Will levies to fund the incoming deposit insurance regime hit deposit takers' bottom lines, cost depositors, or both?

Treasury is seeking feedback on the size of the fund that'll be established to back the incoming deposit insurance scheme, suggesting it could be equivalent to 0.5% to 1.1% of protected deposits, or $600 million to $1.4 billion.

In a consultation paper on the funding strategy for the depositor compensation scheme (DCS), Treasury says the DCS’s costs will be funded by levies on all licensed deposit takers, that will be held in a DCS fund. Treasury proposes a timeframe for building the DCS fund of between 10 and 20 years.

The DCS will be established by the Deposit Takers Act to cover bank depositors in the event of bank, or non-bank deposit taker such as a building society, failing. Depositors will be covered up to $100,000 per depositor per licensed deposit taker. The DCS is expected to commence in late 2024.

Treasury notes the lower end of the 0.5% to 1.1% range is consistent with the approach of setting a target fund size factoring in recoveries from a failed deposit taker but involving greater reliance on a Crown backstop. 

"The lower end of the 0.5% to 1.1% range would likely cover a material proportion of the costs of contributing to a resolution of a large bank, estimated to range between 0 and $3.3 billion. It would also enable the DCS to compensate depositors if multiple non-bank deposit takers failed, even widespread failures in the sector are estimated to cost between $0.8 billion and $0.9 billion," Treasury says.

"The upper end of this range would be more likely to cover the estimated cost of contributing to the resolution of a large bank and enable the DCS to fund most of the upfront cost of paying out the depositors of a medium-sized bank, estimated to be between $1.3 billion and $3.4 billion. The upper end of the range is more consistent with the approach of setting a target fund size that does not rely on the Crown backstop, although this would also depend on the timeframes for reaching the target fund size."

"However, if costs of contributing to a resolution of a large bank tend toward the upper end of the range, the Crown backstop will be needed to meet the shortfall in the DCS fund," says Treasury.

Systemic failure scenarios not modelled

Treasury's not proposing to include "systemic scenarios" in its modelling where multiple large banks fail.

"The likelihood of systemic failure scenarios is more remote than idiosyncratic ones, and there could be very large costs involved in meeting the costs of systemic scenarios through the DCS. As a result, we assess that seeking to fund systemic failure scenarios through the pre-failure levies for the DCS is not consistent with the efficiency principle, particularly given the relatively high concentration of the New Zealand financial system," Treasury says.

It notes that if the DCS fund doesn't have enough money to meet its statutory obligations, the Act will require the Minister of Finance to provide public money to the fund on terms and conditions suitable to the Minister, potentially including setting an interest rate for a loan.

"The commitment to provide this ‘Crown backstop’ to the DCS will provide public assurance that compensation will be provided in a timely manner following the failure of a deposit taker. The Crown is expected to recover a significant portion of these funds from later in the process if a payout is triggered. (For example, once the DCS compensates a depositor, the DCS can ‘stand in’ for the depositor during the liquidation process and receive any money owning to the depositor.) Any remaining money provided through the backstop would be recovered through the levies on the deposit-taking sector over the medium-to-long term."

"The DCS will repay the Government with the money recovered from a failed deposit taker and through levies if the DCS fund is in deficit as a result of the payout event. Levies will re-build the DCS fund once the loan from the Government has been repaid, but the Government’s obligation for providing the backstop for any future event remains at all times," Treasury says.

"The Government maintains a ‘liquidity buffer’ of cash and liquid, high-quality financial assets to enable it to immediately respond to unexpected events, such as economic crises. The Government currently holds $15 billion as a buffer. The liquidity buffer is kept under review to ensure the Government can efficiently and effectively finance its obligations in different economic conditions. The Government’s obligations in connection with the DCS will be part of future reviews to ensure the buffer is sufficient."

No depositor preference

Treasury notes that whilst most comparable countries with deposit insurance have depositor preference, meaning that depositors rank ahead of other secured creditors in a liquidation, New Zealand won't. Depositor preference results in higher recoveries for the depositor compensation scheme, meaning a lower target fund size as the risk of shortfalls is lower, Treasury adds. 

"New Zealand will not have depositor preference, and this has been reflected in the proposed range for the target fund size. The Government decided not to introduce depositor preference given the impacts it would likely have on creditors and deposit takers. Although there would be benefits of a depositor preference, these would ultimately come at the cost of making other creditors worse off."

"A depositor preference may result in smaller deposit takers facing greater challenges attracting and retaining unprotected deposits or wholesale funding, potentially undermining competition, and diversity in the financial system. During consultation for the Review of the Reserve Bank of New Zealand Act, deposit takers also submitted that a depositor preference could increase funding costs, create complexities in resolution frameworks, and potentially significantly alter the funding profiles of some deposit-taking entities," Treasury says. 

'A commercial decision for each deposit taker to determine how to absorb the cost'

Levies during the fund build-up phase would reduce deposit taker profits by an annual average of between 0.6% to 2.4%, Treasury estimates, if the full cost is borne by deposit takers, or deposit rates by between four and 15 basis points, if the full cost is borne by protected depositors.

"Ultimately, it is a commercial decision for each deposit taker to determine how to absorb the cost. The cost could be met through the deposit taker’s profits or transferred to depositors through lower deposit interest rates, higher fees, or higher loan interest rates," Treasury says.

In a separate consultation paper the Reserve Bank outlines options for how licensed deposit takers will fund the DCS.

"Using a flat rate approach, we estimate the annual levies would be around 0.1% of protected deposits for all deposit takers. If a risk-based approach is adopted, and for example a four times difference in the levy rate across different risk buckets is applied, then the levy rates could range from 0.1% to 0.4% for deposit takers across risk buckets. This is under the assumption of building toward a target fund size of 0.8% of total protected deposits within 15 years, which are the median numbers as suggested by the  Statement of Funding Approach [Treasury] consultation paper," the Reserve Bank says.

A flat rate approach means deposit takers pay levies based solely on a percentage of the total value of protected deposits they hold.

Under risk-based approaches, the levy charged on individual, or a group of, deposit takers would reflect the perceived risk they pose to the DCS fund, i.e. how likely it's viewed that a payout event occurs. Credit ratings could be used to capture the risks posed by an individual institution to the DCS fund and to compare deposit takers with different business models.  

Alternatively, composite risk indicators could be used by the Reserve Bank to design the levy approach considered most fit for purpose to measure the risk that each deposit taker poses to the DCS fund. Such an approach could feature capital adequacy, quality of assets, liquidity, business model and management, and/or qualitative measures such as supervisory judgement about the risk management of an entity. 

"The DCS levy will impose a cost on deposit takers. Ultimately, it is a commercial decision for each deposit taker to determine how to digest the cost. The cost might be transferred to depositors through lower deposit interest rates. The cost might also be transferred to other customers in other ways, through fees or higher loan interest rates to maintain a deposit taker’s margin, or be absorbed by deposit takers’ profits," the Reserve Bank says.  

The deadline for submissions on the Treasury and Reserve Bank consultation papers is September 25. Note, there's a third consultation paper on a proportionality framework for developing standards under the Deposit Takers Act.

*The tables below come from the Treasury paper.

**You can also listen to our Of Interest podcast episode on deposit insurance here, and see: Would the incoming depositor compensation scheme be used in the event of a major bank failing?

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