By Alex Tarrant
Opposition MPs are worried bank depositors are being bumped down the pecking order if a bank were to fail, as banks can ring-fence their best assets for institutional investors providing them cheap funding.
Members of Parliament's Finance and Expenditure Select Committee were told on Wednesday that the Reserve Bank of South Africa had banned covered bonds in the interests of depositor protection.
But the New Zealand Reserve Bank, along with a consortium of the big five banks here, believed allowing some use of covered bonds would contribute to greater financial stability, therefore helping better protect depositors from a bank failure.
Covered bonds give banks access to cheaper, long-term funding by allowing them to ring-fence a group of low-risk mortgages into a cover pool. Units in that cover pool are then sold off to investors who receive both a secured claim on that pool and an unsecured claim on a bank's assets.
Due to this dual recourse security, covered bonds generally attract the highest possible AAA credit rating, which is above New Zealand banks' own current ratings.
However, because covered bonds carve off some of a bank's best assets for the benefit of covered bondholders, in the event of a bank failure, bank depositors' claims are diluted as they are not given access to some of a bank's best assets for when they are repaid.
Covered bondholders, on the other hand, are pretty much guaranteed repayment as their lending to the bank is secured over its best and safest assets - generally mortgages with low loan-to-value ratios.
Parliament's Finance and Expenditure Committee is currently reviewing the legislation which will regulate covered bonds issued by New Zealand banks.
Opposition
Opposition members of the Committee worried that if a bank went bust, instead of the proceeds of that bank's assets being distributed fairly across all creditors, some (covered bondholders) would most likely be repaid in full, while regular depositors would have their claims diluted relative to what they would get if all creditors took the hit fairly.
Green Party co-leader Russel Norman argued risk of a bank failure was being transferred more to taxpayers, due to an implicit government bank guarantee, and bank depositors.
Covered bondholders would effectively get off scot-free from a bank failure as they had a ring-fenced pool of assets as security for their investments and another call over a bank's other assets as well.
“Because if your bank goes belly up, and I and all other taxpayers have to bail you out, then we don’t get access to those assets," Norman said to submitter Guy Lethbridge from law firm Russell McVeagh, who was representing a consortium of the main five New Zealand banks.
"So the risk is essentially being transferred to us as taxpayers, which is why you can access capital [through covered bonds] more cheaply. Why would you want to take on that risk [if you were a taxpayer]?” Norman asked.
The reply was covered bonds reduced risk due to the duration of funding, helped with banks' liquidity management, and reduced their funding costs.
Covered bonds also allowed banks to access a wider group of investors who might not be prepared to invest where there was an element of uncertainty.
“There is no transfer of risk," Lethbridge said.
So why was it that the banks were able to access funds more cheaply through covered bonds? Norman asked.
“Because the covered bonds are structured in such a way that the risk to the investor is less,” Lethbridge said.
“That does not, however, mean that someone else picks up that risk.”
Lethbridge accepted that if a bank did fail, retail depositors would not have access to the assets ring-fenced off for the covered bonds.
Labour Party MP David Parker followed up on Norman's line of questioning:
“I think logically, unless the overall risk to the banking sector is lower, because there is a greater access to funds that makes the incidence of failure less likely, upon failure, there must be a transfer of risk that is heightening the risk of one [class of depositor, and] another class of depositor [covered bondholders] has improved security,” Parker said.
Front of the queue
The assets available to all creditors in a failure were divided into secured claims and unsecured claims, Lethbridge said.
“And a covered bond represents a secured claim, so that means that the covered bondholders are at the top of the queue,” he said.
So people with covered bonds had a better security and those without covered bonds – regular depositors - had an inferior security, Parker said. He continued:
“Whereas, without covered bonds, everyone would have the same security and we’d be averaging that risk [across all depositors]; We’re creating different levels of risk for different holders of different securities,” he said.
Lethbridge agreed:
“That’s right. The covered bondholders rank first. If you only look at ranking in isolation from everything else, then it’s very easy to criticise them."
But they should not be considered in isolation, he said. Covered bonds would lead to greater financial stability, and therefore, less risk of a bank failure.
“When you’re talking about covered bonds it’s very easy to focus on the relative ranking, but surely we need to look at the overall net benefits of [allowing them – like greater financial stability]," Lethbridge said.
Banned in South Africa
National MP Maggie Barry got in the last question, asking a Reserve Bank official at the Committee why the Reserve Bank of South Africa had recently banned issuance of covered bonds. South Africa is now the only country to have an outright ban on covered bonds after the Reserve Bank of Australia allowed them last year following lobbying from the banks it regulates.
The answer was that the Reserve Bank of South Africa had a mandate for 'depositor protection'.
“It’s not an objective of the Reserve Bank (of New Zealand) to protect depositors - we have a financial stability objective,” the Reserve Bank official said. There were trade-offs to be considered by allowing covered bonds, but the Reserve Bank believed there would be a net benefit to New Zealand financial stability by allowing covered bond issuance equivalent to up to 10% of a bank's assets.
Norman tried to paraphrase what had been said:
“So what you’re saying is, the Reserve Bank of South Africa has a mandate to protect depositors, and because they want to protect depositors, they don’t want covered bonds because covered bonds increase the risk on depositors by transferring the risk over to depositors?
“But we don’t have a mandate to protect depositors, so that’s why we’re happy to have this,” Norman said.
Labour’s David Parker jumped to the defence of the Reserve Bank:
“That [Norman's explanation] is a little bit simplistic isn’t it? Because your [the Reserve Bank's] view would be you would be protecting the interests of depositors through having a stable financial [system]. So that’s a wee bit cheeky.”
Which was met by nods from the Reserve Bank officials and those of the bank consortium.
Earlier, the Finance and Expenditure Select Committee heard a submission from covered bonds opponent Geoff Bertram. See Gareth Vaughan's earlier piece on Bertram's submission here.
This article was first published in our email for paid subscribers this morning. See here for more details and to subscribe.
50 Comments
1A Purpose
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(1) The purpose of this Act is to provide for the Reserve Bank of New Zealand, as the central bank, to be responsible for—
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(a) formulating and implementing monetary policy designed to promote stability in the general level of prices, while recognising the Crown’s right to determine economic policy; and
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(b) promoting the maintenance of a sound and efficient financial system; and
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(c) carrying out other functions, and exercising powers, specified in this Act.
(2) This section does not limit the functions or powers given to the Bank by any other enactment.
Section 1A: inserted, on 10 September 2008, by section 5 of the Reserve Bank of New Zealand Amendment Act 2008 (2008 No 59).
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What exactly is a sound and efficient financial system?
How exactly do covered bonds increase financial stability? Banks will still be exposed to the same market risks.
If the banks have already issued covered bonds with the permission of the RBNZ why is legislation required now?
The question to be asked here is why for a very long time the local NZ banks were able to fund their liabilities on an unsecured basis and now they apparently cannot?
What is the RBNZ no longer undertaking in it's financial stability actions that make lenders more wary of our local Aussie controlled banks and hence demanding a level of secured lending agreements?
Why should the RBNZ not make provision for local depositors to erjoy the same privilege as the foreigners if there is a problem? - the RBNZ never undertakes any lending to the same banking institutions without the safety of security.
A two speed system of currency credit risk exposure is patently being devised with those most at risk of losing all their money suffering the lack of higher interest rate protection as well no security cover. This preferential system cannot last.
Just as central banks have previously enjoyed one sided ISDA agreements whereby just the commercial counterparties to central bank derivative trades contracted to collateral maintence or principal adjustment to offset marked to market losses, they are are increasingly being re-negotiated in favour of two way maintenance margin status.
The Bank of England has set the tone for our own central bank to face the reality of having it's mark to market liabilities in a swap transaction adjusted by margin payments and/or collateral top ups. A form of secured lending if ever there was one. - now if our central bank is no longer a trustworhty counterparty how can the local commercial banks be considered so?
The banks will just have to endure the same reality and hiding behind the RBNZ bullshit of making the whole system safer by offering secured lending to a select few is what it is.
Some thoughts:
Risk circumstances world wide have changed and risk is now being marked closer to market.
This is not a foreigners/locals battle. It is anyone who is willing to buy the bonds.
Two speed risk has been a feature in corporate risk for a very long time. Almost every corporation would have secured creditors and unsecured creditors in NZ today.
The whole idea that a government (tax payers) can guarantee deposits when those depositors are by and large the exact same people group as the tax payers is what is unsustainable.
Risk circumstances world wide have changed and risk is now being marked closer to market.
Without doubt so let's stop the State (RBNZ) deciding what risk return profile is appropriate for retail depositors to endure while the risk is obviously rising in all spheres of operation.
It took all of a few minutes for Westpac to pass on the RBA's recent 25bps rate cut - but that derisory level of risk adjusted return is not acceptable to some professionals casting their eye over the risk probabilities- they demand collateral on top.
Like an apple with a worm in it, from the outside all you see is a small hole, but the worm is busy doing its damage, cut the apple open and all is rotten.
Time to move your deposits? what else can a poor man do? You need along spoon if you wish to sup with the devil.
Personally I fail to see much of an issue......
a) As long as the covered bond pool is a limited amount, which I think the RB says is 10%? max....
b) and investors lend at a lower rate for longer than a retail depositor would put up with.
c) You undertstand that a deposit is not risk free, just very low, why is there this huge wailing?
d) Stay awake and make contingency measures, have two internet banking (different bank) accounts say that you can move money overnight....""A his and hers" maybe.....
regards
Of course none of it really matters does it when:
Other functions and powers 31 Bank to act as lender of last resort-
The Bank shall, if the Bank considers it necessary for the purpose of maintaining the soundness of the financial system, act as lender of last resort for the financial system.
We're all protected aren't we? We can all get our money out if push comes to shove.
Does this function have any bearing on the soundness/efficiency of the financial system?
Mr Norman thinks covered bonds transfers risk to taxpayers.
But the reality is to stop depositor/capital flight the government would provide a government guarantee (as it has done in the past). This could even be triggered simply to match the policy Australia pursues at the time.
In which instance the tax payer has already assumed the risk. In so far as covered bonds can reduce the capital pressure on banks in tight funding circumstances they may in fact reduce the probability tax payers end up with the risk.
What the banks might consider is bringing their lending practices to a state that their professional lenders feel comfortable with and thus no longer demand two levels of access to their funds.
These principal protecting devices suggest these lenders clearly expect mortgage service default, at some level, because bank lending priorities seem to be based on ponzi tactics, whereby increasingly risky (high LVR, low rate) new loans are necessarily issued to collectively fund pending interest payments on existing mortgages.
It's either that or the government borrows and lends to fund this basic requirement - but the Government has defended budget surplus plans.
While the number of Kiwi's wishing to borrow exceeds those Kiwi's wishing to fund that borrowing (through deposits) off shore lenders making up the slack are in the driving seat.
Once again you are right but on a world wide scale the same demands are obviously unsupportable and the outcomes confirm as much. Thus creating a two speed creditor market for NZ bank liabilities hardly ranks as a lasting solution but rather a lazy extension of a problem engulfed with inequity into the future for others to solve.
Best we suspend those incapable of directing their energies today whilst they collect the salaries of men normally compelled to do otherwise.
Yes it is only a short term band aid. But at this time I think it may pay to be pragmatic.
There are a lot of issues that could impact market availability of funds, the Euro zone could unwind, China could slow down, the US could stall or fall into recession. There are the flow on effects of a China slow down on commodity and other Asian economies and after the US elections there may be military action in Iran.
Any or some of these things could negatively impact funding. So at this stage even though it's not perfect, may have a moral downside and even may not be a great a long term idea I think if it adds to stability we should do it anyway.
Covered bonds are simply a vehicle whereby banks can funds themselves when the world is in turmoil (otherwise think about the consequences) and more importantly in the case of highly ray\ted Australian banks who have good acces to funding markets before others, can fund themselves cheaper i.e. make our mortgages cheaper than they would be otherwise.
I'm personally more than comfortable with the degree of risk management being employed by the banks and the central bank, but nothings certain in terms of tax payer/bond holder/equity holder risk in this world, covered bonds or no covered bonds.
more expensive or just bigger?? CBs are a conduit for cheaper credit, this makes it easier, and we all know easy credit flows into assets (esp housing in NZ) resulting ultimately in a bigger mortgage to pay for a higher priced house.
... but thats not the main point. The point is that under a covered bond, bond holders have LESS RISK than a conventional RBMS and deposit holders have MORE risk. Are depositors aware of this? (I highly doubt it) Are they receiving higher rates to compensate?? (clearly not).
mist42nz,
i think you have difficulties processing logic and articulating your irrational opinion as i have no idea what you are trying to say, but to be kind I'll try to make this as simple for you as possible.
its not free choice re mortgage size when govt / central bank policy reduces risk on debt and increases risk on savings - they are effectively forcing us down a dangerous path ie either inflated bubble asset with govt suppport or savings with negative net gains and higher risk via covered bonds - and if all banks are adopting risky policies fuelled by dereg environment and ultiimate govt bank stop then there is no sensible choice in the market place.
read up on the GFC - you know, that thing that happened a few years back, you might learn something.
4tnz,
buyer beware is not a bad theory in principle, but it depends on what you are dealing with as to what regs or restrictions you put around this eg we could have more up front labelling of risk to be aware of. Food is labelled for this very reason. Ditto share potfolios with the "past gains are no guarantee of future returns". Your average depositor does not have the ability to understand what is going on - but if the term deposits now had a clearly written statement on them prior to purcashe such as "your term deposit no longer ranks first in the event of us going under, you now rank behind covered bond holder A" then that would be a step in the rght direction.
.... and lets not forget - its not just depositors ranking further down the queue, by implication its the taxpayer, hence Russell Norman being rightlly concerned. I am a social conservative who never votes green, but they are the only ones who seem concerneed about society being fleeced by bankers.
@jimmy squirrell - Your average depositor does not have the ability to understand what is going on - but if the term deposits now had a clearly written statement on them prior to purcashe such as "your term deposit no longer ranks first in the event of us going under, you now rank behind covered bond holder A" then that would be a step in the rght direction.
Totally agree. - warnings should be mandatory now that Open Bank Resolution is expected to be implemented next June.
More on the South African move here, page 11.
http://news.coveredbondreport.com/wp-content/uploads/TheCoveredBondReportIssue2.pdf
You could save a deal of reading...! I came back to Neil Days last paragraph.....says it all really.........security is still in flux. Coming up with a template for what a covered bond is — or at least, one that deserves preferential treatment — would be hard enough even without having to take into account the varied structures that have already been developed. he Basel Committee on Banking Supervision faced a similar challenge in coming up with a global compromise that somehow balanced local diferences across a range of areas — and even ater its December framework was announced the debate over implementation still rages. But however diicult it might be — and whether the diferences are down to natural national idiosyncrasies or vested interests — a way of delineating the varied structures and legislations in the covered bond market will have to be found, even if it risks alienating some quarters of the market.
The advent of covered bonds should have lead to a risk premium to unsecured deposits. This has not occurred. Investors should be demanding higher returns to compensate for the increased risk. Sound familiar? This is exactly the same BS that lead to the finance sector demise. The only difference is the RBNZ stood back and did nothing. This cannot happen with the trading banks as the RBNZ is the bank of last resort. Bollard is playing a dangerous game in order to preserve liquidity at mom and pops expense.
Well how hard is it to ask which banks have covered bonds and which dont and what the interest rates are? If they are two say at 4% move to the bank without the covered bond....or ask for a say 0.25% premium.
Who's fault is it if the depositors is as brain dead as the ones that lent into the finance sector? For me it was gob smacking that finance companies were offering depositors small amounts above banks for what was substantial risk...
regards
They all have covered bonds apart from Kiwibank which I believe is about to follow the herd.
The finance company debacle is a seperate issue from the banks where investors are chasing high returns.
In the case of the banks most people are needing somewhere to store their money unless you're prepared to hold physical cash at home.
Have you asked your bank for a premium? Did they give it to you or just direct you to their term deposit rates?
TSB?
Co-op?
and yes if they all are then there is no option, or you keep it under the bed....which if the deflationista's are right, maybe the least risk.
No, I dont have enought $ for them to care.....and I also dont have enough debt for them to care....so Im a non-person.....though their reps turn up at my door every so often try to flog me crappy products I dont need at rates/cost that are awful......hopefully they will give up....
1) I have not asked for a premium at present as Im with kiwibank.
2) I understand that there is always risk, the Q is what is the minimum risk in what circumstance.
3) I think worrying about covered bonds is a side show.....given the huge leverage and likely losses I think depositors will be zero'd out.....
regards
Finance companies deliberately kept their rates lower than they should be so they weren't perceived as risky. They knew a rate 5%+ higher than banks would make them look riskier (even though this was the reality) and discourage investors. They got the maximum amount by just being a few percentage points higher - enough to tempt mums and dads but not high enough to set off alarm bells and get them to question why they were higher.
.........WHERE IS THE MEDIA ?
Captured by bank advertising revenues? Possibly not. Mutterings of record page views at interest .co.nz. suggest otherwise, but maybe printed news/TV is still considered more widely read/viewed, hence this type of story is perceived to be too politically sensitive.
I am at a loss to understand why collectively the nation is behaving as though we are lemmings and are prepared to walk a proportion of their savings over the cliff without a murmur, and yet our bureaucrats are feverishly making favourable arrangements for foreigners. The latter's actions must be tantamount to treason.
Grow up or go away. Your feigned faux naivety is wearing thin.
The State (RBNZ) sets the OCR which anchors the deposit rate - hardly an even market force driven playing field. Bernard publicly claims he believes the RBNZ is captured by the banks.
The banks have no legal need to open their off-balance sheet positions to scrutiny - how do I undertake due care and diligence analysis when I am unable see the positions. Nearly every recent bank blow up is sourced in the derivatives book- witness JPMs $25-30bn CIO blowup.
Whenever you invest there are always going to be unknowns....and the playing field is never even.....your eyes should be wide oepn not wide shut.
I fail to see why one set of investors is entitled to enjoy a risk free rate of return at potentially someone elses expense, moral hazard yet again.
Also I think the banks have said time and time again they follow the OCR because it takes the heat off them and the margins are enough to suit them....these days not so.....oh dear.
Sure they dont have to open their books, at the same time you do not have to invest with them.
regards
My point still stands, that deposits are not risk free, nor should they be....the on lending certianly is not.
If you follow Steve Keen's argument actually banks lend then look for deposits....an interesting reversal..
If depositors withdraw then the bank has to go and borrow elsewhere (offshore) or offer a higher rate to attract you. Really I see it as the same ineptitude displayed with giving money into the finance sector repeated here with deposits.
regards
Covered bonds are well established and bigger in Europe but hasn't stopped their banking system from melting down. When confidence goes and a run starts people don't sit back and anylyse "oh that bank's got long term covered bonds", they yank their deposits and wait to see what happens before putting it back. Don Brash said the whole system ran on little more than confidence and he felt whatever measures were in place (OBR, covered bonds, whatever) if one NZ bank got into trouble the govt would have to immediately step in and guarantee deposits in all the banks to prevent a contagious systemic meltdown. He also said he had come round to the idea that if banks were too big to fail they should probably be nationalised or forced to increase their cash reserves back closer to 25% if they wanted to remain private companies.
Why isn't the issue of too big to fail (relative to market) being discussed in NZ? Way bigger issue here than virtually anywhere else including US. Aussie logic followed here is is you allow them to be big, fat, "low risk" (ie vanilla lending) and don't crimp their profits they will be safe.
Why can't there be non interest bearing accounts that are 100% guaranteed and run by the RB as well as the payments system. If you want interest from your bank deposit its on the same terms as other investments. Bank goes down payments system and these non interest bearing current accounts are unaffected. With interest rates so pitiful anyway I'd rather have the security as probably would a lot of companies for their wages, suppliers etc
"New Zealand Reserve Bank, along with a consortium of the big five banks here, believed allowing some use of covered bonds would contribute to greater financial stability"
i think the article should have stopped at the words "consortium of the big five banks" - covered bonds benefit bankers, pure and simple. They can borrow at lower rates and then lend more at higher margins because additional risk has been passed from the bond holder to depositors. WHY ELSE DO COVERED BONDS ATTRACT A LOWER RATE???? RISK v RETURN is the basic premise driving any investment decision.
How on earth does this create greater financial stablity - more debt is more debt, regardless of how you dress it up. Financial engineering and sophistry is the PRIME CAUSE of the GFC ... so lets add some more engineering to add stability. Just another unfortunate another example of the socialisation of the GFC onto prudent savers (and by implication the govt via bank guarantees).
A dsgrace, pure and simple, but this is the world we live in.
The covered bond attracts a lower interest rate? and over a longer period? Hence the difference between this and the depositor is the premium for the added risk?
Its also a case of supply and demand it seems. After the finance sector meltdown lots of ppl have their money in deposits accounts afraid to put their money elsewhere...and no are not happy they are getting little and they have the perception that the risk to that is significantly changing.......strikes me as vested interest.
Why are ppl with deposits prudent? some years ago they were all in finances companies....whats changed?
I dont see that the Govt is at any more risk than it was before...look on the positive the covered bond ppl are stuck with a term....depositors can withdraw over-night.
regards
people with money in finance companies were rarely prudent, and I never thought they were. But sadly I agree that that with recent developments deposits may no longer be a prudent investment, but that is my point, covered bonds make deposits less safe (without a rise in int rates to compensate). The govt IS at more risk because covered bonds enable lending that would not otherwise occur - the govt is on the hook ultimately for all bank lending, more debt = more risk.
So what does the prudent person do when all they see around them are bubble assets propped up by govt / tax payer largesse OR deposits / govt bonds that are increasinly dangerous due to the increasing liability being assumed by govts and depositors. Franky I dont know. Gold - but thats arguably a bubble? Under the mattress - but then you have inflation to contend with. Hence my frustration - hugely inept and vested interest aligned govt policy has ripped all sense out of the economy, and with it all incentive to do the sensible thing as there are NO sensible options left.
Proof please - this is not a guessing game - people don't invest in questions"
Stephen H - go ask any bank Treasurer for a start, a couple have been making presentations in the past couple of weeks and quite open about their funding situations and covered bond benefit etc...its ain't a secretDo you have a definitive New Zealand Dollar equivalent rate or spread over NZ swap?
European issues have to incorporate two swap spreads to convert proceeds back to NZD, hefty cost here +100 nz bps.
I have never seen an exact quote from a NZ bank of their all up final landed costs.
mist42nz - a fair amount of ignorance shown with that comment - when they are being specific with no.s they don't lie, they don't need to and its not that secret anyway as to what banks got issues away at - what you don't know without asking is their landed cost when they swap it back but they seem quite open about that as it not hard to work out in markets anyway.
I'll try to find out through my contact Stephen coz my memory isn't that good.
If there is anything positive to come out of all this, then this bit would qualify.
“It’s not an objective of the Reserve Bank (of New Zealand) to protect depositors - we have a financial stability objective,” the Reserve Bank official said.
I always thought the RBNZ had that reponsibilty (to protect retail depositors), but obviously I was wrong. So the above statement from the RBNZ, does at least put thier position in black & white.
Mist42nz - "I've worked in marketing and my wife worked in a bank for 15 years" makes you confident enough to the make that comment about others.
Dude, some of us are a thousand pecentage closer to the sitiation, or directly involved, so if some one makes an ignorant (i.e. lacking knowledge) comment on here, they are occassionally going to be called out by someone with knowledge, who bothers to correct your statement for the benefit of the wider audience who come here like me to learn about other subjects they're not so informed about.
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