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Ex-BNZ chairman Kerry McDonald lambasts the RBNZ's oversight of banks for being 'unacceptably complacent, weak, ineffective' & for ignoring depositors' interests

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Ex-BNZ chairman Kerry McDonald lambasts the RBNZ's oversight of banks for being 'unacceptably complacent, weak, ineffective' & for ignoring depositors' interests

By Gareth Vaughan

Former BNZ chairman Kerry McDonald is giving the Reserve Bank both barrels for its hands-off, "naive" and "not fit for purpose" regulation of New Zealand banks, and for "consistently ignoring" the interests of bank customers.

In a submission sent to Finance Minister Grant Robertson and provided to media including interest.co.nz, McDonald lays into the Reserve Bank, saying it's "unacceptably complacent, weak and ineffective" as a bank regulator. Robertson is overseeing a review of the Reserve Bank Act.

Ultimately McDonald wants the Financial Markets Authority (FMA) to take over bank regulation leaving the Reserve Bank with its central bank, including monetary policy, responsibilities. This would mimic the Australian model where the Reserve Bank of Australia sets monetary policy and the Australian Prudential Regulation Authority (APRA) is the prudential regulator of banks. (Interestingly the New Zealand Bankers' Association floated the idea of splitting the Reserve Bank's monetary and prudential responsibilities in a 2013 submission to the Productivity Commission). 

To take on its new role the FMA should be "appropriately empowered, resourced and held to account," McDonald writes, with the interests of depositors "the highest priority."

The key problem McDonald sees with the Reserve Bank is this; "The RBNZ does not know whether the banks which it has licensed to operate in New Zealand are abiding by the terms of their banking licences. The banks are simply required to attest that they are but there is no review, examination or audit process, which is naive in the extreme! This is not tiddlywinks!"

'An industry that routinely demonstrates that it cannot be trusted'

McDonald also argues the Reserve Bank's Open Bank Resolution (OBR) bank failure tool - if used - would exposure bank customers, especially depositors, to an unacceptable level of risk. He says the Reserve Bank "consistently ignores" the interests of bank customers, notably depositors, and relies on "attestation from an industry that routinely demonstrates that it cannot be trusted."

McDonald also highlights issues aired by the International Monetary Fund (IMF) in last year's Financial Sector Assessment Program (FSAP) report on New Zealand. The IMF criticised the Reserve Bank's idiosyncratic light handed regulatory approach, which I detailed here, and said political will and increased resources would be required for beefed up banking supervision.

The IMF judged the Reserve Bank "materially non-compliant" in 13 of 29 international bank regulatory and supervision framework standards, or Basel core principles. The Reserve Bank played this down, saying it came as no surprise, but that it would closely examine the IMF recommendations.

 McDonald describes the Reserve Bank's response to the IMF report as "naive, complacent and entirely unacceptable," reflecting a culture "unacceptable in a bank regulator."

"For this and other reasons I consider it inappropriate and anomalous that RBNZ is both the central bank and the regulator of the NZ banking system. The two functions are quite different and require different skills and capabilities. I therefore recommend that the Financial Markets Authority be designated as the bank regulator and that appropriate arrangement be made for it to develop the requisite 'fit for purpose' policies and capability; and take over the function ASAP. It is after all the 'financial markets authority' and this separation is common globally, including in Australia," McDonald writes.

He notes a key difference between Australian and New Zealand bank regulation is that APRA actively enquires, probes, tests, challenges and identifies issues. In contrast the Reserve Bank does none of this. It doesn't even do on-site inspections.

"So everything looks fine - but the reality is they simply do not know! They simply rely on attestation, in circumstances in which it is simply not credible!" McDonald writes.

An emphasis on self and market discipline

The Reserve Bank believes its hands-off three-pillar regulatory oversight regime focused on self, market and regulatory discipline, with an emphasis on self and market discipline, has served New Zealand well. The regulator is currently reviewing its directors' attestation regime. It says it will detail the findings of the review and outline its proposed response this year.

McDonald notes that New Zealand's big four banks - ANZ, ASB, BNZ and Westpac - are all Australian owned with parential representatives on the New Zealand subsidiaries' boards. Additionally they organise/control many of the senior executive appointments, their systems and processes and policies, and most importantly influence how the New Zealand offshoots respond to a crisis.

"It is of particular importance that the New Zealand boards of the New Zealand licensed banks are required to make all important decisions in relation to and in the best interest of the New Zealand bank, and are expressly not allowed to act in the interests of a holding company - such as the parent bank. But the RBNZ simply does not know if this is being complied with - again a critical issue. It simply - again and naively relies on attestation without audit or other serious testing or enquiry," McDonald writes.

McDonald is a fan of the "BEAR" measures being introduced in Australia to strengthen the responsibility and accountability of Australian bank executives and directors.

'They have deliberately put the bank customers, especially depositors, in a position of high exposure'

On the OBR McDonald argues it entails a serious moral hazard for the Reserve Bank.

"They have deliberately put the bank customers, especially depositors, in a position of high exposure, which they then should, at the very least mitigate by effective regulation - but they don't."

Asked by interest.co.nz to elaborate on this point McDonald said; "As with APRA there should be a much greater priority to protecting depositors - that must be explicit. And the more effective the regulation the better depositors - and everyone else - will be protected."

In his submission McDonald goes on to point out customers have no influence on the appointment of bank directors to ensure they are competent and make astute decisions, especially in the areas of risk they deal with "when the banks have a disturbing history of accepting higher levels of risk to increase profits and executive remuneration."

"The RBNZ consistently ignores the interests of customers, which will often differ from those of the bank, as is highlighted by many of the recent performance failures of banks as they seek to increase profits by inappropriate/illegal means," says McDonald.

He notes APRA, in contrast, aims to ensure the risks undertaken by the institutions it supervises are clearly identified and well managed and that the likelihood of financial losses to consumers are minimised. By doing this APRA strives to act to protect the interests of depositors and to promote the stability of the Australian financial system.

My view

As a former insider with 17 years experience as a bank director in New Zealand and 12 years in bank governance in Australia, McDonald's views deserve serious consideration. 

His strong criticism of the Reserve Bank's light touch oversight of New Zealand's banks aligns with some of the criticisms I too have made of the central bank and prudential regulator. For example, after the IMF review when I asked if the Reserve Bank was little more than an ambulance at the bottom of the cliff, when I argued less dogma and more flexibility was needed in the Reserve Bank's risk management strategy, and questioned its staunch opposition to deposit insurance.

It's also frustrating the Reserve Bank - and Commerce Commission - don't have the ability to tackle excessively high credit card interest rates as the Reserve Bank of Australia does. And when insurer Youi was in the gun it was disappointing the Reserve Bank, as prudential regulator of insurers, was only able or willing to say the outrageous sales tactics exposed by Diana Clement's articles raised "important and serious" issues.

In terms of the ability of the big four New Zealand banks to be run as standalone operations separate from their Australian parents in a crisis, McDonald may not be giving enough credit to the Reserve Bank's outsourcing policy. Being bolstered, this policy is expected to cost New Zealand banks about $550 million, or 2.8% of their cumulative after-tax profits over five years, and is not popular in the big end of banking town.

And on macro-prudential policy - notably through the introduction of the LVR restrictions - the Reserve Bank has been ahead of APRA.

Off the back of the IMF review, the ongoing Reserve Bank review of bank capital adequacy requirements, Robertson's review of the Reserve Bank Act, and March's arrival of Adrian Orr as Governor, there is some hope for a change of attitude at the Reserve Bank.

And I believe attitude is the key issue. Rather than loading an already stretched FMA up with such a big, new responsibility, I'd prefer to see what admittedly would need to be a sea change in attitude at the Reserve Bank. This would undoubtedly require more fresh blood at Reserve Bank HQ than just Orr.

When announcing Orr's appointment Robertson said Orr has the skills to successfully lead the Reserve Bank through a period of change. Let's hope the Finance Minister has more change in mind than just making Reserve Bank monetary policy have a focus on employment as well as inflation. Because it would be nice to have a bank regulator that relied on more than just directors' attestations to know whether things are hunky dory at our banks.

If this is to happen Robertson may need to forsake a dividend or two from the Reserve Bank to allow it to beef up its current funding agreement with the Finance Minister, which currently provides annual funding increases of only about 1% until 2020.

The Reserve Bank receives no direct taxpayer funding through the Parliamentary appropriation process. Its main source of income is the return on investments it holds, which are funded by the issue of currency and by the central bank's $2.8 billion of equity. 

Under the Reserve Bank Act, the Minister of Finance and the Reserve Bank Governor have a five-year funding agreement specifying the amount of the Reserve Bank's income to be used to meet operating expenses in each of those years. The size of the dividend paid to the Crown is determined by the Minister of Finance each August on the recommendation of the Reserve Bank. Last year the dividend was $140 million.

As the IMF pointed out; "The RBNZ operates under specific resource constraints and numbers are insufficient [it has about 240 staff]. Strengthening the regulatory discipline pillar will require increased resources, including technical capacity to develop prudential requirements and guidelines, deepen the analysis that supports the supervisory ratings, and to develop a supervision policy that reflects a balance between risk and efficiency costs of supervision."

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69 Comments

Is this Kerry McDonald the same guy who was on the board of Powerhouse and the National Bank or is it some one else.

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Kerry was a BNZ director from 1991 to 2008, and BNZ chairman from 1996 to 2008.

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Kerry McDonald is no fool and deserves to be listened to.

In earlier parts of his career, he was Chief Executive of the NZ Institute of Economic Research (NZIER) and Comalco NZ. Plus, he was a leading figure in the NZ Business Roundtable. Certainly, he has plenty of experience in regulatory economics.

McDonald has a reputation for being wise and a safe pair of hands.

TTP

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Internationally, in Aussie, UK, USA, there have been an ongoing series of scandals as regulators have found banks misbehaving e.g. Royal commission into banks currently in Australia.

Why none in NZ? Are our banks squeaky clean? Or is Kerry MacDonald right and we have a regulator who leans on the side of banks and ignores interests of customers.

OBR is certainly a shocker from RBNZ and an outlier internationally that puts NZ depositors funds at risk in a crisis.

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overseas they have deposit insurance

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But this is not true if the RBNZ allows banks to have lower capital because it has implemented OBR. The RBNZ has advocated this!, and the result is that a depositor will be killed in an OBR event, and possibly more likely to be killed, but OBR does it cleaner.

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Put a link below to what OBR is. Depositors funds are used to cover losses the bank cannot make up from it's capital, just like creditors losses. No protection in the event a bank can't pay its debts e.g. in a property crash.

https://www.rbnz.govt.nz/faqs/open-bank-resolution-policy-faqs

Have a look at the section "what happens to depositor's funds during the OBR process".

This is very bad for most NZer's, who do have bank deposits and have no protection; unlike in other countries.

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RP,

How so?
Aren't we already essentially covering ourselves? Assuming no free lunch/arbitrage, of course.

The premium attached to our return rates must be intrinsically related to the absence of deposit 'insurance'. So, what's the difference between implementing such a scheme and not, for the general consumer?

The one key difference I can tell you is that having a scheme would significantly increase the rate of reckless banking practices within the industry - One of the cornerstone arguments the RBNZ uses for the approach.

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hi nymad

Are premiums to our return rates better because no deposit insurance? I would argue profit margins of our banks are better than others internationally rather rates depositors receive.

Would having deposit insurance significantly increase reckless banking practices? I don't think so. Risks in the banking sector have typically arisen from other sources like concentration (too big to fail), lack of seperation between retail and investment functions (which was the glass steagall act) etc...

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"Are premiums to our return rates better because no deposit insurance? I would argue profit margins of our banks are better than others internationally rather rates depositors receive."

Proof of that?

"Would having deposit insurance significantly increase reckless banking practices? I don't think so."
Fair opinion.
However, it is wrong.
You even prove this by the directly following phrase "Risks in the banking sector have typically arisen from other sources like concentration (too big to fail)"
Right there you identify the issue of rational behaviour when risk is arbitrarily reduced.
"Too big to fail" works on exactly the same principle. The banks just straight arbitrage the risk that the tax payer takes from them. Essentially another form of moral hazard.

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nymad,

Can you provide hard evidence for your assertion that a deposit protection scheme "would significantly increase the rate of reckless banking practices"?
Since most other countries have such schemes,it shouldn't be too hard to find such evidence-reckless lending that can be firmly linked to the 'moral hazard' of depositor protection.
My own view is that we should have a limited protection scheme,covering say,up to $30,000 per person,per authorised institution.The potentia lcost could be met by a small premium.

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linklater,

Some advice...
Firstly,
You only have to click the button once.

Secondly,
Moral Hazard is a very real thing.
Every entity has to balance risk, right?
So, when risk is artificially reduced (which is, essentially, what such a scheme will do), entities will react in a way that makes up the shortfall left by that reduction.
That is simply rational behavior.

If you need proof of the hypotheses of moral hazard, you need only do a quick Google search.
A great example is the decision of persons to commit insurance fraud.

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nymad,

Mea Culpa-a new computer is my only excuse.

I am well aware of moral hazard-and anything insured from a car to a life,can give rise to fraud. Would you suggest that insurance should be banned because of that? I rather doubt if you would and if you did,you wouldn't get much support.
I note that you didn't produce any proof of your assertion. Why have so many other countries decided that the moral risk is less important than the provision of some level of depositor protection? Are Kiwis really less moral than Australians,who as you know,enjoy a high level of protection?

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nymad,

Can you provide hard evidence for your assertion that a deposit protection scheme "would significantly increase the rate of reckless banking practices"?
Since most other countries have such schemes,it shouldn't be too hard to find such evidence-reckless lending that can be firmly linked to the 'moral hazard' of depositor protection.
My own view is that we should have a limited protection scheme,covering say,up to $30,000 per person,per authorised institution.The potentia lcost could be met by a small premium.

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nymad,

Can you provide hard evidence for your assertion that a deposit protection scheme "would significantly increase the rate of reckless banking practices"?
Since most other countries have such schemes,it shouldn't be too hard to find such evidence-reckless lending that can be firmly linked to the 'moral hazard' of depositor protection.
My own view is that we should have a limited protection scheme,covering say,up to $30,000 per person,per authorised institution.The potentia lcost could be met by a small premium.

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nymad,

Can you provide hard evidence for your assertion that a deposit protection scheme "would significantly increase the rate of reckless banking practices"?
Since most other countries have such schemes,it shouldn't be too hard to find such evidence-reckless lending that can be firmly linked to the 'moral hazard' of depositor protection.
My own view is that we should have a limited protection scheme,covering say,up to $30,000 per person,per authorised institution.The potentia lcost could be met by a small premium.

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"Aren't we already essentially covering ourselves"

Exactly. The tax payer *is* the depositor, they are one and the same.

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1. What you call insignificant could be someones only savings, which I would argue is quite significant to them.

2. There are no such commercial insurance policies, a point David Chaston has made many times on this site.

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It doesn't matter, though.
Either they pay a compulsory premium for 'insurance' (lowering their return), or they effectively self insure by taking the relatively higher return that they currently get.
In both cases EV for the depositor/investor is the same, regardless. It's just in the former choice they have less control over how they spread their own personal risk.

Insurance scheme, or not, the EV for the depositor is the same.

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Hang on - how is it you demand proof from others but then post none to support your own specific claims?

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np, just made me laugh.

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Perhaps I am misunderstanding you Pragmatist but can you explain why those who have saved/are saving a nest egg should be scalped (perhaps for a first home) while those using credit get away free. Credit affects so much of our economy surely?

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"They do not get away free, its not like if the bank collapses their debt will disappear,"

Ill just get back up off the floor.

"Since 2009, 49 financial institutions have paid various government entities and private plaintiffs nearly $190 billion in fines and settlements, according to an analysis by the investment bank Keefe, Bruyette & Woods. That may seem like a big number, but the money has come from shareholders, not individual bankers"

https://www.theatlantic.com/magazine/archive/2015/09/how-wall-streets-b…

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The fines are generally so small compared to the ill-gotten gains that the combination of the fines and complete lack of any other punishment for the misbehavers simply incentivises more of the same behaviour.

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You are treating our main trading banks as finance companies.

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Yes, they are one of many investment opportunities. One with a poor rate of return, risk that is higher than justified by returns if all this bleating about OBR is to be believed. So yes, much like the finance companies of days past. Why should the banks get any special dispensation?

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Because they can create money as debt

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The idea to create an equivalent to the APRA might be compelling except for the fact that the APRA has allowed Australian banks to lend recklessly, and is now only applying weak macroprudential limits to rein it in. The RBNZ has been ahead of the APRA on this front, even though RBNZ' efforts on this have still been weak, ineffective, and neglectful of depositors' interests.

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Very rarely does any government seem to hold banks accountable for their behaviour, or even let the instigators bear the consequences of their own actions. Iceland provides an interesting example of a government not simply applying a wet bus ticket: http://www.bbc.com/news/business-35485876

"Now in the US, the banks are even larger than they were pre-2008. They are not only too big to fail, they are too big to manage and possibly too big to exist. The old phrase was, 'Main Street will never again bail out Wall Street.'

"That's a noble claim, but the evidence suggests that in the UK and the US, and also in the eurozone, where several countries simply have broken banking systems, the taxpayers are still on the hook. Very little has been done, and the day of reckoning is potentially around the corner."

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This may be a very good idea . The cozy relationship between big banks and the regulators has been an issue everywhere for years

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Are Australians depositors any better protected than NZ'ers?
https://www.facebook.com/notes/citizens-electoral-council-of-australia/…

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...one would think, as they have a govt guarantee. We don't.

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I realise what is going on in Austraia but I wouldn't guarantee that it will stay that way given APRA are wanting to implement bail ins. The CEC has been fighting the introduction of bail ins with what looks like a preference to have a Glass-Steagall Act implemented instead.

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Nomi Prins on Central Banks.
https://www.youtube.com/watch?v=5uAmHS-Tc64

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"He notes APRA, in contrast, aims to ensure the risks undertaken by the institutions it supervises are clearly identified and well managed and that the likelihood of financial losses to consumers are minimised. By doing this APRA strives to act to protect the interests of depositors and to promote the stability of the Australian financial system."

If APRA is going to minimise financial losses to consumers then who would stand to lose the most? The person who has bank deposits or the person who's asset has declined in value e.g to homeowner? Protecting the latter group could be viewed as protecting the depositor by default.

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'An industry that routinely demonstrates that it cannot be trusted'. So so true. Given the risks to the entire nation posed by these crazy risktakers we need to get banks under the thumb.

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For depositors, the risks are even worse than the article above makes out due to the National Govt allowing the introduction of "covered bonds".

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This is a trend world wide, the commercial and investment banks have hoodwinked Central Banks as a Regulator very often, resulting in many financial crises, the last big one being the GFC 2008. Central Banks have become very irrelevant and also complicit in many countries when they were co-opted into QE measures to save the Banks. TBTF still rules, and Central Banks don't rock any more...

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We need a PM who understands banking and finance. A man of steel who would sort this in 9 years or even less. Such a person would deserve a knighthood in doing so.

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A man of the People such as that, is busy working on an Auckland property project at the moment using foreign cash.

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Nah..We might have to pay under the table to a Cayman Islands site...on the never ..never.

Or slip it under the mat.

Would have to borrow the money too...from an Aussie Bank...(what interest rate would they charge).

How bizarre. How ironic,

I will take it on for free...Plus expenses. Plus wave the flag on all how we are so supreme on the money go round.

We could make billions...but where would we save it...I keep asking myself.

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The risk of a bank run is not just a a risk to depositors it's a risk to the economy. Letting banks repatriate billions of dollars a year back to Australia, is both bleeding the economy dry and leaving depositors exposed.
If interest rates keep falling as risk of an OBR goes up expect a flight response from depositors, the fight one will never work.

So the options will be something like the Perth Mint, with a guarantee from the WA government. If anyone with a mortgage thinks they won't be affected I'd think again.

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Reading this makes me feel like living in the 3rd world.

OBR: The government advises NZers to save for old age. Imagine just one of the big banks activating OBR and the effect of losing almost all the savings on those people who rely on it for day to day expenses, for example older people. How many would no longer be able to afford staying in a rented home or rest home? Where would they turn to? MSD? Housing NZ? Isn't that the same as socialising the bank?

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Its absurd that there is no deposit insurance scheme in NZ.
I can insure bonds through credit default swaps if I'm a big enough player
I can insure a car and house.

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What about the reverse question - how much premium and on what terms do you want from to offer me deposit insurance?

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The point is that the market provides the option of to buy a house or car with insurance.
The market should provide the same option for savings.

The NZ economy is already too skewed to housing investment and the lack of deposit insurance further skews the system.

Also NZ is an outlier and one of the few developed countries without deposit insurance.

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I have some Kiwibonds. These are implicitly govt guaranteed. Sure 2.25% is not all that flash but in terms of a diversified portfolio..... you know the rhetoric.

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How was the oversight on this case?
http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=119…
NZ banks not aware of the business ethics of the ‘wealthy investor’ immigrant category?
Could NZ follow Australia and deport these offenders?

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The fact it is in court might show the system is working.

Not sure additional oversight of depositors risk would have picked up anything like this.

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False income documentation to secure mortgages - surely this is bank responsibility, given that genuine New Zealanders normally get the third degree investigation from the bank when applying for any loan.
“Banks were also allegedly provided with false income and employment information”
Was there political pressure to let the ‘documentation’ through?

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Who knows what forms of deception have been used here. The article is too brief. It would be very interesting to hear all the details of this case. If/ when the tide turns the naive banks could well be swamped by the sheer volume of cases where the income is not as high as claimed.

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When the s__t hits the fan, no amount of guarantee will suffice. It would just mean that some one has to print/create more money to pay off, resulting in inflation, erosion of value and huge impact on the economy.

The best course would be to have better supervision in place to check the health of the Banks regularly with more hands on oversight and monitoring, increase capital adequacy (not just 10% ball park figure), regular overhauling of the risk weight of bank assets, limit the size of the Banks so they don't grow TBTF (the horse might have already bolted) and also to limit the repatriation of bank profits overseas.

A high level of pro active supervisory leadership is necessary to make sure that Banks here remain robustly healthy and all stakeholders' interests are well protected.

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There is a vast difference between a bank deposit and say the sharemarket,which can be similar to a roller coaster at times.Deposits by individuals should be protected by the huge profits the banks experience year after year. Most people are unaware of the OBR when it comes to as they call it a haircut,I prefer to call it theft, typical of a Nat government policy. To have a business that simply enters figures on a computer that creates a debit and credit and charges interest, then expects the public to bail them out should a failure occur, one can only call it a Mafia Model.

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