The Reserve Bank has revoked ANZ Bank New Zealand Limited’s (ANZ) accreditation to model its own operational risk capital requirement due to a persistent failure in its controls and attestation process.
ANZ is now required to use the standardised approach for calculating appropriate operational risk capital. From March 2019, this will increase its minimum capital held for operational risk by around 60%, to $760 million.
The Reserve Bank requires banks to maintain a minimum amount of capital, which is determined relative to the risk of each bank’s business. The way that risk is measured is important for ensuring that each bank has an appropriate level of capital to absorb large and unexpected losses.
“Accreditation is earned through maintaining high risk management standards, and comes with stringent responsibilities for the bank’s directors and management,” says Deputy Governor Geoff Bascand.
“The Reserve Bank’s role is to review and approve internal models. The onus is then on bank directors to ensure, and attest, that their bank is compliant with the Reserve Bank’s regulatory requirements. To do that, bank directors need to be satisfied that the internal assurance processes that sit behind the attestations are being adhered to.
“ANZ’s directors have attested to compliance despite the approved model not being used since 2014. The fact that this issue was not identified for so long highlights a persistent weakness with ANZ’s assurance process.”
The Reserve Bank had encouraged ANZ to undertake a full review of its attestation process, and assess its compliance with capital regulations, Mr Bascand says. ANZ’s failure to use an approved model was revealed through that review.
“A bank’s disclosure statement is required to contain certain statements signed by each director of the bank. These must state, among other things: whether the bank has systems in place to monitor and control adequately the banking group’s material risks and whether those systems are being properly applied; and whether the bank has complied with its conditions of registration over the period covered by the disclosure statement.
“These directors’ attestations are important because they strengthen the incentives for directors to oversee, and take ultimate responsibility for, the sound management of their bank.
“We continue to work with ANZ in assessing its systems controls before determining any further action.”
ANZ is one of four big banks in New Zealand that are accredited by the Reserve Bank to use their own risk models – the internal models approach – in calculating their regulatory capital requirements.
The Reserve Bank is currently consulting on its capital framework for banks. Among the many decisions to be made, and in part due to proven weaknesses with the internal models approach, it is proposing that all banks adopt a new standardised approach for calculating operational risk capital.
- Attestation regime
A bank’s disclosure statement is required to contain certain statements signed by each director of the bank. These must state, among other things: whether the bank has systems in place to monitor and control adequately the banking group’s material risks and whether those systems are being properly applied; and whether the bank has complied with its conditions of registration over the period covered by the disclosure statement. These directors’ attestations are important because they strengthen the incentives for directors to oversee, and take ultimate responsibility for, the sound management of their bank.
- What are capital requirements?
Bank capital is a source of funding that banks use that stand first in line to absorb financial losses they might make. The Reserve Bank, like other regulators around the world, sets the minimum level of capital a bank must use to fund its operations. The more capital a bank has, the less likely it is to fail.
There are three broad types of risks that banks are required to have capital for:
- Credit risk – the risk that borrowers will be unable to pay back their loans
- Market risk – the risk that a change in market conditions, such as changes in the exchange rate, will cause losses for banks
- Operational risk – other risks that relate largely to the systems of a bank, such as a computer systems failure
- What is internal modelling?
Locally incorporated banks in New Zealand can calculate their capital requirements in two ways: the internal models approach or the standardised approach.
Under the internal models approach a bank is able to use statistical models to assess the riskiness of its business such as the risk of its mortgage loans, or its level of operational risk. The bank’s internal models need to be approved by the Reserve Bank to ensure they are conservatively designed. Banks also need to meet several qualitative criteria to use this approach, such as proper governance and validation of these internal models. The banks in New Zealand that are accredited to use the internal models approach are ANZ, ASB, BNZ, and Westpac.
Under the standardised approach, the amount of capital that is required is prescribed in a set of formulae by the Reserve Bank. This approach is simpler for banks to use than the internal models approach and easier to implement.
- What is an operational risk model?
Operational risk capital requirements are designed to provide banks with sufficient capacity to absorb a wide range and magnitude of operational risk-related losses (from, for example: inadequate or failed internal processes, people or systems; or from external events, including legal risks). Underestimation of the amount of operational risk capital that a bank needs can undermine a bank’s financial soundness and could make it more likely to fail.
- What is the Capital Review?
The Capital Review is a review of the capital requirements that the Reserve Bank sets for locally incorporated banks. It seeks to address several questions about New Zealand’s current framework:
- What should New Zealand’s risk tolerance be for banking crises?
- Do banks have sufficient levels of capital?
- What should the quality of capital be in New Zealand?
- Should we allow internal modelling for capital requirements?
- Should there be a significant difference between internal modelling and standardised approaches?
As part of its current Capital Review, the Reserve Bank is reviewing its capital framework for banks. Due in part to proven weaknesses with the internal models approach and in line with moves by other supervisor banks around the world, the review proposes that all banks adopt a new standardised approach for calculating operational risk capital.
Find out more about the Capital Review.