Deposit insurance is likely to come at a "significant cost" to New Zealand deposit takers, and potentially depositors, especially as the scheme is built up, a government consultation paper suggests.
The latest consultation paper in the Government's ongoing review of the Reserve Bank of New Zealand (RBNZ) Act details the likely costs of establishing a deposit insurance scheme. As reported on Thursday the scheme, introducing deposit insurance of $50,000 per individual per financial institution, is not planned to be fully implemented until 2023. The consultation paper also looks at the likely size of the fund.
The deposit insurer's proposed objective is “to protect depositors, and in doing so, contribute to financial stability.” And its core function will be to "make timely deposit insurance payouts to the insured depositors of a failed depositor taker."
The Government has already decided the deposit insurance scheme will be fully funded by levies on deposit-taking institutions. Additionally the Crown will provide a funding backstop, read government guarantee, to ensure the scheme can meet its obligations to insured depositors.
Table 2 below, from the consultation paper, explores the costs of establishing a deposit insurance fund of between 1% and 5% of insured deposits over a period of five to 20 years. According to the paper, a typical approach in other countries has been to build up the fund over five to 10 years.
"For a 2% fund size built up over 10 years, the levy on a $10,000 deposit would be $22 per year during the time the fund is being built up. If this was not passed onto the depositor by the deposit-taker, it would reduce industry profits by around 5% each year in that transition period. It is most likely the levy would partially impact depositors and partly industry," the paper says.
"These estimates show that deposit insurance is likely to come at a significant cost to deposit takers, and potentially depositors, particularly during the build-up stage or if the scheme is drawn on. To an extent, these costs can be managed through allowing longer timeframes to build up the fund, although this would result in a larger contingent liability of the Crown in the interim."
The paper does argue, however, that the implementation of deposit insurance represents a shift from an uncertain implicit guarantee to a managed explicit guarantee.
"An implicit guarantee arises from the revealed preference of governments to not impose losses on creditors, particularly depositors, in a crisis and therefore assist banks during crisis periods. The amount covered by such an implicit guarantee is uncertain, but results in an effective subsidy on bank’s debt funding. The subsidy is ‘paid’ for by taxpayers to the benefit of banks and potentially their customers. The new deposit insurance scheme will manage the government’s liability and ensures that the beneficiaries of the insurance, member institutions and potentially depositors, pay for it," the paper says.
What about the size?
In terms of determining the size of the fund, the paper notes a wide range of fund sizes internationally, ranging from 0.25% to 15% of insured deposits. It says there are two key factors for determining the fund's size.
Firstly, the availability and adequacy of deposit insurance scheme borrowing, and secondly the resolution authority’s preferred resolution method for different deposit takers.
"In a liquidation, the deposit insurance scheme would promptly payout insured deposits. If there are adequate arrangements in place for the Government funding backstop, it may not be necessary to create a target fund that is large enough to cover the entire amount of the deposit insurance payout. Instead, the deposit insurance scheme would borrow from the Crown, with repayment (including interest) made from recoveries on assets from the failed member and, if necessary, from higher-than-normal levies on surviving members," the paper says.
"In the case of a failure of a large deposit taker the deposit insurance scheme would likely protect depositors by supporting another resolution tool, such as the Reserve Bank’s Open Bank Resolution (OBR) tool. Under such a resolution, the deposit insurance scheme may make a contribution towards the cost of resolution and would not be expected to pay out all the insured deposits of the member. The deposit insurance scheme is also likely to have more time to raise any funding for a shortfall when using resolution tools other than liquidation."
Table 1 below illustrates the obligations that could arise for the deposit insurance scheme under a liquidation and other resolution tools.
"If there was uncertainty around the availability of backstop liquidity and a preference for liquidation as a resolution tool for non-systemic deposit takers, the deposit insurer may want to pre-fund the obligation arising from the liquidation of two medium sized banks, or one medium-sized bank and several small banks or non-bank deposit takers – a fund size of around 5% of insured deposits. Conversely, with adequate liquidity and a preference for other resolution tools over a liquidation for larger banks the deposit insurer may want to prefund the obligation that could arise from the open resolution of one large bank or two medium banks – a fund size of around 1% of insured deposits,"the paper says.
Note the Reserve Bank has designated ANZ New Zealand, ASB, BNZ and Westpac NZ as systemically important banks given their size and dominance of the New Zealand banking sector.
Key design decisions yet to be made
The paper says key design decisions yet to be made include;
1) whether resources that would be used for a deposit insurance payout will be: collected in advance of a deposit taker failure through the establishment of a deposit insurance fund (ex ante funding); obtained after a failure has occurred (ex post funding); or obtained via a combination of both
2) if ex ante funding is desired, whether the scheme’s premium rates will be adjusted according to the risks that members are assessed as posing to the scheme (i.e. a risk-based, or ‘differential’ premium system)
3) on what base (dollar) amount the scheme’s premium rates would be applied (e.g. total insured deposits or total deposits) and how often premiums would be paid (e.g. quarterly, bi-annually or annually)
4) if ex ante funding is desired, the target amount of such funding (i.e., the fund’s target size)
5) the operational approach for the Crown’s funding backstop.
The paper says the proposed approach would see the insurer use a combination of ex ante, forecasts made before the event, and ex post levies determined after the event, from deposit takers to fund the deposit insurance scheme’s obligations.
"It is proposed that the deposit insurance scheme establish a deposit insurance fund in order to help promote depositor confidence in the scheme’s ability to fulfil its payout obligations in the event of a member failure and to reduce the amount of funds the government may need to provide in a failure scenario. In addition, under an ex ante funding model, scheme members that ultimately fail and require deposit insurance payouts would have partially contributed to the cost of these payouts. By contrast, under an entirely ex post funding model, only the surviving deposit takers would incur the payout costs of a failed deposit taker. Finally, there may be practical limitations to how much and how quickly scheme members could pay premiums after a stress event, particularly if they are in poor financial condition themselves."
The paper also proposes a "target size" for the deposit insurance fund, The factors used to determine the target size of the deposit insurance fund include:
1) the ‘severe, but plausible’ failure scenario that the Reserve Bank, as the resolution authority, believes the deposit insurance scheme should be prepared for (recognising that this scenario could involve the concurrent failure of several deposit takers of various sizes, and that the size of the deposit insurer’s obligation for each failed deposit taker would not necessarily depend on the amount of insured deposits of each deposit taker, but also on the resolution tool used to resolve each deposit taker);
2) the ability of the deposit insurer to obtain (borrow) funds, if and when needed (recognising that it may be more challenging for the deposit insurer to borrow large amounts quickly);
3) acknowledgement that funds held in the deposit insurance fund – which would most likely be held in either cash and/or low-yield government bonds – could otherwise be used by deposit takers themselves for more productive purposes, such as lending to the economy.
The paper says the scheme should ultimately, but not immediately, use a risk-based or differential premium system to levy scheme member premiums. It says prefunding would enhance public confidence in the deposit insurance scheme and reduce the need to temporarily access public funds.
"Higher target funding also reduces the potential need for the deposit insurance scheme to impose higher levies on surviving deposit insurance scheme members in the period after a failure event."
The deadline for submissions on the consultation paper, which is being overseen by officials from Treasury and RBNZ, is October 23.
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