The Reserve Bank will receive new bank failure tools including statutory bail-in powers and statutory management oversight, the Government says.
The new tools will come via the Deposit Takers Bill, which flows from the long running review of the Reserve Bank of New Zealand Act.
The Government describes crisis management as a key part of the regulatory system’s financial safety net, along with prudential regulation and supervision, the Reserve Bank’s ability to supply liquidity to the financial system, and the incoming depositor insurance scheme.
"New Zealand’s legislative framework for bank crisis management, being largely based on statutory management, has not been meaningfully reviewed since the late 1980s. Under this framework, the Reserve Bank developed the Open Bank Resolution (OBR) policy to manage the failure of a large bank. The proposed reforms have been informed by international experience and subsequent post-global financial crisis (GFC) reforms. It is therefore timely to consider possible enhancements to New Zealand’s framework," the Government says.
Bail-in powers are designed to help authorities recapitalise failing financial institutions quickly, helping restore viability and capital ratios above regulatory minimums. Although there have been no bank failures in New Zealand in recent years, there have been banking crises in the past, and much of the finance company sector dissolved between 2006 and 2012.
Statutory bail-in is a resolution tool where unsecured liabilities may be written down or converted into equity. Bank liabilities typically include deposits and bonds. The idea is the costs of a deposit taker’s failure would therefore fall on its investors and creditors rather than the public purse. The Government says the Reserve Bank will have the power to direct deposit takers to maintain minimum amounts of liabilities subject to bail-in.
"Statutory bail-in is designed to help resolve large institutions by internalising losses in a manner that allows critical operations to continue and deposit accounts and other services to remain accessible without requiring taxpayer support. While the scope of bail-in is generally set broadly, insured depositors are often explicitly excluded, e.g. under the UK and European Union frameworks. However, those jurisdictions have adjusted their creditor hierarchy to provide a preferential status to insured deposits. I am not proposing to adopt such an approach here," Finance Minister Grant Robertson says in a cabinet paper.
"The appropriate treatment of insured deposits within this framework is still under consideration, but they will be protected by deposit insurance in any case. The scope of statutory bail-in will also be extended to writing down share capital and cancelling shares. The Reserve Bank will be able to require deposit takers to maintain minimum amounts of bail-inable instruments for the purposes of resolution planning."
In terms of fixed-term debt, Robertson says bail-in would only apply to securities issued after the date the Deposit Takers Act or any relevant regulations take effect.
"Prospective application enables investors to assess and price the risk of bail-in into their decision-making at the time of making their investment. This approach was supported by the banking sector. There are likely to be disclosure implications for bail-inable liabilities under the financial markets conduct regime. These implications will need to be worked through with the Ministry of Business, Innovation and Employment and the Financial Markets Authority," says Robertson.
"Bail-inable debt instruments will need to include contractual terms under which the holder of the instrument recognises and agrees that the instrument is subject to New Zealand law on bail-in, and the subordination of that instrument, as applicable, and agrees to be bound by the terms of a bail-in under those statutory powers."
Unsecured liabilities expected to be eligible for statutory bail-in include subordinated capital and debt instruments, any structurally subordinated debt issued to a holding company or a parent, and other unsecured debt such as wholesale debt and uninsured deposits.
Liabilities to be excluded from the scope of a statutory bail-in include secured liabilities such as covered bonds, client assets held by a deposit taker in trust or in a custodial capacity, tax liabilities owed by the deposit taker to Inland Revenue, and employer contributions to retirement savings schemes such as KiwiSaver owed by the deposit taker.
Robertson says resolution of a failed financial institution will respect the normal liquidation creditor hierarchy unless departure from this is required to maintain the stability of the financial system, including maintaining critical financial functions.
The potential introduction of bail-in powers for the Reserve Bank was raised in a 2019 government consultation paper. This noted there could be specific exemptions, such as insured deposits, with bail-in applied in a manner respecting the normal hierarchy of creditor claims. That means equity, the bank owner's stake, and other ownership instruments should fully absorb losses before eligible liabilities are bailed in.
Cabinet has also agreed to the setting of statutory objectives that the Reserve Bank must achieve in performing its function as the resolution authority, and on making powers available directly to the Reserve Bank that are currently only available to a statutory manager. Statutory management is designed to deal with complex corporate failure when normal rules of law and insolvency can't deal with the problems.
Powers currently available to a statutory manager that would be available directly to the Reserve Bank as the resolution authority include the ability to take control of an entity in resolution, to suspend payments, and to set up a new entity and transfer parts of the business of the failed entity to that new entity or another entity.
The Government says the Reserve Bank will get broad powers to intervene in the running of licensed deposit takers, balanced by clear statutory triggers for intervention, and safeguards, including decision points for the Minister of Finance.
"There are other policy matters to work through to support the decisions made by Cabinet, such as the introduction of an after-the-event compensation mechanism to compensate any creditor that resolution leaves worse off than they would have been in a normal liquidation, the ‘no creditor worse off’ safeguard," the Government says.
"For bail-in to be a credible resolution option, it is essential that there is transparency, before any event, on the scope of eligible bail-in instruments, i.e. liabilities subject to write-down or conversion. This will enable investors and creditors to assess the risks associated with, and the pricing of, liabilities potentially subject to bail-in. The nature of those minimum liabilities will be set in prudential standards, including any requirement for contractual subordination to other liabilities," the Government says.
The 2019 government consultation paper noted international experience with bail-in is in its infancy and has demonstrated both benefits and problems.
"The main benefit is the ability to recapitalise a bank while minimising the need for a taxpayer bailout. The Bank of England has noted other significant benefits, including avoiding operational challenges and legal consequences that can arise when transferring some of a failed bank’s business to a purchaser."
"Issues with bail-in include the need for robust valuations before and after the event, to support the determination of whether ‘no creditor worse off than in liquidation’ compensation is required and to mitigate the risk of creditor litigation. Bailing in foreign-held debt instruments also relies on either a contractual, and therefore enforceable, agreement to the resolution authority’s power to bail in, or recognition of the bail-in power by authorities in the jurisdiction in which the debt instrument is held," the consultation paper said.
The Reserve Bank's controversial existing bank failure tool, its OBR Policy, hasn't been reviewed as part of the Reserve Bank of New Zealand Act review. Implementing OBR would require government approval. You can see here how OBR might work should it ever be used.
The Deposit Takers Act will provide the Minister of Finance with the ability to direct the Reserve Bank on the management of risks to public funds in a resolution.
"In other words, the Minister will be able to direct the Reserve Bank to take an action in the course of a resolution provided that it is for the purpose of managing risks to public funds. The intention is that the Minister’s direction power is a residual lever only, to enable the Minister to manage risks to public funds if necessary. It should not be used for day-to-day intervention in a resolution."
Changes are also proposed to the 1989 Public Finance Act. This will address "a long-standing gap" in the Government’s financial crisis management framework by changing the Public Finance Act to authorise the Minister of Finance to approve expenditure in a financial crisis whether or not there is an appropriation in place.
"This authority will be similar to the existing authority to incur expenditure in a civil defence or health emergency. The authority will have several conditions attached to ensure that it does not raise expectations of taxpayer bailouts and will only be used as a last resort to maintain the stability of the financial system and the continuity of critical financial services when all other options were unlikely to succeed or not in the public interest," the Government says.
Decisions still to come in the development of broader bank failure powers for the Reserve Bank cover creditor safeguards, some crisis management issues, transitional arrangements to enable the deposit insurance scheme to be in place prior to the full commencement of the Deposit Takers Act, and how the deposit insurance scheme funding strategy will work in practice.
The Reserve Bank will be required to publish a ‘statement of approach to resolution’ setting out the expected resolution strategies for different types of deposit taker. The Minister of Finance will be consulted in the preparation of this. This, the Government says, is in recognition of the Minister’s interest in the wider economic and social impact risks associated with deposit taker failure and the management of such failures, as well as managing any expectations that public funds will be risked in managing a deposit taker failure.
Robertson's proposing that the statutory triggers for direction powers are where the Reserve Bank has reasonable grounds to believe that:
1 There is a contravention, or a likely contravention, by a licensed entity of its prudential requirements or obligations, including, without limitation, if the licensed entity is insolvent or likely to become insolvent, or is about to suspend payment or is unable to meet their obligations as they fall due; or
2 The business of the licensed entity is not being conducted in a “prudent manner”; or
3 The circumstances of the licensed entity are such as to be prejudicial to the soundness of the licensed entity or the financial system.
"Once an entity has been placed into resolution, the Reserve Bank as resolution authority would have access to the full range of resolution powers. These powers would include the ability to take full control of the entity in resolution or to appoint one or more ‘resolution managers’ to take control of the entity, as a statutory manager would under the 1989 Act," says Robertson.
An exposure draft of a Deposit Takers Bill will be prepared for public consultation, with introduction into the House expected late in 2021.
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