RBNZ sets out to ensure shareholders and creditors absorb cost of any bank failure not taxpayers

By Gareth Vaughan

The country's smallest trading banks TSB Bank and SBS Bank, plus Building Society Holdings and PSIS should they achieve their ambition of becoming banks, will have to meet the costs of implementing the Reserve Bank's blueprint for dealing with bank failures, alongside the big banks.

The central bank's consultation paper on Pre-positioning for Open Bank Resolution (OBR) suggests all locally incorporated banks with retail funding of more than NZ$1 billion be required to pre-position. That includes what the Reserve Bank defines as systemically important banks which are those whose New Zealand liabilities - net of amounts due to related parties - exceed NZ$15 billion such as ANZ, ASB, BNZ and Westpac, plus state owned Kiwibank, TSB and SBS given all three have retail funding of more than NZ$1 billion each.

And should Building Society Holdings - the combined Marac Finance, CBS Canterbury and Southern Cross Building Society and co-operative PSIS secure their sought after banking licences from the Reserve Bank, they too would be required to partake in OBR pre-positioning given they both also have retail deposits of more than NZ$1 billion.

Other financial institutions that don't have retail funding of more than NZ$1 billion can decide to be OBR-capable despite the absence of a regulatory requirement to be, the Reserve Bank says. Open bank resolution plans are often called 'living wills' overseas.

An open bank resolution is an option whereby the bank is open for business on the next business day after its temporary closure following an insolvency event or an event that triggered putting it under statutory management, and is able to provide customers with full or partial access to their accounts and other bank services.

The key feature of the OBR is that creditors are able to access a portion of their funds immediately after the bank fails and is placed in statutory management. The bank can then quickly reopen with the unfrozen or accessible portion of funds guaranteed by government to avert a further run by creditors. Additional funds can be unfrozen at later dates as the final losses are determined.

The Reserve Bank says the OBR policy is intended to act as a resolution tool that dumps the cost of bank failure primarily onto a bank's shareholders and creditors rather than taxpayers, thus minimising moral hazard and providing a continuity of core banking services. The policy, previously known as Bank Creditor Recapitalisation, was developed after a review of the central bank's crisis management policies and instruments following the 1997 Asian financial crisis.

The Reserve Bank says its outsourcing, local incorporation and governance policies were all designed to facilitate the implementation of OBR. Now, the pre-positioning of banks' internal systems represents the next stage in the process.

"While OBR is simple in concept, it is not trivial to execute in a technical sense," the central bank's consultation paper says. "The Reserve Bank is conscious of the cost of installing and maintaining the necessary systems and procedures that would make the choice of OBR in a crisis situation a practical option. Thus, the Bank focuses on a core set of outcomes as a minimum requirement."

What the banks need to 'pre-position'

It says pre-positioning is necessary for OBR to be a practical option. Its broad expectations from OBR pre-positioning are for banks to have systems and processes in place, that in the event of failure, would enable the following to be carried out:

• freeze accounts and process pending payments;

• prevent customers’ access to their accounts;

• determine customers’ account balances, on a per account basis, according to specified rules and as of a cut-off time;

• apply haircut as directed by the statutory manager, with the de minimis option (see more on this below) if required, within a time frame of 24 hours or less;

• apply guarantees as directed by the Statutory Manager;

• resume customers’ access to their transaction and other accounts (including debit and credit cards, and accounts in overdraft) the day following closure; and

• reinstate access by the customer to part or all of their frozen balance, as directed.

The Reserve Bank says it expects banks to be fully pre-positioned by late 2012. It has set a deadline of June 30 for responses to its consultation paper and will then expect detailed implementation plans from banks by September 30.

Moody's warning & haircuts for creditors and depositors

International credit rating agency Moody's Investors Service warned last week the Reserve Bank's pre-positioning push could heap more pressure on the all ready under review Aa2 long-term bank deposit ratings it has on ANZ New Zealand, ASB Bank, Bank of New Zealand (BNZ), and Westpac New Zealand.

Meanwhile, the central bank says the key to the OBR policy is to impose a haircut on all unsecured liabilities but pre-positioning is needed for only the most time critical liabilities - such as transaction, savings and other retail accounts like term deposits and small business accounts - to allow the bank to be re-opened quickly.

Setting the size of the haircut would mean a quick assessment was made of the current value of a bank's assets, plus setting an allowance for prospective losses and other expenses. A substantial buffer would be added, the Reserve Bank says, due to uncertainty about the value of the failed bank's assets.

The haircut could be based on what the central bank refers to as the de minimis threshold, which would be a set value of retail depositors' funds. Only deposits above this value would be subject to the haircut. Any threshold value would be established by the government. The haircut could also be expressed as a percentage of each account in positive balance at the failed bank, rather than as an absolute amount. Creditors would potentially bear full loss up to the haircut value.

The central bank's consultation on pre-positioning for OBR comes after Finance Minister Bill English said on March 11 the government was considering options for maintaining confidence in the financial system when the extended Crown retail deposit guarantee scheme expires at the end of 2011. Protecting just NZ$2 billion of the NZ$210 billion New Zealanders have on deposit, the extended guarantee scheme won't be pushed out further. The only companies party to it are Building Society Holdings, Fisher & Paykel Finance, the Wairarapa Building Society, and PGG Wrightson Finance.

The Government is considering a number of permanent options to manage any future financial market difficulties, English added. These options include OBR.

“This option has been available to the Reserve Bank for a number of years," said English. "This next stage is about engaging with the banks to ensure it could be implemented effectively if required."

Treasury is working on the appropriate form for any government guarantees required to support the on-going operations or any institution subject to the OBR policy.

Lesson from the GFC

Meanwhile, the Reserve Bank points out one of the key lessons from the global financial crisis is the potentially enormous costs associated with supporting troubled banks.

"Some governments that chose to guarantee their banking system's liabilities are now faced with a sizeable public debt burden. The alternative is to make bank shareholders and creditors shoulder the losses of a failing bank whilst ensuring that the payments system continues to function."

"A solution is sought that solves the urgent liquidity problems associated with a bank failure, but does not force all of the losses to be borne by the government."

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