5 Banking

There can be little doubt that financial intermediation is becoming increasingly global. Technological advances and on-going liberalisation of financial markets have contributed to the development of increasingly integrated global capital markets dominated by global financial institutions. (Rodgers 1988, 112)

189 Article 1(2) of the Model Law permits an enacting state to exclude particular types of entities from the scope of the Model Law. The commentary to article 1(2) highlights the need “to protect vital interests of a large number of individuals” and the need to allow “particularly prompt and circumspect” action as reasons for a state excluding types of entities from the Model Law. Thus, the emphasis is on protecting the national community interest in preference to the rights of individuals.

190 In our view, considerable justification is required to exclude an entity from the operation of the Model Law. To be effective, the Model Law should embrace all debtors, regardless of the nature of a debtor’s business. Accordingly, the Law Commission’s starting point is that banks should be included in the Model Law unless there are strong reasons which justify exclusion or modification of the Model Law’s application to them.

191 Factors to be addressed in considering whether banks require special treatment are:

policy concerns underlying both the regulation and insolvency of banks;
the structure of New Zealand’s financial system; and
risks to the system arising from bank failure.

Banking regulation

192 There are in most countries two primary objectives motivating bank regulation. First, the preservation of a state’s financial system. Secondly, the protection of bank depositors from loss.

193 To achieve these objectives banks are typically subject to special regulation, not applied to business enterprises in general. This regulation takes the form of:

ongoing supervision of banks’ activities by a supervisory authority; and
a special insolvency regime designed to limit the adverse effects of a bank insolvency on the state’s financial system.

194 When we speak of “bank” we mean “registered bank” as in New Zealand only those entities registered under s 69 of the Reserve Bank of New Zealand Act 1989 (the Reserve Bank Act) are entitled to use the word ‘bank’ in their name: Reserve Bank Act s 64.

195 New Zealand’s approach to banking regulation differs from the approach generally taken in other states. The Reserve Bank reviewed its bank supervision arrangements and implemented a new approach in 1996. In comparison with overseas approaches, the New Zealand approach is much less prescriptive and requires considerably less monitoring by the bank supervisor.

196 The focus of banking regulation is on protection of the financial system. Unlike many other countries, there is no specific statutory protection of bank depositors. Section 68 of the Reserve Bank Act requires the Reserve Bank to carry out its bank registration and supervision functions for the purpose of:

promoting the maintenance of a sound and efficient financial system; or
avoiding significant damage to the financial system that could result from the failure of a registered bank.

197 Consistent with the lack of a depositor protection objective, licensing of deposit-taking and other banking activities is not required: an institution may take deposits without being required to register as a bank under the Reserve Bank Act. Unregistered deposit takers are not subject to Reserve Bank supervision. Neither is there any official deposit insurance under which the losses of bank depositors in a bank failure are borne by an insurance fund. Moreover, under New Zealand’s domestic insolvency law, bank depositors do not rank as preferential creditors.

198 According to the Reserve Bank’s 1997 Statement of Principles: Bank Registration and Supervision, the bank supervision regime in New Zealand has a strong focus on utilising market disciplines and holding directors and management accountable for the prudent and responsible management of their banks’ affairs (Reserve Bank 1997, 2). This is evident from the requirements that:

banks publish disclosure statements containing a comprehensive range of financial, corporate and risk-related information; and
directors attest to the accuracy of information contained in the disclosure statements, and attest to whether the bank has satisfactory risk management policies and whether those policies are being properly applied.

Placing responsibility on the market place for monitoring financial conditions of banks emphasises that it is not the Reserve Bank’s role to provide a safety net for banks which become insolvent or to shelter depositors or any other creditors from loss.

199 The Reserve Bank is responsible for registering banks under Part IV of the Reserve Bank Act. The registration requirements are intended to limit the registration of banks to financial institutions of integrity and standing in the financial market. These institutions must be able to demonstrate their ability to carry on business in a prudent manner.

200 The Reserve Bank monitors the financial condition of banks every quarter from the information provided by banks’ disclosure statements and from publicly available information. The Reserve Bank consults with the senior management of registered banks on an annual basis.

201 The Reserve Bank has an array of powers available to deal with a bank suffering financial distress or insolvency. Those powers include:

the ability to recommend that a bank be de-registered (s 77);
the ability to obtain information and documents from a bank (ss 95 and 99);
the ability to seek a report on a bank’s financial and accounting systems (s 95);
the power to require a bank to consult (s 111);
the power to give directions to a bank (s 113); and
the power to recommend that a statutory manager be appointed over a bank (s 117).

“Statutory management”

202 Statutory management under the Reserve Bank Act is a discrete form of insolvency regime designed not only to protect the interests of creditors but also the interests of the financial system as a whole. A recommendation is made by the Reserve Bank to the Minister of Finance in order to place a bank into statutory management. The Minister of Finance will then give advice to the Governor-General who will, if the advice is accepted, appoint a statutory manager by Order-in-Council. We return to discuss the powers of a statutory manager later (see para 209).³⁴

203 Statutory management is viewed as an option of last resort for dealing with a failing bank (White 1992, 192). Wherever possible, in our view, another viable solution to avoid the failure of a bank should be utilised. One such alternative, outside the operation of the Reserve Bank Act, is for a failed bank to be wound-up under the standard liquidation procedures contained in Part XVI of the Companies Act 1993.

204 Section 118 of the Reserve Bank Act sets out the grounds upon which the Reserve Bank may make a recommendation to the Minister of Finance that a statutory manager be appointed. Section 118(1) provides:

(1) The Bank shall not make a recommendation under section 117 of this Act unless it is satisfied on reasonable grounds that –
(a) The registered bank is insolvent or is likely to become insolvent; or
(b) The registered bank has suspended, or is about to suspend, payment or is unable to meet its obligations as they fall due; or
(c) The registered bank or any associated person has failed to consult with the Bank pursuant to section 111 of this Act; or
(d) The registered bank or any associated person has failed to comply with a direction under section 113 of this Act; or
(e) The affairs of the registered bank or any associated person are being conducted in a manner prejudicial to the soundness of the financial system; or
(f) The circumstances of the registered bank or any associated person are such as to be prejudicial to the soundness of the financial system.

205 All of the Reserve Bank’s powers under Part V of the Reserve Bank Act – which includes the power to recommend statutory management – are required to be exercised for the broad systemic purposes set out in s 68 of the Act. In the context of the statutory management regime, it seems to us that the purpose of “avoiding significant damage to the financial system that could result from the failure of a registered bank” is of key importance. In our view s 118 when read in conjunction with s 68 of the Reserve Bank Act requires the Reserve Bank to be satisfied that there is, at least, a potential systemic threat arising from the bank failure before statutory management can be recommended.

206 This interpretation is supported by the need for the statutory manager, when exercising his or her powers under s 121, to have regard to both:

the maintenance of public confidence in the operation and soundness of the financial system; and
the need to avoid significant damage to the financial system.

(Note that the disjunctive forms of these concepts are expressed in s 68.) More generally, the intrusive nature of statutory management lends support to a minimum threshold of potential systemic threat to justify statutory management being imposed upon a bank.

207 Although the current wording of s 118 of the Reserve Bank Act (see para 204) does not make it plain that statutory management under the Reserve Bank Act should only occur when there is a potential of systemic financial failure, our view is that the potential of systemic financial failure is the only justification for the intrusive statutory management regime. Furthermore, the powers of the Reserve Bank under Part V of the Reserve Bank Act must be exercised for the broad systemic purposes set out in s 68. In our view to make the position clear an amendment is required to s 118 of the Reserve Bank Act to make clear the circumstances in which statutory management can be recommended. Our proposed amendment in s 8 of the draft legislation stipulates the minimum circumstances giving rise to systemic risk to the financial system.

208 Once a bank has been placed into statutory management the commercial activities of the bank are restricted. Upon commencement of statutory management a very wide “moratorium” applies under s 122. This freezes, for an indefinite period, the exercise or enforcement of a range of rights and claims against the bank such as proceedings, executions, liquidation applications, enforcement by secured creditors, repossessions of property and set-offs without leave of the High Court or the statutory manager: Reserve Bank of New Zealand Act 1989 s 122(2); see also Krasemann v DFC New Zealand Limited [1990] 3 NZLR 606. The moratorium is intended to prevent the bank’s affairs from rapidly falling into a state of disorder and so allows a breathing space within which the situation can be assessed and options considered.

209 In the meantime, the statutory manager takes full control of the bank and has wide ranging powers to manage and reorganise the bank’s affairs. The manager’s powers include the power to:

sell the bank or the assets of the bank (ss 132 and 134);
negotiate an arrangement involving the compromise of creditors’ claims (s 131); and
convert the branch of an overseas bank into a locally incorporated company (s 123).

A statutory manager is, however, under the supervision of the Reserve Bank that has power, under s 120, to direct on the conduct of the statutory management.

The New Zealand financial system

210 The structure of the New Zealand financial system is pertinent to:

the likelihood of a bank failure having cross-border elements;
the types of cross-border risks to which the financial system is exposed; and
the types of institutions which could pose a systemic threat in the event of insolvency.

211 Two striking features about the financial system have been mentioned. One is the dominance of the system by registered banks and the other is the very high degree of foreign ownership in the banking industry (see para 92). In consequence, New Zealand is in the unique position of being almost completely a “host” to the banks operating here. It is therefore highly exposed to the risk of an insolvency of an overseas bank affecting its New Zealand branch or subsidiary operations. Also, we have noted the fact that New Zealand authorities will have no control over the timing of a bank failure which emanates from overseas. The Reserve Bank may be dependent on foreign regulators to supply it with information about an impending problem. A recent publication by the Reserve Bank notes the tendency towards banks effectively being managed from Australia even when the New Zealand bank is locally incorporated (see Rodgers 1998, 114).

Types of systemic risk

212 The failure of a New Zealand bank can significantly damage or in an extreme case lead to the collapse of the financial system. One possibility is contagion risk: ie the risk that the failure of the bank owing large amounts to other banks and institutions will cause severe losses and liquidity problems to those who are owed money. Market disruption can arise where a bank is a party to a large volume of transactions in the wholesale financial markets, such as the foreign exchange and securities markets, or has initiated a large volume of payments through the payment system and subsequently fails to settle. The risk of a run on deposits is the risk of a bank failure causing a generalised panic among depositors. All of these are forms of systemic risk which should properly be controlled by the Reserve Bank through the statutory management process.

SHOULD BANKS UNDER STATUTORY MANAGEMENT BE EXCLUDED FROM THE MODEL LAW?

213 Let us assume that a bank operating in New Zealand, but managed out of another country, has been placed in a formal insolvency regime in that other state. Let us also assume that the Reserve Bank, applying the criteria set out in the Reserve Bank Act, has come to the view that insolvency of this bank creates a risk to the New Zealand financial system. The Reserve Bank then recommends that a statutory manager be appointed and the Minister of Finance acts on that recommendation. An Order-in-Council is subsequently issued to appoint the statutory manager. In these circumstances should the foreign insolvency representative of the bank be entitled to seek relief under the Model Law when the bank is also in statutory management in New Zealand?

214 The Reserve Bank Act is clear in reposing the right of recommendation to initiate statutory management in the Reserve Bank and in the Minister of Finance. The whole procedure, resting as it does in our view on potential systemic financial risk, does not lend itself readily to interplay with the Model Law.

215 We are clearly of the view that once a bank has been placed in statutory management under the Reserve Bank Act no application should be made or be able to be continued under the Model Law. The assets of the bank in New Zealand should be managed by the statutory managers in accordance with the design of the Reserve Bank Act to protect the nation’s financial system.

216 Complete exclusion of statutory management of banks from the application of the Model Law achieves two goals. First, it prevents foreign representatives from seeking assistance under the Model Law when a bank is subject to the statutory management regime. Second, it effectively revokes any recognition granted under the Model Law to a foreign proceeding at any time after the appointment of a statutory manager. Thus, the statutory manager is left to fulfil obligations under the Reserve Bank Act without the possibility of intrusion from foreign representatives.

217 While a foreign representative would be prevented from seeking assistance in New Zealand, the converse would not necessarily be true. A statutory manager of a bank in New Zealand could still seek assistance under the Model Law as enacted in another state provided there was no requirement enacted in that state for reciprocity under the Model Law. But there may be a difficulty because statutory management is commenced by Executive Order rather than by a judicial act. This point has already been noted in the context of statutory management commenced under the Corporations (Investigation and Management) Act 1989 (see para 152).

218 We recommend that banks which are subject to statutory management under the Reserve Bank Act be expressly excluded from the operation of the Model Law. The important point, in our view, is that if there is a bank insolvency in New Zealand which is likely to cause systemic financial failure it is necessary for New Zealand regulators to retain control of assets in New Zealand so that systemic difficulties can be minimised.

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