Response to Submissions: Changes to the Banking Supervision Handbook for Capital Review

0 Response to Submissions Changes to the Banking Supervision Handbook: Exposure Draft for Capital Review Changes. Response to Submissions 17 June 2021

1 Response to Submissions Contents Background ___________________________________________________________________________________ 2 Consultation Process __________________________________________________________________________ 3 Summary of Decisions _________________________________________________________________________ 4 Key consultation topics __________________________________________________________________________ 4 Implementation timetable _______________________________________________________________________ 4 BPR100: Capital Adequacy_______________________________________________________________________ 4 BPR120: Capital Adequacy Process Requirements ________________________________________________ 5 BPR130: Credit Risk RWAs Overview _____________________________________________________________ 5 BPR131: Standardised Credit Risk RWAs __________________________________________________________ 5 BPR132: Credit Risk Mitigation ___________________________________________________________________ 5 BPR133: IRB Credit Risk RWAs ___________________________________________________________________ 6 BPR140: Market Risk _____________________________________________________________________________ 6 BPR160: Insurance, Securitisation, and Loan Transfers ____________________________________________ 6 BPR001: Glossary ________________________________________________________________________________ 7 Part One: Summary of Consultation Issues and Questions ______________________________________ 8 Drafting and presentation of the new BPRs ______________________________________________________ 8 Consequential policy matters arising from the Capital Review 2019 decisions _____________________ 9 Implementation of Capital Review December 2019 Decisions____________________________________ 13 Implementation timetable ______________________________________________________________________ 16 Part Two: Other Matters Raised in Submissions ________________________________________________ 19 BPR100: Capital Adequacy______________________________________________________________________ 19 BPR110: Capital Definitions______________________________________________________________________ 20 BPR120: Capital Adequacy Process Requirements _______________________________________________ 24 BPR130: Credit Risk RWAs Overview ____________________________________________________________ 25 BPR131: Standardised Credit Risk RWAs _________________________________________________________ 25 BPR132: Credit Risk Mitigation __________________________________________________________________ 27 BPR133: IRB Credit Risk RWAs __________________________________________________________________ 28 BPR140: Market Risk ____________________________________________________________________________ 31 BPR160: Insurance, Securitisation, and Loan Transfers ___________________________________________ 33 BPR001: Glossary _______________________________________________________________________________ 34 Annex 1: Updated Capital Review Implementation Timetable ___________________________________ 35 Annex 2: Glossary ____________________________________________________________________________ 36

2 Response to Submissions Background

1. In 2017 the Reserve Bank of New Zealand, Te Pūtea Matua, began a comprehensive review of the capital adequacy framework for locally incorporated registered banks in New Zealand, known as the ‘Capital Review’ (the Review).1 The purpose of the Review was to identify the most appropriate capital requirements for New Zealand banks, taking into account how the current framework operates and international developments in bank capital requirements.
2. Final decisions for the Review were announced by the Reserve Bank on 5 December
3. The key decisions included banks’ total capital ratios increasing from 10.5 percent to 18 percent for the four large banks (identified as ‘Domestic Systemically Important Banks’ – D-SIBs) and 16 percent for the remaining smaller banks. The central factor driving the decisions was to make the banking system safer for all New Zealanders – more capital in the banking system better enables banks to weather economic volatility and maintain good, long-term, customer outcomes.
4. The final policy decisions were shaped by earlier consultation papers, and wide-ranging engagement with industry and other stakeholders. The most recent consultation sought views on ‘exposure drafts’ of the changes to the Banking Supervision Handbook before the new policy is finalised. The Handbook sets out the details of the policy framework and rules that apply to registered banks in New Zealand.
5. These changes were detailed in the consultation paper ‘Changes to the Banking Supervision Handbook: Exposure Draft for Capital Review Changes’.
6. The main changes covered in the consultation material related to:  Changes to restrictions on distributions as banks enter their new capital buffers.  Guidance on likely supervisory actions in response to any buffer breach.  The inclusion of terms sheets that outline the Reserve Bank’s requirements for different types of financial instruments that can qualify as bank capital.  The proposed replacement to the non-objection process relating to capital instruments.
7. The Banking Supervision Handbook has also undergone a restructuring process, as this was one of the key areas for improvement identified during a Regulatory Stocktake that the Reserve Bank undertook in 2015. As part of the consultation, we aimed to modernise the Handbook, including by changing its name to ‘Banking Prudential Requirements’ (BPRs) to better reflect its purpose.
8. For the majority of the new Banking Prudential Requirements material, no major policy changes were intended, but some minor changes were made to clarify areas of ambiguity.

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1 All background documents related to the Capital Review, including previous consultation papers and the Reserve Bank’s responses to submissions, can be found here: www.rbnz.govt.nz/regulation-and-supervision/banks/consultations-and-policy-initiatives/active-policy-development/review-of-the-capital-adequacy-framework￾registered-banks

3 Response to Submissions 8. We reviewed all submissions before making our final decisions and are now publishing the finalised set of BPRs. This Response document summarises the Reserve Bank’s response to the main points raised in those submissions. Consultation Process 9. The Exposure Draft consultation lasted from 17 November 2020 to 31 March 2021. The Reserve Bank received fourteen submissions, which have been published on our website.2 This paper responds to the themes and views raised in submissions, and is not intended to be an exhaustive response to all points raised. Readers are encouraged to refer to the actual submissions for further details. 10. In addition to receiving written submissions, the Reserve Bank also engaged with industry through a series of multi- and bilateral workshops and meetings. In some cases these meetings saw additional issues raised, beyond those included in the formal submissions. Where possible, we have also responded to the additional issues, or points of clarification, that industry raised with us outside of their formal submissions. 11. Submissions also covered several topics that relate to long-standing features of the framework, rather than the specific changes being implemented as a result of the Capital Review. We have responded to some of these points, but in a number of cases we have deferred these additional issues for future consideration. Some of these topics, such as redrafting BPR140: Market Risk, will need detailed assessment and a separate consultation process. Our approach to these deferred topics is also covered in this document. 12. This Response document matches the format of the consultation paper published in November 2020 – Part One of this document covers questions A to R in the consultation paper. Part Two covers other matters raised in the feedback, sorted by BPR. 13. The tables in the following section summarise the issues raised by submitters and the associated decisions made by the Reserve Bank. However, the tables are not exhaustive, and other technical issues are described in more detail throughout the Response.

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2 The Reserve Bank also received correspondence from the External Reporting Board, which was not directly related to the implementation of the December 2019 Capital Review decisions.

4 Response to Submissions Summary of Decisions Key consultation topics Issue Decision Distribution restrictions No changes made Capital Buffer Response Framework Changed deadline for providing capital restoration plan to ten working days from becoming aware of a buffer breach Will consult further on interaction with the countercyclical capital buffer in 2022 Terms sheet templates for AT1 & Tier 2 Replaced with checklist Replacement of non-objection process with a ‘notification process’ No changes made, except for changes to legal sign-off to reflect role of the checklist, and foreign governing law flexibility for Tier 2. Dividend stopper Removed requirement for stopper New Zealand governing law requirement Retained for AT1 capital instruments Removed for Tier 2 capital instruments Implementation timetable Issue Decision BPR implementation date Extended from 1 July 2021 to 1 October 2021, with option to issue newly compliant Tier 2 instruments in advance of 1 October Derecognition of AT1 & Tier 2 Start date extended from 1 July 2021 to 1 January 2022 Output floor Retained at 1 January 2022 start date Dual reporting Retained at Q1 2022 Standardisation of sovereign & bank exposures Retained staged implementation BPR100: Capital Adequacy Issue Decision Solo capital calculations Changes to definitions to allow special purpose vehicles to be consolidated into solo capital Definitions and timing of dividend restrictions No changes at this time Zero-rate floors for capital instruments Will be allowed, but floor only applies to total distribution, not benchmark rate Interest rate reset Reset rate changed to benchmark plus a margin References to interest for Tier 2 instruments Changed to ‘interest or dividends’

5 Response to Submissions Issue Decision Special purpose vehicles No changes – SPVs must issue instruments that meet capital requirements Reference to Conditions of Registration in capital instrument terms and conditions Retained in requirements with no changes CET1 capital No changes made at this time – deferred for future consideration Banks structured as mutual societies Deferred – will be addressed in second half of 2021 Redemption price for AT1 instruments No longer relevant as AT1 template removed BPR120: Capital Adequacy Process Requirements Issue Decision Compendium of models Modified timing for when copies of model compendium must be provided Capital instruments issued in foreign currency Aligned the regulatory treatment of AT1 equity capital instruments with the accounting treatment BPR130: Credit Risk RWAs Overview Issue Decision Application of scalar to supervisory slotting No changes made Calculation of total credit RWA by IRB banks Drafting error amended BPR131: Standardised Credit Risk RWAs Issue Decision Risk weights for reverse mortgages No changes made – will consider in more depth in the future Categorisation of sovereigns, public sector entities and multilateral development banks Deferred for future consideration Issue specific and inferred credit ratings Revised text to provide additional clarity Approved credit rating agencies AM Best added to list, but only for exposures to insurers BPR132: Credit Risk Mitigation Issue Decision Currency mismatch adjustment Added guidance notes Collateral held against guarantee No changes made

6 Response to Submissions BPR133: IRB Credit Risk RWAs Issue Decision Cross-method guarantee and credit derivatives Deferred for future consideration Exemptions from one year floor for effective maturity calculations ESAS balances and overnight placements with parents added back to the list of exemptions Fall-back loan-to-value ratio LVR of 150 percent will be used as the fall-back for an LVR arising from an ineligible calculation Slotting approach for corporate specialised lending exposures No changes made Effective maturity estimates No changes made Calculation of loan-to-value ratio with mixed collateral No changes made Security over Māori Freehold Land Deferred for future consideration BPR140: Market Risk Issue Decision Full review requested by some banks Deferred to 2022 Exclusion of own equity from the interest rate risk calculation No changes – will be considered as part of the full review of the market risk framework Guiding principles Added further guidance Treatment of derivatives Added further guidance Time bands for the allocation of price sensitivity factors Added additional time bands back into tables Categorisation and valuation of recognised and unrecognised financial instruments No changes to the categorisation but replaced the valuation concept of ‘carrying amount’ Time band adjustment for a near hedge Added clarifications Peak capital charge Provided additional guidance Treatment of foreign currency contingent products Updated the guidance Calculation of horizontal disallowances Added worked example and mathematical formulae BPR160: Insurance, Securitisation, and Loan Transfers Issue Decision Loan transfers Revised drafting of BPR160 to recognise a transfer to an unrelated party or to a bank’s ‘ultimate parent bank’

7 Response to Submissions BPR001: Glossary Issue Decision Identification of Glossary terms Option 3: Bolding of defined terms whenever it appears in BPRs Missing references Added some extra terms to Glossary

8 Response to Submissions Part One: Summary of Consultation Issues and Questions Drafting and presentation of the new BPRs 14. Many submitters were supportive of, and generally in agreement with, the drafting and presentation of the BPRs. However, some said that there are areas where the wording of the exposure drafts is unclear and could benefit from further clarification or rewording. The Reserve Bank has incorporated the specific comments and suggestions made by submitters into the final BPR documents, where we believe they enhance the clarity of the capital adequacy framework. 15. The Reserve Bank also sought views on the overall layout of the revised Handbook documents, and what users would like to see in the presentation of these documents on our website. Many submitters agreed that the more modular structure of the BPRs by topic is helpful in making the overall architecture of the capital framework easier to understand. Alternatively, some submitters suggested that the new Basel Framework would be a good model. One bank suggested that providing a combined ‘master’ document may also be useful as it would allow for easier cross reference searches to different BPRs. 16. The Reserve Bank has decided to retain the modular structure of BPRs by topic. We agree that a master document would be useful and will develop one in the future, modelled off the new Basel Framework. 17. In the consultation paper, we also sought feedback on how to present guidance in the BPRs and outlined three different options. All submitters that responded to this question supported Option 1, where guidance is provided in boxes throughout the text, next to what it applies to. Therefore, we have retained this practice in the final BPRs. 18. Several banks suggested that providing additional guidance, or frequently asked questions (FAQs), would be useful in a number of places. More information is provided about this suggestion elsewhere in the document. Our first step in this direction will be to publish FAQs in the future that will focus on questions we receive from entities about capital definitions. 19. One bank suggested it would be more appropriate for some of the guidance included in the BPRs to be incorporated into the main text as explicit requirements. They provided several examples of where such changes could be made. We have reviewed these suggestions and incorporated guidance into the main text as explicit requirements where we have deemed it suitable. 20. A submitter suggested that we include explanatory notes, which identify where the BPRs diverge from those of the Bank of International Settlements and the Australian Prudential Regulation Authority (APRA). The Reserve Bank explained the Capital Review decisions in 2019, and has published extensive background decision papers that we considered during the process. The Regulatory Impact Analysis published in December 2019 also provides a summary of all decisions and assesses the costs and benefits. These documents include discussions of differences with a range of other regulatory regimes. Adding such material to the BPRs would detract from the accessibility of the documents.

9 Response to Submissions Consequential policy matters arising from the Capital Review 2019 decisions Distribution restrictions 21. We proposed a new set of distribution restrictions, given the larger capital buffers that banks will be asked to have (above their minimum capital requirements) once the Capital Review is fully implemented. Currently, banks are required to hold a capital conservation buffer of 2.5 percent of Risk Weighted Assets (RWA). Under the new rules, the full Prudential Capital Buffer (PCB) will be 9 percent for domestic systemically important banks (D-SIBs) and 7 percent for non-D-SIBs. 22. Many submitters were supportive of the proposed changes to Common Equity Tier 1 (CET1) distribution restrictions for banks that have breached their PCB requirements but not their minimum capital requirements. One bank suggested that we should change the CET1 distribution restrictions for D-SIBs so that they are less restrictive (and close to those for non-D-SIBs). The Reserve Bank does not believe there is a strong rationale for making such a change. The more restrictive distribution restrictions for D-SIBs reflects that, since they are systematically important, their failure would have a significant impact on the economy and the rest of the financial system. As such, they should have a greater incentive to rebuild their buffers if they dip into them. 23. A submitter pointed out that, since we have specified CET1 distribution restrictions in terms of a percentage of earnings, banks that have issued more Additional Tier 1 (AT1) capital will be able to provide larger distributions overall than those that have issued less. While we agree that a bank with more AT1 could make larger distributions, this is limited by the cap on AT1 (up to 2.5 percent of a bank’s total capital ratio). Additionally, changing the definition of earnings, to be earnings after AT1 distributions have been paid, would add unnecessary complexity. 24. Many submitters were also supportive of the separate and simpler distribution restrictions proposed for AT1 capital instruments. In the draft proposal, and the final decisions, there will be no restrictions on AT1 distributions up to the point that the banking group’s buffer ratio reaches 3 percent for D-SIBs and 2 percent for non-D-SIBs, at which point distributions will be restricted to 0 percent of earnings. One bank argued that if restrictions on AT1 distributions are to be retained, these should also be changed to be less restrictive for D-SIBs (and closer to those for non-D-SIBs). That would mean that banks would be restricted on paying AT1 distributions if they were within 0 to 2 percent of the PCB. The Reserve Bank does not believe there is a strong rationale for making such a change, for the same reason reflected in paragraph 22 above. 25. Most submitters agreed that the proposed transitional arrangements for distribution restrictions were appropriate. One submitter argued that we have limited distributions at 100 percent of earnings during the transition period, which should be changed. Some published material did give this impression. However, the text of the BPRs makes it clear that there is no upper limit on distributions for a bank meeting the PCB requirements. Capital Buffer Response Framework 26. The Reserve Bank sought feedback on the proposed Capital Buffer Response Framework (CBRF), which is designed to encourage banks to restore their capital positions when they have capital below the PCB requirement but above the minimum requirements.

10 Response to Submissions Submitters were mostly supportive of the CBRF as a suitable way of responding to bank’s declining capital levels. However, some expressed concerns about:  How the CBRF would interact with the countercyclical capital buffer (CCyB).  The need for greater clarity on possible supervisory actions.  The deadline for providing a capital restoration plan after capital levels fall. 27. Under the proposals published in November, there is a ‘useable band’ at the top of banks’ PCB. When banks have capital levels that are less than 1.5 percent below the PCB, they are still able to make distributions up to 100 percent of annual earnings and are not subject to any CBRF-driven changes in supervisory stance. If capital falls any lower, banks’ dividends are restricted to 60 percent of earnings and the bank is required to deliver a capital restoration plan to the Reserve Bank. 28. This ‘useable band’ happens to correspond to the size of the steady-state CCyB. One bank asked whether, if the CCyB was removed to encourage lending, the threshold for the delivery of a capital restoration plan and dividend restrictions would also be moved. They argued that, otherwise, removing the CCyB would not have the intended stimulatory effect. The Reserve Bank agrees that interactions between the CCyB and the CBRF need to be considered carefully to ensure that the CCyB works as intended. We intend to issue a public consultation covering the implementation of the CCyB in the first half of 2022. We will consider interactions with the CBRF at that time. 29. Several submitters requested further guidance about the Reserve Bank’s intentions regarding specific details of the CBRF. One bank noted that the Reserve Bank did not rule out using its supervisory powers in the top part of the buffer and asked for further details about what might be done, to assist them in deciding how to set ‘voluntary buffers’. A second bank asked how information gathering and reporting powers might be used in monitoring the capital restoration plan. Meanwhile, a third bank asked for more detail about what ‘more stringent and more conservative’ might mean in the description of the recapitalisation plan. 30. The answers to these questions are context dependent, which is why the CBRF descriptions provide no further detail. We note that the CBRF does not alter the Reserve Bank’s statutory powers but merely gives guidance on how they are likely to be used in the context of declining capital levels. The BPRs (BPR120) note that regardless of the size of the PCB, the Reserve Bank may take actions at any time to address prudential concerns about a bank, whether related directly to capital adequacy or other matters. For example, this could include pre-emptive responses to systemic issues. What is appropriate will depend on the context and banks may want to discuss this with their supervisors as they are developing a capital restoration plan. An important part of the context is how likely a bank is to breach to its minimum capital requirements, which is the driving force behind the differences between the capital restoration and recapitalisation plans. As such, we cannot commit to specific details about how these issues would be approached in the future. 31. A bank also noted that the deadline for providing a capital restoration plan to the Reserve Bank is ten working days from breaching the point at which Stage 1 of the CBRF applies. The bank suggested changing the deadline to ten days from becoming aware of a buffer breach, rather than ten days from the breach. They further noted that the

11 Response to Submissions Reserve Bank has already accepted that banks are not in immediate risk of insolvency at this point. 32. In response, the Reserve Bank has agreed to change the deadline for providing a capital restoration plan to ten working days from becoming aware of a buffer breach. This amendment has been incorporated into BPR120. 33. Some submitters identified additional risks associated with the CBRF. Banks may set larger management buffers to ensure they do not operate inside the upper zone of the PCB, even temporarily. It may also create a false sense of security as the CBRF is designed to address a decline in capital in isolation, whereas a bank in such a situation is also likely to be exposed to a liquidity crisis. Lastly, markets can respond unfavourably to banks that dip into capital buffers. We have considered these issues, but do not consider these to be sufficient to alter the CBRF. Terms sheet templates for AT1 and Tier 2 capital 34. The Reserve Bank consulted on the addition of terms sheets to the BPRs that banks could use to issue AT1 and Tier 2 capital instruments. In the approach proposed in November, banks would not be required to use the exact wording included in the templates, but they would need to provide a ‘marked-up’ version of the template to highlight any areas where the wording of a specific instrument deviated from the published template. The aim of these template terms sheets was to enhance the standardisation, simplicity, and transparency of the capital framework and to minimise the chances that non-compliant instruments are issued, and to facilitate the replacement of the non-objection process. 35. Submitters had mixed views on the addition of template terms sheets in the BPR110 exposure draft. Three submitters supported inclusion of the templates, which they noted would aid the interpretation of the Reserve Bank’s requirements to issue compliant AT1 and Tier 2 instruments. However, several large banks strongly opposed including the templates, arguing that they are unnecessary and detract from the simplicity objectives underpinning the Capital Review. 36. In particular, these submitters argued that the templates might create confusion. They noted that banks already need to issue a range of documentation to cover the issuance of capital instruments, which often includes summary terms sheets that are developed in consultation with investors. These banks argued that it would then be necessary to prepare a specific terms sheet just for the purposes of meeting Reserve Bank requirements – effectively creating multiple term sheets for the same instrument. 37. The Reserve Bank has developed a checklist to replace the proposed terms sheet templates. The checklist requires banks to provide evidence that the instrument complies with the prudential requirements in BPR110. Completing the checklist will be a mandatory requirement when issuing a new capital instrument, which will help minimise the risks that non-compliant instruments are issued. As an additional measure, the legal sign-off template in BPR120 has been updated to require the lawyers offering a legal opinion to confirm that all the BPR110 requirements have been met, and that these are all documented in the checklist, supported by evidence drawn from the instrument’s documentation.

12 Response to Submissions 38. This was a finely balanced decision. The Reserve Bank’s primary concern is that capital instruments must meet all requirements to be recognised as regulatory capital. However, we have been open to achieving this in a different way and consider that the new checklist, combined with the legal sign-off processes, will achieve this outcome. It will also avoid the risks of duplication or errors that could arise if banks were creating multiple term sheets for different purposes. 39. The Reserve Bank recognises that the removal of template term sheets may remove a useful resource for smaller banks considering issuance of capital instruments. On balance, we determined that the advantages of moving to a checklist outweighed these costs. The Reserve Bank will be available to discuss the policy intent of the requirements with issuing banks to ensure that these are well understood, as described below. Replacement of non-objection process with a ‘notification process’ to issue AT1 and Tier 2 capital instruments 40. We proposed removing the non-objection process concerning the issuance of AT1 and Tier 2 capital instruments (as previously outlined in BS16). This was largely due to the fact that the simpler instrument structure for AT1 and Tier 2 capital instruments arising from the Capital Review decisions leant support to a more streamlined process for issuing these instruments, with the onus on banks and their boards to ensure the instrument meets regulatory requirements. 41. As such, we proposed replacing non-objection with a ‘notification’ process, under which a bank would no longer have to apply for a notice of non-objection to issue AT1 or Tier 2 capital instruments. Rather, a bank would provide the Reserve Bank with a signed legal opinion, following a standard legal template, along with the documentation for the AT1 or Tier 2 capital instrument. Once these documents are submitted, the Reserve Bank will recognise the instrument as AT1 or Tier 2 capital. 42. Submitters were supportive of this change, with two reservations:  Banks were concerned that the legal sign-off effectively made the template terms sheets that were included in the draft BPRs compulsory.  Banks requested the opportunity to engage with the Reserve Bank during their processes to issue capital instruments. They suggested an FAQ-type approach to manage this. 43. Since the Reserve Bank has decided to replace the template terms sheet with a mandatory checklist, banks should no longer have concerns that the legal sign-off makes the templates compulsory. 44. In response to the second point, the Reserve Bank is open to answering questions about policy intent to assist in the design of capital instruments, if there is confusion about the intent of any requirement. We will not provide advice or guidance about the specific wording of terms and conditions, or provide banks with any assurance that their instruments are compliant. The BPRs make it clear that this responsibility sits with banks, including the following reference in the guidance to section B1.1 in BPR120:

13 Response to Submissions ‘… the directors of a bank are responsible for ensuring that their bank’s capital instruments comply with the Reserve Bank’s capital adequacy framework for the entire period that the instrument is recognised as regulatory capital.’ 45. To ensure that there is transparency around these processes, we intend to periodically publish our responses through an FAQ framework as we receive questions from institutions. 46. As noted in the consultation paper, we also intend to carry out periodic reviews of the documentation of instruments on an ex-post basis. The first of these is most likely to take place 18 to 24 months in the future. Legal sign-off process 47. Under the new notification process, banks issuing AT1 or Tier 2 capital will submit copies of the relevant documents along with a signed New Zealand law legal opinion addressed to the Reserve Bank using a standardised template. The standardised legal opinion template is designed to provide the greatest degree of comfort that the instrument meets the requirements in BPR110, while minimising legal qualifications and assumptions. The draft legal opinion template is provided in the Appendix to BPR120. The opinion confirms that:  The terms sheet and programme documents meet the requirements set out in BPR110.  The instrument does not include any terms that override or distort the intended operation of the instrument as set out in BPR110. 48. One submitter provided several comments on the draft legal sign-offs for AT1/Tier 2 instruments and the draft legal sign-offs for amendments to terms of AT1/Tier 2 instruments. The Reserve Bank has incorporated these recommendations into the templates where we believe they enhance the clarity of the legal opinion. 49. As noted above, the legal sign-off template has been modified to incorporate the checklist that has replaced the proposed terms sheet template. 50. In the next section we discuss allowing other laws to govern Tier 2 capital instruments, which affects the legal-sign off process. The amendments we have made to the sign-off process are discussed there. Implementation of Capital Review December 2019 Decisions Definitions of AT1 and Tier 2 capital 51. The Reserve Bank sought feedback on the way the new form of AT1 and Tier 2 capital instruments is reflected in BPR110. As outlined in the 2019 final Capital Review decisions document, the requirement is that AT1 and Tier 2 capital will no longer include contractual features that give rise to conversion or write-off at the point of non-viability. Also in line with the final decisions announced in 2019, the requirement for AT1 is that it is a Perpetual Preference Share (PPS), rather than a note. 52. One submitter opposed the decision to exclude legal form debt instruments as eligible AT1 capital in their submission. They argued that the Reserve Bank was misguided and

14 Response to Submissions driven by economic factors rather than legal issues. As noted in the consultation document, the scope of the consultation was limited to the way the Reserve Bank proposed to implement the December 2019 Capital Review decisions. Therefore, we will not be reopening the decision to disqualify legal form debt as AT1 capital. 53. There are two additions to the requirements for capital instruments that the Reserve Bank consulted on as consequential policy requirements. These are:  For AT1 instruments, the inclusion of a dividend stopper feature, noting that this is a market standard feature and ensures that these instruments perform as ‘preference shares’ in practice.  For both AT1 and Tier 2 instruments, the requirement that the instrument must be governed under New Zealand law. Dividend Stopper 54. Submitters had mixed views on the inclusion of a dividend stopper in the requirements for an AT1 instrument. Two banks supported the inclusion of a dividend stopper, which ensures that PPS perform as ‘preference shares’ in practice. Essentially, if distributions on the PPS are not paid, a dividend stopper will mean that a bank cannot make any distributions on its ordinary share (CET1) capital. This was intended to ensure that CET1 capital absorbs losses first. 55. Those against the inclusion of a dividend stopper argued that it is not necessary for the purpose of absorbing losses on a going-concern basis and is contrary to the Reserve Bank’s intention of avoiding unnecessary complexity. Other submitters suggested that a dividend stopper will limit full flexibility of payment and hinder recapitalisation. One bank noted that it did not support the dividend stopper feature applying to instruments that rank equally with the applicable instrument. 56. We have decided to remove the dividend stopper requirement for AT1 instruments, and reflected this in BPR110. We agree that the dividend stopper is not necessary to absorb losses on a going-concern basis. Banks can include a dividend stopper in a capital instrument if they wish to do so. It is also worth noting that the CBRF includes restrictions on distributions that occur when a bank’s prudential capital buffer falls below specific levels. These restrictions affect distributions on CET1 before AT1. New Zealand Governing Law Requirement 57. The draft BPRs require both AT1 and Tier 2 instruments to be governed under New Zealand law because allowing foreign governing laws adds complexity to the capital framework, particularly in regards to loss absorbency. Confining instruments to New Zealand law also facilitates the operation of the new ‘notification’ process for recognising capital instruments, as New Zealand lawyers will be able to issue the required legal opinions and carry out any audit of issued instruments. 58. Submitters appeared comfortable with the proposed New Zealand governing law requirement for AT1 instruments. Although, several noted that they thought this would present a significant impediment to offshore issuance of AT1, due to offshore investor lack of familiarity with the New Zealand legal system. Feedback from some banks’ offshore financial intermediaries and legal advisers suggests that the market is not ready for a blanket reference to New Zealand law. However, since AT1 instruments are

15 Response to Submissions required to be legal-form equity under BPR110, banks have suggested that there will be little offshore interest for AT1 instruments as foreign investors will not be able to claim the associated imputation credits. 59. The Reserve Bank has decided to retain the proposed New Zealand governing law requirement for AT1 instruments. However, we recognise that this could be an impediment for any bank considering issuing AT1 offshore in the future. It is possible such impediments would decline over time once investors became comfortable with New Zealand-based AT1 instruments. 60. Many submitters expressed concerns about the proposal that the governing law under which banks issue Tier 2 capital instruments must be New Zealand law. They argued that by limiting the governing law only to New Zealand, the domestic market will need to absorb the significant amount of bank capital required to meet the new capital regime. Banks do not believe the domestic market is sufficiently capable of doing so. 61. Some submitters argued that there is no need for this requirement for Tier 2 capital as, unlike AT1, Tier 2 instruments are not required to be legal-form equity. Banks suggested that the pre-Capital Review status quo be retained, as per BS2A and BS2B, which allows for ‘satisfactory equivalents’ to New Zealand law for Tier 2 instruments. Alternatively, banks suggested that a hybrid model, where there is scope to use international governing law in some lower-risk parts of Tier 2 terms and conditions, would be more acceptable for offshore investors if a full foreign governing law approach was not possible. 62. The Reserve Bank recognises banks’ concerns that if the New Zealand law requirement for Tier 2 capital is kept, these instruments might only be issued domestically. This could potentially saturate the domestic capital market and crowd out smaller banks. Therefore, the Reserve Bank will allow Tier 2 instruments to be governed by foreign law, so long as the foreign law is New South Wales (Australia), Victoria (Australia), England or New York. A hybrid approach, where some elements of the Tier 2 instrument are governed by New Zealand law, and some by foreign law, will also be acceptable under BPR110. 63. This change does introduce some risks. These primarily relate to how New Zealand law would be recognised in a foreign court. For example, a foreign court may not recognise New Zealand insolvency proceedings or particular aspects of those proceedings. The Reserve Bank considers that such risks are small if the foreign law underpins a conventional wholesale market, hence the limits on the jurisdictions that are acceptable. 64. Subordination provides an example of this. Contractual subordination will be recognised under New Zealand law. This legal certainty is provided in case law and is codified in section 313(3) of the Companies Act. With a foreign law governed instrument, there is a risk that the subordination clause may not operate as intended. However, our assessment is that the risk is low, given that the permitted foreign jurisdictions in BPR110 underpin a conventional wholesale market. 65. To manage these risks, the Reserve Bank will require a separate foreign-based legal opinion for any Tier 2 instrument that has clauses governed by foreign law, which will need to confirm the performance of the instrument under the relevant foreign law. We will not provide a template for the foreign governing law opinion. Instead, BPR120 has

16 Response to Submissions been redrafted to state what the foreign law opinion needs to cover, such as the enforceability of the terms of the instrument in the respective foreign jurisdiction. Implementation timetable 66. Some of the feedback received in the submissions asked for changes to the Capital Review implementation timetable. The Reserve Bank announced several decisions on 5 May 2021 in the Financial Stability Report. 3 We announced these decisions ahead of the publication of the final BPRs and this Response so that banks have more time to adjust to the new framework. Our detailed responses to submissions on the implementation timetable are outlined below. Extension of BPR implementation date 67. One bank noted concerns about the original 1 July 2021 implementation date of the finalised BPRs. They pointed out that the new policy framework and associated Conditions of Registration will result in a significant restructure of their internal compliance framework, which poses challenges with their 30 September financial year balance date. The bank suggested extending the date that the BPRs come into effect by three months to 1 October 2021. 68. Some other banks suggested that a three month delay would be helpful as it would provide a longer adjustment period between the publication of the final BPRs and when the rules come into effect. However, one submitter noted that a three month delay should only apply to the initial commencement date for the new rules to take effect and not to subsequent dates, such as the introduction of dual reporting or the output floor. 69. In response, the Reserve Bank has agreed to extend the formal start date for implementing the BPRs by three months from 1 July 2021 to 1 October 2021. This will provide banks more time after the final BPRs are published to adjust their systems and internal processes to accommodate the changes. The extension means that banks with 30 September financial year-ends will need to produce their year-end material in accordance with existing prudential requirements, not the new BPRs. 70. The extension of the formal start date to 1 October 2021 means that there is a delay to when the capital definitions will change. In particular, new definitions for Additional Tier 1 capital and for Tier 2 capital will now take effect from 1 October 2021, not 1 July as previously planned. 71. While the new rules will not take effect until 1 October 2021, the Reserve Bank will recognise Tier 2 capital instruments issued in accordance with the new BPRs for the period up to 30 September 2021. This will help embed the new definitions, as well as providing an option for banks wishing to issue capital instruments more promptly. We have published detailed information about how this will work, including draft changes to banks’ Conditions of Registration and modifications to the way we will operate BS16 (Application of requirements for capital recognition or repayment and notification requirements in respect of capital), in the period before 1 October 2021.

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3 The May 2021 Financial Stability Report is available here: www.rbnz.govt.nz/financial-stability/financial-stability-report/fsr-may-2021

17 Response to Submissions Derecognition of AT1 and Tier 2 instruments 72. Several submitters suggested changing the derecognition schedule for AT1 and Tier 2 instruments that will not be compliant with the new framework or allowing such instruments to be ‘grandfathered’ into the new regime. Banks noted that it will take time for them to launch and sell new AT1 and Tier 2 products, but that the derecognition of existing AT1 begins from 1 July 2021 – the same time at which the new rules were originally planned to come into effect. They argued that extending the starting point of the derecognition schedule by six to twelve months would provide more time for them to issue compliant replacement instruments. 73. The Reserve Bank recognises that there was a limited lead time between the finalisation of the new rules for capital instruments and the ability of banks to issue AT1 and Tier 2 instruments, which is reflected in our decision to extend the formal start date for implementing the BPRs by three months to 1 October 2021. Additionally, the start date for derecognition of existing non-compliant capital instruments will be extended to 1 January 2022. This is an extension of six months and helps to provide more time for banks to prepare for issuing new instruments. 74. One submitter also proposed that the derecognition process should only apply to instruments structured as debt, as these are more likely to be inferior from a loss absorbing perspective, so long as they meet all the other requirements for AT1. 75. The Reserve Bank notes that there is already a mechanism in BPR110 and BPR120 that provides scope for a bank to include existing instruments as part of AT1 (or Tier 2) capital. However, to do so a bank would need to complete a number of steps:  The terms of the existing instrument would need to meet all of the requirements in the new BPRs.  All notification processes in BPR120 must be completed. 76. Since there is a way for banks to include existing capital instruments that meet the requirements of the BPR documents, we have made no change to these processes. Output floor 77. One bank requested a delay in the implementation of the output floor for banks that use the internal ratings-based (IRB) approach from 1 January 2022 to 1 October 2022. They argued that this would align with the Reserve Bank’s intention to reduce short￾term capital pressure on banks and allow banks to support lending growth. 78. The output floor means that, when determining its capital ratio, the risk-weighted assets (RWA) a bank calculates using the IRB approach cannot go below a certain proportion of the RWA that it would calculate under the standardised approach. Any decision to change the timing of the output floor implementation would have impacts on the pace of moving towards a more ‘level playing field’ between IRB banks and standardised banks. 79. The Reserve Bank believes the advantages of levelling the playing field outweigh the impacts associated with short term capital pressure. Therefore, we have decided to retain the 1 January 2022 introduction of an output floor set at 85 percent of the standardised outcome for IRB banks’ RWA.

18 Response to Submissions Dual reporting and the standardisation of sovereign and bank exposures 80. Dual reporting means that banks accredited to use internal models to calculate their risk-weighted assets will also need to publish their RWA results under the standardised approach. Dual reporting has no impact on capital ratios and will make the implementation of the output floor easier, as banks will be required to publish their results using the standardised approach. Some banks expect there to be compliance related costs involved in dual reporting. The Reserve Bank does not consider this a strong rationale to delay the implementation of dual reporting for IRB banks from the first quarter of 2022. 81. One of the consequential Capital Review decisions was to standardise all sovereign and bank exposures, meaning that banks could not use IRB models to calculate capital requirements for these exposures. While this issue was not included in any submissions, some banks raised this issue bilaterally with us and noted that a delay would free up resources to focus expertise on driving initiatives to support customer lending and stimulate credit growth. The Reserve Bank believes that the benefits of moving towards a more level playing field between IRB banks and standardised banks outweigh the other factors. Therefore, we have decided to retain the proposed staged implementation of the standardisation of sovereign and bank exposures as set out in BPR130.

19 Response to Submissions Part Two: Other Matters Raised in Submissions 82. Several submissions contained detailed suggestions concerning technical changes to the BPRs. The following section addresses many of the more significant points raised by submitters. However, readers should also refer to the published red-lined versions of the BPRs, which highlight all the changes that have been made. BPR100: Capital Adequacy Solo capital ratio calculations 83. Several submitters raised concerns with the proposed treatment of entities to be included in the solo capital ratio calculation. Under the BPR exposure drafts, submitters noted that funds management, securitisation or covered bond special purpose vehicles (SPVs) will not be eligible to be consolidated in the solo capital ratio calculation. They argued that this would effectively ‘gross-up’ or double count exposures, which would overstate the risk in the solo capital ratio calculation. Submitters requested that we allow these SPVs to be aggregated and consolidated in the solo capital ratio calculation. 84. The aim of this ‘solo consolidation’ approach is that the only entities included in the solo capital ratio calculation are those that are fully under control of the bank and have no external claims on the bank’s asset (from either external creditors or minority shareholders). Only assets that are unquestionably available to creditors of the bank are meant to be included. In the case of internal Residential Mortgage Backed Securities (RMBS), this principle is clearly met, because the bank owns the RMBS constructed in this way. In the case of covered bonds, there are external bondholders, but the effect of the structure is to give them a priority claim on the mortgage loans, while they still have a direct claim on the bank. 85. The Reserve Bank believes this issue has arisen as an unintended consequence of what was meant to be a minor rationalisation in BPR160: Insurance, Securitisation and Loan Transfers. In the process of tidying up the securitisation treatment in BPR160, we removed the references to solo capital ratios. This left banks with only the solo consolidation tests in BPR100, which meant unambiguously leaving the SPVs out of the solo consolidation. We accept the arguments put forward that both covered bond and internal RMBS SPVs should be consolidated into solo capital ratios, and we have amended BPR100 to deal specifically with these cases. We do not see these concerns as relevant for funds management SPVs, or SPVs for externally issued RMBS. 86. Some submitters also noted that the BPR100 exposure draft includes a requirement that, for a subsidiary to be considered exclusively funded by the bank, its liabilities to trade creditors may not exceed 5 percent of its shareholders’ funds. They are concerned that this test is not meaningful for internal RMBS trusts and covered bond SPVs, which have nominal amounts of shareholders’ funds. An SPV could frequently move in and out of meeting the test, hence creating volatility. They therefore suggested that the ‘wholly funded’ test be extended to require that trade creditors may not exceed the greatest of 5 percent of shareholders’ funds or 1 percent of the subsidiary’s total assets. 87. The Reserve Bank agrees that this change would remove the risk of volatility in reported ratios while retaining the intent and substance of the wholly funded criteria, and we have amended BPR100 accordingly.

20 Response to Submissions Definitions and timing of dividend restrictions 88. One bank queried the way that distribution restrictions are defined and suggested the definitions in BPR100 B2.6(6) be changed to provide extra clarity about what is meant by ‘current year’ and ‘aggregate distributions’ 89. There are currently restrictions on dividends that were put in place in response to COVID-19. On 31 March 2021, the Reserve Bank announced that dividends would be restricted to 50 percent of earnings and that this would remain in place until 1 July 2022, at which point the Reserve Bank intends to normalise the dividend settings by removing the restrictions entirely (subject to no significant worsening in economic conditions). Once the COVID-19 related restrictions are lifted, any future distributions will be covered by the rules set out in the BPRs. 90. The definitions in the BPRs are long-standing features of the prudential requirements and we do not see a strong case to alter these. We have engaged in depth with banks about the meaning of the terms used in the current COVID-19 related restrictions. BPR110: Capital Definitions Zero-rate floors 91. Both the Banking Supervision Handbook (BS2A/B) and the BPR exposure drafts state that interest rates should not involve a ‘step-up’ in interest rate margins over time, since that would give issuers an incentive to redeem the instruments. Distributions on most instruments are either paid on a floating or fixed basis for the first five years and are re￾fixed subsequently at the same margin above an appropriate benchmark rate. 92. Several submitters suggested allowing a zero-rate floor on the interest rate payable on capital instruments, even though this would constitute a ‘step-up’ if interest rates became sufficiently negative. 93. A zero-rate floor could be applied to the benchmark rate, which would ‘bite’ as soon as interest rates became negative. Submitters argue that allowing such a zero-rate floor will preserve the margin between capital instruments and ‘senior deposits’ in a low interest rate environment. This would address concerns that the coupon on riskier capital instruments may converge with the coupon on deposits, as banks are reluctant to charge negative interest rates on deposits. 94. While the Reserve Bank recognises submitters’ concerns, we do not believe that it is significant enough to override our preference to avoid interest rate step-ups. Particularly given that we would want to encourage the pass-through of negative interest rates where possible. 95. A zero-rate floor could also be applied to the overall coupon/distribution rate. This type of floor would only ‘bite’ if interest rates were deeply negative since the margin on a Tier 2 instrument is likely to be two percent or more. The proposal for allowing a zero￾rate floor on the overall coupon/distribution rate is stronger than for the benchmark rate. Negative distributions are complicated to operationalise, and there is currently a market expectation that long-term instruments will include a zero-rate floor on distributions.

21 Response to Submissions 96. The Reserve Bank has amended BPR110 to allow a zero-rate floor, by noting that we would not class this to be a ‘step-up’ as part of the overall coupon/distribution rate. 97. Redemption can still only take place with the Reserve Bank’s permission, which can be withheld if there are concerns about a bank’s capital levels. This helps manage the risks associated with ‘step-ups’. Interest rate reset 98. The BPR110 exposure draft includes clarification that a fixed rate reset on an optional call date is not an incentive to redeem for both AT1 and Tier 2 capital instruments. The requirements provide for a reset provided that the new rate is a ‘market rate’. 99. Two submitters argued that the new reset rate should be a ‘benchmark rate (being the same benchmark that has been used for a previous interest rate set or reset) plus a margin (which does not change)’. They said that this is more suitable as the reset may not reflect market rates at the time of the reset. Banks may want to take advantage of the reset mechanism on an optional call date if the benchmark rate has deviated from the original benchmark when the instrument was issued. 100. The Reserve Bank agrees and has changed the reference in BPR110 from ‘market rate’ to ‘benchmark rate plus a margin’. This change will provide more clarity about how the interest rate reset process should work. 101. Banks also asked for assurances that it is acceptable to use a fall-back rate to replace the benchmark rate if the chosen benchmark becomes unavailable. We agree that this is sensible and have amended BPR110 to make it clear that switching to an equivalent fall￾back rate will also not be considered an incentive to redeem. Switching to a fall-back rate will only be allowed when the original benchmark is no longer available and the fall-back rate is designed, as far as possible, to produce a genuinely equivalent interest rate that does not result in a step-up in the margin over prevailing wholesale market rates. References to ‘interest’ for Tier 2 instruments 102. Throughout the BPR110 exposure draft, the distributions paid on Tier 2 instruments are referred to as ‘interest’. This is consistent with the descriptions of Tier 2 instruments as debt in section B3.1. However, the actual Tier 2 eligibility requirements in section D2 do not explicitly require Tier 2 to be debt. 103. A submitter argued that the description of distributions on Tier 2 instruments as ‘interest’ should be changed to ‘interest or dividends’ – as is the case in BS2A/B. They said that this will be important if a co-operative or building society sought to issue Tier 2 in an equity format in the future. 104. The Reserve Bank has amended BPR110 to accommodate entities issuing Tier 2 instruments in an equity format. Any such instruments must still meet all of the prudential requirements to be recognised as Tier 2 capital. Special purpose vehicles 105. A bank stated in their submission that the scope of the proposed special purpose vehicle (SPV) rules for Additional Tier 1 and Tier 2 issuance in the draft BPRs are broader

22 Response to Submissions than the existing rules. They stated that the proposed SPV definition in BPR110 would capture entities that are ordinarily outside the banking group, including entities that the banking group has no control over and entities that would not be consolidated into the banking group. 106. Under the proposed new capital rules, the submitter argued that both a New Zealand subsidiary bank and its offshore parent bank may need to separately issue AT1 and Tier 2 instruments for the same New Zealand bank risk-weighted assets. This would be to comply with both the Reserve Bank’s capital requirements and the offshore regulator’s capital requirements, duplicating the capital cost. 107. The submitter recommended refining the SPV definition to include only entities that are consolidated into the banking group under Generally Accepted Accounting Principles and to exclude entities that are neither owned nor controlled by the New Zealand bank. They argued that issuing capital instruments through an SPV that is not consolidated into the New Zealand banking group could prevent the duplicate cost, without increasing the risk to the New Zealand financial system. 108. The Reserve Bank recognises that there may be additional costs for the parent bank. However, the submitter’s proposed changes would increase complexity and reduce transparency in the New Zealand capital framework, contrary to the principles of the Capital Review. Therefore, the Reserve Bank has decided to retain the definition of SPV as outlined in the exposure drafts. References to Conditions of Registration in AT1 instrument terms and conditions 109. The BPR110 exposure draft includes a requirement to provide in the terms of AT1 instruments that distributions may be limited by the bank’s Conditions of Registration (CoR). The main advantage of requiring the terms of AT1 instruments to state that distributions may be limited by CoR is that it provides maximum clarity that distributions are at risk. This minimises the risk of misselling to retail investors and increases the chance retail investors fully understand the risks involved 110. Several submitters questioned whether this requirement is necessary. Some submitters argued that the important requirement is that the Reserve Bank has the ability to limit distributions. As the CoR provides this power, the submitters stated that there is no need to require the terms of AT1 instruments to also reference CoR. 111. The Reserve Bank has decided to retain the requirement to provide in the terms of AT1 instruments that distributions may be limited by the bank’s Conditions of Registration. However, we note that that any future entities seeking to be registered as a bank would be subject to a detailed registration process, at which point the status of capital instruments would be considered. In such cases, it may also be possible for an entity to amend the terms of any existing document. Common Equity Tier 1 capital 112. Two submitters raised issues regarding the requirements for Common Equity Tier 1 (CET1) capital, covering the rules around voting rights and the distribution requirements. 113. BPR110 requires CET1 ordinary share instruments to provide the holder ‘full voting rights’, noting that ‘one member, one vote’ qualifies as full voting rights for building

23 Response to Submissions societies. The submitters argued that the voting rights requirement is not necessary as it does not affect the loss absorbing characteristics of the shares. 114. BPR110 also states that distributions on CET1 instruments cannot be subject to a ‘contractual cap’. One submitter argued that this should be acceptable if investors agree to it on a ‘bespoke basis’. 115. These two requirements citied by the submitters have not been changed by the Capital Review and are long-standing features of our current framework. While we did not directly seek feedback on CET1 capital instruments as part of this Consultation, the Reserve Bank will consider the submitters’ proposed changes at a future date. Banks structured as mutual societies 116. Three submitters raised points on how the proposed BPRs would impact registered banks structured as mutual societies. Composition of Tier 1 Capital 117. Submitters expressed general support for the eligibility criteria for Alternative Tier 1 (AT1) capital. One submitter noted that there are no barriers in the criteria for banks structured as mutual societies to issue these instruments. 118. However, submitters all stated that the limit of 2.5 percent of Tier 1 capital for AT1 instruments should not apply to banks structured as mutual societies, provided that certain requirements are satisfied. They argued that this would recognise that mutual societies are not required to have share capital like banks structured as companies. Therefore, submitters stated that AT1 instruments can effectively perform as ordinary shares for prudential purposes. 119. The Reserve Bank’s rationale for the December 2019 decisions included a judgement that we were comfortable will loss absorbency of AT1 up to the level of 2.5 percent, but not beyond that. Since this suggestion goes beyond the scope of the consultation, we have retained the current limits on AT1 recognition in the published BPRs. Common Equity Tier 1 (CET1) Capital 120. Some submitters noted that they were encouraged by the steps the Reserve Bank is taking to engage with the sector on eligible CET1 capital that can be issued by banks structured as mutual societies. They stated that they are keen to continue engagement with the Reserve Bank so that mutual entities, who currently face barriers and complexity to issue ordinary shares that meet regulatory CET1 capital requirements, could do so in the future without compromising their mutual status. 121. Submitters made several recommendations where the proposed eligibility criteria for CET1 capital needs adjustment, or a nuanced interpretation, to make them suitable for application to mutual societies. These included suggestions related to distribution and subordination requirements, claims on residual assets, and full voting rights. 122. While the Reserve Bank recognises the importance of working with the mutual society sector to enable them to issue ordinary shares, these suggestions will take more time to work through in an adequate way. The Reserve Bank will continue to work with the sector on these issues over the second half of 2021.

24 Response to Submissions Redemption price for AT1 instruments 123. The AT1 template terms sheet in the BPR110 exposure draft specifies the redemption price to be the same as the issuance price. However, one submitter argued that AT1 instruments should not have a fixed redemption price. They noted that Tier 2 instruments do not have this requirement and that the same flexibility should be built into AT1 instruments. The submitter said this would be most relevant in the case of an early redemption for a tax or regulatory event if interest rates have fallen and the AT1 instrument is trading above $1 (assuming a $1 issue price). 124. This requirement is contained in the template terms sheet but is not present in the BPRs or in our previous rules. Since we do not believe there is any need for the Reserve Bank to specify a redemption price, we have left the final BPRs unchanged. Our decision to remove the template terms sheets will then eliminate the text specifying the redemption price that the submitter commented on. BPR120: Capital Adequacy Process Requirements Compendium of models requirement 125. One bank questioned the meaning of the requirement in BPR120, E1.5(1), that a ‘modelling bank must maintain a compendium of approved models with the Reserve Bank, and must obtain the Reserve Bank’s agreement to the compendium’. They suggested this should refer instead to us agreeing only to the format of the compendium. 126. As the Reserve Bank only approves a bank’s template upon initial accreditation to use the internal ratings-based approach, we have identified some minor drafting improvements to align the BPR120 text better with actual practice. 127. We have also added an explicit requirement for IRB banks to submit a copy of their model compendium to the Reserve Bank: (i) after any model approval; and (ii) after the required annual review. Item (i) happens already in practice, as our standard model confirmation letter asks banks to send us the revised compendium. Item (ii) is new, but should be a minimal burden for banks given that the annual review of the template, and update as needed, is already required. Capital instruments issued in foreign currency 128. One bank noted that the requirement in BPR120 that ‘Capital instruments issued in a foreign currency must be valued for regulatory capital purposes in NZD at the spot exchange rate’ would lead to a difference between the regulatory and accounting treatment of AT1 capital instruments. This is because the accounting treatment would not require on-going valuations at the spot exchange rate. The bank stated that if a bank used currency hedging in these circumstances the impact of foreign exchange movements would be doubled, and would distort the outcome from a capital adequacy perspective. 129. The Reserve Bank has decided to align the regulatory treatment with the accounting treatment, as the funds provided are permanently available to the bank and can therefore absorb losses. AT1 instruments issued in foreign currency should be valued in NZD in line with the appropriate accounting rules for equity instruments, which

25 Response to Submissions generally do not require revaluation at the spot exchange rate. Tier 2 instruments should be revalued at the spot rate, in line with the BPR120 exposure draft. BPR130: Credit Risk RWAs Overview Application of IRB scalar to supervisory slotting risk-weighted assets 130. One bank approached the Reserve Bank about whether it is reasonable for specialised lending exposures that are risk-weighted using the supervisory slotting approach to be subject to the IRB scalar, given that such exposures have standardised-style risk weights. Under the exposure drafts, when the IRB scalar increases to 1.2 from 1 October 2022, it will only apply to credit risk RWAs calculated under the IRB approach – which includes the supervisory slotting approach. 131. The risk-weighted assets of slotted specialised lending exposures are still derived indirectly from a bank’s internal probability of default and loss given default models. This is because a bank must map its internal obligor grade for an exposure to one of the five slotting grades, using the detailed set of criteria provided in BPR133. Therefore, we believe that it is appropriate to apply the IRB scalar to slotted specialised lending exposures, and will not be making the requested change. Calculation of total credit risk RWAs by IRB banks 132. From 1 October 2022, both the output floor and scalar increase for the calculation of IRB banks’ RWAs will come into effect. Two submitters highlighted a drafting error in the BPR130 exposure draft concerning the transition period from 1 January 2022 (with the introduction of the output floor) to 30 September 2022. This would have had the perverse effect of applying a higher floor only from January to September 2022, resulting in a step up before a step down in credit risk RWAs. The Reserve Bank agrees that this was a drafting error and have made the amendments suggested by the submitters. BPR131: Standardised Credit Risk RWAs Risk weights for reverse mortgages 133. One submitter raised several issues regarding the standardised risk weights for reverse mortgage loans (RMLs) in their submission. They stated that the risk weights for RMLs, which have been carried over to BPR131 from BS2A, do not accurately reflect the risk profile of reverse mortgage lending. 134. The submitter requested several changes, which would effectively treat RMLs with an LVR of less than 30 percent in the same way as ‘standard’ mortgage loans and remove the requirement to discount subsequent RML valuations. However, reverse mortgage lending does have distinct differences to standard mortgage loans. For example, an RML does not require regular repayments and is usually repaid when the property is sold. This means that the value of the loan increases with time, as the loan includes the original principle plus interest (compounded). This gives RMLs a risk profile that is quite different from that of a standard mortgage since, in theory, compounding interest could turn a loan into negative equity.

26 Response to Submissions 135. The Reserve Bank’s approach to RMLs was put in place in 2015, after a full consultation with stakeholders and the publication of a Regulatory Impact Assessment.4 We believe that the risk weights determined in 2015 still achieves the Reserve Bank’s objectives of aligning the capital requirements of RMLs with their risk profile in a cost-effective manner. Therefore, we have decided to retain the risk weights for RMLs in BPR131. We are open to considering this issue further in the future and, at this point, intend to look at this issue more fully in 2022. Any changes would include a full public consultation process and regulatory impact assessment of all the costs and benefits. Categorisation of sovereigns, public sector entities and multilateral development banks 136. Several banks approved to use the internal ratings-based approach questioned the definitions and standardised risk weights of sovereigns, public sector entities and multilateral development banks. These IRB banks will be subject to the standardised approach on all exposures falling within these categories from 1 January 2022. 137. Currently, ‘sovereign’ and ‘multilateral development bank’ are not defined, while ‘public sector entity’ is only narrowly defined. Submitters suggested, for example, that entities with implicit government guarantees should be treated as sovereigns. To enhance clarity in this area, there are several considerations that will need to be made. We intend to review and consult with banks again on a coherent set of changes across the definitions at a future date, mostly likely in the second half of 2021. Issue-specific and inferred credit ratings 138. One submitter questioned the mechanics of applying credit ratings to standardised exposures. They said that BPR131 is not clear on the interaction between an ‘issue￾specific rating’ (a rating applied only to a specific issue of securities) and a long-term rating applied to the issuer of those securities. There are an additional set of rules to determine which exposures to a counterparty can carry an inferred rating, derived from the counterparty’s general long-term issuer rating. 139. The requirements in BPR131 outline that banks must use an issue-specific rating, when there is one. However, it also says that if a claim qualifies for an inferred rating based on the issuer’s general long-term rating, banks must use that. This means, for example, a 90-day commercial paper issue might have a Standard & Poor’s A-2 short-term rating, but also qualify for an inferred long-term rating of AA- from Standard & Poor’s. It is not clear, from the BPR131 exposure draft, which one should apply. 140. The Basel Framework, and APRA’s implementation of it, suggests that an issue-specific rating takes precedence over others. The process of inferring ratings should only apply to an ‘unassessed claim’, which is defined as a claim without an issue-specific credit rating. We have amended the drafting to make this clear in BPR131. 141. The BPR131 exposure draft also specifies the risk-weighting treatment for an exposure that carries multiple ratings. The way we have clarified the hierarchy of issue-specific and issuer ratings (as discussed above) makes it clear that multiple ratings only refers to ratings of the same type (only issue-specific ratings, or only inferred ratings) from different agencies. For example, if a debt issue has at least one issue-specific rating from

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4 The October 2015 Regulatory Impact Assessment on Capital Requirements for Reverse Mortgage Loans is available here: www.rbnz.govt.nz/-/media/reservebank/files/regulation-and-supervision/banks/consultations/ria-capital-requirements-reverse-mortgage-loans.pdf

27 Response to Submissions one agency, there is no need to infer any rating from another agency that has not given that issue a specific rating. We have revised BPR131 accordingly to provide additional clarity in this area. Approved credit rating agencies for standardised risk-weighted assets 142. The list of rating agencies that can be used for determining standardised risk-weighted assets have been carried over from the Banking Supervision Handbook into BPR131. These are Standard & Poor’s, Moody’s Investor Services, and Fitch Ratings. 143. In bilateral meetings, one bank asked whether AM Best could be added to the list, at least for exposures to insurers, since the Reserve Bank has already approved AM Best as a rating agency for insurers under the Insurance Prudential Supervision Act. The Reserve Bank has made this change, but only for exposures to insurers. BPR132: Credit Risk Mitigation Currency mismatch adjustment 144. Collateralised exposures are typically made up of derivatives impacted by cash flows in several different currencies. A submitter stated that it would be useful to illustrate how the currency mismatch adjustment rules are to be applied in practice. Otherwise, some submitters suggested that guidance be added to BPR132 making it clear that the currency of a collateralised exposure is the ‘Base Currency’, as defined in the Credit Support Annex (or equivalent documentation) that governs the calculations of the exposure value and the subsequent amount of collateral to be posted. 145. In cases where the Base Currency is not considered the currency of the collateralised exposure, a submitter requested clarification on several scenarios for identifying a currency mismatch, assuming a bank measures and manages the fair value of its collateralised exposures in New Zealand Dollars (NZD). 146. First, the submitter asked, is there a currency mismatch if a bank has an NZD:USD foreign exchange derivative, and:  The counterparty posts cash collateral in NZD.  The counterparty posts cash collateral in USD. 147. Under the first scenario, where the counterparty posts cash collateral in NZD, there is no mismatch. Under the second scenario, where the counterparty posts cash collateral in USD, there is a mismatch. The bank is expecting to get NZD in the future, but is getting USD to collateralise the NZD position. Because the bank is holding USD but expecting NZD, there is exchange rate risk and they should apply the haircut. We have added guidance to make this clear in BPR132. 148. Second, the submitter asked if there is a currency mismatch if a bank has an HKD interest rate swap (i.e. no NZD flows) and the counterparty posts cash collateral in NZD. The Reserve Bank notes that this is a currency mismatch. If a bank is receiving HKD receipts but the collateral is denominated in NZD, then there is a mismatch and the haircut should apply.

28 Response to Submissions 149. The submitter also sought guidance on the treatment of a collateralised counterparty exposure containing a mix of derivatives, where some give rise to a currency mismatch while others do not. Specially, they questioned how a bank should calculate the portion of the collateral to be haircut. The Reserve Bank recognises that this can be an issue, and will allow banks to use any reasonable approach so long as it is consistent with the spirit of the simple case. Collateral held against guarantees 150. One submitter suggested that a bank should be able to recognise cash collateral as a credit risk mitigant for both on- and off-balance sheet exposures. They recommended that Part C of BPR132, ‘On-balance sheet netting’, should be adapted to cover contingent liabilities, such as guarantees provided by a bank. 151. In response, we note that Part B of BPR132 provides for the recognition of collateral, including cash collateral, held against exposures generally and does not restrict the scope of this treatment only to on-balance sheet exposures. The formula for calculating the adjusted exposure amount (in section B2.2 of BPR132) can be applied to any off￾balance sheet contingent exposures and also to loans, with the haircut HE set at 0 percent, given that the exposure is a fixed amount. Part C of BPR132 covers specifically the netting of on-balance sheet loans and deposits. BPR133: IRB Credit Risk RWAs Cross-method guarantees and credit derivatives 152. The recognition of guarantees as a credit risk mitigant in the risk-weighted assets calculation has separate approaches under the standardised and IRB approaches. The two methodologies are fully standardised and fully IRB, respectively. This could cause issues for IRB banks when the guarantor is subject to the standardised approach while the underlying exposure is subject to the IRB approach (and vice-versa). 153. This has not been a significant issue for IRB banks to date, but is expected to become so from 1 January 2022 when they will only be able to use the standardised approach for bank and sovereign exposures. To address this, the draft BPRs outlined that the standardised methodology applies to the whole risk-weighting calculation if either the guarantor or the underlying exposure are subject to the standardised approach. One bank noted that in the case of a corporate exposure covered by an IRB model, the ability to recognise a sovereign or bank guarantee would be of little use under this approach, as it would involve having to switch to the standardised corporate risk￾weighting approach for the underlying exposure. 154. The Reserve Bank agrees that a more nuanced solution could be implemented. However, we do not believe it would be appropriate to allow a modelled probability of default to be used for a guarantor that is a sovereign or a bank. This would defeat the purpose of switching bank and sovereign exposures to the standardised approach. It could also mean that an exposure to a corporate borrower, guaranteed by a bank, would get a lower risk weight than a direct exposure to the same bank. 155. It could be possible to derive a solution that retains the IRB approach for the underlying exposure and also uses the IRB guarantee methodology. This would involve an adaptation to allow the applicable standardised risk weight for the guarantor to be

29 Response to Submissions applied to the covered portion of the exposure. The Reserve Bank intends to collaborate with all IRB banks to determine an approach that works in the second half of 2021. Exemptions from one year floor for effective maturity calculations 156. The definition of effective maturity, which feeds into the IRB corporate risk weight calculation, includes a one year floor, but with certain exceptions. One bank noted that under the BPR133 exposure draft, banks wanting to apply an effective maturity of less than one year to categories of short-term loan or deposit not specifically listed in BPR133 will be required to have policies detailing the transactions where a one day maturity floor is appropriate. These policies will also have to be approved by the Reserve Bank. 157. The bank noted that this means that Exchange Settlement Account System (ESAS) balances and overnight placements with their parent will no longer be automatically exempt from the one year floor (as they were under BS2B). They argued the added approval requirement would be overly onerous given the nature of this lending. The Reserve Bank agrees and has added these two specific categories back in to the list of exemptions, rather than making banks go through the process of getting supervisory approval for them. Fall-back loan-to-valuation ratio 158. The definition of the loan-to-valuation (LVR) ratio depends on using a property valuation policy that meets specified minimum standards. Previously, what LVR to use when the required standards were not met was not specified in the Banking Supervision Handbook. Therefore, we proposed such residential mortgage loans should be set at an LVR of 101 percent in the exposure drafts, to ensure that they would be given the highest risk-weighting treatment. 159. One bank noted that some loans may have actual LVRs of over 100 percent. They suggested using an LVR of 150 percent as the fall-back for an LVR arising from an ineligible calculation, which would not affect risk-weightings but would be much less likely to be confused with an actual LVR. The Reserve Bank agrees that this amendment would enhance clarity. We have made the associated changes to both BPR131 and BPR133. Slotting approach for corporate specialised lending exposures 160. The BPR133 exposure draft outlines the calculation of the exposure amount to be used for slotted specialised lending exposures. As part of these requirements, BPR133 specifies the regulator-determined risk weights that banks must use to derive the credit conversion factors (CCFs) for off-balance sheet contingent exposures that form part of a specialised lending exposure. 161. One bank separately raised concerns with the Reserve Bank that they currently have an approved model for estimating exposure at default for such exposures. Our further analysis of BS2B has led us to recognise that it is possible to interpret it as allowing banks to use their own modelled CCFs for contingent exposures under the slotting approach. In any case we want to accommodate any existing modelling approaches that we have approved.

30 Response to Submissions 162. We have, therefore, revised this part of BPR133 to specify clearly that the modelling approach is available in this case, and also that if a bank has an approved model for determining the exposure amount to be used for slotted specialised lending exposures, it must use it. The regulatory-determined approach will remain only for banks that do not have a modelled approach. We are comfortable with this accommodation as the modelled approach generally results in higher RWAs. Effective maturity estimates 163. One bank requested that we add paragraph 4.97 from BS2B back to the determination of the effective maturity for the corporate exposure class, which states: ‘Where there is no explicit adjustment, the effective maturity (M) assigned to all exposures is 2.5 years, unless otherwise specified.’ 164. The reason we removed this text in the corresponding subpart C6 of BPR133 is that the methodology provided applies in all cases, so the case covered by paragraph 4.97 of BS2B does not arise. Section C6.3(2) of BPR133 specifies a more conservative measure of M that a bank must use if it cannot use the cash flow-weighted approach given by the formula in section C6.3(1). M is subject to a maximum value of five years in all cases. Calculation of loan-to-value ratio with mixed collateral 165. One bank asked how LVRs should be calculated in BPR133 D3.3 when there are additional property, such as business assets, that might be used as security for the associated loans. They provided an example where there is business lending that is separately covered entirely by collateral, such as security over physical business assets, but the business lending is also secured by residential property. The submitter stated that the rules would result in the business lending and the mortgage being used to calculate the loan value in determining the LVR, while the property value would not include the business assets, just the residential mortgage. They felt that this would distort the LVR. 166. We have not made any changes to the BPRs as a result of this feedback. D3.3(1)(a) is clear that if residential property has been used to secure a commercial loan, then the commercial loan should be included in the LVR calculation. The property value should be included in the calculation as described in D3.3, which for a standard residential mortgage loan is the total value of the residential property. 167. Credit risk mitigation in the loss given default (LGD) may be an option, in the example raised by the submitter. This means that if a bank holds collateral against an exposure, the bank may recognise the credit risk mitigation benefit of the collateral in its own estimation approach to LGD. The processes for this are set out in D3.7 of BPR133 and risk mitigation is described more fully in BPR132. Any such risk mitigation should be used in a way that complies with all of the conditions in the relevant BPR. For example, there are a range of conditions covering the use of guarantees. Banks should also ensure that there is no double counting of security. Security over Māori Freehold Land 168. One bank suggested that to support banks in lending to Iwi based on security over Māori Freehold Land, the Reserve Bank should set mandatory loss given default (LGD) rates for all types of mortgages over Māori Freehold Land. They argued that it is difficult

31 Response to Submissions for banks to set LGDs for Māori Freehold Land themselves as there is limited recent experience of forced sale over Māori Freehold Land. 169. The bank’s proposal is beyond the scope of the exposure draft consultation. However, the Reserve Bank is actively working to better understand Māori access to capital in the New Zealand economy, with a focus on bank lending to Māori small and medium-sized enterprises. We will consider the treatment of security over Māori Freehold Land as part of these other work programmes, such as an exploration of Māori access to capital. BPR140: Market Risk 170. Submitters made numerous suggestions concerning changes to BPR140. Several banks wanted a complete rewrite of the market risk framework to modernise it. The Reserve Bank agrees that this would be worthwhile. Subject to other priorities, we will endeavour to commence this work in 2022. Exclusion of own equity from the interest rate risk calculation 171. Some banks argued that, given the level of assets funded by equities in their balance sheet and the long-term nature of such equities, the exclusion of a bank’s own equity position from the interest rate risk calculation could result in a larger outright long position. They argued that this would result in a disproportionately higher capital requirement. To address this, submitters suggested that a bank’s own equity should be included in the interest rate calculation. 172. We have reviewed this suggestion, along with the estimated capital impact. While we are sympathetic in principle, we would need to gain a deeper understanding of the arguments and the likely impact on capital before making this change. We also consider that a wider consultation with industry and other stakeholders is warranted. Therefore, we have made no changes in the finalised BPR140 concerning the exclusion of shareholder equity from the market risk framework. However, we will consider this issue as part of the broader review of the market risk framework. Guiding principles 173. The BPR140 exposure draft was formed based on the Basel Committee’s Amendment to the capital accord to incorporate market risks (BCBS24), published in January 1996, and refers only to this Basel document.5 Some submitters sought clarity on the extent to which BCBS24 can be used. Specifically, they requested further guidance on the valuation of financial instruments and the treatment of derivatives. 174. The Reserve Bank notes that BCBS24 has largely been mapped into the version of the Basel market risk framework that is currently in effect, MAR, as of December 2019. In the final version of BPR140, we have added direct references to specific sections of both BCBS24 and MAR20 to provide banks with further guidance. For clarity, the Reserve Bank does not operate an internal models approach for market risk.

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5 The January 1996 Amendment to the capital accord to incorporate market risks is available here: www.bis.org/publ/bcbs24.pdf

32 Response to Submissions Treatment of derivatives 175. Some submitters requested further guidance on the decomposition and offsetting of derivatives in sections B1.3(2) and B1.4 of the BPR140 exposure draft, and on the valuation of financial instruments in section B1.3(3). 176. In response, we have added references to MAR20 in section B1.4. This should give banks further clarity on the treatment of derivatives, including decomposition and offsetting for all interest rate derivatives and off-balance sheet instruments in the trading book that are sensitive to changes in interest rates. To provide further clarification on the meaning of ‘updated in line with the current market valuation’ in section B1.3(3), we have also added a reference to MAR20 that will provide banks with prudent valuation guidance. Time bands for the allocation of price sensitivity factors 177. The time bands in BPR140 allocate the price sensitivity factors (risk weights) to each financial instrument based on the instrument’s sensitivity to interest rate changes. In the BPR140 exposure draft, we carried over the allocation mechanism from BS2. 178. Some banks argued that the width of the time bands in the BPR140 exposure draft were too large and could have cliff-edge impacts to their capital requirements. They suggested that more granular time bands should be adopted. The Reserve Bank recognises banks’ concerns about cliff-edge impacts. Therefore, we have added additional time bands to the tables in the finalised BPR140 to make the increments smoother. Categorisation and valuation of recognised and unrecognised financial instruments 179. Some submitters requested further clarification on the categorisation and valuation of recognised and unrecognised financial instruments. The Reserve Bank recognises submitters’ concerns that the categorisation of unrecognised and recognised is out of date. However, we have retained the categorisation in BPR140 and have focused on providing clarity to the existing requirements, without making material changes to the methodology. 180. To address submitters’ concerns, we have replaced the valuation concept of ‘carrying amount’, which is applicable for other recognised instruments as outlined in sections B1.3(3)(d), C1.3(4) and D1.3(1)(e) of the BPR140 exposure draft. The new valuation methodology outlines that for these instruments, the value is: ‘… the principal amount of the instrument (or the underlying) or of the notional instruments (or the underlying instruments), updated in line with the current market valuation of corresponding instruments if applicable.’ Time band adjustment for a near hedge 181. If a bank has a near-hedge arrangement, where an asset and liability are in adjacent time bands and their repricing dates are no more than a few days either side of the boundary between the time bands, banks may allocate the asset and liability to the same band. 182. One bank asked how to allocate an asset and liability into the same time band if a bank has a near-hedge arrangement that satisfies section B3.5(4) of the BPR140 exposure

33 Response to Submissions draft. Specifically, the bank sought more detail on the meaning of ‘a few days’ in section B3.5 of the BPR140 exposure draft. In response, we have changed the reference to ‘a few days’ to ‘at most seven days apart’ in the final BPR140. We have also added clarification that a bank may allocate the asset and liability to the same time band by carrying whichever of the two is in the nearer time band forward to the longer time band. 183. The bank also sought more detail on the meaning of ‘adjusting for the actual duration’ in section B3.5 of the BPR140 exposure draft. In response, we have made the guidance in section B3.5 of the BPR140 exposure draft an explicit requirement in section B3.5(5) of the final BPR140, which now clarifies how a bank should adjust the actual duration of the instrument. Peak capital charge 184. One bank noted that the peak capital charge methods had not been carried over into the BPR140 exposure draft. They argued that this would leave industry with no compliance validation reference. We have provided additional guidance in the final BPR140, in section A1.1, to clarify the methodologies that banks may use to derive their intra-period peak capital charge for disclosure purposes. Treatment of foreign currency contingent products 185. One submitter requested guidance on how foreign currency contingent liabilities should be treated in the foreign exchange risk calculation. We have updated the guidance in BPR140 to make it clear that off-balance sheet contingency liabilities in foreign currency, which are certain to be called and are likely to be irrecoverable, should be included in the calculation for the exposure to currency risk in a single foreign currency. Calculation of horizontal disallowance 186. In the explanatory notes for the BPR140 exposure draft, the Reserve Bank asked whether it would be helpful if we presented the horizontal disallowance methodology in the form of mathematical formulae, which is used to calculate the component of interest rate risk arising from yield curve risk. 187. Submitters said that formulae would be helpful to reduce potential interpretation differences. Some submitters also suggested that a worked example, as per BS6, would be helpful for those new to BPR140 and unfamiliar with BS2A and BS2B. In response, we have added a worked example, with mathematical formulae, as an appendix in BPR140. BPR160: Insurance, Securitisation, and Loan Transfers Loan transfers 188. BPR160 contains the set of requirements concerning loan transfers that currently only applies to standardised banks under BS2A, but was always intended to apply to all banks subject to our capital requirements. Under section D1.2, a bank may exclude from its RWA any loan, or commitment to lend, originated by the bank if these have been transferred to another party that is not a related party. One bank argued that originated transactions transferred to a related party should be excluded from RWA, if separation criteria are satisfied.

34 Response to Submissions 189. The BPR160 exposure draft would not allow branch assets to be excluded from capital ratios, because it does not recognise loan transfers to related parties. 190. The Reserve Bank is concerned that allowing loan transfers to all types of related parties could open up a loophole, whereby banks could park loans in various forms of SPVs or sister companies. However, we accept that loan transfers to a parent bank do not raise such concerns, provided the other general criteria for a clean transfer are met. We have therefore revised the drafting of BPR160 to recognise a loan transfer that is to an unrelated party or to a bank’s ‘ultimate parent bank’. BPR001: Glossary 191. In the consultation paper, we sought feedback on how best to identify Glossary terms where they are used throughout the BPRs. Most submitters preferred Option 3, where defined terms are bolded whenever they appear within a document. We have incorporated this into the final BPRs. 192. Several submitters also noted that BPR001 is missing some terms that require definition. We agree that BPR001 should cover several extra terms and have made additions in response to this feedback.

35 Response to Submissions Annex 1: Updated Capital Review Implementation Timetable Date Completed on 17 June 2021 Revised Banking Supervision Handbook published, along with Response to Submissions. Process for banks wishing to apply for recognition of new Tier 2 capital instruments prior to 1 October 2021 communicated to industry. The Reserve Bank will modify its current non-objection processes to accommodate new Tier 2 instruments issued in the period up to 1 October 2021, with the non-objection process completely replaced by new processes from 1 October 2021 onwards. Banks can apply for recognition of new Tier 2 capital instruments, subject to meeting the Reserve Bank’s processes. 1 October 2021 All components of revised Banking Supervision Handbook take effect, including new processes for the recognition of capital instruments. 1 January 2022 Derecognition of non-qualifying AT1 and Tier 2 instruments begins IRB banks required to report IRB and standardised capital calculations (dual reporting). Output floor on IRB exposures set at 85 percent. For IRB banks, sovereign and bank exposures move to standardised approach. Q4 2021 and H1 2022 Consultation on Standardised Measurement Approach for Operational Risk (Q4 2021 or H1 2022). Consultation on the operational framework for the countercyclical capital buffer (H1 2022). The phasing of the implementation of the increase in capital buffers and the IRB scalar is shown below: Date 1 July 20226 D-SIB buffer set at 1% 1 October 2022 IRB scalar increases from 1.06 to 1.2 1 July 2023 D-SIB buffer increases from 1% to 2% 1 July 2024 Minimum Tier 1 capital requirement increases from 6% to 7% Minimum Total capital requirement increases from 8% to 9% 1 July 2025 Conservation buffer increases from 2.5% to 3.5% 1 July 2026 Conservation buffer increases from 3.5% to 4.5% 1 July 2027 Conservation buffer increases from 4.5% to 5.5% 1 July 2028 Countercyclical capital buffer set at 1.5% Non-qualifying AT1 and Tier 2 instruments fully derecognised

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6 Changes take effect from this date, meaning the 1% D-SIB buffer would be reflected in D-SIB banks’ reporting, e.g. on the RBNZ dashboard, for 30 September 2022 (not 30 June 2022). This logic also applies to the IRB scalar and other capital ratio changes.

36 Response to Submissions Annex 2: Glossary Term Definition AT1 capital Additional Tier 1 capital. AT1 capital, perpetual preference shares, is the second highest quality of capital behind CET1. Capital Part of a bank's funding that allows it to absorb financial losses while remaining solvent. Includes the investment of the bank’s shareholders (e.g. ordinary shares and retained earnings). Capital ratio A bank's capital divided by its RWA. A capital ratio is a key indicator of the financial strength of a bank, measuring the losses it can withstand relative to the risk of its business. CET1 capital Common Equity Tier 1 capital. CET1 is the highest quality of capital as it is permanently available to absorb a bank's financial losses. CET1 includes shareholders' investment (ordinary shares) and the bank's retained earnings. Conservation buffer A type of prudential capital buffer that applies to all banks. The conservation buffer promotes capital resilience by requiring banks to maintain capital levels above the minimum requirement. Countercyclical capital buffer (CCyB) A type of prudential capital buffer that the Reserve Bank may increase or decrease over the financial cycle. Increasing the countercyclical capital buffer aims to build banks' capital resilience and guard against financial stability risks. Lowering the countercyclical capital buffer enables banks to operate at lower capital levels during periods of financial system stress, to promote their ability to continue lending to support the economy. D-SIB buffer Domestic-Systemically Important Bank capital buffer. A type of prudential capital buffer that applies to banks that are deemed systemically important and whose failure would have a significant impact on the economy and the rest of the financial system. A D-SIB buffer promotes higher capital strength of banks and lowers their probability of failure. IRB approach Internal ratings-based approach to credit risk. One of the two methodologies available to calculate RWA for banks’ credit risks, IRB involves the use of inputs from credit models developed internally by the bank to a formula specified by the Reserve Bank. The Reserve Bank must accredit a bank to use the IRB approach, and approve the models it uses in its RWA calculation. IRB scalar A parameter in the IRB approach to credit risk set by the Reserve Bank. The IRB scalar adjusts the level of conservatism in the IRB approach’s calibration. Minimum capital requirements A minimum capital ratio requirement. If a bank has a capital ratio below the minimum requirement, it is likely to be in financial distress from a prudential perspective, and the Reserve Bank would likely seek to place it in a resolution. Output floor A limit on the IRB approach. An output floor means that, when determining its capital ratio, the RWA a bank calculates using the IRB approach cannot go below a certain proportion of the RWA that it would calculate under the standardised approach. Prudential capital buffer (PCB) An amount of capital above the minimum capital requirement. A bank that operates with a capital ratio within the prudential capital buffer applying to it would not be in breach of its Conditions of Registration, but it may have restrictions placed on it and be required to rebuild its capital levels over time.

37 Response to Submissions Term Definition Risk-weighted assets (RWA) Risk-weighted assets (RWA) is an adjusted picture of a bank's financial position (e.g. its loan portfolios and other investments, and its operational and market trading activities) that takes into account the risk profile of that financial position. Standardised approach Standardised approach to credit risk. One of the two methodologies available to calculate RWA for banks’ credit risks, the standardised approach requires banks to use Reserve Bank-specified tables to determine the risk weights to apply to different types of loans and other assets. Tier 1 capital Tier 1 capital consists of CET1 capital and Additional Tier 1 (AT1) capital. Tier 2 capital Tier 2 capital, subordinated debt, is capital that can generally only absorb losses once a bank has already entered into financial difficulty. It is therefore considered of lower quality than Tier 1.