Statement of Intent - New Zealand pound · 3 RESERVE BAN OF NEW ZEALAND / STATEMENT OF INTENT t r s x t r s { Strategic priorities We are working to position the Bank to best face

iRESERVE BANK OF NEW ZEALAND / STATEMENT OF INTENT 2016–2019

Statement of Intent2016-2019

iiRESERVE BANK OF NEW ZEALAND / STATEMENT OF INTENT 2016–2019

Reserve Bank of New Zealand Statement of Intent

2016-2019

ISSN 1175-6786

Copyright © Reserve Bank of New Zealand 2016

1RESERVE BANK OF NEW ZEALAND / STATEMENT OF INTENT 2016–2019

Reserve Bank of New Zealand Statement of IntentFor the period 1 July 2016 to 30 June 2019

Contents

Environmental setting and strategic priorities 2 What we do 5 SOI, funding 5 Governance 5 Organisational structure 7 Strategic direction 8 Vision and values 8 Outcomes 8 Reserve Bank strategic priorities for 2016–2019 13 Functions – initiatives 16 Monetary policy formulation 16 Financial market operations 18 Macro-financialstability 20 Prudential supervision 22 Settlement services 24 Currency operations 25 Operations–enablingtheBank 26 Financial management 29


Environmental setting and strategic priorities

Environmental setting

New Zealand’s economy expanded at an average rate of 2.3 percent in 2015, in line with the average pace of expansion since 2010. The economicexpansionhasbeensupportedbyalowpolicyinterestrate,highhousepriceinflation,stronginwardmigration,continuedconstruction growth and a decline in the exchange rate since April 2015.

However,theeconomyfacesanumberofheadwinds,includinglowexport commodity prices, particularly in the dairy sector, weak world demand and a cautious household sector.

Inflationhasremainedbelowthetargetbandof1-3percentduring2015–drivenbyanelevatedexchangerate,fallsinoilpricesandsparecapacityintheglobaleconomy.Stronger-than-expectedgrowthinlaboursupplyhasalsocontributedtolowerinflation.

Theoutlookfortheglobaleconomyremainshighlyuncertain,whichhasledtosomevolatilityinfinancialmarkets.Economicgrowthisslowinginanumberofkeytradingpartnereconomiesandinternationalcommoditypricesremainweak.Centralbanksaroundtheworldcontinuetoadopt

unprecedentedmonetarypolicystimulusinresponsetolowinflation,andthisposesariskforfinancialstabilitybyencouraginghigherleverage,risk-taking and driving up asset prices. The Reserve Bank will continue to deepenitsunderstandingofthecurrentdriversoflowinflationandtheirconsequences for the economy and monetary policy.

TheReserveBankwillcontinuetodrawontheflexibilitycontainedinthePolicy Targets Agreement in managing economic risks and assessing monetarypolicy.Whiletherehasbeenamaterialdeclineinshort-terminflationexpectations,andConsumerPriceIndex(CPI)outturnshavebeenoutsidetheBank’s1-3percenttargetband,long-terminflationexpectations are well-anchored at 2 percent.

Fromafinancialstabilityperspective,NewZealand’sfinancialsystemremains sound and well placed to support economic expansion. New Zealandbanksarewellcapitalised,fundingandliquiditybuffersareaboverequiredminimums,andprofitabilityisstrong.Whilebankshavecapacitytoabsorbanincreaseinproblemloans,sustainedincreasesinhouse prices, and the risk of a sharp correction, could pose additional financialstabilityrisks.


Strategic priorities

WeareworkingtopositiontheBanktobestfacethechallengesahead,and the strategic priorities in the Statement of Intent(SOI)reflectthis.The Bank has adopted eight strategic priorities for 2016-19 to enhance its capacity to respond to this challenging environment. Many of these strategic priorities run across several functions and departments.

Thesestrategicpriorities,whicharedescribedinmoredetailonpages13-15,areframedaroundthreebroadthemes:

• enhancing the Bank’s policy frameworks;

• continuing to strengthen the Bank’s internal and external engagement; and

• improving infrastructure and reducing enterprise risk.

The Bank continually seeks to strengthen its performance and position itself to meet the challenges and demands of the surrounding environment. The Bank’s Funding Agreement with the Minister of Finance allows for a funding increase of 1 percent a year over the next fiveyears.Costsavingsandresourceefficiencieshavebeenidentifiedandarebeingimplemented.

Informing Government

TheBankkeepstheMinisterofFinanceregularlyinformedaboutitsthinkingonsignificantpolicydevelopments,especiallywhereCabinetdecisions,legislationorregulationmayberequired.Thisinvolvesprovidingsubstantiveinformationonandadiscussionoftherationaleforanychangesandtheirpotentialeconomicandfiscalimpactsattheearliestpossiblestagesofpolicydevelopment,includingtimelyengagementwithTreasuryofficials.TheBankalsoprovidesassessments of the expected regulatory impacts of proposed policy developments.

In terms of the 2016-19 SOI,thiswouldincludeinformationon:

• macroeconomic policy in the coming economic cycle, including the implicationsoflowinflationandhowinternationalmonetaryconditionsmay affect the exchange rate and domestic policy settings. It also covers issues relating to the Bank’s implementation of monetary policyandpoliciesdirectedtowardfinancialstabilityandtheirinteractionswithfiscalandwiderpolicysettings,aswellasanalyticalcontributionsthatdeepenunderstandingofNewZealand’seconomicperformanceandmacroeconomicimbalances;

• macro-prudential policy and the effectiveness and development of macro-prudential tools, and consultation on developments in accordance with the Memorandum of Understanding agreed in 2013;

• plans to improve the quality and effectiveness of the regulatory and prudentialsupervisoryregimesadministeredbytheBank;

• activitiesthatsupportawellfunctioningfinancialsystem,includingtheongoingsuitabilityofpoliciesthatreducethelikelihoodofthefailure


ofamajorfinancialinstitutioninNewZealand,particularlyinlightofongoing international developments in prudential standards;

• riskstotheCrownbalancesheetthatmayarisefromthefailureofafinancialinstitutionandthebeddinginofreformsthatmitigatetheCrown’sexposuretothefinancialsector,includingOpenBankResolution(OBR);and

• thescopeandoutcomesoftheBank’scloseongoingcollaborationwith Australian stakeholders through the Trans-Tasman Banking Council and other channels.

• advice on any amendments or updates to the Policy Targets AgreementwhichwillbesignedbytheReserveBankGovernorandMinister of Finance in 2017.

Graeme Wheeler Governor

21 June 2016

Grant Spencer Deputy Governor

21 June 2016


What we do

TheReserveBankofNewZealandisNewZealand’scentralbank.ACrownagency,theBankexercisespowersacrossthefinancialsectorthatarederivedfromseveralpiecesoflegislation:

• Reserve Bank of New Zealand Act 1989. • Insurance(PrudentialSupervision)Act2010. • Anti-Money Laundering and Countering Financing of Terrorism Act 2009(AML/CFTAct). • Non-bankDepositTakersAct2013(NBDTAct).

TheseActscanbeviewedelectronicallyontheNewZealandLegislationwebsite.RegulationsmadeundertheseActscanbeviewedonthesamesite.

Statement of Intent, Funding

Undersection162AoftheReserveBankofNewZealandAct1989(theAct),theReserveBankmustprovidetotheMinisteranSOI for that financialyearandatleastthenexttwofinancialyears.TheSOI is set in the context of the Bank’s longer-term planning and funding. The Bank is fundedthroughafive-yearfundingagreementbetweentheMinisterofFinanceandtheGovernor,whichisratifiedbyParliament.ThecurrentFunding Agreement is for 2015-16 to 2019-20. The Funding Agreement specifieshowmuchoftheBank’sincomecanberetainedbytheBanktomeet its operating costs. This SOI covers the years 2016-17 to 2018-19 ofthefive-yearfundingagreement.

Governance

The Act provides day-to-day operational autonomy to the Bank under the management of the Governor, an important role for the Minister of Financeinsomekeydecisions,andarobustaccountabilitystructurethatinvolves formal roles for the Bank’s Board, the Minister and Parliament (viatheFinanceandExpenditureCommittee).Transparencyisanimportant feature of the framework. For a description of how the Bank’s performance is monitored, see the Bank’s SOI 2012-2015, pp. 33-35.


The Minister

TheMinisterofFinancehasresponsibilityfor:agreeingthemonetarypolicy target with the Governor; approving any decision to place a failing bankintostatutorymanagementortogivedirectionstoaregisteredbank;andseekingCabinetapprovalforproposedregulationsmadeundertheActsadministeredbytheBank.TheMinistercanalsodirectthe Bank to intervene in the foreign exchange market or to impose, for a limited period, an alternative monetary policy target. In these cases, transparent procedures are set out in the Act. A Memorandum of UnderstandingbetweentheMinisterandtheGovernor,dated13May2013,requirestheBanktoconsulttheMinisterandtheTreasurybeforeimplementing macro-prudential tools.

The Bank meets regularly with the Minister and Treasury to discuss a range of issues, including developments in the prudential policy work area,andothermattersaffectingfinancialstability.

Board of Directors

The Reserve Bank has a Board of Directors whose primary function is to keep under constant review the performance of the Bank and the Governor in carrying out their statutory functions. The Board’s monitoring oftheBank’sperformanceisguidedbyaLetterofExpectationsfromtheMinister,andtheboardreportsseveraltimestotheMinisterduringthe year. The Board meets at least nine times a year, with three of the meetings often taking place outside Wellington. The Board receives briefingsontheBank’sactivities,policies,decisions,performanceindicators,financialandotherrisks,andtheperformanceoftheBank’sstatutory functions and the exercise of its powers. At these meetings, the Board may also provide advice to the Governor on the Bank’s performance of its functions and the exercise of its powers.

Each year the Board prepares a report setting out its assessment of the Bank’s and the Governor’s performance, which is provided as advice totheMinisterofFinanceandmadepubliclaterintheBank’sAnnual Report. Through its Audit Committee the Board reviews the Bank’s financialstatementsandinternalandexternalaudits.

When required, the Board makes recommendations to the Minister on the appointment or reappointment of the Governor. The Minister can onlyappointaGovernorrecommendedbytheBoard.TheBoardcanrecommendtotheMinisterthattheGovernorbedismissedifitbelievesthattheGovernor’sperformanceorconducthasbeeninadequateorinappropriate in any one of various respects set out in the Act. The Board appoints Deputy Governors on the Governor’s recommendation.

At the time of writing the Board has seven non-executive directors, and theGovernorisanexecutivememberoftheBoard.ThecurrentBoardmembersareDrRodCarr(Chair);MrKeithTaylor(DeputyChair,andChairoftheBoard’sAuditCommittee);MsBridgetCoates;ProfessorNeilQuigley;MrJonathanRoss;MsTaniaSimpson;MsKerrinVautierCMG;andMrGraemeWheeler(Governor).Boardmembersareappointedforfive-yeartermsandareeligibleforreappointment.


Organisational structure


Strategic direction

Vision and values

The Reserve Bank’s vision is to promote a sound and dynamic monetary andfinancialsystem.Itseekstoachievethisvisionbybeingahigh-performingsmallcentralbank,withvaluesof:

Integrity – Being professional and exercising sound judgement. Innovation – Actively improving what we do. Inclusion – Working together for a more effective Bank.

TheBankaimstodevelopandimplementhighlyeffectiveandefficientmonetary,regulatoryandfinancialpoliciesthatarewellsuitedfortheNewZealandeconomyandfinancialsystem.Itendeavourstoensurethat:theBank’sobjectivesandprioritiesaresound,clearlycommunicatedandunderstood;itsbusinessoperationsarewellmanaged; and it invests wisely in the recruitment, training, development and retention of its staff. The Bank also invests heavily in reviewing and testing its policy frameworks and policy settings in light of domestic and internationalexperience,andensuresthatitsindependenceisbalancedbyappropriatepublicdisclosureandaccountability.

Outcomes

TheBankcontributestotheGovernment’sgoalofimprovingNewZealand’seconomicperformancebytargetingthreestatutoryrequirementsdesignedtofosterconfidenceandstabilityinNewZealand’sfinancialsystem,by:

• maintainingstabilityinthegenerallevelofprices; • maintainingasoundandefficientfinancialsystem;and • providinglegaltendertomeetthecurrencyneedsofthepublic.

Toachievetheseoutcomes,theBankperformsfunctionscovering:

• monetary policy formulation; • financialmarketoperations; • macro-financialstability; • prudential supervision; • settlement services; and • currency operations.

Thelinksbetweenthesefunctionsandthroughtheoutcomestargeted,and the measures used to evaluate performance, are shown in the followingtables.


The Reserve Bank – outcomes, functions and operations

Pricestability

Improved economic performance

Soundandefficientfinancialsystem Legal tender meets currencyneedsofthepublic

Functions

Monetary policy formulation

Financial market operations

Macro-financialstability

Prudential supervision

Settlement services

Currency operations

Operations

HumanResources-KnowledgeServices-FinancialServices-Communications-RiskAssessment&Assurance-Property&Security

Outcomes

Goal


Goal, organisation outcomes, functions, functional outcomes and success measures



Stabilityinthegenerallevelofprices

• TheBankimplementsmonetarypolicyinamannerthatcanreasonablybeexpectedtoseeCPIinflationoutcomesbetween1percentand3percent on average over the medium term, with a focus on keeping futureaverageinflationnearthe2percenttargetmidpoint.

• Measuresofunderlyinginflationshouldgenerallyremainwithinthetarget range.

• The Bank implements monetary policy in a manner that seeks to avoid unnecessaryinstabilityinoutput,interestratesandtheexchangerate.

• Monetary Policy Statements(MPSs)areinformativeandaccuratelyassesstheBank’sperformanceinmeetingtheobjectivesofthePolicyTargets Agreement.


• Adequatebankingsystemliquidity

• Short-term interest rates consistent with monetary policy

• ConfidenceintheefficientfunctioningofNewZealandfinancialmarkets

• Foreignreservesavailableforefficientforeign exchange intervention and crisis management.

• Short-termwholesaleinterestratesaremaintainedatlevelsclosetotheOfficialCashRate(OCR).

• No evidence of payment disruptions due to a shortage of settlement cash in the system, e.g. persistent accessing of the Overnight Reverse Repo Facility.

• Over the medium term, domestic market operations generate a positive return.

• Foreign reserves are maintained at target levels, with liquidity and credit standards met throughout.

• The Foreign Reserves Management portfolio yields a net return on assets that meets or exceeds the benchmarkportfolio.

• Theforeignexchangeopenpositionismanagedsuchthat:

(a) thebulkofactiveforeignexchangepurchases(sales)areundertakenaroundpeaks(troughs)intheexchangeratecycle;and

(b) thenetreturnonthenon-coreopenforeignexchangepositionispositiveoverthecycle.

Pricestabilitymaintained

Function

Functional outcomes

Success measures



Macro-financialstability


InternationalandlocalconfidenceinNewZealand’sfinancialsystem.

• Significantriskstodomesticfinancialsystemstabilityareidentifiedandmonitored.

• Appropriateinstrumentstocounterriskstofinancialstabilityaredeployedinatimely and effective manner, and any potential impacts on monetary policy are understood.

• Information on the risk assessment framework, including the macro-prudential indicatorsthatareusedtoguidepolicysettings,ispublishedinamannerthatassiststheassessmentoffinancialstability.

• AnassessmentofthesoundnessandefficiencyofthefinancialsystemispublishedtwiceyearlyintheFinancial Stability Report(FSR),includingthereasonsfor,andtheimpactsof,anyusebytheBankofmacro-prudentialpolicyinstruments.

• Statisticsarecollectedtoenableanappraisalofthesoundnessandefficiencyofthefinancialsystem,andarepublishedinaccordancewiththeprinciplesandprotocolsofNewZealand’sOfficialStatisticsSystem.

Soundandefficientfinancialsystemmaintained

• Asoundandefficientfinancialsystemthatsupports the functioning of the economy.

Macro-financial stability

• Financialstability,promotedby:

- increasedresilienceofthefinancialsystem during periods of extreme credit growthandrisingleverageorabundantliquidity; and

- dampening of excessive growth in credit and asset prices.

• Thebank,non-bankdeposittaker(NBDT)andinsuranceregulatoryregimes,andinparticular the regulatory changes implemented during the year, promote the soundness andefficiencyofthefinancialsysteminacost-effectivemanner,asdemonstratedbysound regulatory impact analysis of policies it intends to adopt and regular reviews of existing policies.

• TheReserveBank’sprudentialoversightofbanks,NBDTs,insurancecompaniesandpaymentsystemsidentifiesemergingfinancialstressesinatimelymanner;andthe Bank is prepared, where necessary, to resolve institutional failures effectively in conjunction with Government.

• The Bank demonstrates a consultative and transparent approach to its policy development,supportedbyrobustanalysisthatisunderstoodbyregulatedinstitutionsand stakeholders.

• In its decisions on whether to grant licences to new applicants, the Bank takes a consistent approach within the legislative framework.

• TheBank’sAML/CFTsupervisoryactivitiesdemonstrateanappropriaterisk-basedapproach to supervision of reporting entities.

• Supportandfacilitatetheassessmentofthemacro-prudentialframeworkwillbeprovidedbytheInternationalMonetaryFund(IMF)FinancialSectorAssessmentProgramme(FSAP)reviewofNewZealand’sfinancialsystemandpolicyframeworkin2016.

Function

Functional outcomes

Success measures



Settlement services

Currency operations

Legal tender that meets the currency needs of the public.

• AllordersfornotesandcoinsfrombanksthatmeettheReserveBank’sguidelinesarefulfilledwithin agreed times.

• Notesandcoinsingeneralcirculationareofagoodquality,asindicatedbysurveysofthecondition of currency in circulation.

• Thenumberofcounterfeitnotesincirculationshouldbefewerthan10permillionnotesincirculation.

• Currencyisavailabletothepublictomeetplannedandunplanneddemand.

Soundandefficientfinancialsystemmaintained Currency operations

Efficient,reliableandsecurepaymentsystemsthatsupport the functioning of the economy.

• TheavailabilityofpaymentsystemsoperatedbytheBankduringcoreoperatinghoursisatleast99.90percent(thisisthetargetavailabilityspecifiedinthesystems’termsandconditions),asmeasuredoverayear.

• Customer satisfaction with operations and systems development is demonstrated through an annual customer survey in which an approval level of 90 percent or more is achieved.

• Allrisksarewellmanaged,asdemonstratedbypayment’ssystemsexternalaudits.

• Internationalstandardsforpaymentandsettlementsystems(Committeeon Payment and Settlement Systems and International Organization of SecuritiesCommissions)arecompliedwith,subjecttovariationsforlocalNew Zealand conditions.

Function

Functional outcomes

Success measures

1 ThisisthetargetavailabilityspecifiedintheESAStermsandconditions.


Reserve Bank strategic priorities for 2016-19

I. Enhancing the Bank’s policy frameworks

1. Continue to deepen our understanding of the current drivers of low inflation and their consequences for the economy and monetary policy

Aprotracted,verysubduedeconomicrecoveryintheaftermathoftheglobalfinancialcrisishasledtosignificantfallsininternationalcommodityprices,andcentralbanksaroundtheworldaregrapplingwithalowinflationenvironment,despiteunprecedentedmonetarystimulus.TheBankwillundertakeworktobetterunderstandtheinternationalanddomesticdriversofinflationandtheimplicationsformonetarypolicy,andto ensure there is wide understanding of the Bank’s policy choices.

2. Review key elements of the prudential policy framework to better meet the Bank’s soundness and efficiency objective

The Bank will implement changes arising from the regulatory stocktake, andreviewkeyfinancialpolicies,soastobestachievetheBank’sfinancialsoundnessandefficiencyobjective.ThefindingsoftheIMFFSAPmayberelevanttothereviewsthatwillcovertheoutsourcingpolicyforbanks,capitalandliquidityrequirements,crisispreparedness,and the insurance prudential framework.

3. Develop a comprehensive stress-testing framework for the New Zealand banking system

The Macro-Financial and Prudential Supervision departments are developing a comprehensive stress-testing framework to help ensure a resilientbankingsystem.TheReserveBankwillworkwiththebankstofosterbestpracticeintechnicalstress-testingframeworksandprocesses.TheBankwillpromotestresstestsasanintegralpartofbanks’internalrisk management frameworks.


II. Continuing to strengthen the Bank’s internal and external engagement

4. Continue to improve performance culture

Managers will use the Bank’s refreshed performance expectations, competency framework and development process to lead and develop stafftowardsbuildingahigh-performanceworkplace.Continualimprovementinefficiencyandbusinessresultswillbesought,valuedandmeasured. We will engage with our staff to deepen connections to the Bank’saspirationalgoalofbeingtheBestSmallCentralBank.

5. Engage and communicate with stakeholders

TheBankwillmaintainahighlevelofengagement,accessibilityand dialogue with the Board and stakeholders to enhance mutual understanding.Itsapproachtoconsultationwillbeenhancedinlinewithcommitments resulting from the Regulatory Stocktake. The Bank will communicatebroadlyonitspolicies,itsreasoningandtheimpactsofitsactivities through its proactive on- and off-the-record speech programme, briefings,mediaengagementsandonlinechannels.

III. Improving infrastructure and reducing enterprise risk

6. Implement the payments system review

The Bank will progress the implementation of a system to replace the ExchangeSettlementAccountSystem(ESAS),providingreal-timegross settlement services. The Bank will select and commence the implementation of a replacement system for securities settlement and depositoryservices(NZClear).

7. Implement the roadmap for best-practice central bank balance sheet and financial management

Treasurysystemssupporttwokeypolicyfunctions:foreignreservesmanagement(includingcurrencyintervention),andtheimplementationofmonetarypolicy(liquiditymanagement).Systemsrequirementshaveevolvedsignificantlysincetheglobalfinancialcrisis,andtheBankneedsto update key functionality. The Bank will implement an agreed Treasury Systems(Roadmap)Strategytoenhancethemanagementofrisksandreturnsandaiddecision-makingbyprovidingmarket-standardtradevaluation, position and collateral management, and enhanced risk and performance reporting.


8. Develop a plan for the future custody and distribution arrangements for currency

The Bank has undertaken a review of its currency operating model and supporting infrastructure with the aim of ensuring that the currency needs ofNewZealanderswillbemetinthefuture.Thereviewhasassessedthecurrentoperatingmodel,andidentifieddifferentapproachesforthecustodyanddistributionofcurrency.TheBankwillconsultandcollaboratewithkeystakeholdersduring2016-17toensurethatthereview’s recommendations are understood, supported and developed to viableimplementationplans.


Functions – initiatives


Objective

Toachieveandmaintainstabilityinthegenerallevelofprices.

ThecurrentPolicyTargetsAgreementbetweentheMinisterofFinanceandtheGovernorrequiresthattheBank“keepfutureCPIinflationoutcomesbetween1and3percentonaverageoverthemediumterm,withafocusonkeepingfutureaverageinflationnearthe2percenttargetmidpoint”.Italsorequiresthat:“Inpursuingitspricestabilityobjective,theBankshallhaveregardtotheefficiencyandsoundnessofthefinancialsystem,andseektoavoidunnecessaryinstabilityinoutput,interestratesand the exchange rate.”

Scope of operations

The Bank undertakes research and analysis of macro-economic conditionstoenableitto:

• set the OCR seven times a year, or as required, with the aim of keepinginflationnearthemid-pointofthetargetbandof1-3percent;

• publishanMPS each quarter at the same time as four of the OCR decisions. The MPSs set out the Bank’s views on the economy and thebalanceofinflationarypressures,andthebasisfortheOCRdecision;

• announcetheotherthreeOCRdecisions,eachaboutsixweeksafteran MPS; and

• whereappropriateandfeasible,interveneintheforeignexchangemarkettoinfluencetheleveloftheexchangerate,consistentwiththeobjectivesofthePolicyTargetsAgreement.

Environment and policy issues

New Zealand’s economy expanded at an average rate of 2.3 percent in 2015, in line with the average pace of expansion since 2010. The expansionhasbeensupportedbyalowpolicyrate,highhousepriceinflation,stronginwardmigration,continuedconstructiongrowthandadecline in the exchange rate since April 2015. However, the economy hasfacedanumberofheadwindsinthisperiod,includinglowexport


commodity prices, particularly in the dairy sector, weak world demand and a cautious household sector.

Theeconomylookstobeclosetoitspotentiallevelofoutputwithsparecapacitynearzero.However,inflationremainedbelowthetargetbandof1-3percentduring2015.Lowinflationhasbeendrivenbyanelevated exchange rate, falls in oil prices and spare capacity in the globaleconomy.Stronger-than-expectedgrowthinlaboursupplyhasalsocontributedtolowerinflation.Short-terminflationexpectationshavefallen,reflectingaperiodofsustainedweakinflation,althoughlonger-term expectation measures reveal they remain anchored at 2 percent.

Monetarypolicyhasbeenaccommodativeinthepastyearduetoweakinflationoutcomesandweakglobaldemand.Thepolicyratehasbeenreducedby125basispointssincethestartof2015inordertostimulateeconomicgrowthandensurefutureinflationsettlesnearthemiddleofthetargetrange.Furtherpolicyeasingmayberequiredtoensurethatfutureaverageinflationsettlesnearthemiddleofthetargetrange.

Withinthisenvironment,keydevelopmentsthattheBankwillmonitorare:

• whetherinflationexpectationsfallfurtherasaresultofrecentweakinflationandbecomeembeddedinpriceandwagesettingbehaviour;

• developments in the Chinese and emerging Asian economies as they affectglobalfinancialmarketvolatilityandtheNewZealandeconomythrough trade and the exchange rate;

• globaldairypricesandtheireffectsonfarmincomesandthewidereconomy;

• high net immigration in New Zealand and the net demand impact on the economy;

• demandandsupplyimbalancesinthehousingmarket;and

• weak world demand and how this affects oil and other import prices over the medium term.

Initiatives and strategies

The Bank’s Economics department has three key work streams for 2016.

1. Supporttheformulationofmonetarypolicy:understandbetterthecurrentdriversoflowinflationandtheirconsequencesforoutput,consumption,labourmarketoutcomesandmonetarypolicy.

2. Monetarypolicyresearch:ourresearchprogrammewillcontinuetofocusonquestionsfacedbysmallopeneconomies,includingduring2016:dealingwithuncertaintywhensettingmonetarypolicy;thetransmission of monetary policy; developments in commodity prices; andpriceandwagesettingbehaviour.

3. Internationalandexchangerateanalysis:understandbettertheimpactsoflarge-economybusinesscyclesandmonetarypoliciesonNew Zealand.

Success measures

See page 10.



Objectives

Tosupporttheimplementationofmonetarypolicy;toassistintheefficientfunctioningofNewZealand’sfinancialsystem;tomanageofficialforeignreserves; to implement the Bank’s foreign exchange market intervention policy;tomanagetheCrown’sfinancialliquidity;andtomaintaincrisisinterventioncapability.

Scope of operations

TheBank:

• providesadviceonfinancialmarketandinternationaleconomicissues and developments for the formulation of monetary policy;

• implements monetary policy through market operations to ensure that market interest rates are consistent with the OCR;

• managesofficialforeignreservesforuseintimesoffinancialdistressor when foreign exchange intervention is needed for monetary policy purposes;

• managesliquidityinthebankingsystem;

• manages the Crown Settlement Account; and

• actsaslenderoflastresorttothefinancialsystemifnecessary,aswellasassistingintheresolutionofanyfinancialmarketorbankingcrisis.


Globalfinancialmarketsremainedvolatileinthepastyearasparticipantsreactedtorealandperceivedpolicyshiftsbyanumberofmajorcentralbanks.Inparticular,anincreasedfocusonthetimingandconsequencesof policy rate increases in the United States, along with negative interestratesintheEurozoneandJapan,causedsignificantvolatilityin asset prices, especially commodities. Emerging markets, particularly commodityexporters,experiencedsharpboutsofcurrencyweaknessduetocapitaloutflowsandexpectationsoflowergrowth.

Globalmarketsareexperiencingareductioninunderlyingliquidity,drivenbychangestobankandfinancialintermediarybusinessmodels,deterioratingprofitoutlooksandanincreasedfocusontheefficientuseofcapital.Asaconsequenceoftheseglobalshifts,therehasbeenadecreaseinthenumberofactiveparticipantsinNewZealand’sfinancialmarkets.

ThekeypolicyissuesfacingtheBank’sFinancialMarketsfunctionare:

• respondingtolower(andincreasinglynegative)investmentreturns,reducedliquidityandvolatilityinmajorglobalmarketsinconjunctionwithareductioninNewZealandfinancialmarketparticipants;

• improvingthevaluationofunderlyingfinancialinstruments(viaanupdatedTreasuryManagementSystem),whichwillenabletheBanktobebetterpositionedfortheseevolvingfinancialmarketdevelopments; and


• enhancingtheBank’sabilitytorespondwithappropriateoperationalliquidityfacilitiesforNewZealandbanks,ensuringanoperatingenvironment that can withstand anticipated shocks, as well as flexibilitytocontainunexpectedshocksinbothoffshoreandlocalmarkets.


• Implementing the agreed trade valuation solution. This will provide a significantimprovementintheriskmeasurementandmanagementoftheBank’sbalancesheet.

• Improvingresearchcapabilityininternationalmarketsandeconomiesin conjunction with a re-focused market-intelligence-gathering function that incorporates a wider range of offshore and local market participants.

• Improving returns on the Bank’s foreign reserves assets, in an environment of low and in some cases negative yields. This may involve changes to the Bank’s asset allocation, alongside portfolio-return-enhancingstrategiessuchassecuritieslending.ThiswillbecomplementedbyimprovedoperationalefficienciesintheBank’scollateral management operations.

• Improve the valuation of Residential Mortgage Backed Securities (RMBS),reviewthecurrentrepoeligibilitypricing,andlooktointroduce standardised terms and conditions that may help to facilitate a secondary market in RMBS. This could offer an additional funding channelforlocalbanks,providingthemwithmoreflexibilityifliquidityand/orfundingconditionschange.

Success measures

See page 10.


Macro-financial stability

Objectives

Promotethefinancialstabilityofthedomesticfinancialsystemby:

• identifying and assessing emerging system risks in a timely manner;

• advising on the deployment of macro-prudential instruments to reduce system risks arising from extremes in credit cycles, asset prices and liquidity conditions;

• analysingandreportingonthesoundnessandefficiencyofthefinancialsystem;and

• collectingandpublishinghigh-quality,relevantandtimelystatisticsthatenableinformeddecision-making.

Scope of operations

TheBank:

• identifies,monitorsandreportsontherisksfacingthefinancialsystem, including those arising from credit cycles, asset prices and liquidity conditions;

• publishesanFSR twice a year, and other reports, assessing the soundnessandefficiencyofthefinancialsystem;

• implements macro-prudential policy, considers its interactions with monetary policy, and assesses and reports on the effectiveness of the instruments deployed; and

• producesandpublisheshigh-quality,relevantandtimelystatisticsonthefinancialsystemtosupporttheBank’spolicyfunctions.


Lowglobalmilkpricesarecreatingsignificantfinancialpressuresfordairyfarms,withasignificantproportionofthesectorfacingathirdconsecutive season of operating losses. With parts of the sector heavily indebted,banksarelikelytoexperienceariseinnon-performingloans,especially if milk prices are slow to recover from their current lows. Stress tests of the major lenders to the sector suggest losses are likely to bemanageableforthebankingsectorasawhole,butadeclineindairysector credit quality will nevertheless pose challenges for the sector.

Restrictionsonloan-to-valueratios(LVRs),includingnewrestrictionsforAucklandinvestorsintroducedinNovember2015arehelpingtocontainfinancialsystemstabilityrisksbyreducingtheshareofriskylendingonbankbalancesheets.HousepriceinflationinAucklandeasedinlate2015,althoughtherearesomesignsthatitmaybegainingmomentumagain.HousepriceshavebeenrisingrelativelyrapidlyinotherpartsofNewZealand,reflectinglowmortgageinterestratesandsomedisplacement of activity away from Auckland. While house prices outside Auckland remain less stretched relative to income, a continuation of this trend could present challenges for macro-prudential policy.


TheBankhassoughtcommentfrommajorbanksonadocumentsettingoutcomprehensivebest-practiceguidelinesfortheconductofstress-testingexercisestogaugetheresilienceofthebankingsystemtoarangeofadverseshocks.TheBankwillbeworkingwiththebanksinthecoming year to understand their work programmes to improve technical stress-testingframeworksandtoensurestresstestingiswellembeddedinthebanks’internalriskmanagementframeworks.

TheBankiscontinuingtoupgradeandenhanceitscollectionoffinancialdatatoreflectitswiderprudentialsupervisionmandateandensurecoverageofthefullrangeofriskstofinancialstability.Aninsurancesector data collection was implemented in 2015 and a new domestic securitiesdatabasewillbeintroducedshortly.Aprojecttore-developbankingsectorstatisticsisalsowelladvanced,withbanksundertakingtrials of a new data-collection template during 2016.

Thekeypolicyissuesformacro-financialstabilityare:

• understandingtherisksandthreatsfacingthefinancialsystemandassessing the resilience of the system in light of those risks;

• monitoringfinancialpressuresinthedairysectorandtheirimplicationsforbanklendingportfolios;

• keepingabreastofdevelopmentsinthehousingmarket,monitoringthe effects of LVRs and identifying any further policy measures that mayberequiredtopromotefinancialstability;and

• expandingandreshapingfinancialsystemdatacollectionstomeetcurrent and future prudential policy and statistical needs.


Toaddresstheseissues,theBankwill:

• explore additional macro-prudential policy options for managing the financialstabilityimplicationsofhousingmarketcycles;

• workwiththebankstoensurestress-testingmodelsandprocessesaredevelopedinlinewithbestpractice;

• continuetoenhancethereportingoffinancialsystemstabilityandefficiency,andpolicyassessments,containedintheFSRandotherreports; and

• ensure the successful implantation of a new data-collection template forthebankingsectorandintroduceaNewZealandsecuritiesdatabase.

Success measures

See page 11.



Objectives

Toprovideprudentialsupervisionsoastopromoteasoundandefficientfinancialsystem;tolimitdamagetothesystemthatcouldarisefrominstitutionalfailureorotherfinancialsystemdistress;andtocontributetopublicconfidenceintheinsurancesector.

Scope of operations

TheBank:

• registersandsupervisesbanks,settingandapplyingappropriateprudential criteria;

• licenses and supervises insurers, setting and applying appropriate prudential criteria;

• licenses and monitors NBDTs, setting and applying appropriate prudential criteria;

• sets and oversees criteria for the designation of payment and settlement systems;

• supervisesreportingentitieswithintheBank’sremitundertheAML/CFT legislation; and

• applies a framework for undertaking enforcement action in the event ofidentifiednon-compliance.


NewZealand’sfinancialsystemispresentlysoundandwellplacedtosupportgrowthintheeconomy.NewZealandbanksmaintaincapitalandfundingbuffersinexcessofminimumrequirementsandprofitabilityisstrong.Banks’soundfinancialpositionsmeantheyarewellplacedtomanage stresses such as those emerging in the dairy sector.

ThefourmajorAustralianbankscompriseamajorpartofNewZealand’sfinancialsystem,andwemaintaincloserelationshipswiththeAustralianfinancialregulatoryauthorities.

International regulatory standards continue to evolve. Developments in the capital and liquidity standards of the Basel Committee for Banking Supervision are of particular relevance, as they are important international standards for guiding New Zealand policy. We continue to monitor policy developments in similar jurisdictions, such as the outcomes of the 2015 Financial System Inquiry in Australia. The Bank will continue to consult widely on new policy initiatives, including following our process for consulting with the Minister of Finance on any material changes.

The Reserve Bank continues to monitor licensed NBDTs in conjunction withthetrusteecorporationsthatareresponsibleforsupervisingtheNBDT sector. Likewise, the Bank is continuing its implementation of a structured and systematic approach to insurance supervision. As part of theBank’sAML/CFTobligations,theBanksupervisesreportingentitieswithinthebank,insuranceandNBDTsector–assessingtheriskofmoney laundering and monitoring these entities for compliance with the legislation.


The key policy issues facing the Bank’s Prudential Supervision departmentare:

• implementing the outcomes of the regulatory stocktake, in particular a revisedquarterlydisclosureframeworkforbanksandtherestructureoftheBankingSupervisionHandbook;

• ensuringthatstress-testingbestpracticesareembeddedinbanks’risk management frameworks, a joint initiative with the Macro-Financial department;

• ensuringthatcapitalandliquidityrequirementsforbanksremainappropriate,takingintoaccountongoingrefinementstointernationalstandards;

• strengtheningtheBank’scapacitytorespondtofinancialcrises,includingtargetedrefinementstocrisispoliciesandprocesses;

• concludingthereviewoftheoutsourcingpolicyforbanks;

• progressingtheproposedmodifiedframeworkfortheoversightofsystemicallyimportantfinancialmarketinfrastructures;

• thereviewofNewZealand’sfinancialsectorbytheIMFunderitsFSAP and any future policy work as a result of recommendations put forwardbytheIMFattheconclusionoftheFSAP;

• ensuringthattheInsurance(PrudentialSupervision)Act2010providesforarisk-basedandcost-effectiveregulatoryandsupervisory regime;

• maintainingtheBank’ssupervisoryabilitytofacilitateriskanalysiswithin and across regulated entities, having regard to risks associated with(inparticularbutnotlimitedto)lowinternationaldairycommodityprices,elevatedAucklandhousepricesandbankrelianceonglobalfunding markets; and

• refiningourmaturingAML/CFTsupervisoryapproachtoachievethesustainableoutcomeofhavingreportingentitiesbuildandmaintaincompliancewiththeAML/CFTAct2009.



• workwithbankstoensurestress-testingresultsarereportedandusedwithinbanks,inlinewithbestpractice,ajointinitiativewiththeMacro-Financial department;

• completetheoutsourcingreviewbyconsultingonarevisedsetofpolicy proposals and further engaging with interested parties;

• consult on new quarterly disclosure requirements for locally incorporatedbanks;

• restructure the capital-related chapters of the Reserve Bank’s Banking SupervisionHandbookandprogressotherregulatorystocktake-related follow-up work;

• consult on crisis management powers for systemically important FinancialMarketsInfrastructures(FMIs)andtaketheproposedmodifiedFMIframeworktoCabinet;


• work with the IMF and other government agencies to facilitate an efficientandcomprehensiveFSAPreview;

• reviewtheBank’sexistingliquiditypolicyagainstfinalisedinternational liquidity standards;

• reviewtheBank’sbroadsuiteofcapitalrequirements;

• refinecrisismanagementtoolstoassistinmanagingtheriskstotheCrownbalancesheet,andreviewthecaseforamendmentstothestatutory management powers in the Reserve Bank of New Zealand Act 1989 to clarify aspects of the legislative framework for the Open Bank Resolution policy;

• consult stakeholders and undertake a review of the Insurance (PrudentialSupervision)Act2010toidentifyareaswheretheActcouldbeimproved;and

• continuetheimplementationofarisk-basedandstructuredapproachtobankingandinsurancesupervision.Supervisoryactivitieswillthereforeincludemonitoringrisksinregulatedentitiesusingbothpublicandprivatereporting,andmaintainingengagementwithexecutives and directors of regulated entities.

Success measures

See page 11.

Settlement services

Objective

To ensure that payments systems infrastructure and services support the smoothfunctioningoftheeconomy,areprovidedefficientlyandreliably,and meet international standards.

Scope of operations

TheBank:

• operatesthereal-timegrosssettlementsystem(ESAS)andtheNew Zealand central securities settlement and depository system (NZClear);and

• operatestheinfrastructurerequiredforthesettlementofinterbankpayments(SettlementBeforeInterchange),andthatrequiredforforeign exchange transactions through CLS Bank.

Environment and issues

The Bank operates payment systems that are critical to the operation of the economy. Maintaining these systems involves responding to developments in international settlement norms, changes in the settlements landscape in New Zealand and rapid technological change.

The key issue facing the Bank’s settlement services is the need to update payment systems. Technology is changing quickly and existing systems needtobeupgradedinordertosupportdevelopmentsinthepayments


industry.Aprojecthasbeeninitiatedtoensuresystemsareupdatedtomeet evolving requirements.


To address this issue the Bank will progress the Payment Systems Replacement project.

This involves the procurement and implementation of software to replace the current systems used to provide real-time gross settlement services (ESAS),andsecuritiessettlementanddepositoryservices(NZClear).

Success measures

See page 12.

Currency operations

Objective

Tomeetthecurrencyneedsofthepublicbyensuring,asthesoleissuerofcurrency,thesupplyandintegrityofbanknotesandcoins.

Scope of operations

TheBank:

• procures,stores,processesandissuesbanknotesandcoinstothebankingsystem;

• monitorsthequality,andverifiestheauthenticity,ofcurrencyincirculation; and

• issues legal tender collectors’ currency through an outsourcing arrangement.

Environment and issues

Demand for notes and coins continues to grow each year. Cash remains an important means of making payments in New Zealand. Given the heavy use of cash as a medium of exchange, the issues facing currency operationsaretheneedto:

• avert counterfeiting risks. The rapid innovation in copying and printing techniques heightens the need for counterfeit awareness andresilience.Ournewbrighter,moresecureseries7banknotesare


beingrolledout,butthemajorityofbanknotesincirculationarestillfrom the older polymer series introduced 16 years ago;

• managetheissuanceofthenewbanknoteserieswhileremovingtheprevious series from circulation;

• ensurethatthesecurity,safetyandoperationalefficiencyofthecashoperationsarenotcompromisedduringaperiodofsignificantactivity;

• review the levels and locations of contingency reserves;

• ensure appropriate domestic, long-term, secure premises for the Bank’s currency holdings.



• realiseprocessefficiencieswithincashprocessingoperationstosupporttheseparationandremovalofthepreviousbanknoteseries;

• review and implement appropriate changes to the levels and locations of currency reserves; and

• consultandcollaboratewithkeystakeholdersduring2016-17toensure that the currency operating model review’s recommendations areunderstood,supportedanddevelopedtoviableimplementationplans.

Success measures

See page 12.

Operations – enabling the Bank

Continue to improve performance culture

Managers will use the Bank’s refreshed performance expectations, competency framework and development process to lead and develop stafftowardsbuildingahigh-performanceworkplace.Continualimprovementinefficiencyandbusinessresultswillbesought,valuedand measured. We will engage with our staff to deepen connections to theBank’saspirationalgoalofbeingtheBestSmallCentralBank.

People and culture

InlinewiththeBank’svisionofbeingahigh-performingsmallcentralbank,theBankhasundergonesomerestructuringandrealignmentofresourcesinthepastyearinresponsetoatighterfive-yearfundingenvelope. As part of this change the Bank is working with staff on ways thattheycancontributetopositivechangeattheBankandisfocusedonembeddingtheprinciplesofcontinuousimprovement,collaboration,leadership and engagement to support this transformation.

Businessresults,staffengagementandfinancialperformancemeasuresremain positive and the Bank is committed to continuing to improve and measure its performance culture.

The Bank’s vision requires excellence in its people, processes and resources, and the quality of management is a critical factor in strengthening the Bank’s performance. The Bank will continue buildingleadershipandmanagementcompetenciesthroughspecific


development programmes for managers and emerging leaders; and staff will have structured training and development opportunities.

A high level of staff engagement is a key indicator of a high-performing organisation. An annual survey measures the level of staff engagement with the Bank. The Bank will continue to focus on keeping staff well connectedwithmanagementandeachother;enablingstaffandproviding growth opportunities; and recognising performance and contribution.

Thelinkbetweenperformanceandrewardcontinuestobestrengthenedand expectations of high performance are clearly communicated.

The Bank remains committed to providing and maintaining a healthy and safe workplace in accordance with the Health and Safety at Work Act 2015. Our focus is on keeping employees and other people at the Bank safe, as well as improving safety awareness and encouraging involvement in health and safety.

Communications

TheBankwillcontinueitsbroadercommunicationsprogrammeandseekto deepen engagement with a range of stakeholders.

The Bank will continue to communicate the reasoning for and impacts of its activities through its proactive on- and off-the-record speech programme,briefingsforadiverserangeofaudiences,mediaengagements, videos, animated media, appropriate social media and traditionalmainstreammedia,onlinechannels,publicationsandtheBank’s educational outreach programme.

Within the Bank, Communications will support deeper engagement andmotivationbybetterconnectingcolleagues’activitiestotheBank’svision and supporting initiatives to improve our performance culture. The outcomes of key Bank-wide projects and the implementation of the new healthandsafetylegislationwillbeclearlycommunicatedwithBankcolleagues.

Knowledge services

The Bank requires technology that provides a high level of uninterrupted service,functionalityandsecurity,aswellaseasyaccesstoabroadrange of relevant information sources.

KeyinitiativesfortheKnowledgeServicesdepartmentthisyearwillbeto:

• lead the implementation of the Trade Valuation Solution project for the Bank’sfinancialmanagement;

• support the implementation of the software to replace the current systemsusedtoprovidereal-timegrosssettlementservices(ESAS),andsecuritiessettlementanddepositoryservices(NZClear);

• buildadatabaseandreportingservicestosupportseries7banknotequality data;

• continue developing the Bank’s IT security systems to maintain industrybestpracticeandmanagetheincreasingthreatsfromarangeof sources;

• refresh the operating system and other software on the Bank’s desktopenvironmenttomaintainaninnovativeandflexibleuserenvironment; and


• enhance the governance, measurement and reporting of IT services.

Internal financial services

High-qualityfinancialsystemsandprocessesareneededtomanagetheBank’scomplexbalancesheet.Thesesystemssupportworkflows,reportsandprocessesforoperationsinfinancialmarketsandcurrencyoperations.

The Bank will develop a consistent framework to measure performance benchmarksforbusinessplanssothatseniormanagementcanhaveenhancedmonitoringandmanagementofbusinessresources.

In 2014–15 the Bank developed a roadmap for the design and architecture of its treasury systems. The Bank will commence implementation of the roadmap and architecture for the treasury systems environment.

Risk assessment and assurance

The Bank faces a wide range of risks, some general and others unique tocentralbanks.Theidentification,managementandmonitoringofthese risks is key to the performance of its functions and therefore to maintainingasoundanddynamicmonetaryfinancialsystem.

The Bank’s approach to addressing enterprise risks is to ensure that they arebeingidentifiedandmanagedinaproactive,coordinated,prioritisedand cost-effective manner. The Risk Assessment and Assurance Departmentwillbeinvolvedintheimplementationofthenewreal-timegrosssettlementsystem(RTGS)andthedevelopmentofareplacementsecurities settlement system and the implementation of the Treasury

Systems Roadmap, and will have a particular focus on new options for differentoperatingmodelsofcurrencycustodyanddistribution.

The internal audit function will assist in delivering assurance for control frameworks over the Bank’s operations, through the implementation oftheannualauditplan.ThelegalfunctionseekstooverseethebroadrangeoflegalrisksfacingtheBankfrombothprudentialandoperationalperspectives, and support operational functions of the Bank through legal advice and support.

Property, security

The Bank has undertaken a review of its currency operating model and supporting infrastructure to ensure the currency needs of New Zealanderswillcontinuetobemetinthefuture.Thereviewassessedthecurrentoperatingmodelandidentifieddifferentapproachesforthecustodyanddistributionofcurrency.TheBankwillconsultandcollaboratewithkeystakeholdersduring2016-17toensurethatthereview’s recommendations are understood, supported and developed to viableimplementationplans.

ForsecurityreasonstheBankoperatesandmaintainsmodern,reliablesecurityaccessandcontrolsystems.Forefficiencyandenvironmentalreasons the Bank will continue to seek to maintain and extend energy-saving and recycling programmes.

The Bank owns its premises at 2 The Terrace, Wellington and will optimiseofficespaceefficiencyandeffectivenesswiththecompletionofabuildingutilisationprogramme.Thiswillfreeadditionalfloorspaceforlease to external tenants, generating additional lease revenue.


Financial management

Financial structure

Balance sheet overview and funding of the Bank’s operations

The Bank receives no direct funding through the central government budgetaryprocess.Instead,theBank’smainsourceofincomeisthereturnonthesubstantialinvestmentstheBankholds,whicharefundedbytheissueofcurrencyandbytheBank’sequity.

The nature and extent of the Bank’s principal activities that affect its balancesheetaredescribedintheAnnual Report 2014-2015(pages81-82).Foreignreservesmanagement,NewZealanddollarliquiditymanagement and currency operations materially affect the size and structureoftheBank’sbalancesheet.

Under the Reserve Bank Act, the Minister and the Governor are required toenterintoafive-yearfundingagreementtospecifytheamountoftheBank’sincomethatmaybeusedtomeetoperatingexpensesineachfinancialyear.TheBankreportsitsexpenditureagainsttheFundingAgreement in its annual report.

ThecurrentFundingAgreementcoversthefive-yearperiodending30June 2020. It provides funding of $64.0 million for 2015-16 and $69.5 million for 2016-17.

Annual distributions paid by the Bank

The Bank’s annual dividend is determined using the following principles, whichareacombinationofwhatisrequiredundertheReserveBankActand this SOI:

Statement of dividend principles

TheBankshouldmaintainsufficientequityforthefinancialrisksassociated with performing its functions. Equity in excess of that required tocoverthoseriskswillbedistributedtotheCrown.

Ingeneral,unrealisedgainsshouldberetainedbytheBankuntiltheyarerealised in New Zealand dollars. However, the Bank may recommend thedistributionofunrealisedgainswheretheBankbelievesthattheprobabilityofthegainbeingrealisedishigh.


TheamountofthedividendtobepaidtotheCrownisdeterminedbythe Minister of Finance each August on the recommendation of the Bank, having regard to the views of the Board of Directors and any other relevant matters.

Accounting standards

TheBankappliesPublicBenefitEntityaccountingstandardsbasedonInternationalPublicSectorAccountingStandards.TheBank’saccountingpoliciesaredescribedonpages75-82oftheAnnual Report 2014-2015.

DriversoftheBank’sfinancialperformanceandfinancialposition

TheprincipaldriversoftheBank’sfinancialperformanceandfinancialpositionare:

• The value of currency in circulation:currencyincirculationisanon-interest-bearingliabilityfortheBank.Banksarechargedforthefacevalue of currency issued to them and the Bank earns interest, known asseigniorage,ontheinvestmentoftheseamountspaidbybanks.At30April2016,currencyincirculationwas$5.7billion.

• The size of the Bank’s open foreign exchange position and related changes in foreign exchange rates:theBankhasapolicyofholdingsomeofitsforeigncurrencyreservesonanunhedgedbasis.Thisallows it to respond more effectively to a foreign exchange crisis, and to smooth more extreme exchange rate movements. The Bank has abenchmarkholdingofSDR1.0billionunhedgedforeigncurrencyreserves,withtheabilitytoholdmoreorlessthanthebenchmarkoverthe exchange rate cycle. Holding unhedged foreign reserves means thattheBank’snetequitywillfluctuatewithchangesintheexchangerate;foreignexchangelossesmaybeincurredwhentheNewZealand

dollarisstrong,andgainsmayberecordedwhentheNewZealanddollar is weak. The unhedged position increases volatility in the Bank’sfinancialperformanceandfinancialposition.At30April2016theBankheldanopenforeignexchangepositionofSDR1.5billion(NZ$3.1billion).At30June2015theopenforeignexchangepositionwasSDR1.7billion(NZ$3.5billion).

• Interest rates earned on the Bank’s investment in government securities and other securities:theBank’sholdingsofNewZealandgovernment securities are valued at market value, with unrealised gainsandlossesonthoseholdingsbookedtoequity.1 Interest income and realised gains and losses on the disposal of New Zealand governmentsecuritiesarebookedtotheBank’sIncomeStatement.

• The size and performance of the Bank’s foreign reserve management and market operations functions:theBankholdsforeignreservesthatcanbeliquidatedatshortnoticetosupportitsfunctions,includingmonetarypolicyobjectivesandthemaintenanceoforderlymarkets.Foreign reserves are valued at market value. Changes to foreign exchange rates and international interest rates will affect the market valueofthosereserves,andvaluationchangesarebookedtotheBank’s Income Statement.

At 30 April 2016, the Bank had a foreign exchange intervention capacity ofSDR5.2billion(NZ$10.6billion).

• New Zealand government deposits held at the Bank:theBankprovides a settlement account facility to the Crown. The size of New

1 TheBank’sinvestmentinNewZealandgovernmentsecuritiesisclassifiedas‘availableforsalesecurities’.Theseassetsareintendedtobeheldeithertomaturityorforanindefiniteperiodoftime,andmaybesoldinthenormalcourseoftheBank’soperations.Unrealisedgainsonsecuritiesthatareclassifiedwithinthe‘availableforsale’categoryarebookedtoequityratherthantotheStatementofFinancial Performance.


Zealand government deposits held in the Crown Settlement Account (CSA)isabigdriveroftheBank’sbalancesheet.LargerCSAdepositsareswappedintoforeigncurrencyandinvestedbytheBankoffshore.However,netearningsarenotmateriallyaffectedbythisactivity.

At 30 April 2016, the Bank held New Zealand government deposits of NZ$3.3billion.

• Operating expenditure incurred by the Bank. Thefive-yearFundingAgreementspecifiestheamountoftheBank’sincomethatmaybeusedtomeetoperatingexpensesineachfinancialyear.

• The level of equity available for investment and the dividend paid by the Bank:theBankrequiresequitytoabsorbanylossesthatmayarise from carrying out its functions, and equity is reviewed annually to determine the annual dividend. The dividend for the 2014-15 year was $510million,andreportedequityat30April2016was$3.0billion.

Principal financial risk management considerations

Withmorethan$25billioninassets,theBankfacesawiderangeoffinancialrisks.ThesearisemainlybecauseoftheBank’soperationsinthedomesticfinancialsystemanditsholdingsofforeigncurrencyreserves.Therisksinclude:

• credit risks and market risks associated with day-to-day dealings with financialinstitutions,whilemanagingliquidityinthefinancialsystem;

• risks associated with the Bank’s holdings of foreign currency reserves, including credit risk, liquidity risk, interest rate risk and exchange rate risk; and

• operational risks in the transactions and processing areas of the Bank.

More detailed information on the Bank’s approach to managing these risks is outlined on pages 94-105 in the Annual Report 2014–2015.

Financial projections

ThefollowingtableoutlinestheBank’sbudgetedincomeandexpenditurefor2016-17.Thekeyassumptionsunderlyingthebudgetfortheyearended30June2017arethat:

• therewillbenosignificantchangestotheBank’scurrentfunctions;

• therearenomaterialchangestothestructureoftheBank’sbalancesheetbetween30April2016and30June2017;

• projectedinterestandexchangeratesarethoseadvisedbytheTreasury for the purposes of preparing the Government’s Budget for 2016-17;

• therewillbenochangeinthecreditworthinessoftheBank’scounterparties; and

• therewillbenomaterialchangestotheBank’sliquiditymanagementoperations.


Projected financial performance 2016–2017

For the year ending 30 June Budget 2016-17 $m

Operating income: Net investment income 280.9 Other income 11.3 Total operating income 292.2

Operating expenses Bank operations: Personnel 31.6 Asset management 7.6 Professional and contract services 6.3 Other 12.5

Total operating expenses bank operations 58.0

Direct currency issue expenses:2 Net currency issued 18.6 Delivery expenses 0.5 Series7banknotetransitionexpenses 0.5 Total direct currency issue expenses 19.6

Operating surplus 214.6

Projected financial performance Thebudgetisbasedonthekeyassumptionsoutlinedabove.ItisimportanttonotethattheBank’sassetsandliabilitiesaresensitivetochangesininterestratesandexchangerates,andthatactualfinancialresultscoulddiffermateriallyfromthosebudgeted.

As at 30 April 2016, a 10 percent appreciation in the value of the New Zealand dollar would reduce the Bank’s comprehensive3incomeby$282 million, and conversely a 10 percent depreciation in the value of the New Zealand dollar would add $345 million to comprehensive income. A1percentacross-the-boardincreaseininterestrateswouldreducecomprehensiveincomebyabout$244million,anda1percentacross-the-boardreductionininterestrateswouldincreasecomprehensiveincomebyabout$273million.

2 Under the Funding Agreement, external demand-driven direct net currency issue expenses are shown separately from underlying core operating expenses to improve the transparency of the Bank’s underlyingbaselineoperatingexpenses.

3 ComprehensiveincomeincludesearningsbookedtotheBank’sIncomeStatementandalsochangesbookeddirectlytoequity.Themajorityofthesensitivitytochangesinforeignexchangeratesisbookedtothe Income Statement, whereas the majority of the interest rate sensitivity arises on the Bank’s portfolio ofNewZealandgovernmentsecuritiesandisbookeddirectlytoequity.Refertopage99oftheBank’sAnnual Report 2014–2015 for a detailed sensitivity analysis as at 30 June 2015.


Net expenditure4 budget 2016-2017

Net expenditure For the year ending 30 June Budget 2016-17 $000s Monetary policy formulation 10,091 Domestic market operations 4,713 Macro-financialstability 7,733 Prudential supervision 12,797 Foreign reserves management 5,433 Settlementservices (999) Currency operations 26,571

Net operating expenditure 66,339

4 Net expenditure comprises operating expenses less income earned from certain Bank operations as specifiedintheFundingAgreement

Budgeted net operating expenditure for 2016-17 is $66.3 million. The budgetincludesprovisionsforthecostsassociatedwithsignificantchanges in the critical systems and processes that are needed in order to achieve the Bank’s strategic priorities. These priorities include completingthedeliveryoftheseries7banknotes,developingaplanforthefuturecustodyofanddistributionarrangementsforcurrency,progressing implementation of the payment systems review and implementingsystemstoenhancetheBank’sbalancesheetandfinancialmanagement.

Net expenditure Budget 2016-17 $000s

Funding agreement

2016-17 $000s

Funding agreement

under-expenditure

$000sNet operating expenditure excluding direct net currency issue expenses

46,716 49,300 2,584

Direct net currency issue expenses5

19,623 20,200 577

Total net operating expenditure under funding agreement

66,339 69,500 3,161

While the Bank anticipates under-spending of the funding agreement in itsfirsttwoyears,aggregateexpenditureoverthefullfiveyearperiodisbeingmanagedtobeinlinewiththeaggregatefundingprovidedforintheagreement.Theunder-spendingreflectsstaffcostsrelatedtotheconstructionofnewsystemswhichwillbecapitalisedandamortisedoverseveral years, resulting in a timing of recognition which differs from that provided in the funding agreement.

Funding agreement

5 Under the Funding Agreement, external demand-driven direct net currency issue expenses are shown separately from underlying core operating expenses to improve the transparency of the Bank’s underlyingbaselineoperatingexpenses.

Documents

Statement of Intent - New Zealand pound · 3 RESERVE BAN OF NEW ZEALAND / STATEMENT OF INTENT t r s x t r s { Strategic priorities We are working to position the Bank to best face