FMA.
- Transparent arrangements for appointment/removal of RBNZ Governor and RBNZ/FMA boards; reasons for dismissal need not be published.
- Scope for publication of more aggregate insurance sector information.
- RBNZ generally takes supervisory decisions except appointment of statutory manager.
- RBNZ maintains key relationship with MoF and keeps Treasury informed on individual insurers.
- As an independent Crown Entity, FMA is protected from government intervention in supervisory decisions.
- Adequacy of resources at both RBNZ and FMA needs reconsideration.

3. Information Exchange and Confidentiality Requirements
- RBNZ has legal power to obtain information and share with other authorities with similar functions.
- Formal domestic avenue for regular information sharing among relevant authorities.
- International cooperation: RBNZ has cooperation MoUs with Australian and U.K. counterparts and is signatory to the IAIS MMoU.
- Formal agreement not a precondition for information sharing.

4. Licensing
- Licensing requirements in IPSA are clear and comprehensive; RBNZ guidance on interpretation draws on licensing experience when IPSA took effect.
- A number of applications were rejected.
- RBNZ policy is accommodating towards overseas insurers; for branches, RBNZ considers benefits of an overseas insurer’s presence and regards a relatively wide range of jurisdictions as having regulatory arrangements equivalent to those of New Zealand.

5. Suitability of Persons
- Legislation establishes clear framework for suitability; insurers responsible for developing and implementing fit-and-proper policies and certifying compliance to RBNZ.
- RBNZ does not exercise prior approval for key individuals for particular roles.
- Scope of statutory suitability requirements limited to directors, CEO, CFO, and Appointed Actuary.
- Extensive scrutiny of significant shareholders at licensing stage and for changes in control, but no ongoing suitability requirements for controlling shareholders.

6. Changes in Control and Portfolio Transfers
- Legislation requires notification to RBNZ of changes in control and proposed portfolio transfers.
- IPSA’s threshold for control is high relative to international practices; control defined narrowly (focus on majority shareholders) which risks changes in significant owners occurring without RBNZ knowledge.
- RBNZ has received a large number of applications for approval of transfers under IPSA.
- While policyholder protection is not an objective under IPSA, the RBNZ must base decisions on assessment of impact on policyholders.

7. Corporate Governance
- Current framework less comprehensive and binding than ICP requires.
- RBNZ’s 2014 thematic review of risk governance highlights need to:
  - Provide clear and comprehensive articulation of expectations regarding governance to ensure consistent understanding and improve quality of governance.
  - Design an ongoing monitoring strategy to give RBNZ necessary comfort that ongoing self-discipline is effective.

8. Risk Management and Internal Controls
- Legal requirements on risk management and internal controls are less prescriptive and legally binding than ICP requirements.
- Other than the Appointed Actuary, no explicit binding requirements for insurers to have risk management, compliance, and internal audit functions.
- Lack of clear indication of insurer’s responsibility for outsourced functions.

9. Supervisory Review and Reporting
- RBNZ has full supervisory powers and a developing set of tools applied via a structured approach to assessing risk and allocating resources.
- Baseline monitoring appears thorough; supervisors leverage limited resources through thematic work.
- Routine supervisory engagement focused mainly on reporting matters, regulatory transactions, and annual senior management meeting rather than in-depth qualitative assessment of governance.
- RBNZ does not routinely carry out in-depth qualitative interactions for risk assessment or remediation.
- Supervisory resources limited, compromising ability to identify and respond to risk.
- Full set of RBNZ reporting requirements introduced only recently and requirements lack granularity.
- Scope for publishing more details of supervisory approach.

10. Preventive and Corrective Measures
- Legislative framework and RBNZ internal procedures provide for corrective action escalation to enforceable requirements, including directions.
- No requirement to publish corrective actions.
- Not all IPSA powers have yet been used; RBNZ has sometimes deliberately not intervened strongly to ease transition to new regime.
- RBNZ has imposed significant corrective measures on some insurers.

11. Enforcement
- Legislation sets out enforcement tools and sanctions against individuals and insurers, and circumstances for application.
- RBNZ implemented internal procedures to record and manage actual or potential breaches through to resolution.
- RBNZ’s powers largely untested.
- Financial and other penalties may be sought from the court, including against individuals.

12. Winding-up and Exit from the Market
- RBNZ has a range of options for voluntary and involuntary liquidation of insurers and chooses option based on circumstances.
- Policyholder protection is a principle of IPSA, but only specific protective measure is priority of claim for life insurance policyholders in the statutory fund.
- No policyholder protection scheme currently and no intention to establish one.
- Largest life insurer by assets is an Australian branch; home jurisdiction’s solvency standard and statutory fund requirements apply; not required to hold assets in New Zealand; winding-up process and New Zealand policyholders’ rights not within RBNZ control.

13. Reinsurance and Other Forms of Risk Transfer
- RBNZ recognizes importance of reinsurance given natural disaster exposure.
- Responsibility for ensuring appropriateness of reinsurance arrangements largely left to the Appointed Actuary.

14. Valuation
- Valuation of assets and liabilities for solvency purposes broadly in line with ICP standard.
- Rating affected by lack of guidance on choice of discount rates for long maturity businesses.

15. Investment
- Insurers generally permitted to invest freely provided they maintain adequate capital for associated risks.
- Supervisory influence on investments is indirect through capital charges.
- Principles-based approach would normally be accompanied by supervisor monitoring of actuarial analysis and detailed breakdown of investments and changes over time; RBNZ is not collecting the investment information needed for such monitoring.

16. Enterprise Risk Management for Solvency Purposes
- Key gaps identified:
  - Need for a rigorous process of risk identification and measurement (ICP 16.1) involving all aspects of operations.
  - Insurer’s risk management policy should include description of policies towards risk retention and risk management strategies (reinsurance, use of derivatives), and address relationship between pricing, product development and investment management (ICP 16.3).
  - Asset-liability management (ICP 16.5) needs attention.
  - ERM framework should include mechanisms to incorporate new risks and new information on a regular basis and incorporate a feedback loop (ICP 16.9 and 16.10).
- Financial Condition Report (FCR) is objectively prepared and serves a particularly useful function, albeit not as extensive as an Own Risk and Solvency Assessment.

_Appendix VI. Report on the Observance of Standards and Codes: Insurance Core Principles—Summary Assessment (cr17110)_

### 17.   Capital Adequacy

### 17.   Capital Adequacy

### Summary findings
- The solvency standard takes into account the risk profile of the insurers.
- The solvency standard does not address dependencies and interrelationships between risk categories.
- The single solvency control level makes it difficult for the RBNZ to make early intervention.

### Issues identified
- Lack of multiple solvency control levels limits early, less-intrusive supervisory action.
- Solvency information comparability is constrained by:
  - accounting standards allowing some management discretion on disclosure;
  - branches being allowed to present solvency information using home jurisdiction methodologies;
  - additional solvency margins required of some insurers.
- Financial statement disclosure requirements are lacking in the areas of investments, asset liability management, description of risk concentration, and interaction between capital adequacy and risk.
- The RBNZ has recognized that a number of areas in the solvency standards could be made clearer.

### Policy recommendations (Capital adequacy and related standards)
- Having two solvency control levels as described in ICPs 17.3 and 17.4 would enable the RBNZ to make less intrusive early intervention before the financial condition of the insurer deteriorates to a critical level.
- For consistency and efficiency, the RBNZ should develop internal guidance on the appropriate actions for each solvency control level, in particular, the strongest actions to be taken when the insurer fails to maintain the lower solvency control level.
- The New Zealand solvency standard should apply to all statutory funds to improve comparability across branches and subsidiaries.
- The regulatory capital requirements should be established in an open and transparent process.
- The basis and circumstances for using licensing conditions to impose additional solvency margin requirements should be made more transparent.

### Related supervisory and methodological recommendations affecting capital adequacy
- The RBNZ should issue comprehensive ERM guidelines and require insurers to conduct own risk and solvency assessments to identify the relationship between risk management and the level and quality of financial resources needed and available on a group-wide basis (linked to enhancements in the Financial Condition Report).
- The RBNZ should collect a more granular breakdown of assets to facilitate an understanding of an insurer’s investment exposures, including in higher risk or innovative investment instruments, which informs capital adequacy assessment.
- The RBNZ should provide greater clarity on its expectations regarding investment governance (for example, the board’s accountability over investment strategy and investment process).
- The RBNZ should work with the NZSA to establish a methodology for selecting appropriate discount rates (for example, the Treasury publishes a table of discount rates for 50 years applicable to all Government reporting entities submitting valuations to Treasury for valuing insurance claims liabilities under PBE IFRS 4 Insurance Contracts; this table or a variation thereof may be suitable for valuing private insurance contracts as well), which affects valuation of liabilities and hence capital adequacy.
- The RBNZ should require insurers to have a board-approved reinsurance strategy as part of its risk and capital management strategy, include a reinsurance statement in the FCR from both life and non-life insurers, and review reinsurance statements to form its own judgement on compatibility with insurer’s reinsurance strategy.
- The RBNZ should incorporate assessment of the effectiveness of the insurer’s risk management framework into its ongoing supervisory process and strengthen the enforceability of its risk management requirements to ensure consistency in compliance.

*Source: cr17110 - 17.   Capital Adequacy*

### 18. Intermediaries

### 18. Intermediaries

### Intermediaries: legislative and regulatory recommendations
- The government should revise the legislation (as already planned) to strengthen or remove the registration-only regime currently available to intermediaries, introducing minimum requirements for competence and disclosure that apply to all advisers, including insurance brokers.  
- The government should consider a proportionate regulatory regime for insurance intermediation not currently captured by the legislation, including pure sales and intermediation where ancillary to another line of business.  
- The FMA should assess the need for insurance-specific requirements on intermediation as well as an insurance-specific work program, taking into account its overall assessment of risks in financial markets.  
- In that context, they should assess their need, in the medium and longer terms, for more insurance-specific skills and expertise.

### 19. Conduct of Business
- The government and the FMA should review the scope of conduct regulation for insurance, considering all aspects of the insurance product life cycle, and develop a regulatory framework to include:  
  - Minimum standards on all (or all higher risk) issues.  
  - A licensing framework that would provide for screening of new entrants and clear identification of the insurers and intermediaries to whom the regulation framework will apply.  
  - A minimum level of risk-based supervisory oversight applying to the licensed population, avoiding duplication with the existing approach applied to financial advisers.  
- The FMA should review its requirements for increased insurance-specific expertise and overall insurance resources.

### 20. Public Disclosure
- Strengthen disclosure in the following areas:  
  - Risk management (asset-liability management practices, sensitivity of regulatory capital and provisions for mismatching).  
  - Financial position (capital management policy, capital adequacy information).  
  - Investment (objectives, policies and procedures).  
- Consider ways to improve the solvency disclosure information to facilitate comparability across insurers and between subsidiaries and branches (see ICP 17).  
- Enhance the quality of governance disclosure and its enforceability.

### 21. Countering Fraud in Insurance
- In order to ensure a minimum coverage of fraud in its supervisory work and to support insurance company focus on fraud risks, the RBNZ should:  
  - as part of its planning for the development of its supervisory work and resource planning, schedule thematic or firm-specific work on fraud controls; and  
  - in due course include guidance to supervisors on evaluation of fraud risks in the iPRESS framework.

### 22. Anti-Money Laundering and Combating the Financing of Terrorism
- None

### 23. Group-wide Supervision
- The RBNZ should develop a strategy on group-wide supervision reflecting its supervisory philosophy and available resources. It should take into account the significance of its domestic insurers in foreign markets (having a negative impact on New Zealand’s reputation).  
- The RBNZ should review its approach to licensing insurers with a substantial amount of business undertaken outside New Zealand, including whether and when to use its powers under IPSA to set requirements on minimum levels of domestic business.

### 24. Macroprudential Surveillance and Insurance Supervision
- The RBNZ should increase the market wide analysis of the sector from 2017, defining regular outputs (for internal use) such as standard reports on market trends, interconnectedness and other potential sources of systemic risk, as well as templates for the publication of aggregate information (it already has plans for consultation in this area).  
- While in the medium term, stress-testing exercises should be considered, the RBNZ could undertake cross-company analysis of information in Financial Condition Reports, which could be supplemented by requiring increased reporting of sensitivity analysis.

### 25. Supervisory Cooperation and Coordination
- The RBNZ should establish a process to more proactively evaluate the need to identify a group-wide supervisor, and the need to establish supervisory colleges for cross-border insurance groups. Regardless of the outcome, the process will instill the discipline of ensuring clarity of supervisory responsibility.  
- The RBNZ should initiate contacts with the host supervisors where New Zealand insurers have large market shares to understand the risks to New Zealand-owned operations in those markets.  
- The RBNZ should also increase its engagement with insurers with substantial overseas operations.

### 26. Cross-border Cooperation and Coordination on Crisis Management
- Due to the high level of cross border activities, the RBNZ should prioritize its crisis management policy and procedures, while studying how best to achieve IPSA’s principle of policyholder protection in crisis.  
- Due to the high catastrophe risk in the New Zealand market, the RBNZ should require insurers to establish and maintain contingency plans and procedures based on their specific risks in use for going- and gone-concern situations.

### Authorities’ Responses to the Assessment
- The New Zealand authorities (the FMA, MBIE, RBNZ, and Treasury) wish to thank the IMF and the insurance assessors for their thorough assessment of New Zealand’s compliance with the IAIS Core Principles for Effective Insurance Supervision. The New Zealand authorities welcome the opportunity to comment on the IMF’s Detailed Assessment Report (DAR).  
- The New Zealand authorities strongly support the FSAP as a means of promoting and improving both the quality of financial sector regulation and the outcomes that this regulation aims to achieve.  
- At the time of the last New Zealand FSAP conducted during 2003–04, regulation of the insurance sector was very limited. In part as a response to the recommendations of the previous FSAP, a working group was established in 2005 to examine the existing regulatory frameworks for nonbank financial institutions and financial products. As a consequence of that review, the Reserve Bank became the prudential supervisor for the insurance sector with the passage of the IPSA. The review also contributed to a major overhaul of New Zealand’s approach to capital market regulation, and the establishment of the FMA as a general market conduct regulator with responsibilities encompassing the insurance sector.  
- The DAR has acknowledged that the implementation of IPSA and a prudential regime for the insurance sector was a major achievement. The New Zealand authorities are pleased that the insurance assessors have judged that this new regulatory framework is reasonably “well-developed.”  
- The implementation of IPSA was a very demanding exercise for the Reserve Bank, particularly in the initial licensing phase which lasted three years. In addition, the 2010–11 Canterbury earthquakes were an unfortunate but timely reminder of the significance of robust solvency requirements, given the importance of catastrophe risk in the New Zealand market. Today, the insurance sector is in a much better position to absorb a shock of this nature.  
- Following the completion of the licensing process in September 2013 the Reserve Bank began developing and embedding a supervisory framework appropriate for New Zealand conditions that broadly aligns with the approach taken for the prudential regulation and supervision of the banking sector.  
- For the banking sector there is a long-standing ‘three pillar’ approach tied to the interplay between self, market and regulatory discipline. This framework is also appropriate for achieving the Reserve Bank’s statutory objectives for the insurance sector – to promote a ‘sound and efficient insurance sector,’ and to ‘promote public confidence in the sector.’ This systemic focus means the Reserve Bank does not direct its policy and supervisory resources at eliminating all the risks that face individual insurers. Moreover, IPSA is not a zero failure regime – i.e., the Reserve Bank is not required to ensure that no insurer will fail or that there will be no losses to policyholders.  
- The supervisory counterpart to this emphasis on self and market discipline is a risk-based approach reflecting the fact that not all insurers are equally important to the sector or the wider financial system. Moreover, on-site inspections are an inherently more intrusive and costly form of supervision and can, in the Reserve Bank’s view, potentially undermine the incentives on the insurance firm’s own directors and management to identify and manage risks.  
- The DAR has noted a number of areas where the prudential regime falls short of full observance with the IAIS’s core principles. In part, this is due to the on-going implementation of supervisory initiatives in a regime that is still maturing (such as supervisory risk assessments and regulatory reporting by insurers). In other areas the DAR acknowledges the gap in full observance is a function of the emphasis the Reserve Bank places on self and market discipline, reflected in the limited scope for on-site inspections and the relatively lightly resourced approach to supervision more generally.  
- The New Zealand authorities note the recommendations designed to improve the Reserve Bank’s three pillar approach to insurance regulation. Examples relating to improving self and market discipline include enhanced disclosure from insurers and the Reserve Bank, and the expansion of powers to develop standards for corporate governance, risk management and internal controls.  
- A number of the IMF’s recommendations are helping to inform the review of the statutory framework for insurance prudential regulation that is currently underway. The terms of reference for this review were released in April 2016 and an Issues Paper was released in March 2017. The review aims to assess the performance of IPSA to ensure it continues to create the preconditions for a cost-effective supervisory regime that helps achieve a sound and efficient insurance sector.  
- The New Zealand authorities note the IMF’s recommendations regarding conduct regulation for insurance, bearing in mind that the FMA’s reach into insurance is limited to incidences of mis-selling or misrepresentations and the regulation of financial advice as it relates to insurance agents and brokers.  
- The review of the FA Act that is currently underway will go some way to address the IMF’s recommendations relating to intermediaries. However, it is acknowledged that these changes will not affect conduct regulation of insurers themselves or non-advised sales of insurance.  
- The New Zealand authorities will, as priorities allow, consider the IMF’s recommendations and examine the issues relating to the broader question of the scope of conduct regulation for insurance considering all aspects of the insurance product life cycle.  
- As the law reforms for financial advisers are completed, the FMA will reassess resource requirements and the need to consider any insurance-specific work alongside its other strategic priorities and programme of work.

*cr17110 - 18. Intermediaries*

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_Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17110.pdf_