Opinion & Analysis
Maintaining the confidence of depositors is the paramount priority in bank rescues. Governments can easily stump up new bank capital. But if people won't lend their money to the banks then the financial system and economy collapse.
Yet uniquely in the world, our Reserve Bank has devised a rescue system that encourages depositors will flee their banks and try to head for the one it and the Government have saved.
This will happen for three obvious reasons under the Open Bank Resolution process due to take effect in June:
Depositors will be frightened by the Reserve Bank taking a proportion of a failed bank's deposits to recapitalise the institution. Failure is likely to be systemic and contagious in the event of, say, a collapse in the housing market or a drying up of international credit.
This means people will worry their banks and deposits will be next in line for treatment.
The Reserve Bank pledges it will make only a one-off "haircut" on deposits in the failed bank. It won't return for a second bite if the bank's problems deepen. This means new deposits in the rescued bank will retain their full value.
The Government says it will insure the existing deposits of the rescued bank to restore confidence in it. Yet, the Government has rejected deposit insurance for the banking system. This means the rescued bank will be by far the safest depository in the country.
Logically, therefore, depositors in all the other banks would flee their institutions and try to head for the rescued bank. Lucky ones with accounts there will succeed in transferring their money. But the bank won't and can't accept all the money offered so chaos will ensue and public confidence will evaporate.
Ideology has driven the Reserve Bank and Government to this perverse and deeply damaging method for saving banks. The origin lies in the core mantra of the mid-1980s' economic reforms - markets are far better than Governments at enforcing sound discipline in business activities.
Thus, we ended up with banking regulation unique in the world. It is light on regulatory control and heavy on information disclosure. The idea is creditors can make informed decisions about which banks to do business with. Yet, the banks' quarterly disclosure statements are fat with data but thin on insight or early warning signals.
Even the most sophisticated investors in the world were caught out by the traumas of the Global Financial Crisis and the revelations of interconnectedness between institutions. No regulatory regime gave them the tools to anticipate what unfolded.
So it is farcical for the Government and Reserve Bank to believe that the New Zealand public can make informed decisions about which banks to trust with their deposits.
This is why deposit insurance has become the virtually universal norm in banking worldwide. In 1974, 12 countries had such coverage; in 2011, 111 did, according to the International Association of Deposit Insurers. The organisation was created by the G20 in 2000 to help cope with increasing volatility in global financial systems.
The crisis forced New Zealand to adopt temporary deposit insurance in 2008. But it was very badly designed and run because Labour then National governments and the Reserve Bank had no experience in the subject. As a result, for example, insured funds flooded into South Canterbury Finance.
Its subsequent failure has cost taxpayers a net $800 million.
Burnt by this, the Key government won't have a bar of deposit insurance. When Finance Minister Bill English announced the end of temporary insurance on March 11, 2011, he said:
"The Government does not favour compulsory deposit insurance. This is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly."
Does the Government have any supporting evidence for this position? None was forthcoming from English's office this week when this columnist requested it.
The prime minister, however, added plenty of his own anti-insurance platitudes at his press conference on Monday. He did admit, though, he didn't know how much such insurance costs.
Actually, it is easy to find out. You can download the 2013 premium manual of the Canadian government's scheme at http://bit.ly/16Woduv.
Page 2 of the manual shows that the annual premium is 2.778c per C$100 of deposits. This is for banks that score 80 or more out of 100 on regulators' rating system on banks' financial health. Such banks are a good comparison for New Zealand banks.
Governments and central banks mess with deposit insurance at their peril, as the EU has discovered in recent weeks with Cyprus. It tried to shift some of the cost of rescuing the country's banks from international and EU institutions to depositors by giving the latter a haircut.
The plan shocked creditors, retail depositors and institutional investors alike, across Europe, badly damaging the fragile confidence in banking built up over the past six months. To restore calm, the EU had to amend the Cyprus plan and pledge its support for deposit insurance for retail depositors eurozone-wide.
Now more than ever, retail depositors need insurance. Thanks to the Global Financial Crisis, commercial creditors are becoming more sophisticated in the collateral they are securing from banks.
An example here is covered bonds that are secured by ring-fenced high quality housing loans. BNZ introduced them in 2010 and other banks have followed with alacrity. While this security has lowered banks' funding costs, it's a moot point whether this has resulted in higher profits for the banks or lower borrowing costs for customers.
There are plenty of other ways New Zealand banks are ring-fencing assets to the benefit of their secured creditors, as David Tripe and Geoff Bertram analysed in an article in the November 2012 edition of the Policy Quarterly journal of Victoria University's Institute for Governance and Policy Studies.
Their analysis, available at http://bit.ly/10c3750, shows how secured creditors are gaining more protection for themselves should a bank collapse. This is leaving unsecured creditors bearing a growing share of the losses.
If you have deposited money in a bank, you are one of its unsecured creditors. By shunning insurance, the Government has hung you out to dry. No worries, it says, bank stress and failure in New Zealand is very, very rare.
Oh yes? Perhaps Mr Key should read how troubled our banks were in Alan Bollard's book on his experience as the Reserve Bank Governor though the GFC.
- Sunday Star Times
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