Annual Report

ANNUAL REPORT

2008-2009

W E AT H E R I N G T H E S T O R M

Our Vision We promote a sound and dynamic monetary and financial system. W e w o r k t o w a r d s o u r V i s i o n b y:

• Operating monetary policy to achieve and maintain price stability. • Assisting the functioning of a sound and efficient financial system. • Meeting the currency needs of the public. • Overseeing and operating efficient payment systems. • Providing effective support services to the Bank.

Our Values Integrity

• Being professional and exercising sound judgement. I n n o vat i o n

• Actively improving what we do. Inclusion

• Working together for a more effective Bank.

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009

Contents Our Vision and Values................................................................ ifc

The year in review...................................................................... 20

The Reserve Bank of New Zealand – what we do......................... 2

Monetary policy formulation...............................................20

The year at a glance..................................................................... 3 Governor’s Statement................................................................... 4

Financial markets: Domestic markets Foreign reserves management.........................................22

Board of Directors’ Report for the year ended 30 June 2009.......6

Box 1:

Planning and reporting framework............................................. 10

Liquidity management and the Bank’s balance sheet..........25

Strategic Priorities and outcomes 2008-09................................. 11

Financial system surveillance and policy...........................27 Box 2: Non-bank supervision progress.................................29

Reserve Bank departmental structure......................................... 12

Currency operations........................................................30

Board of Directors...................................................................... 13

Depository and settlement services..................................32

Governance................................................................................ 14 Chronology................................................................................ 18

Human resources.............................................................34 Knowledge services.........................................................36 Internal financial services.................................................37 Communications.............................................................38 Property management and security.................................38 International activities......................................................39 Our Financial Statements – an overview..................................... 40

Financial projections............................................................48 Strategic Priorities for 2009-10............................................50 Contents of the Financial Statements......................................... 51

Management Statement.....................................................52 Audit Report.......................................................................53 Reserve Bank of New Zealand 2008-09 Financial Statements............................................................56 Five-year historical financial information............................107

Reserve Bank of New Zealand Annual Report and Financial Statements for the financial year ended 30 June 2009, prepared pursuant to section 163 of the Reserve Bank of New Zealand Act 1989, published September 2009. ISSN 0110 7070 WEATHERING THE STORM

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RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

The Reserve Bank of New Zealand – what we do The Reserve Bank of New Zealand is the nation’s

Financial stability

central bank. It has three main functions,

The Act also directs the Bank to promote the “maintenance of

which contribute to New Zealand’s prosperity

a sound and efficient financial system” and to avoid “significant

and advancement.

damage to the financial system that could result from the failure of a registered bank”. (See pages 27-29 for activity in 2008-09.)

Monetary policy

To achieve these requirements, the Reserve Bank registers

Under the Reserve Bank of New Zealand Act 1989 (the Act), the

to encourage banks and non-bank deposit takers (NBDTs) to

Bank is given operational independence to manage monetary policy to maintain overall price stability. The operational details of the Bank’s inflation target are set out in a separate agreement between the Governor and the Minister of Finance, which is known as the Policy Targets Agreement (PTA). (See pages 20-26 for more detail on monetary policy activity in 2008-09.)

banks and operates a prudential supervision system designed manage their risks carefully. The Reserve Bank acts as banker to the banks, providing inter-bank settlement facilities and related payment services. We advise the government on the operation of the financial system. We manage foreign exchange reserves to enable intervention in the foreign exchange market, if required.

Currency The Reserve Bank issues New Zealand’s currency. As required by statute, we control the design and printing of the nation’s currency. We then issue currency to banks, which they, in turn, provide to their customers. We also withdraw from circulation and destroy damaged or unusable currency. (See pages 30-31.) The Reserve Bank also provides settlement services to the government and financial institutions. Our internal organisation is illustrated in the chart on page 12. Details of the Reserve Bank Board of Directors are provided on page 13. The role of the Board, and the governance and management of the Bank, are described on pages 14-17.

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W H AT W E D O

The year at a glance • Consumers Price Index (CPI) inflation fell from 4.0 percent for the 12 months to June 2008 to 1.9 percent for the 12 months to 30 June 2009. • The Bank lowered the Official Cash Rate (OCR) from 8.25 percent in July 2008 to 2.5 percent by April 2009, where it remained for the rest of the year. • Parliament’s Finance and Expenditure Committee reported on its Inquiry into the Future Monetary Policy Framework. • The Bank extended the range of securities eligible for

• The Bank released a draft Insurance (Prudential Supervision) Bill for consultation. • The Bank released a prudential liquidity policy for banks. • An amended Policy Targets Agreement was signed by the Minister of Finance and Reserve Bank Governor Alan Bollard. • The Bank achieved a 22 percent reduction in building energy use and emission reductions of 108 tonnes of carbon dioxide. • The Bank spent a net $45.7 million on activities covered by its Funding Agreement. For the four years ended 30 June 2009,

acceptance in its domestic liquidity operations, to support

cumulative net operating expenses were $8.5 million less than

debt markets and financial system liquidity.

the corresponding level provided in the Funding Agreement.

• The Reserve Bank Amendment Bill (No 3) was passed, making the Reserve Bank the regulator of NBDTs.

• A dividend of $630 million was paid to the Crown on 3 September 2009.

• The Minister of Finance announced on 12 October 2008 a retail deposit guarantee scheme covering deposits for New Zealand-registered banks and eligible NBDTs. • On 1 November, a Crown wholesale guarantee facility was announced. • The Bank released a consultation paper on related-party requirements and a minimum capital ratio framework for NBDTs.

T H E Y E A R AT A G L A N C E

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RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Gov e r n o r ’ s S t a t e m e n t It is not until we experience a crisis that we know

The Reserve Bank is a full-service central bank, and this has

how fit our regulatory and economic institutions

been hugely important, allowing us to gather information

and practices really are. The global financial crisis

about the New Zealand economy from many sources. This includes our economic monitoring and business visits, our

and subsequent recession continually tested

prudential monitoring of banks and other financial institutions,

New Zealand’s fitness throughout 2008-09.

our financial market informants, our liquidity management

The crisis stemmed from a build-up of global imbalances and

the demand for our banknotes. In addition, we have been able

risky investments made from around the start of the millennium.

to integrate our policy tools across monetary policy, financial

A long period of economic growth and a rising savings pool in

stability and the financial system.

Asia and the oil exporting countries created significant demand for new financial assets and fuelled strong credit growth in many Western economies. New financial instruments proliferated, accompanied by new institutions and new financial markets. This process was supported by a period of unusually low interest rates

operations, New Zealand’s payment and settlement systems, and

Around September/October 2008, events came to a head with advance warning of severe stress in the global funding markets which our banks access, as well as an unusually high domestic demand for cash.

and a general lack of concern for risk on the part of investors.

At this time, we saw our central bank colleagues in advanced

Many countries, including the United States, Australia, the United

financial countries having to react swiftly with a range of

Kingdom and New Zealand, took advantage of low interest rates

orthodox and unorthodox tools, including liquidity facilities,

to borrow heavily for assets like housing, leading to a sharp rise

artificial market support and capital injections.

in asset prices.

We had the advantage of watching them move first, and the

In mid-2008, as interest rates reversed in the United States, the

further advantage of being a single regulator in a less complex

bubble burst. Low-income households there were unable to meet

economy. Working across all our functions, we coordinated a

mortgage payments, mortgage foreclosures soared and lenders

range of measures to address the crisis.

started to collapse. Stress in the US subprime housing market

We ensured we had sufficient cash in position to meet any

spilled into other derivative markets, then money markets,

unusual and urgent needs by the banks. Monetary policy was

eventually leaching into capital and equity markets. Financial

already responding. We swiftly reduced the OCR from 8.25

market stress hit housing in Anglo-countries, and then spread

percent in early 2008 to only 2.5 percent by early 2009, the

across the world into East Asian and European manufacturing

fastest and furthest fall on record.

economies. This global financial stress was quickly reflected in the cost and availability of overseas borrowing on which New Zealand is heavily reliant. However, in common with some other commodity producers, economic activity in New Zealand appears

With our responsibility for financial stability, we had been monitoring the financial system throughout the year, reporting our findings and concerns in our Financial Stability Report. As

to have been less badly affected than in many other countries.

the credit crunch unfolded, we ensured banks could obtain

While the Reserve Bank and others had warned of the risks that

a broader range of securities as collateral, including residential

were building up in recent years, no one foresaw the scale of the

mortgage-backed securities.

world collapse, which took markets by surprise. However, since we were not initially so directly hard hit, we had some time to assess events as they unfolded.

longer-term funding by allowing them to borrow from us using

We began the year with a large foreign exchange exposure, partly due to our intervention in 2007 when we signaled that the exchange rate was then over-valued. We have unwound some of this exposure over the past year.

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G O V E R N O R ’ S S TAT E M E N T

All together, these liquidity and foreign exchange market

Prudential regulation of banks has worked reasonably well,

measures have resulted in a much bigger balance sheet for the

seeing them weather historically difficult circumstances. In

Bank, which in turn has required careful management by our

light of what we have observed, we are looking at increasing

Financial Markets Department.

agricultural capital and bank liquidity requirements for the future

For the last year or two, we had been strengthening our prudential oversight and preparing to regulate non-banks. This work allowed us to monitor bank balance sheet and lending

– ensuring banks lengthen the average maturity of their funding base is a practical step we are taking to reduce the banks’ vulnerability to adverse developments in funding markets.

positions much more closely. In October 2008, as other countries

International regulators in the future are likely to require better

rushed to guarantee their bank deposits, we rapidly helped

tools to regulate financial systems over the economic cycle,

the Government design retail and wholesale deposit guarantee

potentially including dynamic provisioning and counter-cyclical

schemes. We assisted market acceptance with several overseas

capital instruments. We will assess these and other developments.

roadshows. And we encouraged banks to use the wholesale guarantee scheme, particularly in foreign term debt markets, to help bring funders and borrowers back together, to encourage markets to return towards normal.

Some finance companies’ business models have not been sound and will need major repair. Non-bank deposit-taking institutions will be subject to a range of new prudential requirements over the coming year, aiming to bolster them for the future. We have

Bearing in mind this has been a period of intense uncertainty,

also been preparing policies and resources to implement our

we now think we are through the worst. The banking system

prudential supervision responsibilities for the insurance sector.

has held up reasonably well and the macro-economy has not sustained major damage.

Payments and settlements systems worked very well during a testing year, clearing record transactions without stress in

But the experience has highlighted the imbalances and

the week after the Lehman Brothers collapse. Our finance

vulnerabilities in New Zealand that we had previously alerted to.

and treasury staff have coped well with the huge increase

Households have been consuming beyond their incomes, they

in financial market transactions. Our information systems

have borrowed heavily for housing, funding their debt through

people have worked exceptionally hard to keep payments and

mortgages. This situation is reflected in New Zealand’s very large

settlements operating.

current account deficit. Banks have funded much of this credit growth through relatively short-term foreign loans.

The New Zealand financial system as a whole has shown some vulnerability, but has pulled through without too much damage.

In the new world this current account position will need to

The challenge will be to learn from and adapt the wave of

improve significantly to stop our international debt position

international regulation now underway.

mounting further. To date, the exchange rate has not been supportive of a shift in production towards the export and import-competing industries of the economy that will be necessary to improve this situation. At some point the financial markets may become uncomfortable if New Zealand continues to run such large and persistent current account deficits.

We have worked more closely than usual this year with the Minister of Finance and the Treasury to ensure the best outcome for New Zealanders. In such a stressed time we have relied even more than usual on the advice and foresight of senior management to stay ahead of events, on the dedication of Governors and staff to make things work through tough times,

We can take some important lessons from the experience of the

and on the guidance of the Chair and Board when dangers have

last few years.

loomed. They are what make the Bank. I thank them all.

Our monetary policy has worked reasonably well, ensuring prices have been anchored despite a massive international commodities and asset boom. Unfortunately, this has at times been at the cost of export competitiveness, as relatively high interest rates in New Zealand supported our exchange rate at the same time that the US dollar weakened. We are a small open trading economy, and our own policies will be distorted if major economies run overly-loose monetary policy.

Alan Bollard G overnor 17 August 2009

G O V E R N O R ’ S S TAT E M E N T

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RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Board of Directors’ Report for the Y ear ended 3 0 J une 2 0 0 9 This report is made pursuant to section 53A of the Reserve Bank of New Zealand Act 1989.

The Reserve Bank’s Board of Directors is

2.5 percentage points to 6.0 percent over the 18 months to

responsible for keeping the performance of the

June 2009. However, the combination of sound banking and

Bank and of the Governor under constant review across all Bank functions.

payments systems, responsive monetary policy, well-designed liquidity management policy and steady-as-she-goes currency provision (of banknotes and coins) has meant that the country has escaped any sense of panic arising from the international

Functions of the Bank The Reserve Bank of New Zealand Act specifies a range of functions that fall within the Bank’s responsibilities. These include monetary policy, registration and supervision of banks and nonbank deposit-takers, designation of payments systems, provision of currency (legal tender) and financial sector policy advice to the Minister of Finance. The interconnected nature of these functions has been starkly demonstrated by the experience of the past year; information and actions pertaining to one function have had ramifications for other functions, enabling the Bank to respond comprehensively to the extraordinary international

financial crisis. The ability of the Bank to coordinate policies across its functions has been a stabilising factor in an otherwise unstable world.

Monetary Policy For at least four years prior to 2008/09, the Reserve Bank had been hard-pressed to keep CPI inflation within the target range of 1 to 3 percent per annum on average over the medium term, as specified in the Policy Targets Agreement (PTA) between the Governor and Minister of Finance. Inflation stood at 4.0 percent in June 2008. Despite that high level, the Bank began to reduce

developments of 2008-09.

the Overnight Cash Rate (OCR) in July 2008 responding to

Monetary policy is the “primary function” of the Bank. However,

action in reducing the OCR from 8.25 percent in June 2008

this does not mean that other Bank functions are of subordinate importance for the wellbeing of New Zealanders at times of crisis. The importance of financial stability for economic prosperity has been demonstrated by recent international experience; financial failures have led to some developed economies experiencing real GDP declines of approximately 10 percent over the past year. New Zealand has not escaped the effects of the worldwide recession; GDP declined by 2.7 percent in the year to March 2009, and unemployment rose

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BOARD OF DIRECTORS’ REPORT

declining inflation pressures. The Bank’s prompt and decisive to 2.5 percent in April 2009 has been warranted. Annual CPI inflation stood at 1.9 percent in June 2009 and is forecast to fall further. Underlying inflation (according to various measures reported by the Bank) has been within the 1 to 3 percent band over recent months. The Bank’s actions in cutting the OCR have been consistent with keeping inflation within the target range; i.e. preventing the rate from falling below the bottom of the range for a prolonged period.

The interest rate cuts have also been of assistance in meeting the

monetary policy stance is maintained. Over the year, the Bank

PTA’s specification that the Bank avoid unnecessary volatility in

increased the range of securities against which it was prepared

output. Notwithstanding the OCR cuts, GDP has declined over

to provide liquidity. In doing so, its balance sheet has risen

the past year, albeit at a lesser rate than in many other developed

substantially in size. The Bank began the year with a large

countries. New Zealand would almost certainly have experienced

foreign exchange exposure, in part attributable to prior foreign

a greater GDP decline had the OCR not been cut so decisively.

exchange market intervention. The degree of this exposure has

In this respect, the Bank has implemented monetary policy in a

been partially unwound over the past year.

manner that reduces volatility in output.

The Board considers that the Bank’s actions in managing its

The Bank is also obliged to implement monetary policy in a

balance sheet have been prudent and have been effective in

manner that avoids unnecessary volatility in exchange rates and

maintaining the liquidity of the financial system, while also

interest rates. Almost inevitably, the huge OCR reduction has

contributing to greater exchange rate stability and to the

caused market interest rates to fall substantially over the year.

maintenance of appropriate monetary conditions.

However, the consistent nature of interest rate reductions has

The Bank’s internal and external information technology systems

meant that interest rate volatility has not been a concern over

have been pivotal in enabling liquidity management, inter-bank

this period. The New Zealand dollar has exhibited continued

and foreign exchange transactions to proceed smoothly. In this

volatility against some currencies, notably the United States

respect, the Austraclear and ESAS systems have performed

dollar and Japanese yen, over 2008-09. However against other

their required tasks. Their real-time settlement features

currencies, especially the Australian dollar and UK pound, the

(alongside those of CLS Bank’s real-time foreign exchange

New Zealand dollar has been remarkably stable. This relative

settlement) provide reassurance to transactors that settlement

stability (which is exhibited also over the past decade with

risk is avoided when transacting securities. The Bank’s internal

respect to the Australian dollar) indicates that what is often

treasury management systems have been crucial in enabling the

perceived to be instability of the New Zealand dollar is in fact

Bank’s foreign exchange and other transactions to be managed

a symptom of instabilities in the broader international currency

prudently within the Bank.

system. Over the 2008-09 year, there is very little evidence that domestic monetary policy actions exacerbated the volatility of the New Zealand currency.

A key function of the Bank, that is highlighted during times of international financial stress, is the prudential supervision of registered banks. New Zealand banks have withstood the

After each Monetary Policy Statement (MPS), the Bank’s Board

international financial turmoil remarkably well. The Reserve Bank

is required to determine that the MPS is consistent with the

has, for some years, laid stress on a range of risk management

requirements of the Act and with the current PTA.

aspects in order to safeguard the New Zealand banking system.

In each case over 2008-09, we affirmed our view that the MPS

For instance, the New Zealand prudential system places emphasis

met these requirements.

on bank disclosure statements in order to place disciplines on

Financial System Stability and Efficiency

banks with regard to their risk profiles. The Bank continues to

The Bank’s November 2008 Financial Stability Report (FSR), while

developments overseas, the Bank is implementing new policies

not the Bank’s first such report, was the first FSR required under

relating to the liquidity position of banks; such policies may have

amended Reserve Bank legislation. The Board reviewed this

helped mitigate some of the expansionary excesses of recent

report and the May 2009 FSR, and was satisfied that they met

years in New Zealand and internationally had they previously

the Act’s requirements. In the current international environment,

been in place.

each FSR has become an important and comprehensive resource

The Board is aware that some banks have, at times, regarded

for those with a stake in the stability of the financial system.

certain aspects of the prudential supervision regime to be

Maintenance of domestic financial stability in times of

onerous, notwithstanding the generally light-handed approach to

international financial instability requires central bank vigilance

supervision in New Zealand relative to some other countries. We

and action on a number of fronts. Over the past year, liquidity

are pleased that the prudential supervision regime has supported

management has been of prime importance for ensuring that

the soundness of the banking system which has stood up well to

financial institutions have access to liquidity. This has benefits

its greatest test since the 1930s.

develop its system of prudential regulation. In line with similar

both for financial stability and for ensuring that the intended

BOARD OF DIRECTORS’ REPORT

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RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

The Reserve Bank is in the process of implementing a range of prudential policies in its new role as supervisor of non-bank deposit takers (NBDTs). This group of financial institutions plays a distinctive role in New Zealand’s financial system and cannot be treated or regulated simply as banks. The Reserve Bank has therefore been devising appropriate standards and policies for these institutions to meet.

Currency and Premises Provision of currency is a core role for the Bank, and this task is carried out efficiently and effectively. Even here, the information flows have been beneficial for the Bank’s wider functions. For a short period following the Lehman Brothers collapse, the Bank observed increased issuance of high denomination banknotes, potentially signalling a flight to safety. The Bank was able to

The Board is satisfied that the regulatory approach taken by

take this signal into account in its broader policy settings. The

the Bank is appropriate for the circumstances of these deposit

Bank operates a prudent policy of ensuring adequate inventories

takers. We understand that the potential for failure is higher for

of notes and coins to meet unusual demands. This enabled it

some NBDTs than it is for registered banks, and it will be vital for

to meet the fluctuations in note demand through the year. The

depositors to treat each institution on its merits when investing.

Board affirms that the Bank is also well positioned to deal with

This range of risks across alternative institutions is appropriate if

other forms of currency-related risk. For instance, the Bank

funds are to be made available to riskier business ventures that

holds a note reserve in Australia in case of natural disaster in

have their legitimate place in the development of the economy.

Wellington. It can run its payments services and other operations

Guarantees for retail deposit-taking institutions (including banks) were introduced during the past year. The sudden onset of similar guarantees internationally forced the hand of Ministers in Australia and New Zealand to introduce the guarantees suddenly. While meeting their immediate aim of calming market stress, their design lacked some features that a longer gestation period would have permitted. The guarantees are due to expire in October 2010 and a key priority for government, advised by the Bank and Treasury, will be to signal clear replacement policies as soon as is practicable. The future of the wholesale guarantee scheme, introduced during the year, also requires review. A further component of the Bank’s financial stability role is its

at multiple sites in case of site-specific emergency. Following advice from the Board, the Bank is establishing a small office in Auckland that will ensure ongoing business operations in the event that its Wellington sites are completely incapacitated. These additional safeguards will incur some additional expense relative to committing all facilities in Wellington. The international financial crisis is a reminder of the potential costs of not being appropriately positioned to meet crises when they occur. The physical risk-mitigation activities that are being taken by the Bank are necessary to avoid severe dislocation in the event of a Wellington natural disaster, and the Board is fully satisfied that the small additional expense of establishing these new facilities is warranted.

incipient responsibility for supervising the insurance sector. The Bank has been increasing its resources in this field (as it has with NBDTs) in order to prepare policies appropriate for this task. The Board is satisfied that, at this stage, the Bank is proceeding in an appropriate manner with regard to these responsibilities.

Administration and Resources The Bank operates under a five-yearly funding agreement, ratified by Parliament. The Bank’s expenditures covered by this funding agreement continue to be well managed. Excluding a

The information that the Bank gains from all its stability-

charge relating to an actuarial valuation adjustment to the Bank’s

related functions enables it to operate with a wide spread

defined benefit superannuation scheme following the downturn

of information regarding the inter-connected risks that have

in world financial markets,1 the Bank’s net operating expenditure

beset the international financial system over the past two

was $41.9 million over 2008-09. This expenditure was $1.4

years. Coordination of policies (for instance between liquidity

million below the amount specified in the funding agreement.

management and monetary policy with an eye also to individual banks’ liquidity) has been internalised within a single institution, enabling quick coordinated actions to occur. This has been a strength of New Zealand’s institutional structure over 2008-09.

1

The Reserve Bank’s superannuation scheme has long adopted a conservative investment stance that has led to relatively low losses over the past year compared with the majority of superannuation schemes in New Zealand.

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BOARD OF DIRECTORS’ REPORT

The superannuation charge, assessed at $3.8 million, took

Given its heightened financial exposures, the Bank and the Board

total expenditures covered by the funding agreement to $2.4

have reviewed the desired equity position for the institution

million in excess of the funded amount. Nevertheless, the Bank’s

and reviewed the nature of the Bank’s dividend policy. With

expenditure remains $8.5 million below the agreed funding level

agreement of the Minister of Finance, a new dividend policy

over the first four years of the funding agreement. The Board is

has been adopted that essentially distributes gains realised in

satisfied that the Bank is efficiently run while having sufficient

New Zealand dollars over and above those required to ensure

resources to carry out its existing and newly legislated tasks to a

that the Bank retains a sound equity position. The Board is

high standard.

comfortable with the Bank’s planned equity position and with

The Bank retains a highly skilled and motivated workforce that

the new dividend policy.

has been tested over the past year. A number of developments

The Bank’s Board comprises the Governor and seven non-

in world financial markets have been unprecedented over the

executive directors. This year, Chris Eichbaum and Sue Sheldon

current staff’s working lives; yet they have responded in an

were appointed by the Minister of Finance as directors and Keith

assured manner that has resulted in New Zealanders remaining

Taylor has been appointed to the Board as a director starting in

relatively protected from the worst of the international distress.

July 2009. These new appointments meant that we farewelled

It is a credit to the Governors, led by Dr Alan Bollard, and

Marilyn Waring and Paul Baines whose terms came to an end.

the Bank’s staff that New Zealand has fared so well in such

We thank both Paul (two terms) and Marilyn (one term) for the

trying circumstances.

great strengths which they brought to bear in their time with

As described above, the Bank’s balance sheet has expanded

the Board.

over recent years, in part to ensure appropriate financial system

New Zealand and the world still have challenging tasks ahead

liquidity during the current period of international financial

to return the economic and financial systems to normality. The

distress. This balance sheet expansion has led to greater risks

Board is confident that the Bank is well placed to continue

for the Bank to manage with regard to its own exposures. In

performing its role to a high standard in ensuring positive

addition, the Bank’s change in 2007-08 to adopting, as its

financial and economic outcomes for New Zealand.

neutral position, an exposed foreign exchange position on its balance sheet (to give it greater ability to respond to foreign exchange market volatility) and its starting position in July 2008 of a greater than neutral foreign exchange position following the interventions of 2007-08, has led to heightened financial exposures. Over 2008-09, these positions have resulted in a net favourable financial outcome for the Bank.

A r t hur G r i me s

Alison Paterson

C hair

D eputy C hair

17 August 2009

17 August 2009

BOARD OF DIRECTORS’ REPORT

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RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Planning and reporting framework WHERE THE 2 0 0 8 - 2 0 0 9 A N N U A L R E P O R T FITS 2005/06 (I) PLANNING

2006/07

2007/08

2008/09

2009/10

20010/11 new F U N D I N G AGREEMENT

FUNDING AGREEMENT (FIXED TERM)

S TAT E M E N T O F I N T E N T ( R O L L E D F O R WA R D ) D E TA I L E D B U D G E T (II) REPORTING

ANNUAL REPORT M O N E TA R Y P O L I C Y S TAT E M E N T S ( Q U A R T E R LY ) F I N A N C I A L S TA B I L I T Y R E P O R T S ( S I X - M O N T H LY )

Table 1

The Bank adopts a number of Strategic Priorities

This was an increase in spending compared with the previous

in addition to its business-as-usual activities.

five-year period and reflected various factors, including the

Some of our Strategic Priorities for 2008-09 were multi-year priorities, set in the context of our longer-term planning funded through our five-

need to: • invest in the replacement and upgrading of our treasury and document management systems, our economic forecasting and data systems and our core financial reporting system;

year funding agreement with the government

• strengthen our supervisory capability; and

(see page 16).

• ensure that robust business continuity arrangements remain

The current Funding Agreement, ratified by Parliament on 23

The Funding Agreement was amended in April 2008 by

June 2005, covers the five years ending 30 June 2010. Funding

increasing the approved level of net operating expense for

in this agreement was projected to rise from $39 million in the

2008-09 from $41.0 million to $43.3 million and that for

first year (2005-06) to $43 million in 2009-10.

2009-10 from $43.0 million to $46.9 million. These changes

in place.

were required to fund increased policy advice responsibilities and activities associated with greater oversight of non-bank financial institutions.

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PLANNING AND REPORTING FRAMEWORK

S t r a t e g i c P r i o r i t i e s a n d o u t co m e s 2 0 0 8 - 0 9 Last year we adopted a number of priorities, which we report on here. Priorities for the 2009-10 year are on page 50.

Priority 1:

Outcome:

Prudential liquidity policy

After consulting with industry and other interested parties, we finalised a new

Develop and implement a prudential liquidity

prudential regime for liquidity risk management by registered banks. The policy

policy for registered banks.

seeks to ensure that banks maintain robust short- and long-term liquidity, have appropriate internal arrangements for liquidity risk management, and provide clear and useful information to the Reserve Bank and the public about their liquidity risk and how it is managed. We will work on pathways to achieving compliance later in 2009.

Priority 2:

Outcome:

Extended prudential regulatory regime

• Key components of the NBDTs’ prudential regulatory regime are well

Implement new regulatory arrangements for non-bank deposit takers (NBDTs) and develop a prudential regime for the insurance sector.

advanced, including requirements for capital, related parties and credit ratings. We have finished consultation and will introduce relevant regulations later in 2009 and 2010. • We have also recently released a draft Insurance (Prudential Supervision) Bill for stakeholder consultation.

Priority 3:

Outcome:

Management development

All managers are expected to have a comprehensive leadership development

Support management in further developing

programme, including regular 360-degree feedback reviews, induction for new

their values-based leadership competencies.

managers, regular leadership training and individual development planning.

Priority 4:

Outcome:

Economic model construction and implementation

We completed development of a new macroeconomic model called KITT (Kiwi

Introduce a state-of-the-art model into the

System model. The KITT model offers several advantages stemming from the

policy and forecasting process.

fact there has been extensive development of monetary theory and modelling

Inflation Targeting Technology) to replace the current Forecasting and Policy

techniques since our previous Forecasting and Policy System model was built.

Priority 5:

Outcome:

Financial Sector Information System (FSIS) development

We completed the first phase of the development of FSIS, a database for

Design and build an integrated computer

the Bank later this year, improving the quality of, and access to, our statistics.

economic and financial statistics. The system will be implemented throughout

application to improve the collection and analysis of financial sector statistics.

S T R AT E G I C P R I O R I T I E S A N D O U T C O M E S

•

11

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Reserve Bank departmental structure A s at 3 0 J une 2 0 0 9 governors

Assistant Governor Head of Economics John McDermott

Governor Alan Bollard

Deputy Governor Head of Financial Stability Grant Spencer

Assistant Governor Head of Operations Don Abel

D E PA R T M E N T / H E A D S

external functions

Economics

• Monetary policy formulation

Financial Markets Simon Tyler

• Market operations • Foreign reserves management

Prudential Supervision Toby Fiennes

• Financial system surveillance and policy

Currrency and Building Services Alan Boaden

• Currency operations

• Property management • Security

Financial Services Mike Wolyncewicz

• Settlement services • Registry and depository services

• Accounting services • Treasury services

Knowledge Services Tanya Harris

• • • •

Human Resources Lindsay Jenkin

• Human resources strategy and services

Communications/ Board Secretary Mike Hannah

Risk Assessment and Assurance Steve Anderson

12

•

D E PA R T M E N T S T R U C T U R E

internal services

Library services Technology services Project management Web publishing

• Communications strategy and services • Reputation management • Board secretariat

• Risk assessment and assurance • Audit services • Legal services

Board of Directors N on - executive

2

1

3

Dr Arthur Grimes

4

1

5

Paul Baines

6

3

7

8

Sir John Goulter2 DCNZM JP

5

Chair Reserve Bank of New Zealand

Company Director

Company Director

Board of Directors

Corporate interests • Barnardos New Zealand – Chair • EDS (New Zealand) Pension Fund Limited – Director • Fletcher Building Limited – Director • Todd Capital Ltd – Director • Todd Corporation Limited – Director

Corporate interests • Ngapuhi Asset Holding Company Ltd – Chairman • NZ Business and Parliament Trust – Chairman • Opua Commercial Estate Ltd – Director • Packard House Ltd – Director • Paraparaumu Airport Ltd – Chairman • Television New Zealand Ltd – Director

Other interests • Chamber Music New Zealand – Trustee • New Zealand Institute of Economic Research – Board Member • New Zealand School of Music Limited – Director • Queen Margaret College Foundation – Trustee

First appointed 9 February 2000 – current term expires 8 February 2010

Economist Corporate interests • The Hugo Group Ltd – Chair Other interests • GT Research & Consulting – Principal • Motu Economic & Public Policy Research Trust – Senior Fellow • National Infrastructure Advisory Board – Member • Reserve Bank Superannuation Fund – Trustee • University of Waikato – Adjunct Professor of Economics • Victoria University of Wellington – Member, Tax Working Group • Wellington Jazz Trust – Trustee First appointed 3 March 2002 – current term expires 12 March 2012 Alison Paterson QSO Deputy Chair Reserve Bank of New Zealand Board of Directors Chair Reserve Bank of New Zealand Board of Directors’ Audit Committee Company Director Corporate interests • Abano Healthcare Group Limited – Chair • BPAC NZ Limited – Chair • Metrowater Limited – Director • NGC Holdings Ltd – Director • Vector Limited – Director • Works on Paper Ltd – Director • Xenos Limited – Chair Other interests • Ambulance New Zealand – Chair, Oversight Committee • Centre of Research Excellence Growth and Development, University of Auckland – Chair Governing Board • Massey University Council – Member • Nga Pae o te Maramatanga (Maori CORE University of Auckland) – Director

2

First appointed 1 July 1999 – term expired 30 June 2009 Hugh Fletcher

Dr Chris Eichbaum

6

University Lecturer • Senior Lecturer (Public Policy), School of Government, Victoria University of Wellington First appointed 1 August 2008 – current term expires 31 July 2013

4

Company Director

Dr Marilyn Waring

Corporate interests • Fletcher Building Limited – Director • IAG Finance (New Zealand) Limited – Director • IAG New Zealand Holdings Limited – Chair • IAG New Zealand Limited – Chair • Insurance Australia Group Limited – Director • NGC Holdings Ltd – Director • NZI Staff Superannuation Fund Nominees Ltd – Director • Rubicon Forests Ltd – Director • Rubicon Limited – Director • Vector Limited – Director

University Professor • Professor of Public Policy, Auckland University of Technology • Canadian Index of Well Being – Board Member • AUT Economic Development Centre Board – Board Member • Institute of Judicial Studies – Board Member • Association of Women’s Rights In Development – Treasurer

Other interests • Dilworth Trust – Trustee • L.E.K. Consulting – Member New Zealand Advisory Board • University of Auckland Council – Member • University of Auckland Foundation – Member

Company Director

First appointed 10 June 2002 – current term expires 9 June 2012

First appointed 1 February 1995 – current term expires 31 January 2010

7

First appointed 4 February 2004 – term expired 3 February 2009 Sue Sheldon CNZM

8

Corporate interests • Christchurch International Airport Limited – Deputy Chairman • Contact Energy Limited – Director • Electronic Transaction Services Limited – Director • Freightways Limited – Director • Smiths City Group Limited – Director • Wool Grower Holdings Limited – Director • Wool Industry Network Limited – Chairman Other interests • National Provident Fund Board of Trustees – Chairman • Sue Sheldon Advisory Limited First appointed 1 May 2009 – current term expires 30 April 2014

2

E xecutive

S ecretariat

Dr Alan Bollard Governor

Mike Hannah Board Secretary

After balance date, Sir John was appointed Chairman of Northland Deepwater JV Limited.

BOARD OF DIRECTORS

•

13

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Gov e r n a n c e Authority and accountability The Reserve Bank of New Zealand is wholly owned by the New Zealand Government. The Bank’s authority, funding and accountability are based on: • the Reserve Bank of New Zealand Act 1989, which specifies the Reserve Bank’s functions and duties; • the Policy Targets Agreement (PTA), a written contract

The posts of Governor and Deputy Governor are required by statute, the current Deputy Governor also being the Head of Financial Stability. In addition, the Head of Operations and the Head of Economics are currently designated Assistant Governors. The Governor receives advice from a number of internal committees within the Bank. These are: • the Senior Management Group, which meets weekly to

between the Minister of Finance and the Governor detailing

consider the management and day-to-day operation of

the monetary policy outcomes that the Bank is required to

the Bank;

achieve; • the Bank’s Funding Agreement, a five-yearly agreement between the Governor and the Minister of Finance that specifies how much of the Bank’s income can be retained by the Bank to meet its operating costs; and • the Statement of Intent, an annual three-year statement provided to the Minister of Finance covering the Bank’s operating environment, functions, objectives and strategies for the three years, and projected income and expenditure for the first financial year. The Reserve Bank also subscribes to a statement of its Vision and Values. These can be found on the inside front cover.

The Governor

• the Monetary Policy Committee, which meets weekly to advise the Governor on economic and financial market developments; • the Official Cash Rate Advisory Group, which advises the Governor on monetary policy decisions, typically eight times a year;3 • the Financial System Oversight Committee, which meets fortnightly to consider policy issues relating to the financial system; • the Asset and Liability Committee, which meets monthly to consider balance sheet management and related risks; and • the Communications Committee, which meets weekly to consider communications issues and the Bank’s credibility and reputational interests.

The Reserve Bank Act makes the Bank’s Chief Executive – the

A committee comprising representatives of these committees was

Governor – accountable for the Bank’s actions. In monetary

formed during the year to advise the Governor on developments

policy, and in most other matters, decision-making authority

and policy responses to the global financial crisis.

resides with the Governor. The Governor is appointed for a fiveyear term. The Act sets specific criteria for the appointment, reappointment, and dismissal of a Governor. The current Governor, Dr Alan Bollard, took up his appointment in September 2002 and was reappointed in May 2007 to a further five-year term expiring in September 2012.

Board of Directors The Reserve Bank has a Board of Directors, the membership of which is shown on pages 13. Under the Act, the Board of Directors must comprise not less than five and not more than seven non-executive members, who are appointed for five-year

Management structure

terms by the Minister of Finance. In addition, the Governor is a

The Bank’s senior management team is made up of the

is appointed by the non-executive directors for a renewable term

Governor, a Deputy Governor, a Head of Financial Stability, a

of 12 months. The current Chair is Dr Arthur Grimes.

Board member. The Chair must be a non-executive member, and

Head of Operations, a Head of Economics, and the heads of the Bank’s various departments, as outlined on page 12. 3

14

This group also includes the Bank’s two part-time external monetary policy advisers, who provide outsiders’ perspectives to mitigate the risk of narrow information sources. At year’s end, the two external advisers were Ms Bronwyn Monopoli and Mr Earl Rattray.

•

GOVERNANCE

The Board’s primary function is to monitor the performance

The Bank publishes an annual Statement of Intent and an

of the Governor and the Bank, on behalf of the Minister of

Annual Report, which report on governance, corporate

Finance. The Board provides the Minister of Finance with

objectives, strategies, key performance indicators and

an annual assessment of the Bank’s performance, which is

performance. It releases a quarterly Monetary Policy Statement,

reproduced on pages 6-9. It has the responsibility to confirm that

which explains current monetary policy and provides detailed

Monetary Policy Statements are consistent with the Policy Targets

economic projections. It also publishes a six-monthly Financial

Agreement. It receives the six-monthly Financial Stability Reports.

Stability Report, assessing the robustness of the New Zealand

The Board performs its role through regular meetings at which

financial system. On our website (www.rbnz.govt.nz), a

it receives extensive briefings on the Bank’s activities, decisions

Statement of Principles summarises our bank registration and

and policies. At these meetings, the Board also provides advice to

supervision policies.

the Governor. The Board does not direct Bank policy, monetary or otherwise.

We also make information on our policies and activities widely available via an extensive website, quarterly Reserve Bank

When required, the Board makes recommendations to the

Bulletins, research papers, discussion papers, speeches, media

Minister of Finance on the appointment or reappointment of

interviews and brochures.

the Governor. If it believes that the Governor’s performance, in meeting the requirements of the PTA or in carrying out

Financial management

his or her other duties, has been ‘inadequate’, then it can

Financial management overview

recommend to the Minister of Finance that the Governor be dismissed. The Board also appoints the Deputy Governor on the recommendation of the Governor.

Foreign reserves management, New Zealand dollar liquidity management and currency operations materially impact the size and structure of the Bank’s balance sheet as well as its financial

The Board of Directors’ Audit Committee monitors the external

performance. The nature and extent of the Bank’s principal

and internal audit functions. The Committee also receives

financial activities are described in more detail in the financial

reports from the Bank’s external auditor and reviews the Bank’s

statements on pages 56 to 106.

annual financial statements. Directors on that committee during the year were Mrs Alison Paterson (Chair), Mr Paul Baines, Mr Hugh Fletcher, Sir John Goulter and Ms Sue Sheldon (from 1 May 2009).

The Governor is responsible for the Bank’s financial management. He decides on its financial management strategy and he makes all key financial management decisions after consulting the Bank’s Asset and Liability Committee. Implementation of strategic

The Board of Directors held nine scheduled meetings and

decisions is delegated to the Financial Markets Department. The

the Audit Committee three scheduled meetings, as well as

Board’s role is to provide advice to the Governor and to monitor

considering and advising on additional information during

the Bank’s financial performance.

the year.

Parliamentary scrutiny

The Bank’s financial performance is primarily impacted by: • The size and performance of the Bank’s foreign reserves

The Bank’s activities are scrutinised by Parliament’s Finance

management and domestic market operations functions. This

and Expenditure Select Committee. Typically, hearings are

includes management of the Bank’s open foreign exchange

held covering the quarterly Monetary Policy Statements, the

position, as well as provision of New Zealand dollar liquidity to

six-monthly Financial Stability Reports, and the Bank’s annual financial performance.

Public accountability

participants in the domestic financial system. • Changes in both foreign exchange rates and interest rates. • The extent of available funds in the form of equity and currency in circulation4.

An important aspect of the governance of the Bank is its transparency.

4

No interest is paid on currency in circulation. When notes and coins are issued to a trading bank, the trading bank will pay for the currency that is issued by paying funds to the Reserve Bank from that bank’s exchange settlement account with the Reserve Bank. The Reserve Bank invests the proceeds it receives, and the earnings on those investments are known as “seignorage”.

GOVERNANCE

•

15

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Funding of the Bank’s operations The Bank’s main source of income is the return on the substantial

Statement of dividend principles

investments the Bank holds, which are funded by the issue of

The Bank should maintain sufficient equity for the financial

currency and by the government’s equity contribution to it.

risks of performing its functions. Equity in excess of that required to cover those risks will be distributed to the Crown.

Under the Act, the Minister of Finance and the Governor are required to enter into a Funding Agreement to specify the

In general, unrealised gains should be retained by the Bank

amount of the Bank’s income that may be used to meet expenses

until they are realised in New Zealand dollars. However, the

in each financial year. The Funding Agreement comes into force

Bank may recommend the distribution of unrealised gains

only after it is ratified by Parliament. The Act provides for each

where the Bank believes that the probability of the gain being

Funding Agreement to apply for a period of five consecutive

realised is high.

financial years. This contrasts with the arrangements for

Each year the Bank makes a recommendation to the Minister

government departments, which are funded on an annual basis.

of Finance of the amount to be paid as a dividend. The Minister

The Bank’s funding arrangements are designed to strike an

decides how much should be paid having regard for the

appropriate balance between providing a high degree of

recommendation of the Bank, the views of the Board of the Bank

operational independence, and providing strong incentives for

and any other relevant matters.

effective management of operating expenditure, while ensuring accountability for use of resources. Capital expenditure is funded by the Bank, with depreciation of fixed assets included in annual

Risk management The Bank faces a wide range of risks, some general and others

operating expenses. If operating expenses (net of specified

unique to central banks. Of these, the most fundamental risk

revenue) in any year exceed the amount provided in the funding

is making policy errors in relation to monetary policy, or the

agreement, the Bank will fund that excess from equity.

financial or banking systems, thereby causing damage to the

The current Funding Agreement covers the five years ending

economy and to the Bank’s reputation and credibility. Other more

30 June 2010. The Funding Agreement was amended in April

specific risks include:

2008 by increasing the approved level of net operating expenses

5

for 2008-09 from $41.0 million to $43.3 million and that for 2009-10 from $43.0 million to $46.9 million. These changes were required to fund increased policy advice responsibilities and activities associated with greater oversight of non-bank financial institutions.

• credit and interest rate risks associated with our day-to-day liquidity management in domestic financial markets; • risks associated with holding foreign currency reserves, including credit, interest, and exchange rate risks; • risks associated with processing and storing currency, including risks of theft and robbery;

Annual distributions paid by the Bank Amendments were made to the Act in 2008, which established a new framework governing payment by the Bank of an annual dividend to the Crown. Until 2008, the Bank’s dividend was determined using a formula-based approach (i.e., the Act previously contained the formula, known as ‘notional surplus income’, for calculating the annual dividend the Bank recommended to the Minister each year). From 2009, the Bank’s dividend is determined using a principles-based approach. The concept of ‘notional surplus income’ was removed from the Act and, instead, the Act requires the Bank to publish in its Statement of Intent a statement of dividend principles that it must apply in determining its dividend recommendation each year. The Bank’s statement of dividend principles is shown below. 5

16

• risks associated with the operations of payments systems, which can arise from technical faults; and • risks associated with being a small organisation, such as the loss of key staff. The Bank sees risk management as an integral part of the general management task and the responsibility of day-to-day management. The Bank has two units with specific responsibilities in relation to monitoring and managing risk. These are: The Bank’s Risk Assessment and Assurance Department, which is responsible for providing advice on and monitoring the Bank’s risk management frameworks. The internal audit role also resides with this department.

Net operating expenses exclude costs associated with financial instruments such as interest and valuation changes due to movements in interest rates and foreign exchange rates. Also, net operating expenses are determined after netting off certain operating revenue such as rental income and fees for provision of payment services.

•

GOVERNANCE

A Risk Unit within the Bank’s Financial Markets Department,

to the Board, directors sign a declaration that they will observe

which provides specialised advice on financial market risk

confidentiality in relation to the affairs of the Bank and will not

management. This includes recommendations on interest rate,

make use of any confidential information they may acquire

credit and liquidity risk limits, and the reporting of specialised

regarding Bank operations. They also provide lists of their other

measures of financial risk.

directorships and major interests in relation to which they

A Business Continuity Planning strategy has been adopted, with a number of initiatives completed, including a decision to establish an Auckland office to mitigate business support risk

would not wish to receive relevant Board papers or participate in discussions.

in the event of a regional disaster in Wellington. In addition,

Governors’ interests

succession planning is a management priority.

The Governors note the following related interests. In each

The Board and its Audit Committee also contribute to the review of the Bank’s risk management processes.

case, appropriate steps have been taken to ensure that no conflicts arise: • Dr Bollard: The interests of his wife, Jenny Morel, in No 8

Conflicts of interest

Ventures Management Limited.

The Bank maintains policies and practices to avoid or manage

• Mr Spencer: None.

conflicts of interest among all Bank staff, including Governors

• Dr Abel: None.

and directors. The policy requires that all staff act honestly and

• Dr McDermott: None.

impartially, and in no circumstances reveal or make private use of confidential, market-sensitive information. The policy states

Management and monitoring processes

that staff must avoid situations where their integrity might be

Within the Bank, all activities and expenditure must be

questioned, and that their best protection is full disclosure of any potential conflicts.

authorised and in accordance with a comprehensive set of Bank policies and procedures. The Board receives monthly reports

Governors and departmental managers are required to provide

comparing actual outcomes against budget, prepared by the

the Bank with regular updates as to their personal interests, so

Bank’s Financial Services Group. Departments are required

that any potential conflict of interest is recorded. This is done

to provide regular reports that describe progress to date on

quarterly. If any other staff have a particular concern, they can

outputs and projects, and to explain any significant variances.

also record their interests in the same way.

The expenses of the Governor are reviewed by the Chair of the

Staff must not be personally involved, directly or indirectly, in regular trading in wholesale financial markets in which the Bank has, or might have, a significant influence. This includes domestic

Board of Directors’ Audit Committee. Bank involvement in the management of reserves and liquidity is controlled by specific dealing authorisations. Outcomes are watched closely.

wholesale money, bond and foreign exchange markets, interest

The internal audit function within the Bank is performed by

and exchange rate futures, options and swaps markets, and

its Risk Assessment and Assurance Department. The Bank is

instruments linked to shares of regulated entities. At no time

audited externally by the Auditor-General, who has contracted

can Reserve Bank staff own or control shares in entities (or their

PricewaterhouseCoopers as his agent. In addition, the Minister of

parent companies) that the Reserve Bank regulates. The policy

Finance can order a performance audit.

states that staff must not use inside information to benefit when depositing or withdrawing funds from financial institutions, or purchasing or selling bonds or shares, or when changing between fixed and floating rates for a loan. It is unacceptable to use inside information, whether to avoid losses or to make gains. Under sections 56 and 61 of the Reserve Bank Act, the Minister must have regard to the likelihood of conflict of interest in appointing a director to the Board, and directors must disclose their interests in any contract with the Bank. On appointment

GOVERNANCE

•

17

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

C HR O N O L O GY Monetary policy and monetary conditions 2008/09

TWI INDEX

OCR, 90-DAY %

80

9 90 Day Rate (RHS) 8 Official Cash Rate (RHS)

70

7

6

5

60

4 Trade Weighted Index (LHS) 3

50

2

CPI 5.1% 40

JULY 08

AUG 08

SEP 08

CPI 3.4% OCT 08

NOV 08

DEC 08

24 July

21 August

3 September

9 October

1 November

4 December

The Reserve Bank reduces the OCR to 8.0 percent.

The Reserve Bank issues the first of several statements over coming months assuring markets that the New Zealand financial system is sound in the face of turbulence in overseas markets.

The Reserve Bank Amendment Bill (No 3) is passed, making the Reserve Bank the regulator of NBDTs.

The Reserve Bank broadens its liquidity management to lend on the basis of fullysecured Residential Mortgage-Backed Securities.

The Minister of Finance announces a Crown wholesale funding guarantee facility.

The Reserve Bank reduces the OCR to 5.0 percent.

11 September

The Reserve Bank reduces the OCR to 7.5 percent.

12 October

The Minister of Finance announces a Crown retail deposit guarantee scheme covering deposits for New Zealandregistered banks and eligible NBDTs. 23 October

The Reserve Bank reduces the OCR to 6.5 percent.

12 December

The Reserve Bank launches a Term Auction Facility and Reserve Bank bill tenders to support banking system liquidity.

The Reserve Bank further extends the range of securities eligible for acceptance in its domestic liquidity operations, to support debt markets and financial system liquidity.

12 November

19 December

The Reserve Bank releases its November 2008 Financial Stability Report.

The Reserve Bank releases a consultation paper on policies for NBDTs’ related-party requirements and minimum capital ratio framework.

7 November

19 December

An amended Policy Targets Agreement is signed by the Minister of Finance and Reserve Bank Governor Alan Bollard.

18

•

CHRONOLOGY

1

Monetary policy and monetary conditions 2008/09

TWI INDEX

OCR, 90-DAY %

80

9

8 70

7 Trade Weighted Index (LHS)

5

60

4

90 Day Rate (RHS)

3

50 Official Cash Rate (RHS)

2

CPI 3.0% 40

6

JAN 09

FEB 09

MAR 09

13 January

17 February

The Bank announces regular Tuesday Open Market Operations to accept corporate and asset-backed securities.

The Reserve The Reserve Bank Bank releases a reduces the OCR to consultation paper on 3.0 percent. a credit ratings policy for NBDTs.

29 January

The Reserve Bank reduces the OCR to 3.5 percent.

12 March

CPI 1.9% APR 09

MAY 09

Graph 1

20 April

13 May

11 June

The Reserve Bank releases a draft Insurance (Prudential Supervision) Bill for consultation.

The Reserve Bank releases its May 2009 Financial Stability Report.

The Reserve Bank leaves the OCR unchanged at 2.5 percent.

30 April

The Reserve Bank reduces the OCR to 2.5 percent.

1

JUN 09/JUL 09

30 June

The Reserve Bank releases a prudential liquidity policy for banks. After balance date 30 July

The Reserve Bank leaves the OCR unchanged at 2.5 percent.

CHRONOLOGY

•

19

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

The year in review Mo n e t a r y p o l i c y f o r m u l a t i o n The Objective of the Monetary Policy Formulation function is: • To achieve and maintain stability in the general level of

Economy The New Zealand economy has shrunk 3 percent since the beginning of 2008, as a result of subdued trading partner growth, tighter credit conditions and a sharp drop in confidence.

prices. A published Policy Targets Agreement (PTA) requires

The manufacturing and construction sectors have borne the

the Bank to maintain inflation, as measured by the

brunt of the domestic contraction.

Consumers Price Index (CPI), between 1 and 3 percent per annum on average over the medium term. It also requires that: “In pursuing its price stability objective, the Bank shall ... seek to avoid unnecessary instability in output, interest rates and the exchange rate.”

A weak global economy has resulted in sharp declines in international commodity prices and the price of imported goods, which had pushed down tradables inflation. This has seen CPI inflation fall sharply from 5.1 percent in September 2008 to 1.9 percent by June 2009. There have also been signs of an easing in

In our 2008-11 Statement of Intent, we undertook to deliver the following:

underlying inflation and inflation expectations.

Outcome

pressures. Firms reported less difficulty in finding staff, leading

• Stability in the general level of prices.

Initiatives and strategies • Maintain a range of best-practice structural and statistical models for use in forecasting and policy analysis. • Deepen the Bank’s understanding of the inflation process in New Zealand, including price and wage formation; expectation formation and learning; the impact of commodity markets and prices, resource pressures and the international economy; and options for alternative instruments. • Improve the quality, accessibility, relevance and reliability of

The drop in underlying inflation reflects a sharp easing in capacity to lower labour costs. In addition, the increased uncertainty households faced in the labour market and a falling housing market has limited consumer spending over the past financial year, despite tax cuts and lower petrol prices. Lower consumption is playing a key role in the beginning of a rebalancing in the New Zealand economy. Monetary policy has remained focussed on ensuring that mediumterm inflation settles comfortably within the 1 to 3 percent target band. Given the abatement in inflation pressures, the Reserve Bank aggressively eased monetary policy over 2008-09, cutting the OCR by 5.75 percentage points. This response was consistent with our inflation objective while stabilising output.

Reserve Bank statistics.

INFLATION ANNUAL PERCENT CHANGE

And our performance would be measured by: Key performance indicators

5

5

4

4

• Reserve Bank forecasts of CPI inflation – expected to be comfortably within the target range in the second half of • Measures of underlying inflation should generally lie within the target range.

3

(%)

the three-year forecast horizon.

TARGET RANGE

3 2

2

1

1

0

0

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

exchange rate should be avoided.

1995

• Unnecessary instability in output, interest rates and the

Graph 2

20

•

THE YEAR IN REVIEW

How we performed – Key performance indicators The Monetary Policy Statement is the full assessment and accountability document for our monetary policy key performance indicators. As the intense cost pressures have abated over the past financial year, we have not faced the

We completed the first phase of the development of FSIS, a database for economic and financial statistics. The system will be implemented throughout the Bank later this year, and will improve not only the quality of statistics produced by the Reserve Bank, but also analysts’ awareness and access to the vast volume of data we hold.

choice of suppressing output growth to bring down inflation.

During the financial year, Parliament’s Finance and Expenditure

As a result, the aggressive easing in monetary policy has been

Committee reported back on its Inquiry into the Future Monetary

consistent with achieving our key performance indicators,

Policy Framework. The Committee’s recommendations included

with inflation brought back within the target band whilst

several consistent with those in our submission, namely:

stabilising output.

How we performed – Initiatives and strategies During the year, we improved our forecasting process, completing the development of a new macroeconomic model called KITT (Kiwi Inflation Targeting Technology), which captures statistical forecasting models and research into behaviour at the individual household and firm level. The new model will soon replace the current Forecasting and Policy System model,

a. Encourage further work by the relevant agencies to ensure that housing land supply and the development of new subdivisions is not unduly restricted by regulatory or administrative constraints. b. Review the taxation of investment income and the tax treatment of the financing of the purchase of investment assets. c. Encourage the development of a framework under which

which is now more than 10 years old. The KITT model offers

higher thresholds are in place before substantial increases in

several advantages: it covers many sectors, helping to show

government spending (or tax reductions) occur at times when

how monetary policy transmits through activities by households

demand pressures are intense.

and firms; it feeds both demand- and supply-side factors into our inflation forecasts; it is an estimated model, so allowing for uncertainty in our forecasts, complementing a wide range of other information to build up a cohesive picture of the economy. Our research during the year added to our understanding of the inflation process. We analysed possible demographic drivers of

d. Consider whether variations in new migrant approvals could be used as a supplementary tool. e. Allocate additional resources to improve the overall range, quality and timeliness of New Zealand’s macroeconomic statistics.

household inflation perceptions, helping our understanding of how the public form views about future economic outcomes. We looked into how firms respond to the impact of exchange rates on exports through their pricing and hedging. We also used household data to evaluate what drives the strong relation between house prices and consumption. Over the past financial year, we have monitored the international economy more closely, engaging in more independent research and examining a number of issues in depth. This assisted our forecasting. We have also strengthened relationships and information sharing with other central banks.

THE YEAR IN REVIEW

•

21

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Financial markets Domestic markets/ Foreign reserves management The Objectives of the Domestic Markets and Foreign Reserves Management functions are: • To support the effective implementation of monetary policy. • To assist in the efficient functioning of the New Zealand financial system. • To manage official foreign reserves; and to provide effective support and execution for the Bank’s foreign exchange market intervention policy. • To manage the Crown’s financial liquidity. • To maintain an effective crisis intervention capability.

And our performance would be measured by: Key performance indicators • Short-term wholesale interest rates should be relatively stable and maintained at levels consistent with the OCR. • No evidence of payment failures due to shortage of cash in the banking system. • Stabilising market operations are expected over the medium term to generate a positive return for the Domestic Markets function. • Foreign reserves held at the level agreed with the Minister. • Foreign reserves held in a liquid and secure form, suitable for foreign exchange market intervention. • The net return from foreign reserves management meets or exceeds the agreed benchmark.

In our 2008-11 Statement of Intent, we undertook to deliver the following:

How we performed – Key performance indicators

Outcomes

The Reserve Bank operates regularly in the financial markets to

• Adequate liquidity in the New Zealand banking system to

implement monetary policy, to manage the government’s foreign

facilitate payments. • Confidence in the efficient functioning of New Zealand financial markets. • Short-term interest rates consistent with the Bank’s monetary policy stance. • Foreign reserves readily available for foreign exchange intervention and crisis management. • Any foreign exchange market intervention conducted efficiently.

Initiatives and strategies To assist in the formulation and implementation of the Bank’s liquidity policy to be applied to New Zealand-registered banks.

reserves and to ensure an adequate level of liquidity in the banking system.

Domestic markets It has been a tumultuous year in the global financial markets, with unprecedented volatility in global money markets being transmitted into pressure on local money markets. The subprime mortgage crisis, which began in August 2007, intensified through 2008. New Zealand money markets were affected via global money markets, which became progressively more stressed and dysfunctional as lenders became cautious and unwilling to lend funds. In terms of specific Key Performance Indicators: • New Zealand banks obtain a significant portion of their funding in offshore markets, thus, as liquidity became scarce

To complete (in conjunction with Financial Services Group) the

offshore, New Zealand money markets also became tighter.

review of the Bank’s balance sheet and continue to implement

The Bank responded initially by temporarily increasing the

the changes in the balance sheet so that it can best meet the

amount of settlement cash provided to the banking system.

statutory requirements of the Bank (including monetary policy, currency, bank liquidity and foreign reserves).

• However, the failure of Lehman Brothers in the US saw offshore money markets almost break down completely, making it difficult for our banks to source funds for any

22

•

THE YEAR IN REVIEW

Foreign reserves management

significant length of time. We adjusted and expanded our liquidity operations significantly (see box 1 for details).

• The ongoing financial crisis has been an important driver of

New Zealand money market interest rates varied widely in 2008 before our enhanced liquidity facilities took effect and markets settled down (see graph 3). The outcomes were

holdings of foreign reserves over the year as a precaution against the heightened possibility of foreign exchange market

consistent with our key performance indicator to ensure short-term interest rates are “relatively stable and maintained at levels consistent with the OCR”.

dysfunction (see graph 4). Foreign reserves have been held within the range agreed with the Minister of Finance, in line with our key performance indicator. Later in 2008, the Bank negotiated a swap line for US$15 billion with the Federal

THE COST OF OVERNIGHT FUNDING

Reserve Bank of New York to give us greater capacity to fund

16

16

local financial institutions in US dollars, after US dollar money

14

14

markets broke down in the wake of the Lehman failure. This

12

12

swap line will remain in place until at least 1 February 2010.

10

10

8

8

6

6

4

4

2

2

0

0

(%)

INTERVENTION CAPACITY year to 30 june 5.0 4.0 SDR Billions 6

Nov 07 Dec 07 Jan2 8 Feb 08 Mar 08 Apr 08 May 08 Jun 08 Jul 08 Aug 08 Sep 08 Oct 08 Nov 08 Dec 08 Nov 07 Dec 07 Jan 09 Feb 09 Mar 09 Apr 09 May 09 Jun 09 Jul 09

(%)

activity in foreign reserves this year. The Bank increased its

KEY

Overnight FX Swaps

3.0 2.0

NZ Call money market rate OCR

1.0

Graph 3

• In general, the Bank’s cashed-up system proved flexible enough to adequately deal with the dysfunctional global

0 KEY

2005

money markets. Despite the significant variability of interest

Committed credit lines

rates at times during the year, our banks still had sufficient

Foreign reserve assets

cash to make payments and to settle transactions. This is in contrast to other markets where transaction settlement failures increased to historically high levels (e.g., in the US government bond market). • The pressure on money markets saw significant demand

2006

2007

2008

2009

SDR Minimum

Graph 4

• The Bank also adjusted the composition of its foreign reserves portfolio to make the portfolio more liquid and of a higher average credit quality. We gradually reduced our holdings of short-dated bank and corporate paper and replaced those

for the Bank to both lend and take deposits from private

investments with either government securities or certificates

sector banks. The relatively strong credit standing of the

of deposit issued by AAA-rated governments or government-

Bank, and our ability to lend New Zealand dollar funds, in an

backed supranational entities.

environment where long-term funds particularly were difficult to obtain, resulted in the Bank making unusually large profits from domestic market operations this year. 6

A Special Drawing Right (SDR) is the unit of account of the International Monetary Fund and some other international organisations. Its value is based on a basket of key international currencies.

THE YEAR IN REVIEW

•

23

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

C omposition of reserves

R eserves profitability

FOREIGN RESERVES ASSET ALLOCATION BY INSTRUMENT

return on foreign reserves management including open fx position

100 500

80 70

400

60 NZD Millions

50 40 30 20 10

300 200

Jun 09

May 09

Apr 09

Mar 09

Feb 09

Jan 09

Dec 08

Nov 08

Oct 08

Sep 08

100 Aug 08

0

Jul 08

% OF TOTAL FOREIGN RESERVES

90

KEY

0 KEY

Other CD’s (Bank & Corporate)

Reverse Repo

AAA Supra CD’s

T-BIlls

P&L Graph 5

2005

2006

2007

Budget – Benchmark

2008

2009 Graph 6

How we performed – Initiatives and strategies

• Overall returns from foreign reserves have been relatively

As well as our crisis-related activities, we completed projects

strong this year, largely because the weaker New Zealand

related to the review of our balance sheet. We increased the

dollar increases the New Zealand dollar value of our foreign

flexibility and range of tools the Bank has to deal with emerging

currency investments, while the value of the New Zealand

issues in markets, as could be seen by our ability to quickly boost

dollar liabilities funding those assets has remained unchanged.

the level of reserves as a precautionary measure, and by the

To some extent, these foreign exchange gains have been

presence of the open foreign exchange position, which would

offset by higher ongoing carrying costs of holding reserves,

have positioned us well for any significant dislocation in the

reflecting the move from higher-yielding bank paper to

foreign exchange market.

lower-yielding but more liquid government/supranational investments. Foreign reserves profitability relative to benchmark has been strong this year as the New Zealand dollar has fallen while the Bank was holding an open foreign exchange position larger than the SDR 1000 million benchmark position, meeting our key performance indicator on the returns on foreign reserves. The Bank moved to reduce the size of its foreign exchange position and realise some gains last year, once the New Zealand exchange rate fell to lower levels.

24

•

THE YEAR IN REVIEW

Other initiatives undertaken on our balance sheet are described in box 1 on page 25. Work on the Bank’s liquidity policy is described on page 28.

B ox 1

L iquidity management and the B ank ’ s balance sheet

The Bank operates a ‘cashed-up’ liquidity management system, where we provide the banking system with

A ssets

L iabilities

D omestic M arkets I nvestments

sufficient cash for banks to make payments between

• Reverse Repos

each other during the day. This is different to the systems

• FX Assets8

used elsewhere, where banks borrow cash intra-day to

• Government securities

satisfy their payments needs. Banks require significant

• B ank S ettlement A ccounts

Table 2

amounts of cash to make all of their payments between each other during the day, hence their combined demand

The banking system’s demand for settlement cash varies

for settlement cash is large. During the last year, total

over time, reflecting various factors including:

bank settlement account balances have ranged between NZ$6,500 million and NZ$12,000 million. We pay banks interest on their settlement account balances at the OCR7 – thus, from our perspective, settlement accounts are a liability accruing daily interest at the OCR. The cash is provided to the banking system by the Bank using various instruments depending on market demand, including through the purchase of foreign currency investments (hedged back into New Zealand dollars using FX swaps), reverse repos on New Zealand dollardenominated eligible collateral via the Bank’s open market operations, and sometimes also via the purchase of New Zealand government securities from market participants. Table 2 shows a stylised view on how the Bank’s domestic market operations are represented on our balance sheet.

• the relative rate of return of cash held at the Reserve Bank compared to other high-quality liquid investments; • banks’ estimates of the amount of cash they each require to settle transactions on behalf of customers; and • precautionary demand for cash, which depends on the volatility of markets and the availability of funding in money markets. One of the effects of the financial crisis on the banking system in New Zealand was that banks’ access to funding tightened in international markets. This had flow-on effects here – in particular, individual banks became more conservative regarding whom they would lend cash to, and preferred to hold on to cash and leave it in their account at the Reserve Bank as opposed to lending cash to other banks. This led to an increase in interest rates relative to the OCR, which in turn saw us increase the amount of cash made available to the banking system to offset the pressure on interest rates. Another impact on our operations was that we were required to change the types of instrument used to inject cash into the local banking system. Generally, as our banks raise a significant amount of their funding offshore, they prefer to transact FX swaps with the Bank – turning the foreign exchange raised offshore into New Zealand dollars, which are lent to customers in New Zealand.

7

The Bank pays the OCR to banks on balances up to a fixed amount (called a ‘tier’) that varies across banks depending on the size of the bank and the scale of its average payments requirements. Balances in excess of the tier amount accrue interest at 100 points below the OCR. The lower level of interest rates for balances in excess of banks’ tiers tends to mean that banks keep their account balances below their maximum tier amounts.

8

FX swaps used in conjunction with this investment to hedge the foreign exchange risk back to New Zealand dollars.

THE YEAR IN REVIEW

•

25

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009

B ox 1

WEATHERING THE STORM

However, for a while in late 2008/early 2009, the offshore

Much of this collateral was in the form of newly created

money markets were difficult for New Zealand banks to

New Zealand AAA-rated Residential Mortgage Backed

access. Hence, the banks changed the way they funded

Securities. The Bank lent up to around NZ$7,000 million

themselves from using the foreign money markets to

in funds to the local banks in the TAF from October 2008

using the local money market by taking New Zealand

to March 2009, while offshore money markets were

dollar-denominated assets, such as registered bank bills

particularly dysfunctional.

or New Zealand government securities, and giving them to us as collateral in return for New Zealand dollars via reverse repo transactions.

Left alone, the TAF would have led to a significant increase in settlement cash in the system. Banks were looking for term funding, not overnight cash, which they

For a while after the failure of Lehman Brothers in

had plenty of. So the TAF would have left the system

the US, the commercial paper markets in the US were

with an overhang of short-term cash, which would

essentially closed to the New Zealand banks for loans of

have pushed overnight interest rates down significantly

any significant maturity beyond about one month. Banks

below the OCR. We offset this potential overhang by

require funding for longer than a month to effectively

reintroducing Reserve Bank bill sales to take out the cash

offer customers loans for longer maturities. Late in 2008

being injected into the system via the TAF. Typically, the

the Bank moved to fill in this funding gap by introducing

Reserve Bank bills bought by banks were of a shorter

the Term Auction Facility (TAF), which allowed banks to

maturity than the TAF loans being made to the banks.

borrow funds from the Bank for terms up to one year

The net effect has been an expansion of the Reserve

using eligible collateral as security.

Bank’s balance sheet over the course of the year. Table 3 shows a stylised view on how the TAF and Reserve Bank bill operations affected our balance sheet. A ssets

L iabilities

D omestic M arkets I nvestments TA F loans

B ank S ettlement A ccounts R eserve B ank bills

To t a l R B N Z A s s e t s

To t a l R B N Z Liabilities

Table 3

26

•

THE YEAR IN REVIEW

Financial system surveillance and policy The Objectives of the Financial System Surveillance and Policy function are:

And our performance would be measured by: Key performance indicators

• To register and supervise banks so as to maintain a sound and efficient financial system, and to limit damage to the financial system that could result from a bank failure. • To introduce a prudential regime for the insurance sector, and implement new regulatory arrangements for NBDTs.

In our 2008-11 Statement of Intent, we undertook to deliver the following: Outcomes • A sound and efficient financial system in New Zealand. • International and local confidence in New Zealand’s financial system.

Initiatives and strategies • Develop and implement a prudential liquidity policy for banks. • Provide advice on legislation related to the regulation of NBDTs and insurers. • Produce and consult on regulations relating to NBDT regulation. • Complete the implementation of the Reserve Bank’s policy on outsourcing. • Continue to work with banks to improve their capital modelling under Basel II. • Complete the formulation and implementation of the

• Banks comply with conditions of registration and maintain the required minimum capital ratios. • Measures included in the Financial Stability Report provide a basis for assessment of the New Zealand financial system’s stability and the performance of the surveillance function. • Regular crisis exercises demonstrate the Bank’s capability to respond effectively to a crisis situation. • Frequent communication, collaboration and information sharing are undertaken with the Australian Prudential Regulation Authority, the Securities Commission and other domestic and international regulators. • The Minister is satisfied with the quality of policy advice.

Financial system environment Over the last financial year, the stability of New Zealand’s financial system has been severely tested by the continued strains in global financial markets since the middle of 2007. The worsening market turmoil prompted drastic action by governments and central banks in many countries to support their financial systems. The banking sector in New Zealand did not directly experience significant financial losses, but has been facing an increasingly challenging economic and financial environment. Asset quality has deteriorated markedly, with loan impairment expected to rise

Reserve Bank’s crisis management capabilities, assessing

further, albeit not to the same degree as has been seen in the

their robustness through failure management scenarios.

past, or has been witnessed in several other economies over the

• Contribute to the preparations for the Financial Action Task Force mutual evaluation of New Zealand.

past 18 months. While most recently the global economy has appeared more stable, and trading-partner growth forecasts have stopped falling, the near-term outlook remains uncertain. We are closely monitoring domestic credit conditions and international initiatives that may result in changes to international standards in light of the current financial crisis. Under the generally challenging macroeconomic conditions, New Zealand’s payment systems have continued to

THE YEAR IN REVIEW

•

27

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

function well. As at 30 June 2009, there were 18 registered banks in New Zealand, with Australian-based ANZ Bank Group Ltd opening a branch in New Zealand (alongside their existing subsidiary ANZ National Bank Ltd), Southland Building Society becoming a bank (7 October 2008), and ABN AMRO withdrawing from banking (29 May 2009).

How we performed – Key performance indicators Of the 18 registered banks, two have not fully complied with their conditions of registration. In both cases a process is underway to ensure durable compliance with our prudential requirements. The issues described above were discussed extensively in the

How we performed – Initiatives and strategies We have finalised the new prudential liquidity rules for registered banks, after consulting with the industry and other interested parties. The liquidity policy documents were published at the end of June 2009, and we will work with individual banks in the third quarter of 2009 to agree on new conditions of registration to bring the liquidity requirements into effect for each of them. The Bank became the prudential regulator of the non-bank deposit takers in September 2008 when the Reserve Bank of New Zealand Amendment Act 2008 was passed. The Bank has made substantial progress in developing the key components of the regime, and the relevant regulations will be introduced later in 2009 and 2010. See box 2 on page 29 for more details.

recently published Financial Stability Reports, which are the

We have also recently released a draft Insurance (Prudential

Bank’s key accountability document reporting on the soundness

Supervision) Bill for stakeholder consultation.

and efficiency of the financial system and matters related to the

All but one of the large banks are now either in compliance with,

Reserve Bank’s prudential power.

or on a path to achieving full compliance with, our outsourcing

The Financial Stability Reports also demonstrate that the Bank

policy. We are working closely with the remaining bank within an

has been closely monitoring banks for their compliance with

agreed timeline.

conditions of registration, ensuring their maintenance of the

We have completed policy work regarding improving the large

required minimum capital ratios, and assessing the wider

banks’ modelling of credit risks for farm lending. In our view,

financial sector.

the banks’ models are not currently generating sufficient capital

Our assessment is that the domestic banking system has

requirements. We are consulting with banks on amending the

remained relatively healthy. The four largest banks have also

relevant bank capital adequacy framework.

benefited from the resilience of their Australian parents, all of

In its surveillance function, the Reserve Bank has also been

which have retained high credit ratings and strengthened their

assessing the wider financial sector and refining practical

capital positions over the recent months. Funding risks are still

solutions for its crisis preparedness.

elevated, but access to offshore funding markets has eased somewhat for the major banks, partially aided by the Crown wholesale guarantee scheme, along with the Reserve Bank’s expanded liquidity facilities and easier monetary policy. The government also introduced a two-year retail deposit guarantee scheme, to provide assurance to investors at a time when investment sentiment was most fragile. Some NBDTs, especially those that have substantial investments in property development, have continued to experience difficulty in this disruptive environment. The retail deposit guarantee scheme has helped relieve some of the extreme liquidity pressures felt in the sector, and provides an opportunity for participating entities to reorganise and rebuild. The durability of the sector will be reinforced by the new prudential regime.

28

•

THE YEAR IN REVIEW

We have maintained a close working relationship with other regulators, including international agencies, on various joint programmes. We contributed to New Zealand’s response to the Financial Action Task Force evaluation of New Zealand’s compliance with its recommendation on anti-money laundering and countering the financing of terrorism. A report on this evaluation is expected to be released by the Financial Action Task Force toward the end of this year.

B ox 2

N on - bank supervision progress

The Reserve Bank expects to introduce regulations for

The capital ratio measurement framework is based on the

NBDTs later in 2009 and 2010.

standardised Basel II bank capital regime but differs in the

The Reserve Bank has been consulting on related-

following two key aspects:

party and minimum capital ratio requirements since

• only tier one capital is counted as regulatory capital; and

December 2008. A number of changes have been

• risk-weight classes are more finely differentiated by lending

made to original proposals, based on submissions received. For related-party exposures, the proposal is broadly similar to the regime for registered banks, but simplified and calibrated to the NBDT sector. It is proposed that a limit on combined credit exposures to all related parties for the deposit taker or the borrowing group must be specified in the trust deed and fixed by agreement between the deposit taker and the trustee, provided the limit does not exceed a maximum limit of 15 percent of tier one capital. It is also proposed that NBDTs will be required to have a minimum capital ratio of 8 percent if they hold a credit rating and 10 percent if they do not.

type and by security cover. In February 2009, the Reserve Bank released a consultation paper on the type of credit rating an NBDT is required to hold from 1 March 2010. The paper proposed the use of local currency, long-term, issuer ratings for NBDTs, and $20 million total liabilities as the threshold for an exemption from the requirement. Submissions received were generally supportive of the proposal. After consultation, the Bank released risk management programme guidelines in July 2009. These outline sound principles NBDTs should follow in their risk management programmes, which were required from 1 September 2009. Other upcoming developments include governance requirements and liquidity regulations. The governance requirements of each institution (except for credit unions) – to have at least two non-executive directors and a non-executive chairperson – will come into force through an Order in Council, expected around the third quarter of 2009. The draft liquidity policy is expected to be released for consultation in late 2009.

THE YEAR IN REVIEW

•

29

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Currency operations The Objective of the Currency function is:

The environment The value of currency in circulation grew strongly in 2008-09. In

To meet the currency needs of the public by ensuring the

the year to 30 June 2009, it rose by 14 percent to $3.9 billion.

supply and integrity of bank notes and coins.

The numbers of $50 and $100 bank notes in circulation rose by 25 percent and 16 percent respectively. This was due to

In our 2008-11 Statement of Intent, we undertook to deliver the following: Outcome • Legal tender that meets the currency needs of the public.

Initiatives and strategies • Develop a new information system for the management of currency operations. • Investigate possible enhanced security features for bank notes. • Finalise cash distribution arrangements in the event of a pandemic or similar disaster.

And our performance would be measured by:

the increasing use of $50 notes in ATM machines and a surge in demand for $100 notes during the financial turbulence in October 2008. We issued one million $100 notes that month – about six times the normal number for October. The rate of note issues returned to normal levels shortly after the government announced its retail deposit guarantee scheme, restoring public confidence.

How we performed – Key performance indicators Altogether during 2008-09, the Reserve Bank received 388 orders for currency for a total value of $1.9 billion. The Bank met all these orders on schedule and in the denominations requested. This helped ensure that the public’s needs for currency were met during the year.

Key performance indicators

The Bank undertook surveys of the quality of $20, $10 and

• All orders for notes and coins from banks that meet the

$5 notes in circulation. This involved collecting samples of

Reserve Bank’s guidelines are supplied within agreed times.

notes of each denomination from urban and rural areas

• Notes and coins in general circulation are of a good quality

around New Zealand. The quality of the notes was assessed by

as indicated by planned biennial surveys of the condition

examination of a number of characteristics, including ink fade,

of currency in circulation.

tears and damage to security features. The Bank set a standard

• The number of counterfeit notes in circulation should be fewer than 10 per million notes in circulation for each denomination.

30

•

THE YEAR IN REVIEW

that at least 90 percent of notes should be of good quality.

The sample results showed that all the $20 notes collected, 95 percent of the $10 notes and 75 percent of the $5 notes met the required quality standard. Five-dollar notes are often of poor quality because they tend to stay in circulation between shops and the general public more than other notes, with less handling by banks, where poor notes would be identified and sent to the

How we performed – Initiatives and strategies The development of a new Currency Management System is under way to automate data entry, to improve the tracking of currency through note-processing operations, and to upgrade reporting capabilities.

Reserve Bank for destruction. We will be investigating methods

The Bank is reviewing current security features on New Zealand

to improve the quality of $5 notes in 2009-10.

bank notes and potential new features. This is part of our

The number of counterfeit bank notes in New Zealand is very low by international standards. In 2008-09, there were 91

ongoing strategy to be well informed about developments in bank note technology.

counterfeits found by the Reserve Bank, security companies,

The Bank has agreed a set of arrangements with banks and

banks and the Police. This represents 0.71 counterfeits per million

security companies for the distribution of cash around the

notes in circulation. The rate was less than 10 counterfeits per

country in the event of a pandemic or similar emergency.

million notes for each individual denomination.

Reserves of currency are also held in Australia to be sent to New Zealand if, for example, cash in our Wellington building cannot be accessed.

16

16

14

14

12

12

10

10

8

8

6

6

4

4

2

2

0

0

2

2

-4 2003

-4

2008

THE YEAR IN REVIEW

ANNUAL % CHANGE

ANNUAL % CHANGE

CURRENCY IN CIRCULATION

Graph 7

•

31

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Depository and settlement services The Objective of the Depository and Settlement Services function is: • To ensure that payments system infrastructure services are provided efficiently and meet international standards.

In our 2008-11 Statement of Intent, we undertook to deliver the following: Outcome An efficient, reliable and secure payments system that supports the smooth functioning of the economy.

Initiatives and strategies • Continue to make enhancements to Austraclear and Exchange Settlement Account System (ESAS) as agreed with industry representatives. • Establish interfaces that will facilitate inter-operability between ESAS/Austraclear and other providers’ payment and settlement systems, to increase efficiency and meet user needs. • Continue to develop new governance arrangements for ESAS/Austraclear through reporting and consultation on plans. • Improve business continuity planning and disaster recovery capability by arranging for out-of-Wellington business support for payment systems.

And our performance would be measured by: Key performance indicators • Availability of ESAS/Austraclear during core hours is at least 99.95 percent. • Customer satisfaction with operations and with system development is demonstrated through an annual customer survey.

Settlements activity Stable, secure and efficient payment and settlement systems are critical elements of the country’s infrastructure. Payment and settlement systems contribute to economic performance by increasing certainty, reducing risk and allowing the community to complete transactions efficiently. The Reserve Bank is the operator of New Zealand’s real-time gross settlement environment, comprising ESAS and the Austraclear New Zealand system. The ESAS system processes high-value payments between financial institutions on a real-time basis. ESAS is an important component to the service operated by Continuous Linked Settlement Bank, which facilitates simultaneous exchange of both legs of foreign exchange transactions. On average, each day, payments with a value of $36.8 billion are made through ESAS. The Austraclear New Zealand system is a securities clearing and settlement system that simultaneously exchanges cash and securities (such as shares and bonds) between buyers and sellers. The main users of the Austraclear system are financial institutions, large investors, fund managers, brokers and their agents. The average value of payments settled in Austraclear each day is $6.8 billion. Transactions processed through ESAS cannot be revoked once they have been completed. This feature adds to certainty and so reduces risk in the financial system. Features such as irrevocability of payments and the simultaneous exchange of cash and securities (known as ‘delivery versus payment’) become even more important to users when there is instability in financial markets; for example, at the height of market uncertainty around the time of the failure of Lehman Brothers.

• All risks are well managed.

How we performed – Key performance indicators

• International standards for payment and settlement

System availability for ESAS and Austraclear improved from

systems (CPSS and IOSCO) are complied with.

99.23 percent in 2007-08 to 99.77 percent in 2008-09 While this was below our target benchmark of 99.95 percent, availability was significantly better in the later months of the

32

•

THE YEAR IN REVIEW

financial year when we completed an extensive programme of

The ESAS system is a designated system under Part 5C of the

software upgrades required to improve the systems environment.

Reserve Bank Act and the operation of ESAS by the Financial

The impact of interruptions to processing has been small and

Services Group is subject to oversight under the Act by the

processing deadlines were extended on one occasion as a result

Bank’s Prudential Supervision Department. Arrangements are in

of systems issues.

place to ensure proper separation of operations and supervision

In an annual customer service survey, 98 percent of Austraclear members reported that the Bank’s service met or exceeded expectations, slightly up from 97 percent in 2008.

functions together with appropriate management of any actual or perceived conflicts of interest within the Bank. The Bank will apply for designation of the Austraclear system under the new Part 5C of the Act immediately after the relevant legislation is

PricewaterhouseCoopers, on behalf of the Auditor-General,

passed. As part of the application process the Bank will complete

undertakes external audits of the Austraclear system each quarter

a formal assessment of compliance with international standards

and ESAS each year, and audit reports are reviewed by the

for payments and settlement systems and this will be published

Bank’s Audit Committee. All audit opinions were unqualified.

on the Bank’s website.

Improvements designed to enhance the management of risk associated with operating these systems are made continuously.

ESAS and Austraclear systems have back-up, with processing alternating between computer systems located in Auckland and

How we performed – Initiatives and strategies

Wellington. To further mitigate business continuity risk associated

With the software upgrade programme for ESAS and Austraclear

establish a small team of people in a new office in Auckland.

completed, we are concentrating on developing the systems

with all staff being located in Wellington, the Bank is planning to

to deliver improved functionality for system users. This includes implementing new interfaces to registries and other systems.

K ey E S A S statistics

Average daily transaction volumes Average daily transaction values

2005

2006

2007

2008

2009

4,507

5,472

6,081

7,023

7,194

$32.3bn

$36.6bn

$36.3bn

$38.9bn

$36.8bn Table 4

K ey A ustraclear statistics 2005

2006

2007

2008

2009

Average daily transaction volumes

1,131

1,123

1,077

1,119

973

Average daily transaction values

$9.3bn

$9.6bn

$6.6bn

$6.3bn

$6.8 bn Table 5

K ey E S A S - A ustraclear statistics

ESAS-Austraclear system availability during core hours

2005

2006

2007

2008

2009

99.95%

99.94%

99.92%

99.23%

99.77% Table 6

THE YEAR IN REVIEW

•

33

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Human resources How we performed – Initiatives and strategies

The Objective of the Human Resources internal service is:

During a year that put the Bank’s employees under more pressure than usual, the commitment to continual development and

• To provide strategic human resource advice and

growth of leaders remained high.

support services.

Further investment in values-based leadership development

In our 2008-11 Statement of Intent, we undertook to deliver the following:

for managers was a priority and, as a result, all managers are expected to have a comprehensive leadership development programme, including regular 360-degree feedback reviews,

Initiatives and strategies

induction for new managers, regular leadership training and

• Support management in further developing their values-

individual development planning.

based leadership competencies.

As part of future-proofing the organisation, key risk positions

• Continue a formal review of key-person risk within the

were reviewed, and succession planning and talent management

Bank and how it can be mitigated.

strategies are being refined. In the same way, the Bank’s business

• Review the Bank’s staff appraisal and personal

continuity and pandemic plans were reviewed and the decision

development programme.

to establish a small office in Auckland was approved. Work towards opening this office has begun. The recent influenza pandemic alert has resulted in a real-time test of pandemic plans for key operations and these have worked faultlessly. The declining economy has also contributed to lower staff turnover levels over the last year. While the financial crisis has increased work demands significantly, we have been able to retain experienced staff, who have risen to the challenges of a pressured environment.

H uman resource statistics 2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Total staff at 30 June (FTE)

237

199

182

193

210

218

223

221

223

237

Average years of service at 30 June

9.4

9.4

9.2

9.2

8.8

8.0

7.4

7.4

7.6

7.6

10.4%

14.9%

13.5%

11.3%

13.5%

9.0%

9.3%

12.3%

17.4%

9.3%

Annual staff turnover

Table 7

34

•

THE YEAR IN REVIEW

Remuneration Staff

Non-executive directors’ remuneration

The Reserve Bank spent $24 million on personnel in 2008-09.

Non-executive directors’ remuneration consists of directors’ fees.

This included all forms of remuneration, direct expenditure on

Directors’ fees represent consideration for services provided

training, and redundancy payments. Table 8 shows the number

to the Bank for acting as directors of the Bank. Certain non-

of staff who received over $100,000 in total remuneration9, in

executive directors receive additional remuneration due to their

bands of $10,000 in the 2008-2009 financial year.

involvement in Board committees. All remuneration paid to nonexecutive directors is included in the following table. There are

The Governor, Deputy Governor and two Assistant Governors requested they be given no remuneration increase in calendar 2009, in recognition of the seriousness of the financial crisis.

the Bank. 2008 $

2009 $

A Grimes (Chairman)

57,000

57,000

A Paterson (Deputy Chair)

37,875

37,875

P Baines 

27,500

27,500

N on - executive directors

R emuneration in 2 0 0 8 - 0 9 T otal remuneration

no fees paid to the Governor, who is an executive director of

S taff numbers 2009

$100,000 to $109,999

11

C Eichbaum

0

23,352

$110,000 to $119,999

8

H Fletcher 

27,500

27,500

$120,000 to $129,999

7

J Goulter 

27,500

27,500

$130,000 to $139,999

6

S Sheldon

0

4,940

$140,000 to $149,999

10

Rt Hon E Thomas 

25,500

0

$150,000 to $159,999

8

M Waring 

25,500

15,158

$160,000 to $169,999

3

$170,000 to $179,999

2

Total non-executive directors’ remuneration 

228,375

220,825

$180,000 to $189,999

4

$190,000 to $199,999

3

$200,000 to $209,999

2

Insurance and indemnity arrangement

$220,000 to $229,999

2

Section 179 of the Reserve Bank Act provides that every officer,

$240,000 to $249,999

1

employee or director of the Bank is not personally liable for acts

$250,000 to $259,999

1

done or omitted to be done in the exercise or performance in

$260,000 to $269,999

1

$270,000 to $279,999

1

$280,000 to $289,999

1

$310,000 to $319,999

1

$330,000 to $339,999

1

Act, unless the exercise or failure to exercise the power was in

$400,000 to $409,999

1

bad faith.

$570,000 to $579,999

1

Total staff receiving $100,000 or more

75

Table 9

good faith of that person’s functions, duties or powers under the Act. Under section 179A of the Act, the Crown provides an indemnity to every officer, employee or director of the Bank and certain other persons for any liability arising as a result of exercising or failing to exercise any power conferred under the

The Bank also provides income protection insurance to specified senior executives, and for other staff it provides insurance that Table 8

9

extends the cover available from the Accident Compensation Corporation for work-related accidents.

Total remuneration includes the annual cost to the Bank of all elements of contracted remuneration (salaries, any benefits provided, fringe benefit tax, superannuation), plus any bonuses or redundancy payments. The information in table 8 sets out the amount unconditionally earned during the financial year. The remuneration of the Governor is set by the Minister of Finance on the recommendation of the Board’s non-executive directors, who also determine the remuneration of the Deputy Governor. The Bank’s remuneration policy is to pay all staff on the basis of performance on the job, while having regard to prevailing market conditions based on salary surveys and assessments made by an independent remuneration consultant.

THE YEAR IN REVIEW

•

35

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Knowledge services The Objective of the Knowledge Services internal service is:

How we performed – Initiatives and strategies As was the case elsewhere in the Bank, the Knowledge Services Group was required to ensure services could meet demands in

• To provide strategic information management and information technology services.

In our 2008-11 Statement of Intent, we undertook to deliver the following: Initiatives and strategies • Design and build an integrated computer application (FSIS) that will meet the Bank’s statistical data processing, storage and access needs. • Consolidate, modernise and automate systems and

a rapidly changing environment, as well as deliver on the Bank’s planned projects. We continued to consolidate and modernise programmes, and increase our understanding of emerging technologies, and how these may assist in developing the Bank’s Information Management and Information Technology strategic direction. Our FSIS project is designed to improve systems for capturing and reporting statistical data. The initial phase has been completed. Subsequent phases will involve enhancing the core system to meet our changing data requirements, incorporating existing

infrastructure in a more integrated way to better support

surveys, retiring legacy systems and establishing FSIS as the

the Bank’s business functions.

centralised store for the majority of Bank data.

• Upgrade internally developed computer applications over the next two years to ensure the software versions used are fully supported and, where possible, standardised. • Continue to enhance the Bank’s business continuity infrastructure, through planning an out-of-Wellington business support centre for critical functions and other back-up computing arrangements. • Extend the Bank’s knowledge management strategy by automating frequently-used processes and implementing tools that allow easy sharing of information and documents across teams; and continue digital capture of archive records and physical documents. • Continue to enhance the Bank’s web services. • Develop the Bank’s information, records and data management capability to provide more flexible and userfriendly solutions.

We have completed projects to develop the storage area network environment, upgraded our telecommunications services, and refreshed the Bank’s desktops and laptops in line with their lease life. As the demand for web-based solutions increases, we continue to enhance our web presence, both intranet and internet. Our Knowledge Centre is continuing to improve the management of unstructured information, as well as digitally capturing archives and records and contributing to the management of the Bank’s Museum. A strong focus continues on business continuity planning and a Bank-wide exercise will be completed by the end of 2009. The Bank is currently establishing an office in Auckland to provide critical support services in the event of a regional disaster and is also improving our disaster recovery computer facilities, which are located in Auckland. In the next year, enhancements or replacements will be made to the financial management system, and currency processing, payments, and treasury systems.

36

•

THE YEAR IN REVIEW

Internal financial services The Objective of the Internal Financial Services is: • To provide support services for the Bank’s key financial operations, including financial reporting and management

How we performed – Initiatives and strategies The new statutory dividend regime, described on page 16, was passed into law in September 2008 and was applied for the first time for the year ended 30 June 2009.

reporting; compliance with corporate governance and

The Financial Services Group is responsible for processing

accountability responsibilities; settlement operations; and

transactions in the Bank’s foreign reserves and liquidity

treasury accounting and compliance reporting.

management operations. While we continued to enhance

In our 2008-11 Statement of Intent, we undertook to deliver the following:

the Bank’s core treasury system during the year, the stress in international financial markets led us to modify our system to accommodate changes in liquidity management instruments

Initiatives and strategies

and practices.

• Improve the calculation of amounts available for

The group also provides management and financial

distribution by the Bank, as a dividend to the Crown, from

reporting, and internal accounting operations services. We

a formula-based approach to a principles-based approach,

have commenced a project to replace our existing financial

and effect this through the relevant sections of the Act.

management information system. The choice of a new system

• Continue to enhance workflows, reports, and processes for financial operations and securities transaction activities. • Review options for replacement of the Bank’s own accounting systems. • Initiate preparation of the Bank’s Five-Year Strategic Plan and Funding Agreement for the period 2010-11 to 2014-15.

will be made this calendar year, with implementation in the 2010 calendar year. The Bank will also extend its treasury system to replace the system currently used to manage the processing of notes and coins. Detailed planning required to prepare the Funding Agreement for 2010-11–2014-15 is under way. The new Funding Agreement will need to be completed before May 2010 for ratification by Parliament shortly thereafter.

THE YEAR IN REVIEW

•

37

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Communications The Objective of the Communications internal service is: • To provide strategic advice and management for the Bank’s external and internal communications and for the maintenance of its reputation and credibility.

Many more speeches are delivered off the record so that we can explain our activities to general audiences while ensuring markets are not confused by repeated messages. We also published one brochure (two in 2007-08) and eight factsheets (eight in 200708) to provide wider understanding of the Bank’s functions and activities.

In our 2008-11 Statement of Intent, we undertook to deliver the following:

We continued to support education initiatives, including the Bank’s

Initiatives and strategies

students. Teams compete to assess economic conditions and

• Deliver the Bank’s key messages in light of an uncertain environment, and the new regulatory regimes for nonbank financial institutions. • Provide the Bank with timely information, and with advice on reputational risks and opportunities, with strategies for their mitigation or utilisation. • Further develop the Bank’s communication capability in a volatile environment, including participating in a transTasman crisis exercise. • Enhance financial literacy, through promotion of the Bank’s role as prudential regulator and support for inter-agency financial literacy programmes.

How we performed – Initiatives and strategies We are very aware that how well we communicate can enhance or detract from our ability to perform our key policy functions. Communicating clear, credible messages

annual Monetary Policy Challenge for senior secondary school deliver their own ‘Official Cash Rate decision’. The competition was won by Scots College from Wellington, ahead of Columba College (Dunedin) and Westlake Boys’ High School (Auckland). We continued to provide financial support to the Enterprise New Zealand Trust’s work to establish financial literacy unit standards.

Property management and security The Objective of the Property Management and Security internal service is: • To provide appropriate accommodation for the Reserve Bank to ensure that all functions, including cash operations, can be conducted unimpeded in a secure environment.

In our 2008-11 Statement of Intent, we undertook to deliver the following:

is important all the time. That need was heightened as the financial crisis spread. We increased our external communication through news releases, speeches, news media conferences and webcasts, business briefings and our website. We delivered four speeches on the record and 52 news releases (two and 48 respectively in 2007-08). A particularly busy period followed the Lehman Brothers collapse in September 2008, when we sought to communicate a strong sense of direction and purpose to financial and economic markets, a number of new liquidity measures were announced, and the government’s retail deposit guarantee scheme was launched in October 2008.

38

•

THE YEAR IN REVIEW

Initiatives and strategies • Plan and refurbish the building to meet current and future Bank needs for accommodation. • Maintain the building at the required standard, with fully let tenanted areas. • Assist in the establishment and maintenance of off-site accommodation for business continuity planning purposes. • Upgrade the civil defence capability of the Reserve Bank and provide support to tenants. • Implement cost-effective measures to further enhance energy efficiency.

How we performed – Initiatives and strategies

International activities

The Reserve Bank maintains its own premises in Wellington to

The Reserve Bank maintains a number of international

ensure it has secure, appropriate accommodation.

relationships, including those with other central banks and

The Reserve Bank’s main building on The Terrace in Wellington

multilateral organisations. We also participate in a range of

has remained fully tenanted throughout the year. We refurbished

international conferences and workshops.

and occupied an area on one floor previously occupied by a tenant, in order to provide space required due to additional financial sector regulatory work. The tenant has entered into a new lease for the remaining space on the floor. Two other floors occupied by the Reserve Bank will be refurbished over the coming year to meet related accommodation requirements.

The Bank continued its active engagement with the Executive Meeting of East Asia and Pacific central banks and monetary authorities, EMEAP. In addition, it also hosted the meeting of the Bank for International Settlements (BIS) Working Party on Monetary Policy in Asia, held in Auckland in June. The aim of this meeting was to discuss the effects of the macroeconomic

The Wellington business continuity site has been used and

developments and financial stability issues facing central banks in

tested several times over the year. It continues to provide the

Asia and the Pacific. In addition, a BIS Governors’ meeting in July

required support as intended. Research is under way in Auckland

shed further insight into the outlook for many of our trading-

to provide a base from which to operate a small business

partner economies.

support office. Each staff member has a civil defence backpack, which now includes an emergency ration pack with a long shelf-life. The Security team has provided logistical support for the Bank’s civil defence capability, ensuring equipment and supplies are

The Bank is actively engaged on New Zealand’s interests in the IMF through advice on a wide range of policy issues and through the secondment of staff to New Zealand’s Constituency Office at the IMF.

kept updated. Key Bank staff and tenants have taken part in

The first phase of the New Zealand-Pacific Remittance Project

Coordinated Incident Management System (CIMS) training

reached fruition with the establishment of a regulation

courses. CIMS is a recognised structure used and understood by

enabling the introduction of new card-based remittance

emergency services.

products. An offering of this product now in the market has

A comprehensive energy audit was undertaken in 2007-08.

an inclusive transactional cost of 3.5 percent, giving remitters a

Following this initiative, implementation of the recommendations

competitive option.

was undertaken in 2008-09. A major element of energyuse reduction required further study of the air conditioning programmes, and the monitoring of changes. The final report showed the Bank achieved a 22 percent reduction in building energy use and emission reductions of 108 tonnes of carbon dioxide. Less intense monitoring will continue over the coming year. Integration between all major security systems has been successfully achieved and maintained, resulting in a high level of effective, automated surveillance.

Phase two of the project (the New Zealand-Pacific Financial Capability Project) will focus on financial education linking remittances and financial services. The purpose will be to strengthen the financial capability of Pacific peoples in the Pacific region. The Bank’s international linkages continue to deepen through ongoing engagement with world-renowned academics and a steady flow of visitors from other central banks and international organisations.

A replacement main electrical switchboard has been constructed and installed. This new unit is designed to provide robust new technology over several decades. Associated with this project is the replacement of the Bank’s old generator. The new generators will provide full standby power for the whole building.

THE YEAR IN REVIEW

•

39

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

O u r f i n a n c i a l s t a t e m e n t s – a n ov e r v i e w The Bank has achieved a very strong result this financial year. The nature of the Bank’s business and its financial position, nevertheless, are such that, together with changes to interest rates and exchange rates, financial results can be expected to fluctuate more than they have in the past. 2009 $m

2008 $m

Net profit

906

535

Net operating expenses

45.7

38.1

Dividend paid to government

630

168

Total assets

30,922

25,162

Foreign reserves intervention capacity

11,741

10,534

2,967

1,926

Total equity

40

•

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

N et profit

• Foreign exchange gains of $481 million were made in 2009 (2008: $344 million). • Net foreign exchange gains were $370 million after deducting $111 million of interest costs incurred in holding unhedged foreign currency assets. In 2008, net foreign exchange gains were $225 million after deducting interest costs. • Since June 2007, when the Bank first intervened in the New Zealand dollar foreign exchange markets, the Bank’s foreign exchange position has generated returns of more than $583 million, after taking into account interest funding costs. The Bank’s funding costs are the difference between interest paid to borrow funds in New Zealand and the interest earned when the funds are invested in foreign currency. • Gains of $187 million were made on financial assets because of lower market interest rates (2008: a loss of $7 million was made).

N et operating expenses

• The increase in net operating expenses is because of: • the costs of establishing staff and resources to regulate non-bank deposit takers and insurance companies; and • a $3.8 million charge relating to the Bank’s defined benefit superannuation scheme. This was incurred because the scheme’s actual investment returns were lower than the return the scheme is expected to make over the long-run.

D ividend paid to government

• The annual dividend has been determined using the dividend principles (listed on page 16). Previously, the dividend was determined using a formula contained in the Reserve Bank Act.  

T otal assets

• The main reason for the growth in the Bank’s assets was $7 billion lent to New Zealand financial institutions at market rates of interest for terms of up to 12 months. This lending is secured largely against mortgage loans made by those institutions. The support was a response to the international financial crisis, when New Zealand financial institutions were having difficulty obtaining funding from offshore markets. • In the wake of the international financial crisis, the expansion of the Bank’s assets and liabilities, as shown in its balance sheet, is relatively modest when compared with central banks in other developed countries. The Bank has not had to fund the banking system through the crisis to the same extent as many other central banks. In some cases, those central banks’ balance sheets trebled in size because of the massive funding support.

F oreign reserves intervention capacity

• The foreign reserves intervention capacity enables the Bank to sell quickly foreign currency and buy New Zealand dollars, should market conditions require it. • An open foreign exchange position allows the Bank to sell foreign currency outright without having to later purchase or borrow foreign currency, but it also means the Bank’s foreign assets and liabilities are not exactly matched (or ‘hedged’). This means changes in foreign currency exchange rates may result in losses or gains. • At June 2009, the Bank had an open foreign exchange position of $3.9 billion (2008: $4.4 billion).

T otal equity

• Equity provides the Bank with the financial capacity to absorb losses and carry out its functions in adverse financial conditions. • During the year, equity grew by over $1 billion because of a $600 million capital injection from government, as well as a strong financial performance.

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

•

41

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

O u r f i n a n c i a l s t a t e m e n t s – a n ov e r v i e w Review of financial performance and financial position Income

NET PROFIT 2009 A ctual $m

2008 A ctual $m

The Bank’s main sources of income are:

Interest

Income: Net interest income

282

234

Foreign exchange gains

481

344

Gains (losses) from changes in the market value of financial instruments

187

(7)

Other investment income

2

2

Net investment income

952

573

8

8

960

581

54

46

906

535

Other operating income Total income Total operating expenses Net profit

Most of the Bank’s interest income is from investment of either: • the Bank’s equity (funding from government plus retained earnings); or • funds (assets) that result from selling notes and coins to banks.

Foreign exchange gains Significant changes in foreign exchange rates for the Bank’s foreign currency holdings contributed $370 million to net investment income in 2009, after deducting $111 million for the cost of borrowing funds for foreign exchange (2008: $225 million net contribution from foreign exchange after funding costs).

Changes in the value of financial assets

total operating income & net profit year ENDED 30 june

When interest rates fall, the value of assets tends to rise. In

1200

2009, lower interest rates, both within New Zealand and globally, resulted in valuation gains of $187 million for the

1000

year (2008: a loss of $7 million was incurred).

($m)

800 600 400 200 0

2005

2006

2007

2008

2009

KEY

Total operating income

42

•

Net profit

Graph 1

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

Operating expenses

operating expenses 2009 A ctual $m

Staff expenses

2008 A ctual $m

24.3

22.3

Net currency issued expenses

5.6

4.2

Asset management expenses

7.4

7.2

12.6

12.4

Other operating expenses Total operating expenses excluding actuarial loss on defined benefit superannuation scheme

• Operating expenses were $53.7 million in 2009 (2008: $46.2 million). • Operating expenses were higher in 2009 because of the increased costs of providing policy advice and oversight on non-bank financial institutions, such as finance companies and insurance companies. • In 2009, operating expenses included an actuarial loss on the Bank’s defined benefit superannuation scheme

49.9

46.1

of $3.8 million (2008: $0.1 million). This cost reflects a shortfall in the superannuation scheme’s actual earnings compared with the earnings the scheme is expected to

Actuarial loss on defined benefit superannuation scheme Total operating expenses

3.8

0.1

53.7

46.2

return in the long-run. • Excluding the actuarial loss, operating expenses were $49.9 million in 2009.

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

•

43

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

N et operating expenses I N R E L AT I O N T O the F unding A greement 2009 A ctual $m

Total operating expenses excluding actuarial loss on defined benefit superannuation scheme

2008 A ctual $m

49.9

46.1

3.8

0.1

53.7

46.2

8.0

8.1

Net operating expenses in relation to the Funding Agreement • The Funding Agreement is a five-year agreement between the Minister of Finance and the Governor of the Reserve Bank covering the Bank’s operating expenses. • The net figure is based on operating expenses less

Actuarial loss on defined benefit superannuation scheme Total operating expenses Income retained under the Funding Agreement

income from services such as transaction fees and rents received from letting office space. • Net operating expenses were $45.7 million in 2009. This was $2.4 million above the $43.3 million level provided for in the Funding Agreement for the

Actual net operating expenses

45.7

38.1

Net operating expenses specified in the Funding Agreement

43.3

41.0

Funding Agreement under-expenditure (over-expenditure)

(2.4)

2.9

2009 year. • The actuarial loss on the Bank’s defined benefit superannuation fund of $3.8 million (2008: $0.1 million) has been included as an operating expense. • Excluding the actuarial loss, net operating expenses were $1.4 million below the Funding Agreement.

NET operating EXPENSES IN RELATION TO THE FUNDING AGREEMENT

• Cumulative underspending of the current Funding

(INCLUDING ACTUARIAL LOSS ON DEFINED BENEFIT SUPERANNUATION scheme) year ENDED 30 june 50 40

($m)

30 20 10 0 KEY

2005

2006

Actual net operating expenses

44

•

2007

2008

Funding Agreement

2009

Graph 2

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

Agreement during the four years to 30 June 2009 was $8.5 million.

Financial position

F inancial position as at 3 0 J une 2009 $m

2008 $m

• The Bank lent funds to the trading banks and other financial institutions to help them cope with the global financial crisis. As a result, assets grew by $7 billion

Assets: Foreign currency financial

19,460

Local currency financial

20,754

11,366

4,307

Other assets

96

101

Total assets

30,922

25,162

in 2009. • In lending those funds for terms of up to 12 months, the Bank has taken security over certain high-quality lending undertaken by those institutions, mainly residential first mortgages. • On the liability side, the main features were:

Liabilities and equity: Foreign currency financial

5,539

4,605

Local currency financial

17,770

14,925

Currency in circulation

3,923

3,448

723

258

2,967

1,926

30,922

25,162

Other liabilities Equity Total liabilities and equity

• resuming the issuing of Reserve Bank bills to manage liquidity of the New Zealand dollar ($2 billion issued at 30 June 2009); and • substantial growth in the amount of currency in circulation. • At 30 June 2009, unrealised gains of $111 million were recorded on the Bank’s holdings of New Zealand government securities ($32 million unrealised loss in 2008). Changes in the value of the Bank’s holdings of

LOCAL AND FOREIGN CURRENCY ASSETS

government securities are accounted for as a direct

AS AT 30 june

change in the Bank’s equity and are not recorded in the

50

Bank’s net profit for the year.

40

• Equity is the difference between the value of the Bank’s

30

• Equity has increased by more than $1 billion due to a

($b)

assets and its liabilities. capital injection of $600 million received on 2 July 2008

20

and the retention of part of 2009 earnings. The Bank’s increased equity is because of the risks associated with

10

providing new liquidity management facilities. 0 KEY

2005

2006

Foreign currency assets

2007

2008

• Unrealised gains have also been retained in equity

2009

and will be available for payment to government once

Local currency and other assets Graph 3

realised or when they are likely to be realised.

LOCAL AND FOREIGN CURRENCY LIABILITIES AND EQUITY AS AT 30 june 40

($b)

30

20

10

0 KEY

2005

2006

Equity Local currency and other liabilities

2007

2008

2009

Foreign currency liabilities Graph 4

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

•

45

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

FOREIGN RESERVES INTERVENTION CAPACITY AND NET OPEN FOREIGN EXCHANGE POSITION

Foreign reserves intervention capacity and net open foreign exchange position

AS AT 30 june 2009

• The Bank needs to be able to intervene in foreign

15

currency markets. The foreign reserves intervention capacity is the measure of the Bank’s ability to quickly sell foreign currency and buy New Zealand dollars,

10 ($b)

should market conditions warrant that. • An open foreign exchange position allows the Bank to sell foreign currency outright without having to

5

later purchase or borrow foreign currency, but it also means that the Bank’s foreign assets and liabilities are not exactly matched (or ‘hedged’). Changes in foreign

0 2005

KEY

2006

2007

2008

2009

currency exchange rates may therefore result in losses or gains.

Intervention capacity Net open foreign exchange position

Graph 5

• Foreign reserves intervention capacity grew from $10.5 billion to $11.7 billion.

2009 $m

Net open foreign exchange position

3,881

2008 $m

4,444

• An unhedged currency position is one where the risk is not offset by a matching holding. During the year, the Bank reduced its holdings of unhedged foreign currency reserves and, at 30 June 2009, held an open foreign exchange position of $3.9 billion ($4.4 billion in 2008). As a result of selling part of its unhedged foreign

CURRENCY COMPOSITION OF NET OPEN FOREIGN EXCHANGE POSITION

currency assets, the Bank realised foreign currency gains of $434 million.

AS AT 30 june 2009

• The pie chart shows the composition of foreign currencies included in the net open foreign exchange position.

KEY

EUR

CAD

USD

JPY

AUD

OTHER

GBP

46

•

Graph 6

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

Dividend to government

2009 $m

2008 $m

630

168

Dividend to government • The Bank will pay $630 million to the government in 2009 ($168 million in 2008), including realised foreign exchange gains of $434 million. • The amount the Bank will pay in 2009 was determined under the statement of dividend principles which are

DIVIDEND COMPARED WITH NET PROFIT

listed on page 16. This is the first year that the new

year ENDED 30 june

dividend principles have been applied.

1000

• Before 2009, foreign exchange gains were not included 800

in the statutory formula for calculating the annual dividend to the government.

($m)

600 400 200 0

2005

2006

2007

2008

2009

KEY

Net profit

Dividend

Graph 7

O U R F I N A N C I A L S TAT E M E N T S – A N O V E R V I E W

•

47

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Financial projections

The following table outlines the Reserve

projected N et operating expenses 2 0 0 9 - 2 0 1 0 2010 B udget $m

Bank’s budgeted net operating expenditure for 2009-10. Budgeted net operating expenditure has been prepared using the

Operating expenses:

same accounting policies that are used

Staff expenses

in the preparation of the Bank’s financial

27.2

24.3

Net currency issued expenses

5.3

5.6

statements for the year ended 30 June

Asset management expenses

8.3

7.4

2009, as described on pages 61 to 67 of this

Other operating expenses

14.3

12.6

Annual Report.

Total operating expenses excluding actuarial loss on defined benefit superannuation scheme

55.1

49.9

0.0

3.8

55.1

53.7

7.8

8.0

47.3

45.7

Actuarial loss on defined benefit superannuation scheme Total operating expenses Income retained under the Funding Agreement Net operating expenses Funding Agreement under-expenditure (over-expenditure)

48

2009 A ctual $m

•

FINANCIAL PROJECTIONS

(0.4)

(2.4)

The increase in budgeted operating expenditure to $55.1

N et E X P E N D I T U R E B Y F U N C T I O N

million (2009 actual: $53.7 million) primarily reflects the

NET EXPENDITURE*

expansion of the Bank’s regulatory responsibilities for non-bank financial institutions, the costs of establishing a

2010 B udget $000

2009 A ctual $000

Monetary policy formulation

10,144

10,593

Domestic market operations

7,627

5,619

12,527

11,947

for the year ended 3 0 june

new office in Auckland, and depreciation of new systems. In 2009, operating expenses included an actuarial loss of $3.8 million on the Bank’s defined benefit superannuation scheme. No actuarial loss is budgeted in 2010. Projected net operating expenditure for 2009-10 is

Functions

forecast to be $47.3 million against a level of $46.9 million

Financial system surveillance and policy

provided for in the variation to the Funding Agreement.

Currency operations

9,050

9,598

The additional $0.4 million of expenditure in 2009-10

Foreign reserves management

7,062

7,431

will be drawn from underspending in the previous four

Settlement services

593

354

30 June 2009, the cumulative underspending of the

Registry and depository services

(140)

(452)

current Funding Agreement was $8.5 million.

Other outputs

417

652

47,280

45,742

years of the Funding Agreement. For the four years ended

Net expenditure

*Net expenditure comprises operating expenses less income earned from certain Bank operations as specified in the Funding Agreement

FINANCIAL PROJECTIONS

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49

RESERVE BANK OF NEW ZEALAND ANNUAL REPORT 2008 – 2009 WEATHERING THE STORM

Strategic Priorities for 2009-10 D e pa rt m e n t

F inancial M arkets

Ensure the banking system has sufficient liquidity to meet its ongoing funding needs.

P rudential S upervision

Ensure that the registered banks maintain adequate capital, through close monitoring of asset quality and prompt supervisory responses.

E X PLANATION

The ongoing global credit crisis is making it more expensive for banks to maintain adequate levels of liquidity and to raise term funds. The Bank has already implemented several measures to ensure adequate liquidity, and is assessing options should the need for further measures arise. The Reserve Bank will further increase its monitoring of registered banks’ prudential status with a particular focus on early identification of any deterioration in asset quality and of any impact this may have on capital adequacy. If necessary, the Bank will take supervisory action to ensure that any problems identified are dealt with promptly and effectively. The Bank will finalise and implement new liquidity requirements for registered banks and will review capital requirements in the light of international developments and experience in New Zealand.

E conomics

Support effective monetary policy for inflation targeting in a world of volatile financial and economic conditions.

The economic and financial crisis has markedly changed the shocks hitting the economy. It has also complicated the influence of monetary policy on financial conditions. The Bank will develop analytical tools and research knowledge in response. In particular, this includes coping with the challenges presented by asset price and credit boom/bust cycles, advising on the appropriate mix of monetary policies for economic stabilisation, and enhancing data collection and communication with other agencies.

K nowledge S ervices / E conomics

Implement our Financial Sector Information System (FSIS), significantly improving the management of statistics and enabling new prudential data collections.

FSIS is a computer application that will integrate the Bank’s statistical data and enhance the processing and storage of, and access to, the data. The project is entering its second phase, in which existing surveys will be migrated into FSIS, and new surveys will be established for nonbank deposit takers (NBDTs) and the insurance sector and for other external data.

P rudential S upervision

50

Priority

Introduce a prudential regime for the insurance sector, and implement new regulatory arrangements for NBDTs.

In 2008, legislation was enacted to make the Bank the prudential regulator of NBDTs. In 2009-10, the Bank will progressively develop and implement the new regulatory framework for NBDTs. Legislation for the prudential regulation of insurers is being drafted under the Insurance (Prudential Supervision) Bill, expected to be enacted during 2010 and covering life, general and health insurers. The Bank’s objective is to regulate NBDTs and the insurance sector so as to promote the maintenance of a sound and efficient financial system, and to avoid damage to the financial system that might result from the failure of a NBDT or an insurer.

B ank - wide

Improve business continuity and disaster-recovery capability through the establishment of a business support office in Auckland.

The Bank has been ensuring it has systems in place to enable it to continue functioning in the event of a range of crises. It will establish a small office in Auckland to provide business continuity in payments and market functions in the event of a physical disaster in Wellington.

B ank - wide

Engage and develop staff to meet the challenges of a volatile financial and economic environment.

In challenging economic times, staff are affected both professionally and personally. The challenge can motivate staff because of the nature of the work, but they will be under pressure nevertheless. We must ensure that the right staff are doing the right work, that they remain focused and motivated, and that they have the opportunity to continue to develop their skills and knowledge.

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FINANCIAL PROJECTIONS