Eight years ago last month, Reserve Bank governor Alan Bollard told New Zealand directors that he was concerned about the state of corporate governance in the finance and banking sector, both at home abroad.
His address was sadly prophetic. But did his warnings ensure that New Zealand banks and businesses navigated the wash of the global financial crisis better than most? And have the problems he identified eight years ago been acted on?
Dr Bollard talked to NZ Management’s writer-at-large Reg Birchfield on the anniversary of his speech, one he admitted he couldn’t remember delivering.
You said at the beginning of your 2003 speech that corporate governance was not topic that had, until then, attracted much public attention. Is governance more in the spotlight now?
That was the time of the Enron crash and scandal which focused some attention on the role of governance. But I agree, public interest in governance has increased. We have learned lot about it since then, much of which has been corroborated by the Global Financial Crisis (GFC).
Should more people be interested in how well directors perform?
They will pay the price if they are not.
How well do you think institutional governance has performed in the eight years since you gave your speech?
My focus is inevitably on the financial sector and we have seen quite few regulatory developments in the banking, finance company and insurance industries that are very important.
But the GFC was the important issue for me. We had to deal with Australian (owned) banks through this period. They sometimes wanted to retrench resources or draw control back into Sydney or Melbourne. So couple of years ago we put in place some local incorporation and outsourcing requirements to better deal with stress events such as this and to tighten inter-group arrangements.
The changes we have implemented are good basic governance principles that sheet home responsibility for both management and board operations. We wanted an authoritative New Zealand board that would have contract with the chief executive in New Zealand. The CEOs did not need to be New Zealanders, but needed to know their responsibilities to New Zealand law.
The law has also been changed to give us responsibility for the regulation of non-bank deposit takers, finance companies, building societies and credit unions, which requires RBNZ to put in place governance requirements for directors. We are also doing this for insurance companies to apply fit and proper tests for their directors.
Is finance sector governance now more robust?
I look at it in two ways. The story around finance companies has not been happy one. Some of the problems, though not all, have been governance issues. Now, for the first time, finance companies must have two independent directors, the chair cannot be an employee or related party of the company and they must meet some proper tests. We think this will get rid of some of the egregious behaviour we saw in the past.
The banking story is quite different. We always had properly constituted boards. What we have been trying to do is get the right balance between the parent bank and the local New Zealand subsidiary. Reinforcing the roles of the New Zealand boards and their chairs is crucial to that.
The banks in New Zealand and Australia did not suffer the problems experienced in the Northern Hemisphere. They were not much involved in investment banking for example. And we have not had the same incentive payment problems around board and senior management level that led to institutional instability.
Is there is better general understanding of how important good governance ensures better risk management practices generally?
Many New Zealand directors have had to confront this issue over the last few years. Local businesses have, I think, done better over the last few years than in the past. We probably had about four times as many business failures during the economic downturn in the late 1980s and early ’90s than we are seeing this time. That reflects the problems businesses then had with managing risk.
This time we are seeing much better hedging of financial risks, particularly exchange rate risk, and better understanding of other sorts of risk. There is, for example, more formal use of board audit and risk committees. I think there has been significant improvement in board performance here.
Given what you said in 2003, do you think more notice might have been taken of what you were saying about inadequate governance and risk management?
I don’t think we were any more prophetic than others at the time. Many regulators looking at the banking systems in those days were talking about risk. They understood the principles but didn’t, I guess, expect to see it happen in the way it did.
This was time when asset prices and credit flows were building up and, in some countries, inflation was building up and yes, they did represent the ingredients for collapse. We could see the risk but did not pick how it was going to turn out. We did not pick sub prime, derivatives and the market-to-market issues that evolved. Sadly, nor did anybody else.
Could New Zealand have done anything earlier to mitigate the risks?
The sources of big risk and contagion were not in New Zealand. We learned pretty quickly what was going on with American banks like Lehmans. And it wasn’t long before we were getting real signs through the financial markets of funding and confidence problems in the local industry. If anybody had forgotten how connected we are with the rest of the world they were rapidly reminded.
You said in 2003 that “how well or poorly an economy performs” depends on where companies invest and use their resources and that was determined by management and governance strategies, not political policy-makers. How well do you rate New Zealand’s management and governance performance in that regard?
I generally rate that pretty well. But we suffer from New Zealand’s smallness and remoteness. You see lot of volatility in decision-making and business confidence. We have clear examples of that with our emergence from the global crisis. Businesses did not have the confidence to re-invest even though they could see for themselves that they would soon lack (productive) capacity. The same happened after the Christchurch earthquake. Being small, we suffer from that kind of volatility.
You also mentioned the need for fulsome disclosure in the financial sector. Are you now happy with New Zealand’s disclosure requirements?
Finance companies will have to disclose more than they have in the past. Disclosures in that sector were inadequate. The banking sector is different. We set up regulation in the banking sector around 1990 based on quite light-handed regulatory focus and lot of information being put out. That has been only partially successful.
We expected more analysis of bank results by financial analysts and the media. There is little more academic analysis now, but it has not really put much pressure on the banks or provided any real insights into how they are performing.
This past year we have agreed to reduce some of the reporting requirements. lot of the stuff we asked for is outdated by the time it is released. We want less volume but more up-to-date information.
Much of the information we got under regulation during the crisis wasn’t as useful as the confidential and more-timely information the banks volunteered. We have maintained much of that dialogue.
Are you satisfied that relatively light-handed approach to banking regulation is still appropriate?
Absolutely. We have tightened up bit. We make distinction between regulation and supervision. Regulation provides the laws by which the banks must abide. Supervision involves going in and forming view of the state of the bank’s books, who they are lending to and how good their risks
