RBNZ reviews banks' risks

The Reserve Bank thinks the rules protecting against this risk are not working as well as they should.

It fears an overly conservative interpretation of the rules is putting a handbrake on banks' daily business activities. 

The problem is an extension of recent changes that increased the amount of capital that banks must hold. This was intended to reduce the risk of banking failure, which has happened overseas and been calamitous for thousands of people.

But banks don't just face risks from their daily lending, but from the ancillary activities of people at the bank. This danger is known as connected persons exposure.

As an example, a connected person, such as a bank's owners, may have substantial outside interests such as loans, leases, deposits, equities or bonds. The RBNZ says a New Zealand bank could be severely affected by a failure of these investments.

But it says the rules to safeguard against this sort of collateral damage have been in place for 10 years without substantial change and need to be updated.

Moreover, the trading banks have complained of ambiguity and inconsistency in the way the policy is written. To make sure they don't get it wrong, banks are erring on the safe side, and interpreting the rules too conservatively.

This is constraining their ability to manage credit and market risks appropriately and efficiently. The RBNZ acknowledges that this problem exists and says they warrant a review of the rules.

However, it warns the essential principle of the policy is sound. It says safeguards for connected exposures remain an important part of overall prudential controls of the banking industry. Equally important are attestations by bank directors in relation to managing conflicts of interest.

However the RBNZ is proposing changes such as giving banks better access to risk mitigation, such as connected persons' abilities to draw on their own funds to offset a failure. It suggests the amount of money involved is huge, and could cause banks' overall risk exposure to vary enormously.

The views of the banking industry are being sought in respect of these proposals.