By Gareth Vaughan
The fund backing New Zealand's incoming depositor compensation scheme is going to be small, will take a long time to reach its target level, and the lack of depositor preference in the scheme is a mistake, according to a deposit insurance expert.
Geof Mortlock, an international financial regulatory consultant who does work for the International Monetary Fund and World Bank specialising in financial system stability, resolution of bank failures and deposit insurance, spoke about the depositor compensation scheme in a new episode of interest.co.nz's Of Interest podcast.
The scheme, expected to be launched in mid-2025, will provide protection of up to $100,000 per eligible depositor, per licensed bank, building society, credit union and deposit taking finance company, in the event of deposit taker failure.
Finance Minister Nicola Willis has decided the fund backing the scheme, to be funded through levies paid by deposit takers, will be built up over 20 years to a size equivalent to 0.8% of protected deposits, or about $1 billion.
Mortlock says other countries typically have a fund size equivalent to between about 1% and 4% of protected deposits, and he recommends taking about 10 years to build the fund up to its target level.
He says the NZ scheme would likely be used for the failure of a non-bank deposit taker or small bank, but wouldn't be sufficient for the failure of a medium-sized or big bank, the failure of which would require "alternative mechanisms." Nonetheless Mortlock says it is worth having the scheme.
"I think it's definitely worth having because there are quite a sizable number of small deposit takers out there. And at some stage, one of them is going to fail. Hopefully not for a long time. But statistically, if you look around the world, there are occasional bank failures, and most of them tend to be small."
"For a small deposit taker or a medium sized one, I think having a deposit insurance scheme is really important, and I think it helps in two ways. It reduces the risk of what we call interbank contagion, where one failure can trigger multiple runs across the banking system. And secondly, it helps to reduce the risk for the taxpayer, because it means that there is a dedicated fund paid in by deposit takers and therefore [this] reduces the need for government funding," says Mortlock.
"But for a large bank failure, it is not going to be sufficient. And if you look around the world for a large bank failure, deposit insurance funds are not typically used anyway."
An option for a larger bank failure is the Reserve Bank's Open Bank Resolution (OBR) Policy. In the podcast Mortlock explains why he thinks it would be "potentially catastrophic" for the Reserve Bank to use OBR, and he doesn't think a Finance Minister would allow them to.
In the podcast he also talks about what other resolution options could be for a large bank failure, what products the scheme will cover, the impact deposit takers paying a levy may have on deposit rates, how the Reserve Bank should administer the scheme, bail-in, depositor preference and more.
Depositor preference means depositors rank ahead of other secured creditors in a liquidation. Mortlock says it helps reduce the risk of runs on banks, and facilitates bail-in whereby unsecured liabilities such as bonds may be written down or converted into equity in the event of a bank failure.
At the moment, with OBR, NZ is "about the only jurisdiction I can think of outside of some dubious ones, which would apply a haircut to deposit liabilities and no depositor preference," Mortlock says.
"So if you're a wholesale depositor in a bank and the banking system is looking shaky, and you know that the OBR is out there and could be triggered, what are you going to do? I think you're going to do a preemptive run. And what would that do? That would almost certainly mean that the [Reserve Bank] Governor, joined by the Minister of Finance, would have to say, a, we're not doing OBR, and b, we are putting in place a temporary guarantee of all wholesale deposits. Just the opposite of what you would want to have to do. So I think it is a foolish policy, OBR, and made even more foolish by the absence of depositor preference."
*You can find all episodes of the Of Interest podcast here.
12 Comments
None of this would be required if banks weren't fractionally reserved.
by Audaxes | 28th Sep 22, 7:54pm
What multiplier effect? There is no fractional reserve banking in NZ - the limiting control of bank credit creation moved from the asset side of the ledger to the liability side many decades ago.
According to the Reserve Bank, the new capital requirements mean banks will need to contribute $12 of their shareholders' money for every $100 of lending up from $8 now, with depositors and creditors providing the rest.
by Audaxes | 16th Jun 22, 8:20am
This nonsense from Bloomberg has to stop.
Balance-sheet reduction from the Fed, the ECB et al will contract liquidity yet more. But just as rising liquidity floats all boats, falling liquidity can simultaneously sink them all. Every dollar of the monetary base supports $10 of credit, but every $1 destroyed in QT takes $10 of credit with it.
The Federal Reserve abandoned fractional reserve banking completely on 26 March 2020. Link
We all joked that the first bank to be OBRed won, as once re opened on the Monday everyone would move there funds there from the other 3... as You reopen with an RBNZ Guarantee, and whoever moved would be safe from a haircut
... what a stupid scheme
Bs11 takes this logic and leverages it....
Changing the fund size - depending on economic conditions - could be another tool to control the money supply.
FYI: Back in the old days, many countries insisted banks held reserves with the central banks and governments would increase / decrease the reserve requirements to restrict / expand the money the banks could lend. (And as you'd imagine - banks hated it.)
This is why you shouldnt first of all place all your hard earned papermoney aka FIAT money in the bank who will magically multiply it and lend it out 10x over aka fractional reserve banking .
It pays to diversify and own hard assets like gold, silver, art , real estate, bitcoin + certain crytpos. It is for me one of the basics of finances.
Banks don't take deposits and they never lend money. They are in the business of purchasing securities. When one gets a bank loan, the loan contract is a promissory note. The bank purchases that contract from the borrower. Now the bank owes the borrower money and it creates a record of the money it owes, which we call deposits - source.
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