Reserve Bank distances its incoming bank failure tool from the Cyprus situation, says deposit insurance schemes blunt incentives to manage risk

By Gareth Vaughan

A new Reserve Bank policy that could be used to deal with a bank failure is "markedly different" from proposals to resolve the banking crisis in Cyprus, the central bank says, and would facilitate a rapid and orderly resolution of a collapsed bank.

The Reserve Bank's comments come after the Green Party yesterday, and Labour Party today, called, respectively, for deposit insurance and the protection of the first NZ$30,000 of all bank deposits. Separately, NZ First leader Winston Peters tweeted that his party was calling for a bank depositors’ guarantee scheme to protect the savings of "blameless Kiwis" during any financial crisis.

In a rare move, the Reserve Bank issued a statement today seemingly in direct response to the politicians reaction to the events in Cyprus and subsequent media coverage. Reserve Bank Deputy Governor Grant Spencer said deposit insurance wasn't a substitute for the incoming Open Bank Resolution (OBR) policy or any other bank failure resolution tool.

“It is a separate issue altogether. The New Zealand Government has looked hard at deposit insurance schemes and concluded that they blunt the incentives for investors and banks to properly manage risks, and may even increase the chance of bank failure," said Spencer.

“Deposit insurance is widely used in Europe, including Cyprus, but hasn’t prevented banking failures, as we saw during the Global Financial Crisis.”

Overnight the Cypriot Parliament rejected a European Union-International Monetary Fund €10 billion bailout deal. It proposed a levy of 6.7% on bank deposits of up to €100,000 and 9.9% thereafter, and would see depositors exchange a proportion of their deposit for a shareholding in their bank.

'Greens irresponsible'

Meanwhile, a spokesperson for Finance Minister Bill English, who is overseas, told interest.co.nz: "It is irresponsible for the Greens to be creating unnecessary concern when nothing has changed for people who have bank deposits. In fact, the OBR makes depositors better off, not worse off, in the very rare and unlikely event of a bank failure."

"It is also important to note that New Zealand’s banks are among the strongest in the world,” English's spokesperson added.

Meanwhile, Spencer said depositors’ money in New Zealand has only ever had temporary guarantees, such as under the Crown Retail Deposit Guarantee Scheme from late 2008 to December 2011.

“If their bank fails, depositors have always needed to understand that deposits are not guaranteed. What OBR does is facilitate a rapid and orderly resolution of a bank failure - it does not change the fact that depositors and other creditor funds are at risk," said Spencer.

“Fortunately, bank failures in New Zealand are rare. The major banks in New Zealand are amongst the most highly rated (in terms of their credit ratings) in the world. We saw their resilience through the Global Financial Crisis.”

Spencer said the alternative to OBR is for the Government to bail out banks with taxpayers’ money, which would come with potentially enormous fiscal costs, or to close the failing bank, which comes with large economic costs.

“The Cyprus situation is very complex, it is a systemic collapse and not a case of just one institution failing. It must be seen in the context of the broader European sovereign debt and banking crisis. Further, the Cyprus banking system is dominated by a large foreign deposit base, from Russia in particular," said Spencer.

NZ and Cyprus 'incomparable'

And echoing Spencer's comments, English's spokesperson said the situations of New Zealand and Cyprus are incomparable.

"Cyprus is broke. New Zealand is experiencing moderate growth and as recently as yesterday the IMF said that the Government’s approach was striking the right balance. The World Economic Forum Global Competitiveness Index recently ranked New Zealand’s banks third in the world for soundness. They are well capitalised and new capital requirements will make them stronger still. Nothing has changed."

Bank deposits are not guaranteed and if a bank fails, there are no good options. The alternatives are either a government bailout, which leaves taxpayers carrying sometimes enormous losses – or liquidation," English's spokesperson said.

"OBR provides another tool in the toolkit. Before it was used the Government would consider a wide range of factors, including the impact on depositors. The OBR provisions are in line with regimes being drawn up by other developed countries, except that New Zealand does not support a deposit insurance scheme. They are difficult to get right and the Government’s view is that, perversely, such schemes may even increase the risk of failure because neither the banks nor depositors have the same incentive to properly monitor and manage risk."

The spokesperson added that some of the reaction to the Cyprus situation was because there is a deposit insurance scheme in place there, yet it was not going to protect depositors from the levy.

"OBR actually helps depositors, because it allows for the bank to reopen the next day (hence the 'open bank' in the title) and means that customers would be able to get full or partial access to their accounts and other banking services while an appropriate long-term solution to the bank’s failure is identified."

"Some of their deposits could be frozen, but the remainder would be available and would actually be government guaranteed. On the other hand, if a bank went into liquidation, that process could be complex and time-consuming, during which time customers would not have any access to their funds or banking services," the spokesperson added.

The initial losses would be borne by a failed bank’s shareholders.

"The OBR is not intended to be the only option in the event that a bank gets into difficulty, but it is an option. Apart from liquidation or a government bail-out there may, for example, be circumstances in which a private sector solution is available."

So what is OBR?

The Reserve Bank is moving to add the OBR policy to tools it could potentially use in the event of a bank failure.

The implementation of OBR would see all unsecured liabilities that rank equally among themselves, including deposits, having a portion frozen. The Reserve Bank says the OBR policy could save taxpayers' more than NZ$1 billion regardless of whether there is a bank failure or not.

All locally incorporated banks with retail deposits of more than NZ$1 billion are required to pre-position their technology and banking systems to meet Reserve Bank OBR requirements by the end of June this year. This includes banks ranging from newcomers the Co-operative Bank and Heartland Bank right through to the country's biggest bank, ANZ New Zealand. See all our OBR related stories here.

The Reserve Bank says the key processes of OBR would include the following phases:

• imposition of statutory management;

• closure of access channels and freezing liabilities;

• freezing a portion of pre-positioned customer accounts and freezing all other creditors’ claims in full (overnight process);

• bank re-opens for core transaction business and allows customers to access the non-frozen portion of their funds;

• release of an equivalent portion of all other liabilities in due course;

• release of additional frozen funds, if available, following more accurate assessment of losses; and

• decisions on the bank’s final resolution.

(Updated with comments from Bill English).

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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36 Comments

He forgot to add "we don't want to do anything that impacts on bank profits or shareholder dividends"
 
Deposit insurance - affects profits. If you let us stay fat and profitable we won't fail
 
Higher capital requirements - affects profits. Why prepare for a financial crisis every 10 years or so. So onerous!
 
"We saw their resilience through the Global Financial Crisis.” I think the wholesale and retail deposit guarantees helped and the billions in emergency liquidity from the RB and Fed without which the banks were toast.
 

The New Zealand Government has looked hard at deposit insurance schemes and concluded that they blunt the incentives for investors and banks to properly manage risks, and may even increase the chance of bank failure," said Spencer.
 
If and only if you are right Mr Spencer, why is it the case you openly court the local banks with RBNZ/Govt.created NZD credits, swapped for inordinately cheap, NZ bank, borrowed USD?
 
View Section 10, line:  FX Swaps and Basis Swaps and
 
Government liability column: Feb 2013  $9.427 billion - how much do you swap out to the banks in return for cheap USD collateral? - all of it?  - do the banks not pay a paltry net ~2.75% for such liquidity funding?
 
The moral hazard in total could not be less blunt than the comment I lodged on interest .co.nz yesterday.:
 
It reduces the moral hazard of expecting a government funded bailout," Hawkesby said.
 
Nobody seems to mind the execution of moral hazard undertaken each time one of the Australian owned NZ banks secures super cheap funding in the US rule 144 market probably from a primary dealer credit recipient of freshly Fed monetised US Treasury debt.
 
Shall we move on to the, no doubt approved, recent supranational NZD Kauri Bond issuance which is swapped to NZ banks liabilty ledgers after inordinately cheap NZ Bank USD funding is swapped to the issuers account. Read article
 
Where are the incentives to curb risk excess when access to super cheap printed USD is available to swap with cheaper credit wrapped NZD issuance?

Seems worse than the Cyprus model - RBNZ arent even naming the % of the frozen amounts.
'release of additional frozen funds, if available'
Bank depositors are unsecured creditors - better to be a borrower than a saver - yet again.

You do remember that outstanding loans of a bank are on it's balance sheet as assets - and - they can be recalled on demand either by that bank or whoever they sell those assets to. They wont care if you have the money or not and can take your house.

Yes and if you look at the paper by Geoff Bertram and David Tripe in Victoria Policy journal, they calculate that after taking out all the secured creditors there is approximately 58% remaining for the liquidators to access. So who knows what percentage ordinary shareholders would eventually have taken off. Reserve Bank of New Zealand is surely doing great work on its spin, together with Bill English's spin doctors. Yet it in this time they have not sought to inform the public properly or even go on record as insisting each bank informs its customers. 
Cyprus has shown us it is a total political loser of a policy to hit small shareholders who up to now have been out of bounds.

Maybe Spencer could explain to the public where they rank in the queue particularly vis a vis covered bonds

Do they really think deposit insurance is meant to prevent banking failures? Or are they trying to confuse the public. Same thing with the insurance being taxpayer funded instead of by the banking sector and liquidation beeing "bad" for the economy.
Looks like we get  confirmation after confirmation the authorities are not to be trusted.

We are being deliberately misled. More bluntly, lied to.
 
And they are not even good liars.

Principles of Modern Banking :
1. Never trust the Banks (no matter how big or nice they look and feel)
 
2. Never trust the politicians (no matter how nice or feelly they are)
 
3. Never trust the systems.
 
4. Keep only minimum cash required for your business cashflow.
 
5. Have multiple bank accounts with multiple banks
 
6. Have overseas Bank account with internet access.....
 
Do I need to list more ???

I dont understand all this banking jargon and stuff ... but ..
 
my interpreation of the difference between OBR and Deposit Insurance is

(a) the cost of deposit insurance would be born by all bank customers, depositors and borrowers
whereas
(b) If an OBR event occurs (due to the borrowers) the OBR cost is worn by depositors only

The absolutely appalling performance by the Reserve Bank and The Treasury in the recent NZ retail deposit scheme should not be used as excuse for not having a proper retail deposit protection for depositors.
The catch-cry by politicians and economists and financial commentators of all sorts in recent years is that NZers are not saving enough.  
And now the same people are blaming depositors for being greedy in wanting some slight security for their savings and told that it is their responsibility to determine the risk involved with each bank.    
And banks are allowed to expatriate their profits without hinderance - and without consequence when they over-extend.    The depositors will pick up that risk.
Why save anything is now the real moral hazzard.
A sad state of affairs.
 
 
 
 
 
 
 
 
 
 
 
 
 
 

billsay. the rbnz had the opportunity to diversify away and let the finance sector consolidate which would have created some real competition for the big 4 australian banks. they didn't allow this to happen by taking the shotgun approach. most of this crumbs have been absorbed into the banks and relent into the housing market thereby skewing things further. we are now in the hands of australia. no longer in control of our destiny. profits are moving off shore. margins  for investors squeezed, and bank margins continue to rise unchecked. the risk profile of investors here as taken a massive step backwards with the actions of rbnz over the past couple of years.

Jim Sinclair on OBR:
 
"The IMF is at the root of this in Cyprus and in New Zealand, considering them too small to matter, but the IMF had their head handed to them today."
 
"Such a move by New Zealand is extremely high risk... Confidence that no depositor will suffer is the glue that has held this system together. Break that confidence, and you break the system."
 
jsmineset.com

I have to disagree there.
The bailout of Greece was a political event organised by EU politicians, not the IMF.
These politicians decided they would "solve" the Greek problem by forcing (oops I mean asking) private bond holders to take a write down.
Cyrpriot banks were those bond holders and as a direct result are insolvent.
 
The fact is those Cypriot banks need money but the rest of Europe doesn't need the those Cypriot banks.

 
Hi Gareth,
There seems to be much ado about nothing when it comes to the OBR.  The noise being generated by the likes of Russell Norman (who incidentally I voted for), the Labour party and the large lunatic fringe interest.co.nz has managed to attract over the years seem intent on stirring up controversy and conspiracy theories rather than actually looking at the cold hard facts. 
The facts are the OBR is a fantastic policy.  If you look back over New Zealand’s history, although we haven’t had a deposit guarantee for the vast majority of it, the Government has in fact protected deposit-holders and the wider community from the impact of a failed bank or Corporation.  BNZ in 1990 ($1b), Air NZ 2002 ($885m), South Canterbury Finance 2010 ($1.2b), AMI 2011 ($500m).  Our track-record points to all the large banks having an implied government guarantee.
This begs the question, is this the right approach for tax-payers, investors, shareholders & institutions.  Can the Government afford to bail out one of the big four banks who have assets in excess of $60b each?  Does a deposit guarantee drive the right behaviour for investors (deposit holders)?  Does a guarantee result in institutions acting in a responsible and sustainable manner?  Does a guarantee not privatise the profits and socialise the losses?
In regards to the Government’s ability to bail out  a large bank, the more accurate question is at what cost.  A $60 billion bailout would be 30% of GDP, the flow-on effect to credit ratings, availability of credit, interest rates charged to mortgage holders and a subsequent grinding to a halt  of the economy as has happened in Ireland and Spain is unthinkable.  The alternative as seen in Iceland where deposit holders weren’t made whole but where the economic recovery has been swift and the Governments books protected appears much more palatable.  We aren't Cyprus either, we dont have an ECB there to lend us a hand.
If we look at the impact our temporary explicit Government guarantee had it did four things.  It protected our Financial Industry from a liquidity driven collapse (tick), it cost the taxpayer a substantial amount of money – over $1b (cross), it drove an increase in risky behaviour by both investors and institutions (cross), it made whole a depositors (?).  The analysis has already been done by the likes of Brian Gaynor, but South Canterbury Finance is a recent glowing example of the dangers of a deposit guarantee and the disturbing impacts to behaviour of both deposit-holders – who according to Norman are unable to “ judge the soundness of their bank” – and the institutions themselves.  After the institution of the deposit guarantee money flocked to the highest returning investments as they all had the same risk – a sovereign AA guaranteed one.  In this case it was Finance companies, who had previously been abandoned after the collapses of their peers.  Within the space of one year from the enactment of the guarantee, South Canterbury Finance’s deposits (borrowings) had grown $418 million or 30% and lending by $308 million.  Not only that much of the lending was into non-core activities – property, and not even in the South Island.
The “positive outcome” of depositors being made whole is lost when weighed up against their own questionable behaviour and the cost to the taxpayer.
On the other hand I believe OBR is the best option there is for dealing with what is a lose-lose situation.  Government finances are protected, investors are forced to question the place they hold their funds, institutions will be motivated to evaluate risk more thoroughly without a Government backstop and both the risk and return sits with shareholders and deposit-holders – where it belongs and most cash is still evailable to keep the sqeaaky wheel oiled.
 
Asher

You need to read about the Anstalt bank in Austria 1931. The depositor panic destroyed the currency, assets and caused the economy to crumble and unemployment to sky rocket.
 A run on a bank won't just affect depositors it affects everyone.
The RB needs to get banks to take less risk and be more prudent with their lending. A bank collapse will be catastrophic  for our economy.
 
>>>>
 
In it, we see the ordering of the debt supercycle - what we'll call here the debasement cycle - quite clearly: Lax lending standards and easy money led to a credit bubble, eventually resulting in bad loans, touching off major losses at too-big-to-fail financial institutions without adequate capital, followed by government guarantees of the banks (i.e. bailouts), and ultimately resulting in a collapse of the monetary system.
 
The problem was not tight money in the critical years that began the depression starting in 1929, but all of the easy money - the real estate bubble, the stock market bubble, and the explosion of consumer spending - in the decade prior that were consequential.
Like today's crisis, this was a fatal conceit that we could have everything by cheating the laws of nature; that there is a shortcut to prosperity wherein savings and hard work can be averted.
 
http://www.realclearmarkets.com/articles/2012/08/22/anstalts_shadow_loom...

Andrewj I tend to agree with you around the cause of the problem.  However given the current situation the OBR is the lesser of evils within the range of options available.  I think if a bank opened the next day with 80% of your funds still available you are much less likely to have a country-wide bank run on all institutions.
 
Mish who also takes your position on easy money was able to see "Of all the central banks, the Reserve Bank of New Zealand has the most sensible policy for the most sensible reasons of all the central banks."
Read more at http://globaleconomicanalysis.blogspot.com/#B4FwLeHYQ3YfbHP7.99
 
 

This is more like it.
 
Shorter.  Easier to read.

Asher,
several points

  • People are easily bored on the internet. More than a screen of writing, unless witty and entertaining, is ignored.  And if there is a whiff of sychophancy towards politicians or the banks then your audience may gag and stop reading. I stopped reading yours shortly after reading the following:
  • The facts are the OBR is a fantastic policy.
  • To which I thought. Jeepers. No need to read further.  In Your Opinion the OBR is a fantastic policy. In other peoples opinion the policy is a Turd that was never fully polished and there is much doubt as to whether there may be any pearls lurking beneath the surface.  You lost me when you presented opinion as fact, when, in my opinion, your opinion is tending towards sychophancy

Cheers

 
Quite true Gibber.  Poor line written early in the morning OBR is great is opinion not fact.  I did support my opnion by facts, but nonetheless criticism valid.  It wasn't my intention to do one solid block, but again agree very hard to read...I will keep these in mind for next time.
 
Cheers

Good post Asher.  A few carraige returns helps to split it up.
 
The truth is more important than entertainment value.

The truth is Asher better not work another day for renumeration denominated in NZD, as he /she will have no place safe to store the tokens of that effort.
 
I myself have only worked 20 years out of 60 so I am willing to take a haircut on my savings - and anyway they were made with the limited effort of guile and little else.
 
Not so for my aged parents and their cohort...I wish anybody well that can steal and regale us with the outcome after depriving them of their hard earned savings.

What alternative are you suggesting?  Governments bail out every poorly run failed bank so that deposit holders are made whole?  The OBR is not stealling Stephen, in the event of a failed bank the moneys already stolen, gone, paid out to owners, managers, wasted on low quality loans etc.  The OBR is a structured approach to liquidation without resorting to dipping into everyones pocket (ie. the govts) to pay back deposit holders. 
 
Just remember shareholders lose everything first and then unsecured creditors (deposit holders).  A normal liquidation like the Finance sector ones we have seen in NZ, the deposit holders lose access to 100% of their deposits for up to years whilst the accountants work out who gets what.  This is not a fantastic solution for anyone young or old. 
 
The OBR enables the bank to free up deposits (70% who knows) and then refund the rest of the 30% if they have assets to support it.  Stopping a bank getting to this point is the ideal solution, but not having a process which deals with emergency situations is just foolish.
 
 

Stephen, in the event of a failed bank the moneys already stolen, gone, paid out to owners, managers, wasted on low quality loans etc
 
Exactly -lets put the RBNZ to work to curb such ridiculous situations as this recurring at any lending point in the future.
 
Stock trucks had already rolled in to remove his 300-cow dairy herd, which could be sold by the receiver to recoup some of the $5.6 million in loans and fees Mr Gray owes Rabobank.

But thats a lot of debt and only a tiny farm, he had big ideas but only little arms.

Shame the bank was silly enough to embrace his dreams with depositors money -not much different to Auckland housing.
 
I guess Telecom executives have little choice but to cut back on staff to raise their incomes to service exclusive mutlimillion 110% LVR mortgaged homes -  but not much good will come of the smaller but nonetheless collectively significant pending mortgage failures of the dismissed. 
 
Do depositors deserve to wear the costs of this apparent suicidal stupidity.

Sorry as an aside youve worked 20 out of 60 years...are you planning on working till your 80 or did you start young?
 
Cheers
 

None of the above.

OK if you are going to argue for OBR, and you admit in the end a bank failure would be a lose-lose situation, what are you as a person going to do to help get a situation where banks don't get into trouble like this?
Banks are structurally very precarious. These crisis have been happening for decades, long before the GFC. According to IMF data, there were 145 banking crises, 208 monetary crashes and 72 sovereign debt crises between 1970 and 2010. This represents a total of 425 systemic crosses, an average of more than 10 countries getting into trouble every year. 
We in the New Economics Party have launched a petition calling for a Parliamentary Enquiry into the best methods of making banks stable. We are suggesting that such an enquiry includes consideration of the paper called The Chicago Plan Revisited by Jaromir Benes and Michael Kumhof, which works out a great method to avoid bank runs altogether. They are building on the wisdom of economists like Irving Fisher, Milton Friedman and Henry Simons and revisiting a plan from the 1930s.
Neither taxpayer bailouts, government guarantees or customer bailouts would be necessary if the The Chicago Plan Revisited was implemented.

I think there can be no doubt people no longer have the rock solid faith they once had in the banking system. The result will be a watering down of bank deposits over time.
Cheap US money will fill the gap.....for as long and much as is necessary.
Cheers

The Open Wallets Resolution: the sneaky little miscreants....
Covered bonds and now the 'OBR' are setting a nice little precedent in the type of behaviours we should expect from our bankers, aided and abetted by our Govt. MF Global segregated accounts style of appropriation. And now the placeating platitudes being trolleyed out to justify theft.....errm I mean 'contribution' by savers.
 
While we should of course be saving this is yet another hyprocritical mixed message that while saving is 'important' savers and savings are actually sacrificial....aka available for misappropriation. Is this the alterior motive to Kiwi Saver? Pools of $ for bankers to dip into.
 
If we're now all compulsory 'investors' then the risk parameters have changed and the interest rate should reflect that. And then make sure 'Home Loaners' are prepared for a 'contribution' as well if it's going to be a fair system...just add it to the tab with interest.
 
If it wasn't for the Cyprus situation it would have all been nicely packaged away for a 'rainy day'. Thanks to BH for being observant on this.- I must admit my eyes glazed over at yet another euphamistic banking acyronym and this is the 'clever' trick and also illustrates the stragetic disengenuousness of the processes in play. Obviously the marketing departments thought hard about the packaging for con-sumption. -In the parlance of Sore Loser (great posts btw)
 
Is NZ being used as a test bed for these practices?....trying it out on an a generally compliant and trusting nation first? A confidence trick essentially cashes in trust equity that's been built up..but generally only works once so you have to loot and run so to speak. Which seems to be increasingly the style that we're seeing and the open looting by Bankers and their Governments become bolder.
 
If anyone missed it..."Plunderball". Now you're playing whether you want to or not.....
 
http://www.golemxiv.co.uk/2013/03/plunderball-the-new-euro-banking-game/

s

yes 'typically risky housing ventures'
but note that the Australian banks, in Australia, require a separate mortgage insurance for any house loan > 80%  which will repay the bank all monies owing if the loan goes into default.    
http://smh.domain.com.au/real-estate-news/safety-net-comes-at-a-cost-for...
So why does the RBNZ permit unimpeded lending at 90% or 95% ?
The OBR is becoming the moral hazzard.
Depositors are not the cause of any of the problems.    Banks should only loan at 80% - or should require the person taking out the loan to bear the responsibility (via insurance) if must be.
No wonder Australian depositors are covered up to A$250,000 per account while the overpaid NZ bureaucrats in RBNZ & Treasury continue their academic and nonsensical approach in asking depositors to do the evaluation of the banks and their risks.  

“Fortunately, bank failures in New Zealand are rare. The major banks in New Zealand are amongst the most highly rated (in terms of their credit ratings) in the world. We saw their resilience through the Global Financial Crisis.”
In 1990 the New Zealand people had to bailout the BNZ to the tune of $380 million dollars to avoid a collapse.

 Greenman......You might find the banking fraternities AUS / N.Z resilence during the crisis had more to do with a flood of hot money seeking sanctuary, combined with a property market gone hog wild  in stark contrast with Globaly developed economies...
 Don't forget they are susiduaries of greater organisations , always exposing them to risk offloads.

Don't forget they are susiduaries of greater organisations , always exposing them to risk offloads.
 
And also to not forget the covered bonds which now allow cherry picking mainly from overseas of the good assets left in a NZ bank in trouble - and the RBNZ move to put depositors at increased risk with RBNZ opposition to deposit insurance.
The same Australian banks have A$250,000 insurance per depositor per bank - while the RBNZ opposes such in NZ.