Reserve Bank wary of deposit insurance proposal

Reserve Bank wary of deposit insurance proposal

New Zealanders have around $150 billion invested in term deposits and savings accounts, but many people may not realise their deposits are not guaranteed.

New Zealand is one of the few developed nations that does not have some sort of deposit insurance scheme.

Labour, the Greens and New Zealand First have all previously voiced support for the idea. In Australia deposits are protected up to a limit of $250,000 for each account holder at each institution.

But the Reserve Bank (RBNZ) is opposed to the idea.

"Deposit insurance blunts incentives for banks and depositors to monitor and manage risks properly," says RBNZ's head of prudential supervision, Toby Fiennes.

He spoke at an event hosted by the New Zealand Bankers Association and BNZ in Auckland.

Mr Fiennes told the audience that deposit insurance lowers banks’ interest expenses and also makes interest payments less sensitive to the risk the bank may be taking.

The RBNZ says these risks could be offset by risk-based pricing of the insurance. But it believes in practice it is "difficult to achieve" and "also favours some parties relative to others: for example, people with larger deposits and those who manage their affairs to create multiple protected deposits."

"A financial system in which depositors can afford to be indifferent to the risk of the bank they invest in will be a weaker financial system - people will chase return with no regard for risk," Mr Fiennes says .

"It is of course true that many people expect governments to stand behind their deposits. That expectation was reinforced by the widespread Government guarantees (including in New Zealand) during the GFC. The existence of an expectation, though, is not a sound reason to adopt deposit insurance."

Mr Fiennes argues that a "key virtue of our Open Bank Resolution (OBR)  tool is that it provides authorities with the ability to impose losses on creditors without closing the bank. This supports market discipline and improves incentives on investors and larger depositors to monitor banks."

Critics say that it is unrealistic to expect smaller depositors to read the banks' disclosure statements. Nor is it an ideal situation to have them rely on larger investors and depositors to do it for them.

New Zealand's banks are considered to be among the safest in the world. But in the unlikely event a bank became insolvent, what would happen?

"Distressed bank is closed overnight and placed into statutory management," The RBNZ says. "This decision is made by the Minister of Finance on recommendation from the Reserve Bank. Upon reopening the following day, a portion of the creditors' (including depositors') funds are frozen to cover anticipated losses."

"Access to the remaining funds and other critical banking services would be made available from the next business day, and the Government would provide an explicit guarantee on the unfrozen portion of creditors' funds to minimise the risk of a mass withdrawal of funds by depositors (a bank run). This would allow the bank to continue playing its role in the financial system and thereby minimise disruption to critical functions such as the payment and settlement system."

This would limit the Government's (and taxpayers') exposure. But it would mean that part of the money customers have placed in savings accounts or term deposits could be used to prop up the bank.

That is the theory. But would it happen in practice?

It is hard to imagine that any government would allow a customer's funds to be used to bail out a bank. Imagine the voter anger and the political fallout if that happened?