A Test for Effective Market Supervision of New Zealand Banks

A Test for Effective Market Supervision of New Zealand Banks Abstract The Reserve Bank of New Zealand’s (RBNZ) regulatory regime for banks relies on a combination of self, market and regulatory discipline. It follows a specific disclosure regime to support its reliance on market discipline, and this disclosure regime calls for the ready availability of two documents: the Key Information Summary and the General Disclosure Statement. The RBNZ points to retail depositors as essential market participants with the potential to exert market discipline on banks, but there are differing opinions as to their effectiveness in this role. This paper provides background comments and develops, in the New Zealand context, arguments in support of the Llewellyn & Mayes (2003) prerequisites for the exertion of effective market discipline by stakeholder monitors. We conduct empirical tests relative to some of the Llewellyn & Mayes (2003) prerequisites but find little evidence to support the proposition that they are being met among New Zealand retail depositors. 1 1. Introduction The Reserve Bank of New Zealand (RBNZ) exercises a self-described “light-handed regulatory regime for banks, which relies on a combination of self, market and regulatory discipline.” ( RBNZ, 2004, p 1). It applies a specific disclosure regime to support its reliance on market discipline, and this disclosure regime calls for the ready availability of two documents: the Key Information Summary and the General Disclosure Statement. The RBNZ points to retail depositors as essential market participants with the potential to exert market discipline on banks. However, there are differing opinions as to their effectiveness in New Zealand in this role. In particular, there are differing views over whether the disclosure statements are effective in assisting market participants to monitor their banks. In this paper we provide background comments and develop, in the New Zealand context, arguments in support of the Llewellyn & Mayes (2003) prerequisites for the exertion of effective market discipline by stakeholder monitors. We conduct empirical tests relative to a sub-set of the Llewellyn & Mayes (2003) prerequisites but find little evidence to support the proposition that those prerequisites are being met among New Zealand retail depositors. This paper is organized as follows. In Section 2 we provide a background discussion on banking supervision and market discipline. In Section 3 we introduce the New Zealand context. Section 4 outlines the methodological approach to our empirical work, the results from which are reported in Section 5. Section 6 summarizes and concludes. 2. Background There appears to be consensus across numerous political jurisdictions that some form of government regulation of financial systems in general, and banking systems in particular, is beneficial. Societies and their governments probably come to this conclusion because of the significant economic and social benefits financial systems provide (Levine, 1997), and also because of the likelihood that most modern financial systems would experience substantial disruption, and concomitant adjustment costs, if a large institution failed. As Llewellyn & Mayes (2003) put it: 2 “Markets are concerned with the private costs of a bank failure and in principle reflect the risk of this in market prices. The social cost of bank failures, on the other hand, may exceed the private cost and hence the total cost of a bank failure may not be fully reflected in market prices.” (p 22) Goodhart et al (1999) express a similar sentiment when they say “exit is cont