Are the banks too safe? Or not safe enough?

The Government has unveiled a plan to protect depositors in the event of a bank collapse, but key questions have not yet been answered. Thomas Coughlan analyses the plan.

ANALYSIS: More than 10 years ago, in a back room at the Auckland Town Hall, then Prime Minister Helen Clark put New Zealand on the hook for $133 billion — more than half the size of the New Zealand economy at the time.

She made an on-the-spot call to guarantee depositors’ money should their bank, or finance company collapse like many in the United States and Europe were doing. 

Clark had not planned on unveiling the scheme, having woken up that morning expecting to deliver a fairly standard election-year speech. But word had come down the line that Australian Prime Minister Kevin Rudd was planning to unveil his own deposit scheme that day. There were reasonable fears that should Australia act alone, New Zealanders would shift their deposits out of New Zealand banks to Australia where their money would be safer.

The scheme put New Zealand on the hook for $133 billion, according to the Auditor-General’s report, although only $2 billion was ever paid out. 

Clark had no choice, and her speech was swiftly amended to include an announcement of a full deposit scheme, the details of which had to be worked out later in a coffee and pizza-fuelled weekend, according to then Governor Allan Bollard’s memoir of the event. The scheme was continued by the Key Government before being allowed to expire 2011. 

Now, the Government wants to bring it, or something similar back, and permanently. 

Protecting (small) depositors

On Monday, Finance Minister Grant Robertson and Prime Minister Jacinda Ardern announced that Treasury and the Reserve Bank would begin work on a successor scheme that would be permanent. The Government has proposed capping the guarantees at between $30,000 and $50,000. This covers 90 percent of individual bank deposits in New Zealand, but only 40 percent of the total amount of money deposited in bank accounts. 

New Zealand is an outlier in the developed world in that does not have a deposit guarantee scheme. Currently, under the Reserve Bank’s Open Bank Resolution regime, distressed banks temporarily close, and depositors may be forced to take a “haircut” to recapitalise the bank. 

There is also an implicit moral hazard guarantee, which means distressed banks would likely be bailed out by the taxpayer in the event of a banking crisis. Ardern gestured to this in her post-Cabinet Press conference today saying the scheme was about “trying to prevent a situation where taxpayers pick up the cost when something goes wrong." 

While few details about how the scheme would work were made public today, Robertson said that most international schemes were funded by a bank levy to fund them. He said this was supported by Government intervention in the scheme’s early years. 

This means there is still a chance taxpayers will find themselves on the hook for distressed banks, while the scheme gets going. There is also a chance the scheme could include an EQC-style crown guarantee. This would mean the Government would top-up the scheme in the event a wave of bank failures exhausted the scheme’s funds, however Robertson said that he was confident the bank levy would be sufficient “if we design the scheme well”. 

Designing the scheme well will mean trying to balance the competing objectives of limiting exposure to the taxpayers, guaranteeing individual depositors, whilst also making sure the scheme doesn’t become so onerous that consumers are hit with painful additional fees. 

This is possibly the motivation behind the relatively modest $30,000 - $50,000 cap for the scheme, which falls short of similar schemes in countries like the United Kingdom and Australia, where £85,000 (NZD$163,000) and $250,000 ($263,100) are guaranteed. New Zealand’s previous scheme guaranteed individual depositors up to $1 million. The Auditor General’s report on the scheme said that this put the Government’s total liabilities at $133 billion. 

Perverse incentives and unintended consequences 

There are also risks of unintended consequences. Like the previous scheme, the new guarantee will also apply to non-bank lenders like finance companies. These are generally considered to be slightly riskier lenders than banks, and consequently offer better rates of return. But a deposit guarantee scheme effectively means a deposit in a finance company and a bank bear the same level of risk.

The Government tried to address this by charging institutions a small fee to participate in the scheme, based on their credit rating. The better the credit rating, the less the institution paid. But this was to no avail, and depositors flocked to risky institutions. 

The Auditor-General noted that in 2009, one finance company’s deposits grew from $800,000 to $8.3 million under the scheme. South Canterbury Finance saw its deposits grow by 25 percent after the guarantee was put in place. When it eventually collapsed, the Government was forced to pay out more  than $1.5 billion to depositors.  

There is also uncertainty over how the $30,000 - $50,000 cap will be policed. There is potential for depositors to split their deposits into multiple accounts at multiple institutions, allowing them to enjoy an effective guarantee of deposits far in excess of the cap. 

Today’s announcement plays out against the backdrop of another Reserve Bank plan to make banks safer. It has proposed banks hold more capital relative to the amount of money they lend. The Bank says this will enable banks to survive a one-in-200 year crisis, meaning the likelihood that depositors or taxpayers would be called on to recapitalise a filing bank. 

But the banks hit back, possibly because the Reserve Bank estimated it would cost them 70 percent of profits over the next five years. They said it would add costs to their operations, some of which would be passed on to consumers. (The Reserve Bank isn’t so sure — noting New Zealand has some of the most profitable banks in the world). 

Benefits and costs

Whatever the Reserve Bank lands upon, the threat of rising costs remains. Should a bank deposit scheme be lavished on top of the capital requirements changes, New Zealanders may find themselves hit with multiple additional costs. On the other side of the ledger, they would enjoy both extremely safe banks, and a deposit guarantee in the very unlikely event something went wrong. 

Banks make the argument that too much regulation suffocates a healthy level risk-taking in the sector. Unfortunately for them, the revelations surrounding former ANZ CEO David Hisco will rather undermine this argument, playing as it does, into the narrative of the lavish banker lifestyle. The fact that it came while ANZ made a serious error in the way it calculated its risk capital only compounds the bad smell around the banking sector currently. 

The Government will no doubt find itself on solid ground calling for more protection for depositors. The fact that nearly all developed countries have some version of the scheme only strengthens their argument for one. 

Before last week, the Government would have been that banks could make good on not so subtle threats to claw back the cost of bank capital charges by reducing agricultural lending, adding consumer charges, or ratcheting up interest rates. 

But Hisco’s conduct likely covers the Government on this. The banks may indeed charge additional fees, but not before executives liquidate their wine cellars. 

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