New Zealand government boosts central bank capital

New Zealand’s government has provided the central bank with more capital and an indemnity, bolstering its ability to intervene in the foreign exchange market when needed.

Finance minister Grant Robertson decided to inject NZ$500 million ($305 million) into the Reserve Bank of New Zealand (RBNZ) following recommendations from the Treasury, according to a report dated May 19.

The report, made public last week, said the injection would take place on or shortly after July 1.

“The bank’s current level of foreign reserves for intervention have not been updated to reflect the growth in the New Zealand economy and global financial markets and may no longer be sufficient in some scenarios,” the Treasury said in the report.

It said the amount of extra capital was determined based on the RBNZ’s loss-modelling work. The additional capital would be sufficient to cover the central bank’s risks resulting from holding and managing a higher level of foreign reserves, including exchange rate, interest rate and counterparty risks.

The move came after the RBNZ board and Robertson agreed to adopt a new foreign reserves framework in January, under which the country’s foreign reserves will be increased. The new framework also gives the RBNZ the right to decide when to intervene in the foreign exchange market in case of market dysfunction. In the past, the central bank would need to seek approval from the finance minister to conduct FX interventions.

New Zealand’s foreign reserves had been largely unchanged since 2007, the central bank said in January. The RBNZ and the government believes the expansion of the economy and the FX market in the past 16 years means that the country needs a larger reserves pool to draw upon in times of crisis.

Further capital injections remain possible. The RBNZ has said it would not reveal the total size or the composition of the capital increase due to market and policy sensitivities. RBNZ governor Adrian Orr has said the transition will take place over a number of years to minimise market impact.

New Zealand’s reserves are divided between the RBNZ and Treasury, though most are held by the central bank. The country’s reserves rose to NZ$27.6 billion in July, from NZ$21.9 billion in June. The RBNZ’s “foreign reserve intervention capacity” was NZ$12.9 billion in June.

Meanwhile, the government also agreed on July 26 to grant an indemnity to the RBNZ. The Treasury report did not disclose its size.

The indemnity would cover potential foreign exchange losses in the unlikely event that the central bank conducts a significant intervention using hedged foreign reserves, the Treasury said.

“An indemnity would cover situations where the bank intervenes in the foreign exchange market beyond its positive net foreign asset position where it is effectively ‘short’ foreign currencies,” the Treasury said. It added such situations would be rare.

Providing an indemnity was preferable to a much larger capital injection upfront, the Treasury said. Providing the RBNZ with the extra capital and an indemnity does not create an additional cost to the government or directly increase the country’s net debt.

However, the financial support does enable the central bank to take on additional risk, such as foreign exchange risk, the Treasury said. Losses and gains arising from these risks would flow through to the government.