Deposit Takers Act: proportionate regulation a challenge

17 July 2023

We recently published an update on the Deposit Takers Bill, following the report of the Finance and Expenditure Committee. Since then, the Bill has rapidly passed through its third reading and has been enacted.

The debates during the Bill’s passage through Parliament underlined the emphasis, now evident in the Act, on trying to get “proportionality” right – that is, tailor regulation to a diversity of market participants.

Only some parts of the Act come into force immediately. Those parts include provisions empowering the Reserve Bank of New Zealand (RBNZ) to issue standards and requiring licensed deposit takers to comply with those standards; and provisions relating to levies, and creating regulations and RBNZ advice around those levies.

From here, the RBNZ’s immediate focus will be on:

  • Designing the proportionality framework, which is required to be published within nine months of enactment (towards the end of Q1 2024);
  • Preparing the statement of funding approach, that is relevant to the setting of the levies imposed on deposit takers to pre-fund the Depositor Compensation Scheme, which is required to be published within a year of enactment (towards the end of Q2 2024); and
  • A series of workshops regarding these projects and the Depositor Compensation Scheme (DCS).

Regulators’ dilemma: under and over-regulation

As noted in our last update, the Act contains a newly inserted requirement that the RBNZ publish a proportionality framework. This addition was recommended by the Finance and Expenditure Committee in response to concerns raised by smaller non-bank deposit takers (NBDT) that “one size fits all” regulation would result in an unmanageable compliance burden and drive them out of business.

The framework will set out how the RBNZ intends to achieve proportionate regulation and supervision when it develops its prudential standards. Those standards may cover all manner of subjects of regulatory interest, including the governance of deposit takers, capital ratios, management of liquidity risk, credit ratings, bail-in instruments, recovery plans, loan concentration, risk exposures, information disclosure and aspects of the DCS.

Smaller NBDTs had said that even the prospect of the new regulation was making it harder for them to secure deposits. The Committee considered these concerns were justified and emphasised the importance of continuing to ensure New Zealanders have access to a diverse range of entities in the deposit-taking sector. “Proportionality” is the key concept by which the Act is intended to achieve the right balance between under- and over-regulation of the sector.

During the Parliamentary debates, proportionality and competition were key topics of discussion:

  • Committee members from both sides of the aisle emphasised the Committee’s concerns that smaller NBDTs, like credit unions, building societies and finance companies, not be “drowned in regulation”, noting that they had fewer resources than the big banks but an important role to play, including by providing finance to people who may find it difficult to access traditional forms of banking services.
  • Committee member Ingrid Leary (Labour) highlighted the Act’s intent for the RBNZ to remain accountable to Parliament in developing the framework, noting the Act’s “very strong” recommendation that the RBNZ “come back to brief the Committee of a future Parliament before that framework is finalised”. If adequate proportionality was not achieved such that the Act had a chilling effect on the deposit-taking sector, then Parliament wanted to have oversight of that, she said.
  • Nicola Willis, National’s finance spokesperson, noted the debate was taking place “in the shadow of the collapse of banks overseas” and the reality of how “digital banking” allows for a rapid run on the bank. But the desire to protect fellow citizens from risk should not come at the expense of a “healthy financial sector”. She sent what might have been a shot across the bows from any incoming National government when she put “on the record the concern, certainly from members on this side of the House, that it will be particularly important that regulations made in this area live up to those intents and that the effect of the regulation is monitored carefully to ensure that it isn’t having perverse effects”.
  • Minister of Finance Grant Robertson commended the Committee’s changes to the Bill’s principles and purposes around proportionality and accessibility as a “very significant and important change”, noting that “while we all know … that having a safe and sound financial system is the goal of this legislation, adding to that, the fact that, within that, accessibility is important and that a diversity of institutions that provide services to a diverse range of New Zealanders, I think, enhances this legislation, makes it more relevant for the times we live in”.
  • The particular example of requiring credit ratings was referred to as “the most extensive” of unnecessary compliance costs by Andrew Bayly. The Minister of Finance was asked to provide further comment on the RBNZ’s power to grant exemptions for the need for credit ratings under the Act. He suggested the exemption power was just the kind of “wiggle room” afforded to the RBNZ to achieve the balance of both flexibility and stability in the financial system.

Chapman Tripp comments

Finding the right balance between under- and over-regulation is always a tightrope walk:

  • In the US, the recent collapse of regional lenders First Republic, Signature Bank and Silicon Valley Bank has highlighted the downside of relative light-touch regulation applied to smaller lenders deemed to pose less risk as they are outside the “too big to fail” camp.
  • It appears the Commerce Commission will also soon be grappling with issues of proportionality, given recent confirmation that the market study into personal banking will include consideration of the impact on competition of bank regulation and regulatory capital rules. We can expect the Commission’s findings to inform future legislative developments in this area.
  • Getting proportionality right across all the prudential standards – for example, setting DCS levies at the right level for all players – will be a real challenge.
  • Submitters who were concerned about the degree of power given to the RBNZ in the Act may find some comfort in the strong emphasis from Parliament that it wants to supervise the development of the proportionality framework.

The debate showed that prospects of bank failure and protecting depositors is front of mind for almost all of the members who spoke (with the prospect of moral hazard created by the DCS receiving almost no airtime). While regulations and resolution processes are in place to avoid or at least minimise the impact of such a failure, banks will no doubt be thinking carefully about the challenges that the modern social media age, and seven-day payment processing in particular, may pose, should there be a loss of confidence in a bank.

Directors’ due diligence obligations

One of the more significant changes to the Act made in the course of the Finance and Expenditure Committee process was the moderation of the directors’ due diligence obligations. Those changes included:

  • Removing from the Act restrictions on use of indemnities and insurance for a breach of the directors’ due diligence requirements. Existing indemnity and insurance restrictions in s 162 of the Companies Act 1993 will still apply to locally incorporated deposit takers.
  • Inserting a defence permitting a director or NZ chief executive in discharging the due diligence duty to rely on information and professional/expert advice from other directors, or employees or professional advisers or experts in certain circumstances. The relevant clause is based on s 138 of the Companies Act and provides that the defence can only be made out where the relevant individual acted in good faith, made proper inquiry and had no knowledge that reliance is unwarranted.

The changes were referenced briefly in the debates, and the reliance defence was particularly acknowledged as striking a balance between allowing directors to rely on advisors and executives, while also not absolving directors if they act inappropriately.

The timing of the directors’ due diligence guidance, required by s 97 to be published by the RBNZ, is uncertain. The Act provides that the guidance must be published within six months of s 97 coming into force, but the date on which that will occur is unspecified. There is nothing that says s 97 must come into force before the provision containing the substantive duty (s 93), although some flexibility has now been built into the Act to allow for particular sections to come into effect before or after others. A decent lead time between the publication of guidance and the actual duty coming into force will be important.

Extension of RBNZ search powers

Broad powers already given to the RBNZ in respect of investigations and searches have been expanded in the version of the legislation enacted. The search power has now been expanded to cover not only a “place”, but also a “vehicle or other thing”. The SOP introducing the change made it clear that “other thing” includes internet data storage facilities.

This expansion is particularly notable in light of the trigger for the relevant search power to be exercised. The search power provision is expressly said to be “similar to” s 29 of the Financial Markets Authority Act 2011. That power can only be utilised in reasonably narrow circumstances: reasonable grounds to believe that a person has engaged in, or is engaging in, contravention of financial markets legislation and belief that the search will find evidential material.

The trigger for the search power under the Act is, on its face, lower. The warrant for a search can be issued as long as there are reasonable grounds for believing only one of the following:

  • The person has contravened, is contravening, or is likely to contravene a prudential obligation; or
  • It is necessary or desirable for the purpose of determining whether to exercise any powers conferred on the RBNZ under the Act that an investigation of the affairs of the person should be carried out.

As a result, the circumstances in which the search power could be invoked are quite broad. Prudential obligations will vary in scope and significance, and all that is needed is a “likely” contravention of one. The question of whether the search is “necessary or desirable” in the context above necessarily involves a substantial amount of value judgment by the RBNZ.

As with the proportionality debates, the evolution of these provisions shows Parliament has taken seriously the need to strike the right balance of under- and over-regulation. Ultimately, time will tell if the Act has got it right, ensuring the deposit-taking sector can flourish while providing adequate protection to depositors and to the broader financial system.

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