Liquidity net hard to cast over non-bank sector 03 February 2010 6:00PM Sophia Rodrigues The diverse business models of non-bank deposit takers is posing the biggest challenge to the Reserve Bank of New Zealand, keen on imposing additional liquidity requirements for such entities.The RBNZ says determining whether an entity is a NBDT or not may not be straightforward in some situations, but also says the core NBDT sector comprises two separate business models - the bank-like savings institutions and deposit-taking finance companies.To promote a sound and efficient financial system and avoid future failures of a deposit taker, the RBNZ developed a prudential regulatory regime that requires an NBDT to meet certain criteria to get a rating from an approved agency by March 2010. The regulator also requires an NBDT to have, and comply with, a risk-management program. The RBNZ is now entrusted with the task of prescribing liquidity requirements that need to be included in trust deeds.In a consultation paper outlining the policy options for regulating liquidity risk, the RBNZ says that it may not seem sensible to specify a single set of precise requirements across the sector. Specifying minimum requirements could make each NDBT complacent in judging its own liquidity risk; and tailoring different liquidity requirements for different business models would decrease consistency and comparability, the RBNZ argues.The second issue facing the RBNZ is to determine whether liquidity requirements should be imposed on the deposit taker or on the borrowing group which it is a part of. The RBNZ's view for now is that requirements should be on the borrowing group, as it guarantees the deposit taker's liability and also because it would prevent regulatory arbitrage occurring within a borrowing group.To deal with the two specific issues, the RBNZ is considering three approaches. One is whether it should refrain from prescribing further liquidity requirements by regulation, and only ask for liquidity requirements to be included in the deposit taker's trust deeds. The second option is to standardise definitions, prescribe a measurement framework, and leave it to the trustees to determine their own quantitative requirements. The third option is to specify precise quantitative requirements against liquidity and mismatch ratios.The RBNZ has emphasised that its main focus while finalising the liquidity policy would be to ensure there is consistency in treatment of similar institutions, that adequate information is provided to depositors to distinguish between high-risk and low-risk deposit takers, that there is effective risk management by deposit takers and lastly that unnecessary compliance costs are avoided.