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Document obtained by highlights the different wave lengths Treasury and the RBNZ are on as they design a deposit protection regime

Document obtained by highlights the different wave lengths Treasury and the RBNZ are on as they design a deposit protection regime
Adrian Orr

By Jenée Tibshraeny

The Treasury advice on bank capital and deposit protection insurance, slammed by the Reserve Bank (RBNZ) for reflecting “deep-seated confusion”, has been revealed. has obtained a copy of the advice Treasury provided Finance Minister Grant Robertson on October 5 that prompted the RBNZ to stage an intervention (as reported on here).

The RBNZ on October 8 wrote to Robertson to air its “serious misgivings” about Treasury’s “flawed and misguided” advice. 

A copy of the advice, released under the Official Information Act, confirms Treasury wanted the RBNZ to push pause on its bank capital review, so it could be better aligned with a deposit protection regime being designed by both agencies as a part of a review of the Reserve Bank Act.

The RBNZ ignored Treasury and in December announced banks would have to hold a lot more capital to make them stronger.

The pinch now is, the agencies are still required to iron out what a new deposit protection regime should look like, despite it being evident they have completely different views of such a scheme’s role in the financial system.

(A deposit protection regime sees banks pay levies into a fund, so that if they go under, this fund can be drawn down on, so depositors get a limited amount of their money back).

Treasury: Deposit protection could lower bank capital requirements  

Treasury in October suggested the RBNZ announce “interim” bank capital levels in December, and clarify that a “final” decision would be made once the revamped Reserve Bank Act is in place.

“One of the purposes of deposit insurance is to reduce the costs of a bank failure to the economy and society. These costs should influence the assessment of bank capital requirements,” Treasury said.

It said a deposit protection regime could lower capital requirements “materially”.

“Stakeholder submissions to both reviews have strongly called for better coordination between them to ensure an overall coherent policy framework,” Treasury said.

However, the RBNZ swooped in and told Robertson bank capital and deposit protection are “distinct policies” that “serve different purposes”.

“’Bank capital policy’ is the fence preventing bank failure and ‘bank resolution’ is the ambulance at the bottom of the cliff.”

It said Treasury’s suggestion to lower bank capital requirements was like saying the fence should be taken down because the metal is needed for a high-spec ambulance.

The RBNZ believed crisis prevention needed to be prioritised above post-disaster clean-up.

It said that if it accepted Treasury’s “unconvincing and overstated” “conceptual linkages” between bank capital and deposit protection, and delayed its bank capital changes, it wouldn’t be doing its job maintaining a sound and efficient financial system.

Indeed, the RBNZ stuck to its guns, and is requiring banks to collectively hold an additional $20 billion of capital. However, this requirement is being phased in over seven, rather than five years, as initially proposed, and a broader range of types of capital can be used.

But wait, there’s more…

Treasury also criticised the RBNZ’s modelling, implying its capital proposals set the bar too high for banks.

It said the stress tests the RBNZ did as a part of its review were more severe than those it had done in the past. But even still, the results supported lower capital levels than proposed.

Finally, Treasury suggested the RBNZ treat big and small banks more differently than proposed.  

It said the failure of a smaller bank wouldn’t cost society as much, so it “may be inefficient to have non-systemic institutions hold such a high level of capital”.

“In addition, for smaller institutions the introduction of deposit insurance would further reduce the economic costs of failure,” Treasury said.

Deposit protection regime designed from opposing starting points

While Treasury and the RBNZ have different views of the role deposit insurance should play and how the scheme intersects with other parts of banking regulation, they still need to work together to decide what the regime should look like.  

The RBNZ/Treasury team working on the scheme in July said their preliminary analysis indicated it should have a limit of $100,000. This would mean that if a bank collapsed, people with money deposited in that bank would get up to $100,000 back.

However the team noted the RBNZ favoured a limit of around $10,000. The RBNZ believed deposit protection would only protect the financial system by preventing a run on a bank if all funds were covered. Given this would be too costly, it argued a low limit, designed solely to “avoid hardship”, was the way to go.  

Cabinet in December landed on $50,000 as the limit, based on the fact this would cover 90% of individual deposit accounts and 40% of funds (reflecting that the vast majority of New Zealanders have deposits worth less than $50,000).

It’s yet to decide exactly which products deposit protection will cover, the amount and nature of prefunding the scheme will need from the industry, the conditions for the government funding backstop, where the scheme will be located, and how it will be governed.

Treasury and the RBNZ will also continue to consult on the possible role of depositor preference, where preferred depositors’ claims are paid out before the claims of other unsecured creditors in the event of a liquidation.

An Independent Expert Advisory Panel, appointed by Robertson, is also providing advice on the matter.

Final decisions are expected around the middle of the year.

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This revelation should make bank depositors flip out :

According to the Reserve Bank, the new capital requirements mean banks will need to contribute $12 of their shareholders' money for every $100 of lending up from $8 now, with depositors and creditors providing the rest.

Currently, the risks and rewards are not evenly balanced between bank shareholders and unsecured creditors underwriting the banking system.

Well if shareholders provide all the funds a bank lends out, is it still a bank or would you call it an investment fund?

But there is no funded lending undertaken by bank shareholders. There is just the magic of swapping money less borrower and bank IOUs.

We start with the idea of credit creation, specifically a swap of IOUs between a bank and myself involving a bank loan that is my IOU and a bank deposit that is the bank’s IOU. Nothing could be simpler, and yet the mind rebels, especially the well-trained economist’s mind, because this simple operation increases my purchasing power without decreasing anyone else’s. It seems like alchemy, or anyway a violation of some deep conservation law. Real productive resources are the same as they were before, and the swap doesn’t change that, does it? Spending of the new purchasing power adds another layer of perplexity.

If spending increases but real resources do not, then it seems logical that the increased spending must exhaust itself in higher prices—that is the intuitive appeal of the quantity theory of money. My purchasing power may increase, but everyone else’s decreases because their money balances buy less. From this point of view, the alchemy of banking seems like a kind of theft, something to be deplored in the name of economic science and if possible outlawed in the name of the general good.

A simple concrete example may help to fix ideas. Let us suppose that the swap of IOUs is a mortgage loan, and that I use my new purchasing power to buy your existing house. At the instant of sale, I swap one asset for another, and you swap the other way around, presumably because each of us prefers the asset held by the other. For present purposes, the important point to appreciate is that the alchemy of banking has made this sale possible, by creating new means of payment that you are willing to accept. After the sale, the bank’s new IOU is owed to you instead of to me. In fact, by accepting the bank’s IOU as payment, you are funding the bank’s loan to me, at least temporarily.

But that’s not the end of the story. You were willing to accept new purchasing power as means of payment for your house, and in doing so you wound up funding the bank’s mortgage loan in the first instance. But by no means does that mean that you are willing to fund the loan for its entire term. Indeed, what matters after the moment of payment is not so much your own portfolio preferences as the preferences of the rest of the world to whom you pass along the new purchasing power as you spend it. The question is, when you are no longer funding the loan, who is and in what form? Read more

Thanks for that. It seemed to clarify a few things. Not sure there aren't other unidentified assumptions that throw spanners into their neat and tidy theories (or is that delusions). They appear to assume the funding regime is static and stable, rather than having periods of apparent stability and periods of volatility, ala Mandelbrot.

For instance, during a period of falling interest rates you would expect stable demand for government bonds, but, er, who would choose to buy negative interest bonds during a time of rising rates?

There's so many banking red flags at the moment how can they fail customers now? Just look at Westpac's risky activity: Aussie regulator orders Westpac to set aside extra $500 million in capital. "The lender was also accused of breaching money laundering and counter-terrorism finance laws, with Westpac publicly accused of 23 million breaches".

Some background material from the US Federal Deposit Insurance Corporation annual report:

While smaller banks (community banks) in the U.S. make up just 12 percent of banking industry assets, they hold "41 percent of the industry’s small loans to farmers and businesses, making them the lifeline to entrepreneurs and small enterprises [...]": Link

Every deposited dollar should have the same protection across all banks regardless of "size" of the bank, otherwise distortions appear and then you will get larger banks splitting into smaller subsidiaries in order to comply and have lower costs so make more margin.

Unfortunately that argument has already been had and lost... see the bank capital requirements where the big 'Domestically Significant Banks' have to hold more capital. There is already a distinction.

interesting history of how we got to this place where banks are no longer deemed as one of the safest places to store your wealth, its like we have come full circle from the early days of banks where it was safer to put your money under your mattress

Except that money was real back then. A claim on physical gold, not merely an IOU of unknowable real value.

Yes it's not surprising that everyone here squirrels their wealth that they have in to other investments like property, (which usually means that they have to take on more debt), Though banks need savers and depositors in order to lend so why are they not looking after us.

Westpac's 5-year CDS is currently trading at 28bp (so you can insure against WBC defaulting on unsecured debt for 28bp p.a.). It hasn't been this low since pre-GFC, it was 55bp a year ago. Professional investors are telling you Westpac have never been safer.

It just goes to show how uninformed many of the comments are.

You've got to be kidding me. Well I know some Professional Investors who are very angry with Westpac so go pull the other one Te Kooti. Here's a Reuters article on the subject: Australia Westpac's board set to survive investor anger over payments scandal. "Westpac Banking Corp, grappling with a money-laundering scandal and accusations of enabling child exploitation payments, could see angry investors vote on Thursday against its proposals on executive pay and the re-election of a long-serving director."

It's utterly irrelevant what you, the press or your "professional investors" think. Westpacs CDS tells you that the market has never viewed them more favourably from a credit perspective.

If you don't understand that, I suggest you do some reading and stop embarrassing yourself.

LOL Considering you've got NO EVIDENCE, which I presented in the article and there are a lot more. Do you think we were born yesterday?! Do you really think that anyone would trust a bank that has so violated money laundering banking regulations with more than 23 million transactions are alleged to have breached anti-money laundering and counter-terrorism finance laws, and the bank is facing the prospect of fines that may total more than $1 billion. Not to mention the facilitated transactions enabling child exploitation in the Philippines.

And do you know that more than $6 billion wiped off Westpac's share price! So I really couldn't give a rats ass what any Westpac CDS said, because it's their shear negligence that counts!

Article: Westpac is now the main banking horror story and its financial pain is yet to come.

The entire financial universe is aware of WBC's AML breaches Einstein. I'll spell it out to you one last time, Westpac has never been viewed as a better credit than it is now. What you or I think is irrelevant, the facts are all that matter. I don't care for Westpac one jot, but I can't abide ignorance.

Agree..I would not put one cent in Westpac

Yes it's not surprising that everyone here squirrels their wealth that they have in to other investments like property

Dripping with irony. People use whatever wealth they have and use bank privilege to 'lend into existence' to leverage into property thereby creating price distortions. So when you say it's "not surprising", you're behaving exactly as the ruling elite want you to behave, even if you don't fully understand the fragile mechanisms that enable you to do what you do.

I think you may have missed my point JC, though you did pick up on the irony which is good. What I was trying to point out is that we, (here in NZ) don't have much choice at the moment to protect our savings as the rest of the Western world does. And yes I do understand the "fragile mechanisms" thank you very much. Which is why I've bypassed them, paid off my mortgage and now considering moving my savings off shore and away from NZ altogether!

They really are dragging their feet on protecting Customers savings funds aren't they! I really am giving up on NZ as a dead loss of a country, which seem to be happy to allow external banks like the big four to play rough shot and are caught red handed in illegal lending practices and allow money laundering as seen with Westpac's recent activity. But they simply don't care if this results in customers losing all their life savings.

Treasury thinking is in line with the banks, and the Treasury folk with deep banking experience.
Poachers don't make great gamekeepers, if they never had the awareness of being a poacher.

Just what makes Treasury advice experts is beyond me. They said splitting of the Electricity Corporation would result in reduced power prices. While we know what happened subsequently, which had the effect of inefficient generation due to pricing.

Treasury is largely filled with academics, educated at Harvard that free market exists. Thankfully we have a reserve bank governor who past results suggests he knows better.

I think Treasury are right and the RBNZ are wrong here. The insurance scheme and the capital plan are linked.

The problem with the RBNZ analogy “’Bank capital policy’ is the fence preventing bank failure and ‘bank resolution’ is the ambulance at the bottom of the cliff.”.. is is the question of how much you should pay for that ambulance is intrinsically linked to the quality of the fence at the top of the cliff.

I find it quite concerning that the RBNZ, who is responsible for licensing insurers, doesn't understand this simple concept.

Would you pay the same to insure a house against fire if you installed sprinklers, smoke alarms, had extinguishers in every room and a fire station was opened next door? No. It doesn't mean there isnt merit in having insurance or making the house safer but how much you should pay is directly linked to the prospect of the risk occurring. Insurance 101.

Both Treasury and the RBNZ fall under Robertson's remit.. they are publicly warring and he hasnt the intellect to understand the debate.

It's best to keep the debate to the reality, and not argue the analogy.

OK... so if you make a bank safer .. how much would you pay to insure it? The point is the same. It is intrinsically linked.

Simply, if you are going to make the banks hold that much capital then I don't want to pay for insurance... and to be clear, it will be the depositors who ultimately pay for it.

Let's agree that the banks need be made safer.

I want the banks to be strong (from a depositors point of view). Transacting sound business, conducting sound and productive activities.

I suggest increasing a banks capital is a method to made banks stronger, financially and also influencing bank and banker behaviour.

I suggest improving the depth of insurance a deposit holder may access has nothing to do with making a bank stronger financially, or improving the behaviours of banks and bankers.

I suspect you are paying too little attention to the concept of moral hazard. Moral hazard and the human condition.

As a supplementary point. The mechanism of how a deposit holder is made good once a bank has failed is not clear.
For example, as a bank faults, first its deposits are bailed in and converted to equity. Then the bank goes on to fail. Issue is; when the bank failed, there were no deposits, as they had already been transformed to equity - therefore nothing to guarantee.

Lending against a guarantee or and insurance policy is poor banking business in itself. The Treasury and bankers themselves should know this, and should not be asking deposit holders to do such.

No argument with me about banks needing to hold more capital. Nor would I argue against improving the depth of insurance a deposit holder may access. On these points we agree.

My point above, and I'll repeat for clarity, is about the cost of that insurance. How do we determine the appropriate cost of insuring a deposit against a bank failure without considering the chance of the bank failing. Does Westpac have the same chance of failing as say Heartland Bank? Should the cost of insuring a depositor be the same?

In regards to Moral Hazard - I'd argue that moral hazard is intensified with the introduction of deposit insurance as depositors will pay less attention to the credit metrics and safety of the bank.

If you are referring to the moral hazard of bank executives being sheltered from their risk taking then I would agree and have previously stated on here that NZ Banks should be subject to a BEAR regime similar to Australia where they would be civilly and criminally liable for any shortcomings. This should be introduced alongside any deposit insurance scheme.

In terms of shareholders, as long as deposit insurance is paid after all capital is consumed and shareholders wear the losses and this is clear in the deposit insurance scheme then it addresses any moral hazard there too.

Capital adequacy is skin in the game for private banks, whereas deposit insurance is skin in the game for taxpayers. A healthy mix of both with limited taxpayer liability for derivatives losses seems reasonable. I like the RBNZ approach.

"Panics do not destroy capital; they merely reveal the extent to which it has been destroyed by its betrayal into hopelessly unproductive works.”

John Mills

1) Conceptually it is absurd that a depositor cannot buy full insurance. (depositors end up paying the cost of any deposit insurance scheme) Just about every other asset can be insured.

2) Given 1, the insurance limit should have been set at NZD250,000 so that there is a level playing field across the Australasian market in terms of CER, given Aussie has a AUD250,000 scheme.

you can buy insurance... as covered above in an earlier comment. A credit default swap would cost you 22bps p.a.

FYG - an ANZ 5 year term deposit is currently offering 2.65%..... you could insure it and earn 2.43%.

Re your comment about Australia... the fact that a 5 year term deposit in Australia only yields 1.2% compared to the rates above would be worth considering. If NZ depositors were asked if they wanted a guaranteed deposit but were willing to accept ~1% less in terms of interest I suspect the conversation may sour somewhat.