If a bank failed and the Open Bank Resolution Policy was implemented, how would it affect bank depositors, bondholders and shareholders?

The haircuts taken by depositors in Cyprus' banking crisis earlier this year caused a publicity storm over the Reserve Bank of New Zealand's incoming bank failure tool, the Open Bank Resolution Policy (OBR).

Under attack from the Greens, who were joined by the Labour Party in calling for the reintroduction of a deposit guarantee scheme/deposit insurance, the Reserve Bank strived to distance its OBR from the Cyprus debacle. Finance Minister Bill English weighed in saying it was irresponsible for the Greens to create unnecessary concern when nothing had changed for New Zealand bank depositors.

New Zealand is the only OECD country without explicit deposit insurance. See more on this here.

OBR is touted as a potential tool the Government could use - if a bank failed - as an alternative to a liquidation or taxpayer funded bailout that would keep a bank open for business. The Reserve Bank says, if used, OBR would facilitate "a rapid and orderly resolution of a bank failure" without changing the basic legal framework around ranking of creditors in a wind-up or insolvency.

In an April speech the Reserve Bank’s head of prudential supervision, Toby Fiennes, pointed out it was a well-established legal principle that people stand to lose money if a business that owes them money cannot meet all its obligations. Banks were the same as any other business in this regard, Fiennes added, and OBR wouldn't change the ranking of creditors.

"Shareholders will be the first to lose their investment. Once shareholder funds are exhausted, subordinated creditors bear losses, followed by all other unsecured creditors on a pari passu basis, meaning that those with an equal legal claim get equal treatment. This is the same as in a liquidation," Fiennes said.

Below we've put together a chart showing how risk moves downwards from shareholders to covered bondholders to give context to where depositors (and others) sit in the pecking order in comparison to other bank creditors.

The only secured deposits on a New Zealand bank balance sheet interest.co.nz is aware of are those issued by ANZ subsidiary UDC Finance. As of March 31 UDC had NZ$1.467 billion worth of secured debentures on issue,  with NZ$2.125 billion worth of UDC tangible assets pledged as collateral for the debentures.

New Zealand's registered banks are required to prepare their information technology systems by June 30 this year so they could accommodate OBR if it were to ever be implemented. 

The de minimis

Under OBR a troubled bank would be placed into statutory management. The statutory manager would freeze the bank’s liabilities including deposits. The idea is to release customers' transaction accounts as soon as possible. So instead of their accounts being frozen for a lengthy period as they would under a conventional liquidation, a proportion of customers' money would be unfrozen and released for the start of the next business day, with a government guarantee to prevent further runs on the bank. The frozen funds would then be released in whole or in part as possible.

As noted above, under OBR shareholders would be the first to lose their investment. Once shareholder funds were gone, subordinated creditors would be next to wear losses, followed by all other unsecured creditors.

There is, however, scope for a “de minimis”. This would be  a nominal dollar amount in relevant customer accounts protected from haircuts and fully available to account holders when the bank reopens the next business day after the appointment of a statutory manager. The purpose of this de minimis is to help customers with limited resources fund everyday expenses. The Minister of Finance would decide whether to set a de minimis amount, and determine what this amount is if one is set. See all our OBR related stories here.

The Reserve Bank says the key processes of OBR would include the following phases:

• imposition of statutory management;

• closure of access channels and freezing liabilities;

• freezing a portion of pre-positioned customer accounts and freezing all other creditors’ claims in full (overnight process);

• bank re-opens for core transaction business and allows customers to access the non-frozen portion of their funds;

• release of an equivalent portion of all other liabilities in due course;

• release of additional frozen funds, if available, following more accurate assessment of losses; and

• decisions on the bank’s final resolution.

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28 Comments

As noted above, under OBR shareholders would be the first to lose their investment.
 
Let's suppose the Australian owned banks' local shareholder funds are the property of the parent banks.
 
What if a portion (>shareholder funds) of the so called hot foreign wholesale funding has been lent by the Australian parent and then swapped from AUD to NZD via the agency of a currency swap arrangement?
 
And what if swap agreements are exempt from the pre-position exigencies of OBR - in other words they are settled and paid up before unsecured creditor haircuts are enforced in the event of a state of bank insolvency being declared?
 
The RBNZ confirmed to me that swap agreements are exempt from OBR oversight. Further legal investigation is warranted.
 
And let's not forgot our banks are borrowing significant sums above the local NZ deposit base to fund excess lending. Read more
 
"In all our research we continue to highlight that the New Zealand banks' level of wholesale funding is a key constraint on the rating," said Yu. "They (the banks) have improved their position (since 2011), but even with this improvement, the banks' levels of wholesale funding is still a key concern."
 
In January Moody's highlighted that, at more than 140%, the New Zealand banking sector has the highest loan-to-deposit ratio out of 13 Asia-Pacific countries. Of the big four banks, S&P figures as of December 31, put ANZ's at 135.9%, ASB's at 136.6%, BNZ's at 162%, and Westpac's at 147.4%. Kiwibank's was 109.9%

Stephen, swap agreements wouldn't be exempt from the Open Bank Resolution process. All liabilities that are not "pre-positioned" would remain frozen in full until the bank statutory manager has had the chance to process the haircut and release the "good" portion.
I included a table in this story that shows what would & wouldn't be "pre-positioned" under OBR.
http://www.interest.co.nz/kiwisaver/64001/kiwisaver-funds-held-banks-won...

Fundamental to this deposit creation principle is the percentage of deposits that a bank lends out. The description above used a 100% loan-deposit ratio, meaning that all deposits are lent out. In traditional banking this ratio was always below 100%. For example, years ago, Westminster Bank (before it merged into National Westminster Bank), intended to lend out 86.5% of every deposit. For every £100 deposited, the bank lent out £86.5, while the remaining £13.50 was retained in the banks reserve with a small portion of it kept in the Bank of England. In practice, this ratio was the bank’s control tool on deposit creation process, ensuring that the amount of money supplied to the market was limited. According to this principle, for every £1 deposited, a bank lends out £0.865. After only 5 cycles the amount is reduced to below £0.50 and after 32 cycles it is below 1 penny. If this process continued forever the total amount of money lent out of a pound would be less than £6.41. With every cycle of deposit creation, a bank built up its reserves, ultimately collecting almost entire £1 for every £1 initial deposit. Added to capital repayments, interest payments on loans and the bank’s own capital base this system ensured that that there was always enough money in the bank for every depositor.
 
On closer examination there is a remarkable difference. With every cycle of the 86.5% loan-deposit ratio every £1 deposited is reduced becoming less than £0.50 after 5 cycles and less than 1 penny after 32. With a loan-deposit ratio of 137% — lending £137 for every £100 — not to mention 174% or indeed 322%, the story is drastically the opposite. Imagine a banker gets the first £1 deposit in the first week of a new year and lends it out. Imagine that twice every week in that year the amount lent out comes back to him as a deposit and he sustains such deposit creation process with a ratio of 137% twice every week for the year. This is a perfectly plausible scenario on the current electronic financial markets. By the following New Year’s Eve, the final amount he finally lends out from the original £1 is over £165 trillion (165 with 12 zeros, or over 16 times the amount governments have so far injected into economy). The total amount lent out in a year by a banker is over £447 trillion. Significantly with a loan-deposit ratio 100% or above no reserve is created.
 
http://gregpytel.blogspot.com/2009/04/largest-heist-in-history.html
 
 Could be time to leave BNZ.

The chart is only an indication of what might happen...the Beehive and the banking bosses can decide whatever they want. "There is, however, scope for a "de minimis"....expect nothing... 
Savers need to recognise that they are far better off staying oncall and preparing to grab all their cash out of any bank at an hours notice.
That as soon as the OBR "make it up as we go along" plan kicks off...the whole economy is likely to crash with property leading the dive...and those with the cash will have a chance to pick up the bargains.

Exactly, for all the whinning no one has yet commented on the difference in liquidity. An on-call depositors such as myself can move the money in as little as 2 hours.  The so called covered bonds and shareholders need days to realise the cash.
Huge difference IMHO.
Bargins need a return though, lets say we see a 75% loss of the house value, that in turn suggests wages wil also take massive hits even if wages are sticky they will deflate. One nasty tail spin.
regards
 

Example the Irish. When the music stopped, somehow, someone extracted a govt. gtee for the bondholders - no reason. Conclusion: when the fan is hit, rules become more a set of guidelines...
 
With the example above, these operations would seem to have no real parents, as for when the tune did stop they would appear to be treated as orphans and worse...
 
Enough to make Capt. Jack blush..
 

But in the case of the irish the irish tax payer (and their kids and grandkids) became liable.  There certainly was an adequate reason for covering the Irish banks, if they had not no one would have been able to buy food, kind of dodgy inside 3~5 days IMHO. 
The NZ OBR policy seems to be more like the Icelandic model in that the interested parties did in fact take a hit. Personally Im still trying to grasp if the OBR is really that bad for an alert and competant depositor. Bear in mind that depositor is also a tax payer and therefore on the hook to a degree when in fact it should be the shareholder(s) and lenders to the bank. Now it maybe that say the first $100k of a NZers (ie someone living in and paying tax in NZ) savings are covered, but beyond that no I think its better that the OBR forces losses on all the interested parties first, moral hazard and all that.
regards
 

Steven as a depositor you are a lender to the bank. 

Vanity Fair contributing editor Michael Lewis shows how Merrill Lynch and two troubled Irish banks convinced Ireland’s finance minister, Brian Lenihan, to sign off on having his country’s taxpayers foot the bill for an estimated €106 billion in property-related losses. Lenihan and the Irish government approved the measures to make foreign owners of Irish bank bonds—including Goldman Sachs and German and French banks—whole again.
 
http://www.vanityfair.com/online/daily/2011/02/michael-lewis-on-how-merr...
 
we try and reference things, but its been mentioned before and, BH's site not that phone friendly..
 

This is obviously the biggest issue that no-one wants to deal with.
"The Reserve Bank says, if used, OBR would facilitate "a rapid and orderly resolution of a bank failure" without changing the basic legal framework around ranking of creditors in a wind-up or insolvency."
 
There is no willingness to change the basic legal framework that ranks creditors.  
When is a persons hand not in the till? When it's legal!

I hate the way covered bond holders go to the top of the queue, and this happened at the expense of existing depositors, Its like a whole lot of rich people, just elbowed out a lot of hardworking retired Kiwis, !WTF.

A depositor's lesson to the banks and Government should be a priority. 

but arnt nz depositors far more liquid? ie if a depositor like myself believes their bank(s) is about to fold, they transfer the money elsewhere.  The so called bond holders and share holders cant move in a few hours? or can they?
regards

Where to?

Your internet banking might be able to "move" them quickly but that won't make them cleared funds immediately and that transaction can be canceled/reversed.

Steven, you are cannon fodder. Your bank of choice doesn't give a shit about you and a message box that says "Sorry, Technical Error", when you try to log on to move your funds will confirm that.

Clearly the time has come for us to be able to see the honest risk state of the bank we deposit savings into...the published material is deliberately confusing and highly questionable....Start by wacking the bank with a 30% fall in property values...Bernard's call yes!....what would a 30% haircut to value do to your banks standing?
As I understand the current situation, the big four that run this economy are allowed to determine their own risk measurement tool....doh!
 

Having just returned home after a longer than anticipated stay in hospital,i can assure you all that no one in my ward was worried about housing prices,interest rates etc.
They were all concerned about continuing to be able to live.
However my opinion is that if we have no bank gaurentee's then we should all invest in property.
Now off to the Gold Coast for more r&r as soon as i get a clearance.
 

Get well Ngakonui G.... enjoy some R n R on the Coast...Cheers. ave one for me.

On 6th May the Australian Prudential Regulation Authority (APRA) released proposed implementation of the Basel III liquidity in Australia.  http://www.apra.gov.au/adi/PrudentialFramework/Documents/Draft_APS_210_L...
    Para 25.    "....For the calculation of the Level 2 LCR, an ADI is to take into account restrictions on the transferability of liquids across borders. No excess liquidity is to be recognised in the consolidated LCR unless there is reasonable certainty about the availability of such liquidity. "
I wonder what the cross border insolvency dimensions of OBR are for each of our biggest 4 banks?
 

The Devil  once again lives in the detail Jethro
Here's a snippet from Quigleys input 2002, I'll put up the PDF for a read to anyone interested, but as i keep saying there is no clarity under OBR about which of the Continuing Bank Principals still apply.......
 

Specifically, sub-section 13A(3) states that “If an ADI becomes

unable to meet its obligations or suspends payment, the assets of the ADI in Australia

are to be available to meet that ADI’s deposit liabilities in Australia in priority to all

other liabilities of the ADI”. The ordinary interpretation of this provision is that, in the

event of the insolvency of the Australian bank, depositors at New Zealand branches of

the bank will rank behind Australian depositors in claims against the Australian assets.4

 

http://www.iscr.org.nz/f223,4547/rbnz_policy_paper_290502.pdf

ouch..... So the Q is why hasnt / or hasnt? our Govn put in place legislation preventing such a financial transfer?
 
regards

yep Hi Steven, the reason I put this up was for those who wished to read the Quigley amendments further,contained in the whole PDF........essentially , under continuing Bank Principal , the Minister could intervene to determine what should be determined as a secured deposit, in other words ordinary deposits under extrodinary circumstance.
 Now the reson I keep brining this up is, under OBR , are the amendments to the Banking Regulatory act  now defunct, as there is no clear ruling either way.
Cheers matey. 

Bill English is right , Greens & Labour are irresponsible.They dont have the required competencies to govern a Pub crawl,   let alone a modern free market economy like New Zealand , given the stupid things they come up with
This bunch of losers who cannot find proper jobs , are a merry gang of idiots who are not in touch with reality ,  offering  all sorts of things they cant provide , including

  • 3 bedroomed houses for all of us in Auckland for under $300,000
  • A massive reduction in our electricity bill equal in % to the gross marging of the power generating companies. 
  • And now wthout any understanding of modern banking systems , they see fit to compare our banking system  with the island of Cyprus ( a badly run tax haven with even  lower levels of tax compliance by its own citizens ) and the Cypriot banking system which is a shaky edifice built on Russian laundered money

They fail to realise that about 80% of our banks values  are covered by the Aussie taxpayer ,and the next one of size is KIWIBANK , by implication covered by the NZ Government  ( NZ Taxpayer  )
 Judge for yourself whether Labour are in touch reality and whether the Greens are really  in touch with anyone or anything on planet earth

Bill English is right , Greens & Labour are irresponsible.They dont have the required competencies to govern a Pub crawl,.....
 
And you just staggered outside to inform us? Thank you once again, until next time. 

Ha...!

Again first rule spread any deposits arround
2nd rule don't deposit with banks with covered bonds
3rd rule don't deposit with banks with off shore or cross border parents
4th rule keep deposits short (on call) is best
Don't be scared to move deposits arround to show that withdrawals occur regularly
KevinR

This article is a very useful educational tool. The problem is that it presents a scenario in which a single bank fails. What happens if we have a systemic failure as has happened overseas? It is reported that the banking system in many western countries, think the local atm machine, was within hours of complete shut down in the recent financial crisis. In the event of such a situation we would be faced with a crisis where cash was king, never mind your "theoretical" holdings in our banks.
Where would you get the money, as in bank notes, to carry on life?
It seems that the only bank to park your immediate reserves is the mattress bank.