The RBNZ will be closely watching how the Depositor Compensation Scheme affects risk-taking in the non-bank deposit-taker sector. In the second of two articles on the DCS, Nick Stride looks at how the scheme could change behaviours.
By unanimous agreement – the introduction of the Depositor Compensation Scheme on 1 July will trigger a flight-to-safety as depositors run for cover.
What’s more arguable is the size of the money-go-round and how it will influence behaviour in the loans and deposits sector.
That some depositors will split deposits into chunks of $100,000 to ensure as much of their capital as possible is covered seems certain.
But with only 29 institutions currently covered – of which 14 are registered banks - large depositors will need to move funds into the non-bank deposit-taker (NBDT) sector to achieve maximum coverage.
Perhaps the most strongly-worded submission to the Reserve Bank’s long development process was from the Taxpayers Union (TU), which argued it’s “well-established that the risk strategies of deposit-takers respond strongly to the introduction of deposit insurance.”
Pointing to the flood of money into finance companies following the introduction of the Crown retail deposit guarantee in 2008, the TU says there is “a high probability there will be a surge of deposits into the higher-risk NBDT sector, and especially the finance company sector.”
The RBNZ itself is more cautious.
While acknowledging “the DCS is likely to change the risk-profile of most deposit-takers,” it should “place downward pressure on deposit rates and increase competition in the deposit-taking market, by increasing the sensitivity depositors have to the interest rates they are offered.”
It “maintains the assumption that there will be some of this behaviour in the sector, however significant behavioural change will require a review and recalibration of the levy calculation.”
David Tripe, a former banker, a Massey University professor specialising in banking, and a director of Gold Band Finance says deposit rates could fall “significantly.”
“The extra amount that the relevant finance companies and other NBDTs have to pay to attract deposits will be reduced, as depositors will no longer be subject to the same risk of loss.
“It’s likely clients of the NBDTs will still earn a premium, because [the NBDTs] are not as well-known in the market as the major banks, but it will no longer be as much.”
Tripe says that, with the DCS guarantee covering only $100,000 per institution per depositor, international experience suggests there will be no change in rates for deposits greater than that amount.
“We also don’t expect that the higher fees [levies] paid by riskier institutions will cause those institutions to lower their deposit interest rates.”
The RBNZ says “deposit-splitting” activity will swell the size of the “levy base” of deposits covered by the DCS. It follows that the NZ-wide levy bill shared by deposit-taking institutions will rise also.
What remains to be seen is the extent to which levy costs will be passed on to depositors.
That will vary from institution to institution, depending on factors such as services offered, community involvement, established relationships or “the benefits of mutuality.”
“There remains a limitation in our understanding of the extent that deposit-takers will pass on the cost of levies to their customers through deposit rates and other fees,” it says in its July 2024 Regulatory Impact Statement.
“While our estimations have indicated minimal economic incidence falling onto depositors, it will require a case-by-case analysis after commencement.”
Much-mentioned but little-defined in the consultation documentation is the “moral hazard” the scheme potentially introduces.
The argument is that, with investors de-sensitised to risk (at least for the first $100,000), deposit-takers will be incentivised to make high-interest rate, riskier loans so they can offer higher deposit rates.
The Taxpayers Union isn’t shy of sheeting moral hazard home to finance companies.
“Finance companies operate within a different set of moral hazard concerns than banks do, which deposit insurance schemes interact with to drive the sort of risk-seeking behaviour that makes the Crown deposit guarantee more likely to be activated,” it says in a submission.
The RBNZ’s response is that the Depositor Takers Act (DTA) “allows us to act to minimise the risks of high-impact failures.”
In particular it points to the new prudential framework currently under construction for implementation during 2027 and a framework for “managing and resolving any deposit taker in financial distress.”
Any temptation to go “risk-on” will be mitigated, says the RBNZ, by the “composite risk factors” approach to levy-setting, whereby deposit-takers’ soundness is reviewed regularly, including prudential capital, asset quality, and profitability.
Until the full DTA standards apply in July 2028, it says, it will be monitoring the sector closely.
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