Geof Mortlock argues the RBNZ Board needs to do a great deal more to demonstrate it is performing its statutory responsibility to assess the performance of the Bank and its Governor

By Geof Mortlock*

For many years I have been an observer of the Reserve Bank Board. Each year I read their annual report to see whether the Reserve Bank’s non-executive directors might do the job to which they were appointed. In my judgement, the Board has failed year after year in doing its job of holding the Reserve Bank and its governor to account. And, sadly, this year is no exception. 

The Board’s annual report for the year to June 2019 falls well short of what is needed to meaningfully assess the performance of the Reserve Bank governor and the Bank itself. And yet in the last year, more than ever before, the Board has been presented with many examples of matters to which their critical attention should have been turned, and on which a meaningful assessment could have been expected. I say this because, in the last year or so, the Reserve Bank and its governor have failed significantly in a number of important areas. And yet we see no comment from the Board on this. Nothing at all.  Indeed, quite the opposite. The Board’s report read as if the Bank and the governor had had a splendid year and that all was well at No.2 The Terrace. In reality, that is far from the truth. The Bank has done some things well, for sure, and I give them credit for that. But there have been some glaring failures that need to be addressed, and the Board is the main line of defence in that regard.

Let’s step back for a minute and recall what the role of the Reserve Bank’s Board is under the Reserve Bank of New Zealand Act. It is important to do this because the Reserve Bank Board is not like the board of most companies or other organisations. Unlike most boards, the Reserve Bank Board does not have any responsibility for setting policies, for managing risks or for executing policy decisions. All of those functions rest with the Bank’s senior management and specifically its governor (now with the addition of the role of the Monetary Policy Committee). Rather, the Board has the following specific functions:

• To recommend to the Minister of Finance the appointment of the Reserve Bank governor and deputy governor, where the appointment is made by the Minister.
• To keep under constant review the performance of the Reserve Bank and the governor.
• To give advice to the governor on matters relating to the Reserve Bank’s functions and exercise of its powers.

If the Board has concerns about the performance of the Reserve Bank or governor, the Reserve Bank Act requires the Board to advise the Minister of Finance in writing and may recommend to the Minister that the governor be removed from office.

In essence, therefore, the Board is a performance assessment body, and it performs this role as agent for the Minister of Finance under authority from Parliament. Rather oddly, because of a failure in the governance structure set up in the Act, the governor sits on the Board, despite the conflict this inherently entails. However, the Board report is, in substance, from the non-executive directors – as it should be.

It is in this context that I have looked at the Board’s annual report, published as part of the Reserve Bank annual report. It was a disappointing read. It largely reads as if it were drafted by the governor or one of his staff, rather than being penned by the non-executive directors. It lacks rigour, objectivity and any meaningful assessment of the Bank’s and governor’s performance. Much of the content of the report relates to a description of the Reserve Bank’s actions and contextual events over the year under review, as opposed to the Board’s assessment of those actions (or absence thereof).  Although some description of the Bank’s activities over the year is obviously necessary, the bulk of the report should address the Board’s assessment of the Bank’s and governor’s performance, rather than summarising what the Bank has been doing. It should also address the basis on which the Board has determined its assessments. I will turn to that matter now, for that is one of the key failings of the Board.

The Board report is largely silent on the criteria it applies in assessing the Reserve Bank’s and governor’s performance in any of the Bank’s areas of responsibility. There is no attempt to specify the performance metrics applied by the Board. This is an odd omission, given that an assessment of anyone’s performance can only be undertaken intelligently and reported on by reference to performance criteria. It is rather like a school report that gives the student a particular grade without reference to the basis on which that grade was determined. I fear that the absence of any assessment criteria or performance metrics in the report might reflect the absence of any serious thinking by the Board on these matters. I hope I am mistaken in that regard. If they have done such thinking, and do have comprehensive criteria for reaching a view on whether they are satisfied with the Bank’s and governor’s performance in each functional area, then these criteria should be disclosed as part of their report, at least in summarised form. However, the report is thunderously silent in that regard.

For example, there is no or little reference to the criteria by which the Board has assessed:

• the extent to which the Bank has discharged its monetary policy obligations, aside, obviously, from reference to the Policy Targets Agreement;
• the effectiveness of the Bank’s public communications on monetary policy;
• the extent to which the Bank has met its statutory objectives in regard to the promotion of a sound and efficient financial system;
• the effectiveness of the systems, processes and staff associated with the prudential supervision of banks and insurers, and the regulation of non-bank deposit takers;
• the extent to which the Bank identified sufficiently accurately and in a timely manner any breaches of prudential or AML requirements, and responded appropriately;
• the capacity of the Bank to undertake assessments of the adequacy of governance and risk management in banks and insurers;
• the adequacy of the Bank’s financial resolution policies and processes;
• the management of foreign currency reserves;
• the oversight of the payment system;
• the operation of the settlement system; and
• the adequacy of the Bank’s prudential policy and consultation processes.

The absence of these criteria fundamentally compromises the effectiveness, integrity and transparency of the performance assessment function. It also greatly reduces the accountability of the Board.

The absence of clarity on performance metrics is not solely a failure of the Board. It is also a failure of the Reserve Bank itself. The Bank has consistently failed to identify, publish and report against meaningful assessment criteria in respect of its functions, with the exception of monetary policy. The Bank’s annual report was largely silent on the issue of performance metrics across its functional responsibilities. Instead, the Bank described its policies and actions, and patted itself on the back in numerous sections of its annual report. There was, not surprisingly, a general absence of self-criticism. And there was little in the way of analytical substance to the assessment of how well or poorly the Bank and governor had performed their duties.

The monetary policy function has the benefit of a quantified policy target, but that is not a substitute for a set of specific performance criteria covering the monetary policy function (e.g. relating to forecasting accuracy relative to private sector benchmarks, clarity of communications, assessment of the impact of monetary policy decisions on employment, etc). The other functions of the Bank, such as prudential regulation and supervision, regulation of the payment system, operation of the settlement system, management of foreign exchange reserves and currency management, are all lacking in meaningful, published performance metrics.

Accordingly, a major area of focus for the Minister of Finance and the Board should be the specification of comprehensive performance assessment criteria across all of the Bank’s functions. I hope this will be a feature of the proposed new governance arrangements. A strong case can be made for the Minister of Finance to specify performance criteria across all of the Bank’s functions in the context of setting policy objectives for the Bank. I will discuss this issue in a future article.

There is also a need for criteria with which to assess the performance of the governor. The Board’s report was devoid of any helpful content in this regard. Indeed, rather astonishingly, the Board report was largely silent on any assessment of the governor per se.  Any assessments of performance made in the report were expressed in terms of the Bank and said little about the performance of the governor himself.

I appreciate that, to a large degree, the assessment of the governor draws on the assessment of the Bank. Ultimately, any material failure by the Bank across any of its functions is the responsibility of the governor. However, beyond this, specific criteria can and should be used to assess the performance of a governor relating to his or her management and conduct.

For example, performance criteria could be expected to cover such matters as:

• the quality of the governor’s decision-making and policy leadership;
• the governor’s role in the Monetary Policy Committee (e.g. in facilitating an effective committee decision-making process, encouraging full participation by all members and seeking to avoid the dominance of any one person in the committee’s deliberations);
• the governor’s conduct in managing relationships with stakeholders, including regulated entities, foreign regulators and the news media;
• the effectiveness of the governor’s public communications, including quality of speeches and handling of news media conferences;
• the temperament displayed by the governor; and
• the governor’s internal management performance and leadership in promoting a desired organisational culture.

One would hope to see the future incarnation of the Board develop a set of performance criteria along these lines and apply them in a transparent manner. The Minister of Finance also needs to turn his attention to this, given that the governor is ultimately answerable to the person who appointed him – i.e. the Minister.

What I found particularly disappointing in this year’s report was the lack of any meaningful commentary by the Board on some key issues that arose during the year under review. After all, it has been an eventful year. In particular, I found it remarkable that the Board said nothing meaningful in relation to the following matters, given the prominence of the issues in question:

• There was no observation from the Board on the need for a much-improved approach to consultation on prudential policy initiatives, in view of the many parties who have criticised the Reserve Bank’s lack of professionalism in its consultation on various prudential policies.
• No mention was made in the Board report about the need to improve the discipline around cost/benefit analyses of the Bank’s policy proposals.  This is striking, given that the Reserve Bank has not yet released a cost/benefit analysis in relation to the bank capital proposals, and says it will only do so once the final decision is released. As a matter of process, it is appalling that a government agency only releases cost/benefit analysis at the end of the consultation process, once decisions have been made, and not at an early stage so that interested parties can assess the costs and benefits of different policy options and bring scrutiny to the cost/benefit analysis itself. It is a key failure in process. Yet nothing from the Board on this.
• The Board made brief reference to the Bank’s capital proposals. Among other matters, it observes: “The quality of the consultation process, engagement with the affected institutions and the Bank’s willingness to provide additional information or undertake further analysis in response to feedback, have been key areas of focus for the Board.” But no commentary is made on the Board’s assessment of the many concerns that have been raised – from many parties – about the substance of the capital proposals, the poor quality of analysis underlying the them, the shoddy consultation process and the lack of any rigorous cost/benefit assessment. The absence of any substantive discussion on these matters in the Board report is an abdication of responsibility by the Board.
• There was no comment from the Board on the quality of public communications from the Bank and its governor. Public communications are an important element in the success or failure of any organisation with multiple stakeholders, and is even more so for the Reserve Bank, given its span of functions, their economic importance and the operational independence the Bank enjoys in exercising its powers. Yet the Board said nothing in substance on this matter. For example, there was no comment from the Board on the relatively few formal speeches given by the governor on monetary policy or financial stability issues in the last year or so. There was also no comment from the Board about the need for a more disciplined and professional approach by the governor in the interviews he gives and off-the-cuff remarks that he tends to make. After all, there have many examples in the last year of a ‘shoot-from-the-hip’ style of commentary from Mr Orr or testy exchanges in front of the camera – something that might be appropriate for a radio jock or talk show host, but not the governor of the central bank.
• There was no assessment of the Bank’s capacity to perform its prudential supervision functions, having regard to the absence of any on-site assessment framework and its limited pool of people with the skills, knowledge and experience required to perform the role of supervisors. There was no mention made of the fact that the Reserve Bank fails to meet around 50% of the international standards on banking supervision (and probably much the same for insurance supervision), and no suggestion that the Board was seeking to ensure that senior management is addressing these failures.
• The Board report made brief reference to the very high staff turnover rates in the last two years. But there was no discussion of the Board’s view as to the causes of high staff losses – e.g. whether the losses of senior staff might reflect failings in the senior management team and/or the emergence of an unhealthy culture within the Bank. Nor was there any commentary as to whether the Board is satisfied that the Bank has sufficient breadth and depth of knowledge, skill and experience in the senior management team or at lower levels.  Instead, the Board makes a supportive statement about appointing more women to leadership roles in the Bank. I would question the wisdom and judgement about prioritising gender balance over a far more important balance that is needed – i.e. the much-needed balance of skill, knowledge and experience in the Bank (regardless of gender, ethnicity, religious orientation or any other irrelevant considerations).
• There is no analysis in the Board report on the adequacy of the Bank’s relationships with other regulators, especially the important issue of cooperation and coordination between the Reserve Bank and the Australian Prudential Regulation Authority (APRA). Given that many of the key policy issues being advanced by the Reserve Bank concern the nexus between home and host authorities, in recognition that our banking and insurance systems are dominated by Australian institutions, a cooperative and coordinated cross-border regulatory framework is essential if we are to get to an optimal outcome for New Zealand.  The autarkic, bunker approach adopted by the Reserve Bank will prove very costly for New Zealand.  A much more coordinated trans-Tasman framework would enable New Zealand to achieve a sound financial system at lower cost than the approach being pursued by the Reserve Bank.  And yet the Board report was silent on the issue of cross-border cooperation and coordination.
• And, finally, as noted earlier, the Board report was astonishingly silent on any assessment of the performance of the governor himself, including with respect to management style, relationships with stakeholders, and conduct. Similarly, no assessment was made of the deputy governor. This is a significant omission. I certainly hope that the Board makes comprehensive performance assessments of the governor and his deputy behind the scenes and that these are conveyed to the Minister. A summarised assessment would be appropriate for the Board report.

I could easily go and list many other significant omissions from the report, but I do not think it necessary. The point is clear enough. The Board needs to do a great deal more to demonstrate that it is performing its statutory responsibility to assess the performance of the Bank and governor.

The last observation I would make in relation to the Board report is the absence of any reference to the extent to which, if at all, the directors have engaged actively with external parties in the course of assessing the performance of the Reserve Bank and governor. The Board refers to its discussions with external appointees to the Monetary Policy Committee, which is as one would expect. But there is no reference to the Board having consulted in a meaningful way with other external parties to obtain their perspectives on the performance of the Bank and its governor, including representatives of regulated entities, industry associations, academics, foreign regulatory agencies, Members of Parliament, Treasury, Financial Markets Authority and the news media. I am aware that the Board has occasional luncheons and the like with various stakeholders. These provide an opportunity for dialogue, for sure. But they are not a substitute for a focused engagement with stakeholders – one on one – in such a manner that enables the Board to deepen its understanding of stakeholders’ views on specific matters relating to the Bank’s performance and that of the governor. In the absence of this, there is a considerable risk that the Board is overly dependent on – and indeed captured by – the views expressed to it by the Bank’s senior management.

All in all, the Board’s report fails as a meaningful record of assessment of the Bank and governor. No doubt much goes on behind the scenes that cannot – obviously – be contained in the annual report. And I do not question the capability and integrity of the non-executive members of the Board. They are good people. However, based on this report and the Board’s previous efforts, and my knowledge of how the Bank operates, I am of the view that the Board has consistently failed in adequately discharging its duties under the Act. It is not providing a meaningful mechanism for assessing the performance of the Bank and governor, and for holding them to account. The Board needs to lift its game.

Maybe the proposed changes to the Reserve Bank’s governance arrangements will facilitate a more effective engagement by the Board. I hope so. But that then raises another issue. The new Board (as I understand the government’s in-principle proposals) will be a true governance board responsible for the overall management of the Bank – i.e. a decision-making board. If I understand it correctly, that Board will set policy and take ultimate responsibility for the governance of the Bank (but where monetary policy decisions will be made by the MPC). It will therefore no longer be a performance monitoring board in the way it now is. That raises the question of how the performance of the Reserve Bank can be meaningfully assessed and by whom. The same issue applies to the Financial Markets Authority and other regulatory agencies. In other words, who assesses how well or poorly the regulators/central bank are doing their job?

The government’s proposals envisage the Treasury being the principal monitoring agency overseeing the performance of the Reserve Bank. I support that approach, provided that the Treasury is equipped to do the job well. My fear, though, is that the Treasury is spread over so many functions and is staffed so thinly (albeit with able people), that they will struggle to perform the monitoring role to good effect. I therefore suggest that a more effective mechanism for ensuring an effective process for assessing the performance of the Bank and its governor, and other regulators for that matter, might be through a new mechanism – a completely separate performance assessment body. This is what the Australian government is introducing to oversee the performance of APRA and ASIC. Many other countries have similar arrangements, under which regulatory bodies are subject to regular, independent performance assessment under mandate from Parliament. I urge the Minister of Finance and government to consider that option.

*Geof Mortlock is an international financial consultant based in Wellington who undertakes extensive assignments globally for the International Monetary Fund, World Bank and other organisations, dealing with a wide range of financial sector policy issues. He formerly worked at senior levels in the Australian Prudential Regulation Authority and Reserve Bank of New Zealand.