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.