Ruth Richardson’s Reserve Bank Act and Don Brash’s reign as Governor made New Zealand world leaders in banking regulation. Others came to learn from the then breath-taking simplicity of our three principles:

• How to give independence to a central bank.
• How to give it a clear and non-conflicting mission (in our case integrity in the value of money) and
• How banks can survive without a state guarantee.

Many followed our lead on the first two. Few followed our refusal to guarantee deposits. Commentators wondered whether we’d sustain it in a crisis. Now we know – we didn’t.

To their credit Labour Ministers did not buckle to heavy political tempation to rescue investors as finance companies folded. But finallly, during last year’s election campaign under the spectre of world financial collapse Clark and Cullen introduced the crude guarantee that was supposed to expire in October 2010. .

Now Bill English has refined it in the Retail Deposit Guarantee Act passed this week. It tells retail investors with banks and finance companies they may have an extra year of state guarantee.

But it will cost the banks and finance companies more than now, so that if they can wean themselves from it they could make more money. Perhaps they can be forced by cost into living without the guarantee. And if they’ve expressly rejected the guarantee, perhaps there will be some credibility to future government warnings against expecting a rescue. 

The new law does not deal with the guarantee of wholesale deposits. Nevertheless it is establishing conditions for laborious reduction of the state rescue ‘moral hazard’ that is currently supporting and distorting banks all around the world. Clearly they can now expect taxpayer rescue no matter how imprudent they are. They’re too big to fail.

So we may be quietly regaining world attention to the quality of our  banking regulation, despite having most of our banks under greater regulatory influence from outside.

This week’s leader in The Economist,  highlights the importance of such policies.

"Some guarantees are still plainly needed now, but a firm deadline of, say, five years for the final expiry of the governments’ various crisis-induced pledges should be set globally. With the world economy in better shape, this looks more realistic than it did six months ago. But even then the implicit assumption will linger that banks will always be bailed out. This is the core problem. There are two possible responses to it: regulate banks to try to make them safer, and attempt to limit the implicit guarantee. Both approaches are now needed’"

Under the heading "Lord of the ratios" last week’s Economist (3 September) drew attention to the NZ Reserve Bank’s renewed thought leadership. They reported on the requirment for a "core funding ratio" focussed on liquidity.  The Economist conclusion is slightly dismissive "there is a limit to how far a funding ratio can go. Forcing too much liquidity on banks stifles credit. And in a genuine crisis, central banks will still need to step in".  But this week’s editorial shows the importanc of the current work.

There has been little mainstream media recognition of the significance of the current work. Check out the Reserve Bank Q and A for detail. Interest.co.nz has covered it. You’ll not find much elsewhere – they’re too busy worrying whether Bill English’s family housing will cost $30k  or $40k.

Getting banking regulation right could be millions of times more valuable to taxpayers.

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