In the Phase 2 document released today, Deposit Insurance, funded by a bank levy is proposed. Unlike the Australian $250k scheme (which is not activated until the Government says so, and is taxpayer funded initially), the NZ scheme is for a lower amount with a protection limit in the range of $30,000 – $50,000. Implementation will probably take at least two years.
One question so far not answered is the interaction with the deposit bail-in. Generally bail-in stops a failing bank from failing, whereas deposit guarantees are activated on failure. So bail-in might stop deposit guarantees even being called on…
Depositor Protection
Why is a range of $30,000 – $50,000 for the proposed depositor protection scheme proposed?
Available data suggests that a protection limit in the range of $30,000 – $50,000 could fully protect from loss more than 90 percent of individual bank depositors in New Zealand, while leaving the majority of banks’ deposit funding exposed to risk. This would strike the right balance between protecting small depositors from loss and enhancing public confidence in the banking system on the one hand, while maintaining private incentives to monitor bank risk taking on the other. It would also be broadly consistent with international schemes in terms of the share of deposits and depositors that would be fully protected (albeit relatively low in terms of the absolute dollar value of protections).
More work will be required to choose the limit within this range that is the best for advancing the public policy objectives chosen for the protection scheme. The consultation seeks feedback on these choices.
The Reserve Bank is proposing high capital requirements for banks which should reduce the risk of bank failure. Why is depositor protection required if the risk of bank failure is small?
Even with high capital requirements, banks can still fail for a variety of reasons. Regulation, supervision, resolution, and deposit protection all make up a ‘financial safety net’ that supports a stable and resilient financial system and protects society from the damage caused by bank failures. The safety net tools interact and overlap, which can make it seem that not all of the tools are necessary. However, if the safety net is incomplete, it will be difficult to find effective solutions for dealing with serious problems in the banking system. This means that capital tools that help to keep banks safe and sound at the ‘top of the cliff’, must be complemented by robust tools to deal with banks that may still fall to the bottom.
The OECD and IMF have warned that, without depositor protection, New Zealand is vulnerable to contagious bank runs. Bank runs can escalate into banking crises that destroy social and financial capital. For New Zealand’s safety net to be effective in good times and bad, the tools within the net must each be strong in its own right, and work well together.
How will the risks associated with moral hazard be addressed in the proposed depositor protection scheme?
Moral hazard arises when people are protected from the consequences of their risky behaviour. If deposit protection is introduced, depositors may take less care when assessing the risks associated with their banks, and banks may take less care with depositors’ money. Moral hazard costs are part of the reason why New Zealand has until now chosen not to have a depositor protection regime.
There is considerable international experience on how to design an effective deposit protection scheme, within the broader financial safety net, that mitigates moral hazard. International experience demonstrates that strong regulatory monitoring of deposit-takers’ corporate governance and risk management systems goes a long way to addressing the moral hazard of depositor protection. Maintaining private monitoring incentives is also important, and can be achieved through carefully calibrating the protection scheme’s scope of coverage. For example, setting the protection limit at a level that fully covers most household and small business depositors, but leaves large institutional depositors exposed to risk, will support private monitoring incentives. In conjunction, having effective resolution tools (that make it more credible investors’ money is at risk should their institution fail) can sharpen monitoring by institutional investors.
International practice and guidance, as well as the views of experts and the public, will inform the design of New Zealand’s depositor protection scheme.
What are the costs of funding the proposed depositor protection scheme and who will bear these costs?
A primary tool of the protection scheme will be insurance. Deposit insurance transfers the risks and costs of bank failures away from depositors onto an insurance scheme. This will come with upfront costs of establishing a deposit insurer, and ongoing operational costs.
Modern deposit insurance schemes are normally funded by levies on member banks, supported (where necessary) by temporary lending paid for by taxpayers. If the insurance scheme is accompanied by a depositor preference, this might also increase banks’ non-deposit funding costs as risks are transferred from depositors onto institutional investors.
Details of the scheme, including costs, are still to be worked out in the next phase of the work programme. To the extent that depositor protection increases banks’ average costs, this might be passed on to customers through higher mortgage rates or lower deposit rates. Alternatively, costs might be absorbed by banks’ own margins and retained earnings. The extent to which costs are shared between banks and their customers depends on competition and contestability in the sector.
A fuller cost-benefit analysis will follow as we learn more about the specific design features of New Zealand’s depositor protection scheme.
When will the depositor protection scheme be introduced?
A work programme running alongside the Reserve Bank Review process will develop a depositor protection scheme that is best for New Zealand. The work programme will be guided by a framework setting out some key design principles for an effective scheme, and will draw (where relevant) on international standards and best practice. The work programme will determine the:
- mandates and powers
- governance and decision making structure
- coordination arrangements with other safety net providers
- membership and coverage arrangements
- funding and pay-out mechanics, and
- design features to mitigate moral hazard
that are appropriate for New Zealand’s protection scheme. The Review Team’s discussions with the global coordinating body for deposit insurers indicates that the path from policy recommendations to scheme implementation will probably take at least two years.
