Reserve Bank highlights importance of market discipline

The Reserve Bank today highlighted the importance of market discipline as one of three pillars that help maintain the stability of financial institutions.

In a speech this evening hosted by the NZ Bankers Association and Bank of New Zealand, Head of Prudential Supervision Toby Fiennes said: “Our regulatory and supervisory framework is based on the three pillars of self-discipline, regulatory discipline, and market discipline.”

“The importance we place on market discipline is strongly reflected in our prudential framework, where we have less intrusive supervision than is standard internationally.”

Market discipline happens when investors and depositors influence the behaviour of a financial institution by deciding whether or not to supply funding, and what price they want for their funding, or by withdrawing their funding completely.

Mr Fiennes said that effective market discipline requires good access to relevant and timely information, having the right incentives to use the information, and a competitive environment that lets investors and depositors shift between financial institutions.

He said that aspects of New Zealand’s regulatory framework such as the Open Bank Resolution policy and not having deposit insurance reinforce these incentives.

“A financial system in which depositors can afford to be indifferent to the risks of a bank they invest in will be a weaker financial system. People will chase return with no regard for risk,” Mr Fiennes said.

New Zealand has 25 registered banks, 31 licensed non-bank deposit takers and 98 licensed insurers – so investors and customers have the opportunity to choose an institution that balances risk and return.

“Most of the time, the financial system efficiently channels savings into productive investment but the presence of external risks, occasional market failures and the extremely high cost of financial crises means that additional regulation is needed to bolster self-discipline and market discipline,” Mr Fiennes said.

“So we have detailed disclosure rules, requirements to have sufficient liquidity and capital, and rules around governance, for example,” Mr Fiennes said.

The Reserve Bank will shortly consult on a “dashboard” concept, in order to provide more timely and consistent disclosure of banks’ financial positions. This will better support market discipline through good, accessible, standardised information to investors and depositors.

Speech – Regulation and the Importance of Market Discipline

Bulletin – The importance of market discipline in the Reserve Bank’s prudential regime

ENDS

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