Some form of bank deposit protection is starting to look inevitable since three former Reserve Bank governors are now supporting it.
However, they also continue to support the “open bank resolution” system the central bank began developing when Don Brash was governor.
That’s despite the many OBR critics who have described it as unconscionable because it pushes risk onto those least able to manage it, and that it’s something no government will ever allow to happen.
OBR is clearly politically unpalatable because it means forcing all the mums, dads and their kids with bank deposits to take a financial ‘haircut’ to help shore up a failing bank.
New Zealand is the only OECD country without some form of deposit protection.
In his submission on phase two of the review of the Reserve Bank Act, Brash actually takes the most expansive view of deposit insurance, while at the same time taking a swipe at current governor Adrian Orr’s plans to force the big four banks to lift their risk-weighted equity capital to at least 16 percent from the current minimum 8.5 percent level.
Brash says he doesn’t have a view on how much capital banks should have, although he suspects it’s higher than the current minimum, but he says it’s “almost certainly less than the remarkably high 16 percent figure.”
When Brash was governor, the minimum tier 1 capital banks had to hold was just 4 percent and could include hybrid type securities, those that behave like debt most of the time but which can be converted into equity when required, as well as pure equity. Hybrid securities cost about a fifth of the cost of equity.
Brash says higher minimum equity levels for systemically important banks – he includes Kiwibank and TSB Bank in that category as well as the big four Australian-owned banks – would “materially reduce the risk of their getting into trouble.”
But “in addition, to make it politically feasible to adopt an OBR ‘solution’ in the unlikely event that, despite the high level of mandated equity, a systemically important bank got into trouble, I would recommend that deposits up to some level – perhaps $100,000 – should be protected by a government guarantee funded by a levy on all individual deposits up to that agreed level in systemically important banks,” Brash says.
Former acting governor Grant Spencer and the man he replaced until Orr took over, Graeme Wheeler, opt for a much smaller ‘de-minimus’ level of government guarantee, both suggesting $10,000 per customer per bank, although Spencer suggests up to $20,000 might be considered.
To put these amounts in perspective, Australia’s government guarantees deposits up to a cap of $250,000 per depositor in any authorised deposit-taking institution, including credit unions and building socities, in the event of a bank or other business failure.
“The status quo is not satisfactory as depositors are not protected in a systematic or politically sustainable manner,” Spencer says in his submission.
While the finance minister of the day would have the discretion to protect a small unspecified level of deposit per customer, “I agree that a more explicit level of support should be established,” Spencer says.
But he doesn’t like the idea of deposit insurance. While it would meet the objective of enhanced consumer protection, it “would potentially generate the greatest moral hazard problems,” he says.
He noted that when the GFC era deposit guarantee scheme was introduced in 2008, “authorities were reluctant to apply larger premia to the smaller, riskier institutions, resulting in the net risk-adjusted returns biased in favour of the riskier institutions.”
Wheeler says he doesn’t support “depositor protection schemes that involve the government pre-committing to protect depositors up to a large specified amount.”
Such a scheme “undermines the current approach to the RBNZ’s prudential framework where considerable emphasis is placed on the board of a bank as a primary governance body,” he says.
Although it has the power to prosecute bank directors, the Reserve Bank has never done so.
Providing an explicit guarantee in advance of any bank failure “changes the incentives facing managers within the bank. It could lead to a greater appetite for risk taking by management, less effective governance by the board of the bank and reduced oversight of banks by depositors,” Wheeler says.
There’s scant evidence that depositors do exercise oversight of banks.
“Even if the government pre-commits taxpayer funding or additional public borrowing in advance of any bank failure, there could be no assurance that the government’s fiscal risk would be capped at the level of the pre-commitment. There have been several examples of countries in recent years that have bailed out deposit holders at higher levels than previously committed,” Wheeler says.
Protecting deposits also changes the order of ranking of other bank creditors. “in turn, wholesale funders and other investors will seek to offset this risk by demanding higher returns for financing the back. This would raise bank-funding costs and banks would seek to offset the higher funding costs by lowering the returns to depositors that have the depositor protection,” Wheeler says.
Limiting the protection to $10,000 per depositor “would provide some transparency as to the government’s position and help reduce some of the negative effects outlined above of pre-committing to very large sums of a deposit insurance scheme.”