Opinion: This scheme has 2 big holes to drive trucks through

I called for a bank deposit insurance scheme in March and again last week. I should have been careful what I wished for. We now have a scheme that Rod Petricevic could (in theory) use to launch new government-guaranteed finance company to repurchase loans from the receivers for Bridgecorp. It could also be used by Doug Somers-Edgar to fire up the Money Managers empire again. Allan Hawkins could start raising money for his Budget Loans finance company and promise that it was backed by the government. Yet it may do nothing to solve the fundamental problem facing our major banks -- a shortage of wholesale funding between banks. Our banking system could still freeze up in the same way that the European and US systems have and this plan does not stop that. Let me explain.

This is a deposit guarantee scheme for all deposits by non-banks (ie people and businesses) in banks, building societies, credit unions and finance companies. Everyone taking deposits can apply and can in theory be accepted. All depositors, except other banks, can be sure their money will be guaranteed by the power of the government to tax. As long as the deposit taker hasn't breached its trust deed (ie hasn't defaulted on interest or capital payments on time) then the Reserve Bank can accept them into the scheme. Currently that clause rules out Petricevic, but not Somers-Edgar, who has only closed his finance company to new deposits rather than breached his trust deed. It would also be open to convicted fraudster Allan Hawkins, who currently does not take money from the public for his finance company. The scheme is extraordinary in its scale, breadth, depth and scope. It guarantees everything for two years, except for the deposits that banks and other financial institutions hold in each other. It was thrown together in a hurry and it is far from perfect, which is understandable. But it can be improved. Don't get me wrong. We needed something extraordinary to deal with an extraordinary situation in the Northern Hemisphere. Even the head of the International Monetary Fund has said there is a significant risk of a systemic meltdown in the banking system. Europe's governments are taking drastic action to save their system. There's a couple of huge holes and inconsistencies to be addressed or we risk a repeat of the sort of deluge into dodgy finance companies that helped get us into this mess. We also risk not dealing with the core of the problem, which is the freezing of lending between banks in the Northern Hemisphere migrating down south. Firstly the finance company truck. As I hinted at the top, there really is not much to stop Rod, Allan and Doug applying for a guarantee. Whether they'll get one is another thing. The Reserve Bank is still working out the rules. They may well include exclusions for bankrupts, alleged liars, convicted fraudsters and anyone they deem not to be "fit and proper." They should include what I call the 'fancy car' test. Anyone with a late model sports car should be excluded. But there's nothing specific to block these type of property developing Bentley coupe driving wide boys from starting up finance companies yet. Every finance company wannabe will be licking their licks. They'll be working on schemes and dreams about new developments or buying bankrupt holes in the ground as we speak. Just imgaine. They will be able to offer deposits at 10% with a government guarantee. If they're quick enough they'll be able to do their business before the two years runs out and leave an even bigger smoking hole in the ground for the government (ie the taxpayer) to clean up. Let's hope the devil in the details from the Reserve Bank closes this big hole. The second big truck sized gap in the scheme explicitly rules out bank deposits in other banks as being covered by the scheme. This effectively means inter-bank lending is not covered. Why is this important? Currently more than a third of New Zealand bank lending is funded from international wholesale markets, which means our banks have borrowed from other banks overseas. The scheme announced in Australia yesterday does provide a government guarantee for these inter-bank loans.  There is now a big risk that foreign banks will see they can be guaranteed if they pull their money out of New Zealand banks and put them into Australian banks. Much of this foreign short term wholesale lending done by New Zealand banks is done with either parent banks in Australia or one of the other three Australian banks so withdrawing it would be pointless. However, the risk is with the non-Australian foreign banks pulling their money out of New Zealand and moving it to Australia. As I write European governments are announcing a government guarantee scheme for inter-bank lending there, similar to the British government guarantee offered for such lending by British banks.   Currently the inter-bank markets within Australia and New Zealand are not frozen. They are definitely frozen in Europe and the United States. There is a risk that freeze will extend to New Zealand and Australia. When it does our Reserve Bank will have no choice but to expand the scheme to wholesale deposits too. There is another problem with the way this scheme has been developed and announced. Helen Clark took the dangerous decision to include it as the centrepiece of her election campaign launch yesterday. She also didn't inform National Leader John Key and Finance spokesman Bill English before doing it, and neither did the Reserve Bank Governor, it seems. Key and English have supported the scheme to remove the danger of a political fight endangering confidence in our system. But they are being forced to sit on their hands while Clark and Cullen display their "decisiveness" courtesy of the power of incumbency. Clark could have announced it this morning in tandem with Key and English and painted it as a 'war cabinet' style act of broad government. Instead, she chose to portray it as the act of a decisive, responsive government. Only days earlier Cullen had downplayed the idea and has actively opposed it over the years. This is policy making on the hoof dressed up as a bold plan to use the power of government for good. Playing politics with confidence in our banking system is a corrosive and dangerous thing to do. Helen should have held her breath and done the decent, statesmanlike thing. It may well come back to haunt us all.