Towards a framework for promoting financial stability in New Zealand

Central banks, like the Reserve Bank of New Zealand, make judgements and take actions to promote the stability of the financial system. This involves making decisions in inherently uncertain situations. For example, how is financial stability defined? How can we recognise an imminent financial crisis? And, how is a financial crisis best mitigated or recovered from? This article presents a step towards a broad conceptual framework for promoting financial system stability and guiding the Bank's policy actions. We argue that the preconditions for financial stability are met when all financial system risks are being adequately identified, allocated, priced and managed. The financial system is made up of markets, institutions, and payments and settlement systems. Financial system risks broadly include credit, liquidity, market and operational risks. All of the preconditions are important to best ensuring that the financial system is resilient to a wide range of economic and financial shocks, and able to absorb financial crisis losses with least disruption. The preconditions for financial stability also best ensure that the financial system is efficient in its delivery of financial services, and allocating resources throughout the economy. In making assessments of financial stability, the Reserve Bank does not have a single, well-defined quantitative measure. Instead we draw on a variety of information, practices, and ongoing research. The Bank conducts regular surveillance of financial risks and reports on its assessments in the twice-yearly Financial Stability Report.