No guarantee deposit insurance will follow

Expectations that desposit insurance will follow the end of the government's deposit guarantee in just over two years could be unrealistic.

Finance Minister Bill English told the Sunday Star-Times consideration had not yet been given to introducing some form of the deposit insurance schemes which operate in most OECD countries, but not in Australia and New Zealand.

However, it is expected that either Treasury or the Reserve Bank, and more probably the latter, will be asked to look at such schemes, and whether they should be introduced for the continued protection of New Zealand depositers after December 2011.

When the government guarantee was introduced in October last year, it was widely assumed it was necessary to prevent another finance company crisis as savers moved money away from investments that were no longer guaranteed.

Last week's extension of the guarantee has effectively given finance companies 14 months to shape up to the government's new regulatory and prudential regime for non-bank deposit takers, or ship out of the business altogether.

Banking analyst Godfrey Boyce says the next logical step is for the government to introduce some form of deposit insurance to provide a minimum level of consumer protection on an ongoing basis.

"Part of the reaction to the global financial crisis has been to have consistency across regulatory regimes, and New Zealand and Australia are looking like outliers in this regard," said Boyce, head of financial services at KPMG.

In the US, the Federal Deposit Insurance Corp was created during the Great Depression, and now insures deposits in banks and savings institutions for at least $US250,000. The scheme is funded by premiums banks pay for deposit insurance cover, and variations of the scheme exist in 119 countries.

Such institutions are usually part-government run or established, and in some cases are part of the country's central banking system. Others are private entities, either with or without government backing.

The argument against such schemes is that they actually fuel bank crises by encouraging financial institutions to take unecessary risks the so-called "moral hazard" argument which both New Zealand and Australia have taken to heart.

It is a stance which Russell McVeagh banking partner Ross Pennington believes New Zealand will be unlikely to ditch.

Pennington said no one would bat an eyelid when the deposit guarantee was lifted from the four major banks in New Zealand. And finance companies which were able to meet tough new requirements being demanded by the Reserve Bank will likely attract similar depositer confidence that the big banks enjoyed.

"I am not sure finance companies fully realise how tough and blunt the new rules are," said Pennington. In some ways it would now be easier to be a bank than a finance company, he said.

While New Zealand could not act in isolation on its banking regulations, "to be honest, the history of deposit insurance in the US is not a happy one. There are 8000 banks in the US, and they fail all the time", said Pennington. Small savings institutions regularly exploited deposit insurance schemes and lost money in crazy ventures, he said.

And while New Zealand will take careful note of what Australia did, it had shown a readiness to take its own line nevertheless. It had not followed Australia when that country made depositors preferred creditors who received money before other senior creditors.

"So we are not afraid to go it alone, and I can't see the Reserve Bank being quick to change a philosophy about deposit insurance it has held for a long time," said Pennington.