Auditor-General says Treasury hasn't documented the analysis and thinking behind its South Canterbury Finance oversight as she suggested in 2011

By Gareth Vaughan

Treasury's response to the failure of insurer AMI was carefully thought out as it put to work lessons learnt from running the Crown retail deposit guarantee scheme, the Auditor-General says.

But she also says Treasury hasn't documented the analysis and thinking behind its South Canterbury Finance oversight as she asked three years ago.

The Auditor-General's office has published a report that looks at Treasury's progress on recommendations from a 2011 Auditor-General's report on the implementation and management of the Crown retail deposit guarantee scheme.

In this fresh report Auditor-General Lyn Provost notes of four recommendations made to Treasury it hasn't carried out the fourth recommendation, which was to document its dealings with South Canterbury Finance. And nor has Treasury carried out a formal post-project review of lessons learned from the Crown retail deposit guarantee scheme, Provost says.

"The Treasury’s reasons for this include that: The Treasury considered many of the risks and issues arising from the original scheme when working on the extended scheme in 2009; there are now fewer non-bank deposit takers that could pose similar risks; the unique nature of the Scheme limits the extent of lessons that could be applied to a future scheme; and specific lessons are being covered in detail in the work within the Trans-Tasman Banking Council (through which it works with the Australian Treasury on crisis management arrangements) and the Financial Stability Key Initiative."

Through its Financial Stability Key Initiative Treasury aims to create a framework to limit future risks, and better manage risks that arise.

The Auditor-General says Treasury has done a lot of work on this initiative, which contains milestones, a risk register, a breakdown of resources and costs, and quality controls. Progress includes signing a memorandum of understanding with the Reserve Bank including both general and macro-prudential financial stability arrangements, working with the Australian Treasury on crisis management arrangements, and improved project management practices to strengthen risk identification, communication, and planning to deal with other unexpected events like natural disasters.

'Carefully thought out AMI response'

Provost says whilst the Crown retail deposit scheme achieved its key goal of preventing bank failure, there were practical challenges in implementing it.

"The speed with which the Scheme was designed and implemented demanded a disciplined project management approach with formal and comprehensive management disciplines, and strategic oversight. In our view, this was not evident," she says. See more in my opinion piece 'Treasury's ambulance at the bottom of the Crown retail deposit guarantee scheme cliff wasn't good enough' here.

Meanwhile, Provost says Treasury used the collapse of AMI Insurance after the February 2011 Christchurch earthquake as an example to show her how it has applied a more controlled approach to support a major distressed financial institution.

"In our view, a carefully thought-out response is evident. The Crown has sought to minimise risk to public funds and, at the same time, has provided support that mitigated the immediate risk of AMI Insurance failing. This provided important assurance to insurance holders in Christchurch, at a stressful time, that their claims would be met," says Provost.

Following the earthquake AMI approached the Government for financial support.

"The Treasury’s approach was on an 'as needed' basis for support, taking control only if AMI did not find another investor in time to resolve its solvency problems. This meant that the Crown did not have to exercise immediate control, which would have meant taking the burden of risk," Provost says.

"The Crown provided an incentive to AMI: find a long-term investor to avoid the unattractive (to AMI) situation of removing AMI’s board of directors. Further contingencies were put in place, including requiring AMI to meet multiple sets of conditions from the Reserve Bank. The eventual resolution was that AMI found a purchaser for its other, more saleable, business, with the Crown taking ownership of the part of AMI’s business that dealt with Canterbury earthquake claims (now called Southern Response Earthquake Services Limited)."

"Southern Response can claim on the Crown only once its own reinsurance and other reserves are substantially exhausted. This has resulted in assurance to insurers that claims will be met, with less cost to the public than a 'bailout'," says Provost.

AMI's 'good book" was sold to Insurance Australia Group for $380 million.

'Treasury's effectiveness could only be tested in a real crisis'

The Auditor-General's other recommendations to Treasury were setting up project planning and monitoring frameworks with an approach to crisis management planning, and carrying out a formal post-project review after implementing any significant policy initiatives. Provost says Treasury has responded positively to the recommendations about improving project management and implementing a planning, monitoring, escalation, and reporting framework.

"Generally, the work that the Treasury has done so far and is continuing to do should provide better resilience to pressure on the economy and clearer lines of action in the event of another financial crisis," says Provost.

"How effective the Treasury’s work is can only be tested in a real crisis situation. It is important that the governance roles and responsibilities for the Treasury, the Reserve Bank, and the Minister of Finance in the event of another financial crisis are clear."

Provost's new report comes after Treasury last year revealed if it had to reintroduce a retail deposit guarantee scheme it would be tougher than the one put in place in 2008. Treasury also said New Zealand being the only OECD country without deposit insurance increases the risk of a retail bank run should there be a significant loss in depositor confidence.

 'Kevin Rudd's 'panic'

The Crown retail deposit guarantee scheme ran for 38 months from October 2008 until the end of 2011 and cost taxpayers' the thick end of $1 billion largely due to the demise of South Canterbury Finance, which was tipped into receivership on August 31, 2010 triggering a taxpayer funded bailout of almost $2 billion.The company's receiver, McGrathNicol, said in its final receiver's report it had recovered $774.6 million, leaving taxpayers with a shortfall of about $805 million.

Former South Canterbury Finance directors Edward Sullivan, Robert White and ex-CEO Lachie McLeod are now on trial following charges laid by the Serious Fraud Office.

Introduced during the 2008 election campaign by the Labour Party led government at the height of the global financial crisis, the scheme at its zenith saw taxpayers' guaranteeing about $133 billion. Ultimately nine finance companies failed with debts guaranteed by the taxpayer before the much smaller extended Crown retail deposit guarantee scheme, introduced by the National Party-led government upon the initial scheme's expiry in October 2010, ended on December 31, 2011.

In 2012 Michael Cullen, Finance Minister when the Scheme was introduced, told interest.co.nz New Zealand was forced into a much more comprehensive, open ended scheme than it had been considering by the "panicky" actions of Australian Prime Minister Kevin Rudd.

This article was first published in our email for paying subscribers on Thursday morning. See here for more details and to subscribe.

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?

We welcome your comments below. If you are not already registered, please register to comment or click on the "Register" link below a comment.

Remember we welcome robust, respectful and insightful debate. We don't welcome abusive or defamatory comments and will de-register those repeatedly making such comments. Our current Comment policy is here.