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Bernard Hickey looks at the RBNZ plans on how it would handle a bank failure; it is a plan that would socialise losses and likely involve haircuts for depositors. Your view?

Posted in Opinion
What would happen if a bank run happened here?

By Bernard Hickey*

Did you know the Reserve Bank this week revealed its plans to manage the failure of one of the big four banks?

The release of any other disaster plans for a major part of the New Zealand economy would be big news, but not so much for banking.

The Reserve Bank, the big four banks and the government will be quietly pleased about the lack of publiclity.

No one wants to highlight the risks involved in our very large and concentrated big four banks, who collectively make up the most concentrated banking system in the developed world with liabilities worth 180% of GDP.

Also, the government doesn't want too much of a debate about how it would deal with a bank failure, particularly given the events of the last five years.

The last time our government guaranteed the big four banks, along with finance companies and building societies, there was no debate. The deposit guarantee scheme imposed over that mad weekend of October 11-12 in 2008 left a dangerous legacy. It has now expired, but it has created a dangerous expectation in the minds of depositors.

New Zealanders now believe that if one of  the big banks were to fail the government would step in and guarantee them.

The Reserve Bank this week did its best to tip toe up to this expectation and tap it on the shoulder to say New Zealanders shouldn't necessarily expect that.

The banking system regulator has been working hard ever since that weekend in October 2008 to come up with a way to allow a bank to fail and be reconstructed over a weekend without a government bailout in a way that doesn't disrupt the economy.

The Reserve Bank is calling this tool 'Open Bank Resolution' (OBR) and this week released its regulatory impact assessment of so-called pre-positioning for OBR.

This forces any bank with more than NZ$1 billion of retail deposits to make sure its computer and management systems can flick the switch on OBR if necessary.

Under this scenario, a statutory manager would be able to shut down a bank on one day, freeze a proportion of its unsecured liabilities (including retail deposits), and reopen for transactional business the next day.

Over that day the bank would be able to close all its access channels (online, branches, ATMs etc), freeze some of its liabilities and then reopen for business at 9 am the next day.

This allows the bank to keep operating while the statutory manager works out who will take a 'haircut' or losses on their shareholdings and deposits. The assumption is that shareholders will be wiped out first, but there is a risk unsecured term deposits may also have to take a haircut.

New Reserve Bank Governor Graeme Wheeler pointed out in this week's announcement that this OBR process is not set in stone and it only provided a 'very real alternative to bailout' by the government. So the moral hazard remains, as does the uncertainty for householders and voters with NZ$111.4 billion in household deposits in banks at the end of September.

Unfortunately, it means the banks have the best of both worlds.

They still have the implied guarantee from the government, which effectively reduces the interest rate they have to pay regular savers and is not paid for in the form of any deposit guarantee fee to the government. Taxpayers still face the risk of seeing bank losses socialised in future while today's profits are privatised.

A much more honest solution would be for the government and the Reserve Bank and the banks to openly state that a government bailout would not occur - a sort of a guarantee of no guarantee.

Term depositers would demand a higher return to compensate for the higher risk and it would properly remove the moral hazard that currently subsidises the profits of Australian banks.

--------------------------------------------------------------------------------

This piece was first published in the Herald on Sunday. It is used here with permission.

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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22 Comments

Hmmmmmmmmmmmmmmmmmm

Hmmmmmmmmmmmmmmmmmm

Another big risk is the

Another big risk is the implicit but never discussed government guarantee of Fontera.
Ergophobia

Isn't that solution called

Isn't that solution called 'TAF'? ;-)  A broker gleefully told a mate that by end of year/early New Year, Fonterra will have to issue bonus shares as they have grossly underestimated demand and with all buyers and little sellers it will be an illiquid market. Under DIRA legislation Fonterra has to ensure it will be a liquid market.  Therefore bonus share offer will be forced on them.  Having said that, they did mention a bonus share offer as a solution to high share value, in pre-taf meetings. So it sounds like it was planned to happen this way anyway??

 

Whats Fontera's debt

Whats Fontera's debt though?
I thought it was quite large...
regards

This is taken from their

This is taken from their Annual review notes: Economic debt to debt plus equity ratio was 39.1% at 31 July 2012. There are others on here that are more qualified than I to say if this is high or if there is more meaningful data to tell debt level :-)

How long does it take to

How long does it take to amend the laws to make retails depositors to have first claim on all assets of a bank, should it fail ? As long-term stakeholders in the banks, they should get first dibs at the distribution from the assets. All other claims should be subsidiary to that only. If some one wants to lend money to the Bank, outside of the deposits, let them take care. Why should they get any preference ? Then even others who deal with these banks would be compelled to be prudent.

One will have to think outside the box, with bank failures a real possibiility in the future, the way the world economies are going, involving huge costs to the citizens.
Supporting banks by guarantees per se is not wrong, but not getting the right price for providing such guarantees is wrong and foolish and not capitalistic. Governments in the west are failing massively on this score. Exhuberant Alan and Helicopter Ben both got it wrong, and regulation has gone out of the door.

What rot, depositors are not

What rot, depositors are not long term stakeholders, they can move anytime the interest is better else where. Indeed they have one advantage a real stakeholder doesnt, they can move all their money with a click of a mouse.
regards

Provided that you don't find

Provided that you don't find a notice starting with those words... "Due to technical difficulties..." on your screen when desperately trying to quickly mouse your money out!
 
 

Simple really....keep any

Simple really....keep any deposits short term and be prepared to go oncall when you smell the fear...prepare the secret place to stash your cash and stock up on stuff you really need...By now every Kiwi peasant should have a larder full with food and a garden that produces food not grass to cut.
The bank bosses will be bailed out..count on it...Kiwi peasants will get the short end of the stick...Wheeler et al know the system is a credit corruption...they know what's likely to be down the road the can has been kicked along

SmoKey, what you say makes

SmoKey, what you say makes good sense and if banks breach their capital adequacy ratios, they should be nationalised with deposits protected - all shareholder equity and creditors gone. But Jokey and gang see it a different way: they have recently changed the law to put bankster institutions like Goldmans at the front of the queue; via Covered Bonds, an odious thing hitherto illegal. Bernard, to his credit, has written extensively on the matter.
Ergophobia    

Why should tax payers protect

Why should tax payers protect depositors?  As a PAYE I would have no profit in the bank or the deal between the two parties so I fail to see why I should be involved.
Thing about covered bonds the money is locked in. Depositors can move in a few hours. 
Its unlikely IMHO that we'll be caught be surprise over a default...things are going to have to look very hairy. like a Greater Depression scale...it would I think take a year or two to get that bad by then you move on.
regards
 

Steven, taxpayers need banks

Steven, taxpayers need banks and banks need to be stable. I'm not a fan of big govt but this is a case where there always will be govt$ as last resort and it is reasonable that the social contract should apply here. Depositors have no voting rights or bank busniness policy input and term depositors cannot just leave at a click of a mouse. 
Regards, Ergophobia   

I dont agree on the social

I dont agree on the social contract at least not from your angle.  I think its essential that banks are open as they allow essential  money transactions thats the essential social contract bit I agree with. 
The problem beyond that is the moral hazard, why should depositors money be safe at an innocents expense?  I dont see why.  The depositors lend for gain, and everything in life is a risk....what you want is to shift that risk from one "guilty" party to an innocent one....I totally dont agree with that.
Term depositors take on a higher interest rate at the increased risk, I have instance withdraw on my money, so I sacrifice greed for speed. 
Your call on that.
I certianly dont see why that risk should be removed, its your profit I have no part in, yet you expect me to bail you out for your bad decision.
regards
 
 
 
 
 
 

There are people like me just

There are people like me just waiting in the fringe if such dispicable acts of corruption to save a bank, ANY bank take place. The party is over for em.
The "too big to fail" ? No. Just try it Wheeler! 

Justice, So what can a person

Justice,
So what can a person do? Banks are so intertwined that if one fails, all of them will be in trouble if not bailed out by the government, who is backed by us tax payers. Hmmn...
To transfer funds electronically between accounts at the same bank is as quick as a click, even interbank transfers will only take a day or two, which would be futile if a bank fails, however transfering them overseas is a different story, one that is not as quick as one would like it to be. One certainly can not do this electronically, one has to got o the bank.
Trouble ahead, trouble behind....Casey Jones, you better watch your speed!                            (The Grateful Dead.)
If depositors are not safe from "haircuts" (silly euphemism!), then where does one keeps one's money?
Physical gold in an overseas vault, and rental properteee.. mon ami!
Hevi Groswaite

Justice, So what can a person

Justice,
So what can a person do? Banks are so intertwined that if one fails, all of them will be in trouble if not bailed out by the government, who is backed by us tax payers Hmmn...
To transfer funds electronically between accounts at the same bank is as quick as a click, even interbank transfers will only take a day or two, which would be futile if a bank fails, however transfering them overseas is a different story, one that is not as quick as one would like it to be. One certainly can not do this electronically, one has to got o the bank.
Trouble ahead, trouble behind....Casey Jones, you better watch your speed!                                  (The Grateful Dead.)
If depositors are not safe from "haircuts" (silly euphemism!), then where does one keeps one's money?
Physical gold in an overseas vault, and rental property mon ami!
Hevi Groswaite

The problem I see with this

The problem I see with this is, what are you supposed to do with your term deposit?
The current banking system essentially operates as one large bank, as they are all under a central bank
Back in the day where banks issued their own notes (ie.http://en.wikipedia.org/wiki/Free_banking) if you suspected a bank was making imprudent loans (BankA) etc you could withdraw and invest in another more prudent bank (BankB). The value of the notes for BankA would fall, with the value of notes for BankB would increase. Thus BankA would have to tighten up their lending activies etc.
But at the moment, the central bank is always there to provide liquidity to failing institutions and will lend against virtually any collateral (even dodgy mortagage paper). The northern rock bank run was also a failure of the Bank of England to act as lend of last resort in a timely manner as well as the obvious stupidity of northern rock being relient on short-term financing of their loan book.
Presently there is no way to protect yourself, by getting outside of the system as it were, other than to spectualte on an asset, property, gold, shares etc.
Also how in practical terms is a simple depositor supposed to analyse a bank balance sheet, when the banks themselves are allowed to keep so much off-balance sheet in esoteric entities?
Much of which the reserve bank has actually presided over, such as the issuing of covered bonds, letting overseas investors jump ahead of local depositors, were a bank to be liquidated. Who voted for that?
Again there is no choice as they are all doing in with RBNZ sanction.

Robby 217 - You can buy bank

Robby 217 - You can buy bank or any other stocks in Australia and use the options market for regular monthly income. There's a few tricks and a bit of learning.

Would be a coup if the

Would be a coup if the relevant authorities could get Sheila Bair over to consult on the issue.
http://www.businessweek.com/videos/2012-11-01/former-fdic-chair-sheila-b...
http://online.wsj.com/article/SB1000087239639044481310457801906293285199...
 

This is exactly why covered

This is exactly why covered bonds are such a big issue.