PM John Key and the RBNZ are wrong in their opposition to deposit insurance, says NZ-based advisor to international deposit insurers' body

PM John Key and the RBNZ are wrong in their opposition to deposit insurance, says NZ-based advisor to international deposit insurers' body

By Gareth Vaughan

Two key arguments used by the Reserve Bank and Prime Minister against the introduction of deposit insurance are disputed by international deposit insurance expert and University of Auckland Professor David Mayes.

Mayes told interest.co.nz there's limited evidence to support the Reserve Bank's argument that a deposit insurance scheme would increase moral hazard, and make banks more susceptible to failure. And he's even more dismissive of John Key's view that deposit insurance would prove too costly for consumers because banks would pass on the cost of any deposit insurance levy to consumers.

"The costs of deposit insurance are trivial," said Mayes. "In particular if deposits are not insured banks have to pay more for them so in many respects it (deposit insurance) pays for itself."

And in terms of the moral hazard argument; "There is only limited evidence of such moral hazard. On the whole deposit insurance systems cope outside major financial crises. They are designed for the occasional failure not the wholesale collapse of the financial system."

Mayes is Professor of Banking and Financial Institutions at the Auckland University Business School. He has been an advisor to the Bank of Finland's board, and Professor of Economics at London's South Bank University. He has also worked as chief economist at the Reserve Bank of New Zealand. His comments came after interest.co.nz contacted the International Association of Deposit Insurers (IADI), with questions about the Reserve Bank and Key's comments. Carlos Isoard, IADI's Secretary General, replied that it was IADI's policy not to comment on domestic matters, but Mayes, a member of the IADI Advisory Panel, had offered to respond.

The IADI represents 67 deposit insurers from 66 jurisdictions. It's based at the Bank for International Settlements in Basel, Switzerland.

In a speech last week, Toby Fiennes, the Reserve Bank's head of prudential supervision said New Zealand was the only OECD country without explicit deposit insurance for reasons mainly to do with moral hazard and the sheer difficulties of defining boundaries and pricing. The Reserve Bank believed it better to keep risk of failure very low, including through a strong regulatory regime, than to build structures that could distort incentives and behaviour, said Fiennes.

'Big banks don't expect to be allowed to fail'

Fiennes also went on to say that deposit insurance isn't always effective in preventing bank runs by retail depositors, noting Britain's Northern Rock suffered a "classic retail run" in 2007, despite there being a deposit insurance scheme in place.

However, Mayes said it's not clear that there is much distortion except in developing countries or emerging markets.

"The main (New Zealand) banks do not expect to fail (and) neither do they expect to be allowed to fail," said Mayes. "I doubt if they believe OBR (the Reserve Bank's Open Bank Resolution policy) will be applied."

"Northern Rock experienced a run because the insurance was partial. After the first £2,000 the depositor took a haircut of 10% and the upper limit was £35,000, well below present limits (which are £85,000). No one now believes co-insurance of this form works and almost everybody except the British didn’t believe it worked then," Mayes added.

"In any case this is a very strange example as it illustrates the problems from not having deposit insurance rather than having a well designed scheme."

Fiennes also said deposit insurance is hard to price accurately and fairly, and comes with difficult boundary issues. He questioned whether it should just be for banks, or whether the net should be spread wider to include finance companies, building societies and credit unions.

But Mayes said everybody faces this problem and they make judgements about how to scale risk weighted contributions.

"No doubt the balance is not right but it applies the right sort of incentives to become less risky. To my mind all deposit taking institutions should be properly supervised and hence eligible for insurance. We (New Zealand) are in a small minority in thinking otherwise," said Mayes.

"Those who don’t fail always contribute more than those who do - this is the nature of insurance. It is normally only the small who fail outside the global financial crisis of course. Large banks get a considerable subsidy as it is so this only rights the balance a little."

'OBR needs deposit insurance'

An important issue, Mayes added, is that deposit insurance is not an alternative to OBR. One of the arguments the IADI makes for deposit insurance is that ordinary small depositors can't be expected to monitor, or indeed be able to monitor, the banks with whom they have deposits.

"OBR is a sensible idea as it resolves the problems in the large banks swiftly with minimum recourse to the taxpayer. But it only makes sense with deposit insurance. Then there will be no run if people hear a rumour about a bank being in trouble. As it is you will get the Northern Rock problem," Mayes said.

Both Labour and the Greens have pledged to re-introduce deposit insurance should they get into government. Labour's finance spokesman David Parker says a Labour-led government would ensure the first NZ$30,000 of all bank deposits were protected and not subject to a haircut in the event of a bank failure. And Greens co-leader Russel Norman says NZ$100,000 is a "fair level" of protection for New Zealand savers. In his speech Fiennes did say deposit insurance could "easily" be accommodated within the central bank's toolkit.

New Zealand had deposit insurance through the Crown retail deposit guarantee scheme, which ran for 38 months from October 2008 until the end of 2011 and cost taxpayers' around NZ$1 billion largely due to the demise of South Canterbury Finance.

Meanwhile, New Zealand's registered banks are required to pre-position their systems by June 30 this year so the OBR process can operate, if it's ever activated. It's touted as an alternative the Government could use in the event of a bank failure to a liquidation or taxpayer funded bailout. The Reserve Bank says OBR's primary purpose is to ensure the financial system continued to function as smoothly as possible by keeping payment systems open so people and businesses could transact with each another.

The de minimis

Under OBR a troubled bank would be placed into statutory management. The statutory manager would freeze the bank’s liabilities including deposits. The  idea is to release customers' transaction accounts as soon as possible. So instead of their accounts being frozen for a lengthy period as they would under a conventional liquidation, a proportion of their money would be unfrozen and released for the start of the next business day, with a government guarantee to prevent further runs on the bank. The frozen funds would then be released in whole or in part as possible.

Under OBR shareholders would be the first to lose their investment. Once shareholder funds were gone, subordinated creditors would be next to wear losses, followed by all other unsecured creditors.

There is, however, scope for a “de minimis”, potential insurance of sorts. This would be  a nominal dollar amount in relevant customer liability accounts protected from haircuts and fully available to account holders when the bank reopens the next business day after the appointment of a statutory manager. The purpose of this de minimis is to help customers with limited resources fund everyday expenses. The Minister of Finance would decide whether to set a de minimis amount, and determine what this amount is if one is set.

The table below, from a Reserve Bank consultation document, demonstrates how the de minimis would work.

*Note, the video interview was recorded after this story was written, so although the material covered is largely the same, David Mayes' quotes in the story don't match his comments on the video identically.

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It is more than extraordinary that the RBNZ and the PM refuse to seriously consider deposit insurance.  The very same Australian banks which operate in NZ have no difficulty in applying deposit insurance of A$250,000 per depositor per bank in Australia.   
 
In NZ, there is deposit insurance of NZ$ zero dollars per depositor per bank from the very same banks - based on decisions by the NZ government and the RBNZ.  It is time for this unique NZ approach to be seriously challenged and reconsidered.
 
 
 

Could be the government is not in a financial position, to make good on deposit insurance.

We are inclined to agree, if you look at it this way.
As we mentioned earlier looking back at SCF, the gtee got that last wod of money into SCF, letting insiders take last slurp.
Then there were the crown a ledged fibbing hence the Timaru defendents.

Galling to see Lucky ask to be excused.

So govt & treas. Could be saying never again.....

Internationally they would be looking at the Irish example and the pressure to bail out the bond funds. Could be saying noway-Jose....

And 80's example of bnz.

Looking back it seems a dep insurance scheme works well when not needed, however once triggered it ends up costing several times what you thought worst case, as every last player looks to bust thru the door and grabb the loot.

Henry, who is "we"?

Well usually it's Queen Elizabeth Gareth...if you mean in the first person, outside that Henry could be in the Ministery......slip of the object pronoun....maybe..?

I did wonder if he was using the royal we...

Yes I'd guessed that Gareth , I was just being mischievous......I'm stll waiting for a bite on the first person , third person...with baited breath.

More than bloody likely A.J.......the asset run will just break surplus, but....now we have the AU with their own surplus shortage problems and some of that problem is going to find it's way onto our books....
 Sweet baby J....line me up another Chinese dignitary to lick.

Under most deposit schemes abroad, the banking sector bails out failed banks, not the government.

There are a variety of deposit insurance schemes, but  NZ (RBNZ and the Government) is unique in the world in putting the onus on depositors to assess the risk of individual banks and then ensuring it's the depositors who then are penalized for banking failures.  
 
It is the Government's responsibility to regulate the banking industry in a prudent way, rather than to put depositors at risk with the OBR without deposit insurance of some sort.   
 
 

Anyone who believes the RBNZ can act fast enough to protect banks operating in NZ from the Tsunami of failures that will hit overnight from offshore, is stark raving stupid. If you have savings...spread the cash across several banks...stay short term.
The OBR is enough of a threat to ensure any news of trouble will quickly become a crisis..that is the fault of the OBR silly game.
OBR makes matters less stable.
 

They will not do it kimy...they will "play the game" as Spencer urged and pump the created credit into the bubble in rural and residential property..while driving down deposit rates leaving savers with nowhere to go but into property as well....this is the madness this govt has been happy to run with.
An increasing % of ppl understand that holding cash is for the old and weak...the message is PROPERTY....freehold is best...and more than one is better....and a family trust is paramount...and working beyond the reach of the IRD is necessary and smart living.
This is why the lifestyle plots are rising in value...the weak will end up renting in the high rise Auckland slums that will spread south.
Long live the power of the banking bosses for they rule the country.
 
 

Just you hold on a minute there Kimy. Sheesh. Next you will be wanting banks to match their funding profile to their lending profile. I mean, come on now, you can't seriously want a banking system based on sanity can you?

Banks only exist and remain mandated by the government to borrow short, lend long. Anything else would be considered unprofitable - matched books are rare indeed.

Yeah... isnt borrwing short term and lending long term a strategy for maximising profits.
ie... They are playing the yield curve game.
Also..yeah... inherently risky...    but that is why we have Central Banks..
No one else would be mad enuf to borrow short term for a long term project....    ( unless they had a Cenral Bank as a lender of  last resort )

Exactly - insurance companies were at one time restricted to matching assets to contracted liabilities - not sure same exists.

When I skim through the commentary on this one I can't believe how much banks have changed from what they were set up to do. They were set up as somewhere more secure than the mattress for ordinary people to put their savings. The banks then were able to put that money to work, paying the depositor a fee (interest).
Now that money is defined as a "major liability"!!! Why then do I have to use a bank at all? Why when I ask for my money in cash do I get told, sorry it msut be paid into a bank account! How do I get off that merry go round?
Can we take banks back to the basics? as Mayes said "neither do they expect to be allowed to fail". By what right do they get to believe that they are more important to society than the people who make up that society?
As organisations and individuals, they must be more accountable. 

Exactly. They are supposed to be a better alternative than storing your money under teh mattress. Depositors aren't investors either, becuase the return they get after tax is largely just in line with inflation anyway. If people wanted to invest their money, you don't put it in the bank. Perhaps we need a government run bank that is government guaranteed. Otherwise if banks can take 20-30 of peoples money, people may as well justy spend that money. No incentive to save.