"Financial prudence" should have been a significant consideration for Treasury in its oversight of the Crown retail deposit guarantee scheme and Treasury should have been more willing to intervene to prevent finance companies significantly increasing their taxpayer guaranteed deposits once they had the guarantee in place rather than merely looking to recover what it could after a company fell over, the Auditor General says in an audit report on the implementation and management of the scheme.
Controller and Auditor-General Lyn Provost says Treasury was in a reactive mode for too long, responding to needs as they emerged rather than systematically anticipating and preparing for the next eventuality as it oversaw a scheme guaranteeing up to NZ$133 billion of investor funds.
Provost notes that from the outset, the advice from officials was that the decision to include finance companies in the scheme carried significant risk. Ultimately nine finance companies with deposits covered by the scheme, which ran from October 2008 until October 2010 failed including South Canterbury Finance, causing the Crown to pay out about NZ$2 billion of taxpayers' money to depositors. As Provost notes, It'll be some time before the various receiverships are completed and the total amount recovered from the finance companies is known. But expected recoveries are currently estimated at about NZ$900 million of that NZ$2 billion leaving the taxpayer with a NZ$1.1 billion loss.
"Once deposits with these (finance) companies were guaranteed, depositors could safely move investments to where they would get the highest return, irrespective of the risk of company failure," Provost says. "The finance companies also had less reason to minimise risk in their investment activity. The Crown was carrying much of this risk."
"During 2009, the Treasury watched some of that behaviour eventuate. Deposits with finance companies under the Scheme grew, in some instances significantly. We saw one example where a finance company’s deposits grew from NZ$800,000 to NZ$8.3 million after its deposits were guaranteed. At South Canterbury Finance Limited, the deposits grew by 25% after the guarantee was put in place."
South Canterbury Finance was able to offer 8% interest rates to investors whilst carrying the guarantee as it desperately attempted to attract much needed longer-term funding, in a move that rivals argued allowed it to distort the investment market.
'Treasury didn't see itself as able to interact with a finance company to try to moderate its behaviour'
She says from mid-2009, Treasury was closely monitoring these changes and the individual companies that were identified as being at risk.
"However, it was largely doing so to prepare for potential payouts. It did not see itself as able to interact with a finance company to attempt to moderate that behaviour, even when it could see the Crown’s potential liability increasing markedly. The view appeared to be that it was better to recover what funds it could after an institution failed, than try to influence events before a failure," Provost says.
"In essence, the Treasury remained in a reactive mode for too long, responding to needs as they emerged, rather than systematically anticipating and preparing for the next eventuality."
'Financial prudence should have been a consideration'
Treasury's approach relied too heavily on a presumption of minimal intervention and gave insufficient weight to the need to manage the overall potential cost to the taxpayer, she says.
"Although the Scheme’s primary objective was to secure depositor and public confidence, and it was accepted that this would involve a significant cost, financial prudence should still have been a significant consideration," Provost adds.
She saw no evidence of the growing financial risks being considered at a strategic level or informing the Treasury’s ongoing policy analysis and advice to Ministers on options.
"Although there were ongoing discussions with Ministers about policy settings, we did not see evidence of strategic analysis of the range of options alongside the unfolding risks. In particular, we consider the evidence of increasing deposits and liability should have prompted more policy work."
Furthermore, the same approach was seen in how individual applications were considered.
"In our view, further enquiries could have been made of some financial institutions as part of the application process. The Treasury and the Reserve Bank of New Zealand did not seek additional information in the early days of the scheme, because they were squarely focused on the objective of depositor confidence. At that time, managing the size of the Crown’s potential liability was not the primary concern," Provost says.
"Although we cannot say definitively that more immediate close monitoring would have reduced the overall cost to the Crown, closer monitoring could have helped identify risks for earlier consideration and possible management."
Meanwhile, other problems weren't foreseen at the beginning, such as that the Crown would be liable for interest that continued to accrue on deposits after a finance company failed but before payouts were made. She acknowledges that problems were to be expected with a scheme put together in such haste.
"In my view, the Treasury should have recognised this from the outset, and established an ongoing work stream for identifying problems and providing advice on options for addressing them. This work did not begin until 2009. However, the Treasury did then take steps to improve the effectiveness of the scheme. It was later modified twice in ways that addressed many of the problems."
Although Treasury repeatedly responded well to the immediate operational needs, it didn't appreciate how important it is to “get ahead of the wave” as quickly as possible, to maintain a clear and comprehensive view of the strategic picture and start planing and managing accordingly. She says Treasury officials say they've learned from the experience, and now take a more structured approach to crisis situations.
"Overall, the Scheme achieved its goal. No banks in New Zealand failed, and there was no run on banks. Many of the other finance institutions also survived the global financial crisis. The economy was stabilised," Provost says.
"However, there have been costs. Nine finance companies in the scheme failed, causing the Crown to pay out about NZ$2 billion to depositors."
A lack of overall governance meant there was no coherent strategic overview to inform the evolving thinking and work on individual tasks. This affected the practical work needed for the successful operation of the scheme, the approach taken to managing the scheme’s major risks, and how and when the hastily put-together scheme was reviewed and refined over time.
Treasury rejects suggestion it should've intervened more
Treasury Secretary Gabriel Makhlouf rejects Provost's view that more intervention in finance companies might've reduced the fiscal risks of the scheme.
“The guarantee scheme was already a very significant, but necessary, intervention in New Zealand’s financial system," Makhlouf says. "The Treasury considered a range of further interventions but couldn’t find a case where intervention was more likely to create a better outcome. All interventions carry a degree of risk and we don’t believe that the Auditor General’s report gives sufficient weight to the risks that further interventions would have created,” Makhlouf says.
“I’m pleased to have this independent external view of how the Retail Deposit Guarantee Scheme worked and pleased that the report finds that the Treasury generally ran the scheme well. The report will be a key resource in ensuring that we learn as much as possible from that experience,” Makhlouf adds.
(Update replaces earlier BusinesDesk story).