RBNZ to review Open Bank Resolution policy settings once depositor compensation scheme is launched

The Reserve Bank says it will review its Open Bank Resolution (OBR) bank failure tool once the planned depositor compensation scheme is rolled out amid suggestions from the New Zealand Bankers' Association (NZBA) that the OBR will remain the Reserve Bank's primary resolution and depositor protection tool for large banks.

Bank lobby group NZBA makes this suggestion in its submission to Parliament's Finance and Expenditure Committee on the Deposit Takers Bill. The Bill will introduce a depositor compensation scheme (DCS) to cover bank depositors in the event of bank, or non-bank deposit taker such as a building society, failing. Depositors will be covered for a total of $100,000 per institution, per depositor.

OBR is a tool that could be used if a bank failed, as an alternative to a liquidation or a bailout funded with public money, that would keep a bank open for business. There's a detailed explanation on how OBR could work here.

'An extremely complicated and novel issue'

Describing OBR as the Reserve Bank’s current primary resolution tool for large banks, NZBA says it largely exists outside of legislation. NZBA goes on to say OBR was developed by the Reserve Bank to make use of general statutory management powers and was created to provide bank customers with potential ongoing access to their money if their bank failed.

"NZBA understands that, after the Bill is enacted and the DCS is created, the Reserve Bank intends to maintain OBR as its primary resolution and depositor protection tool for large banks. Even if a deposit taker enters liquidation, receivership or resolution, DCS payouts are only triggered if the Reserve Bank determines to issue a notice under clause 193 of the Bill," NZBA says.

"Under the Bill OBR continues to be built from legislated powers provided to the Reserve Bank, including inputs from the DCS, but will itself remain as an internal process of the Reserve Bank."

"However, OBR is technical, not well understood by the public generally, and was created specifically to serve a system that did not provide a Government deposit guarantee or insurance scheme to depositors. OBR is also entirely unique to New Zealand. This means there are no examples of OBR and a deposit guarantee or insurance scheme successfully co-existing," says NZBA.

"At a base level, therefore, meshing OBR and DCS, as well as the Reserve Bank’s new general resolution powers under the Bill and the overlapping ‘statutory management’ powers under the Corporations (Investigation and Management) Act 1989 that we understand are proposed to remain, is an extremely complicated and novel issue."

"NZBA submits that further Reserve Bank engagement and work should be factored in to resolve core concerns, before the DCS comes into force," NZBA says.

'Introduction of DCS will enhance the depositor protection provided by OBR'

Asked about NZBA's suggestion that the Reserve Bank plans to keep OBR as its primary bank failure and depositor protection tool for large banks after the DCS is introduced, a Reserve Bank spokeswoman says OBR is currently the primary tool to manage the failure of banks with more than $1 billion in retail deposits, which covers small as well as large banks.

OBR provides for a failed bank to remain open for business, with customers able to access their accounts the following business day, the spokeswoman says. She says the introduction of the DCS will "enhance the depositor protection provided by OBR," with depositors protected up to $100,000 per depositor per institution as part of the OBR process.

"Once the Deposit Takers Bill comes into full force, the Reserve Bank will be required to publish a statement of approach to resolution on expected resolution strategies for dealing with failed deposit takers. As part of producing that document, we expect to undertake a review of the current OBR policy settings. This would involve seeking the views of industry and other stakeholders," the Reserve Bank spokeswoman says.

Deposit insurance fund 'won't be big enough' for the largest banks

Speaking in interest.co.nz's Of Interest podcast in August, international financial regulatory consultant Geof Mortlock suggested the DCS might not be used if one of the country's biggest banks failed.

Mortlock said he anticipates a deposit insurance fund will be built up through levies paid by deposit takers over seven to 10 years. It's value might ultimately be equivalent to 3% to 4% of the total amount of deposits insured throughout the banking system.

"Realistically would it be used to facilitate a resolution for a very large bank? I don't think so because it won't be a big enough size to really make much of a difference to the resolution of the largest banks. In the case of the largest banks the resolution would probably take the form of some type of recapitalisation of a slimmed down version of that bank, or some kind of business transfer," Mortlock said.

"And some of the funding would come from shareholders' funds being written down, maybe some from bail-in, depending on how that is structured, maybe there might be a need for a contribution from the deposit insurance fund, but that would have to be capped at what it would have paid out under a least cost depositor payout. And I think realistically for a large bank it would be quite constrained in what a deposit insurance scheme could really contribute."

Any need for a government bailout using public money would depend on the extent of losses.

"If the large bank that is failing has got a pretty significant capital base, and if it does have a tranche of contractual bail-in debt, that might be sufficient depending on just how big the losses are, that might be sufficient to finance the resolution of it without the need for government funding," said Mortlock.

"If the losses are very deep, and if the government did not want to go beyond any contractual bail-in debt, so if it did not want, for example, to apply a haircut to wholesale funds through a statutory bail-in mechanism, then some form of government resolution funding might be needed."

"If you look at Britain or Europe they have a separate systemic resolution fund that the large banks pay into designed to cover this sort of situation. Other jurisdictions such as Australia have an ex-post systemic resolution funding mechanism, so there's no ex-ante systemic resolution fund paid into by large banks in Australia. But the government has a pre-appropriation mechanism in law that enables funding to be used for, potentially, large bank failures," said Mortlock.

"But the aim should always be to minimise the amount of taxpayer funding that is put in, to try to fund the resolution as much as one can through the balance sheet of the failed entity."

In the Government's Half-Year Economic and Fiscal Update this week Treasury noted Cabinet has agreed to implement a DCS with a target timeframe of 2023/24. The Deposit Takers Bill has been introduced to Parliament and is at the select committee stage.

"The DCS will be administered by the Reserve Bank of New Zealand and will be fully funded over time by levies on licensed deposit takers," Treasury says.

"The funding framework for the DCS will be determined through a funding strategy and levy regulations set by the Minister of Finance. The funding strategy and levies are expected to be determined prior to implementation of the DCS."

The Reserve Bank expects the Bill to come into force in mid-to-late 2023.

What about bail-in standards?

Meanwhile, NZBA notes the potential for bail-in standards is included in the Bill. This is even though it emerged in February that the Government had decided not to give the Reserve Bank statutory bail-in powers.

Bail-in powers are designed to help authorities recapitalise failing financial institutions quickly, helping restore viability and capital ratios above regulatory minimums. 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 Reserve Bank’s recent capital review expressly removed all contractual bail-in instruments from recognition as regulatory capital, setting New Zealand apart from international practice on the basis that instruments with contractual bail-in were not considered appropriate in the New Zealand context," NZBA says.

"Further guidance (and, given the cost to deposit takers already incurred to move away from contractual bail-in, consultation) is needed if bail-in instruments are being considered for reinstatement."

"The Bill should also be clarified that any required contractual bail-in is not retrospective and will not affect existing instruments, either by deeming amendments to be made to the contractual terms or requiring issuers to change those terms. Without such clarification there is a risk of confusion and undue concern for existing investors," says NZBA.

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.

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