Does the RBNZ's living wills policy mean taxpayers will be off the hook if a major bank fails?

By Gareth Vaughan

The Reserve Bank's move to get banks to pre-position for its Open Bank Resolution (OBR) policy means there is now less expectation the government would use taxpayers money to bail out one of the country's major banks if it got into strife and more pressure for the Australian parent bank to cough up to stabilise its New Zealand subsidiary, says international credit ratings agency Moody's Investors Service.

Marina Ip, the Sydney-based assistant vice president of Moody's financial institutions group and sub-sovereign group, told interest.co.nz  that the OBR policy, or living wills, meant that instead of the government being the one expected to bail out a bank if it gets into trouble, the OBR policy "clearly outlines" an alternative step that could be taken in the event of a bank failure whereby shareholders and debt holders - working up through subordinated to secured and senior debt holders - would pick up the tab.

"Because this is one of the tools that they may use, it does from a government point of view, have less expectation that the government will use its own funds to bail it out and that it will now most likely rely on the equity holder to stump up first for the support and then it goes up the (debt holder) ranking in terms of level of claim," Ip said.

She added, however, that the OBR policy was only one of the tools the Reserve Bank could use "to bring a bank back to life." What ultimately happened could depend on the size of losses.

"If it was a small amount they might put it (OBR) into play because they could be easily absorbed by an Australian parent by injecting capital to cover. If (losses) are slightly larger there could be a different decision because from a franchise and reputation position New Zealand might not want to see one of its banks attract negative headlines," Ip said. " If it's something more systemic, if there's two or three banks involved, they might react differently."

Ip said what the Reserve Bank was proposing was "quite reasonable."

"From our perspective that level of (government) support is somewhat reduced by having a open bank resolution policy but it probably doesn't go so far as to say there was an implicit government guarantee beforehand," she said.

Effectively the the OBR policy is the Reserve Bank's blueprint for dealing with bank failures. It has suggested all locally incorporated banks with retail funding of more than NZ$1 billion be required to pre-position for the OBR which potentially means redesigning  the core banking systems at each of the banks. All the country's major retail banks - including ANZ, ASB, BNZ and Westpac which are the four systemically important banks given their New Zealand liabilities, net of amounts due to related parties, exceed NZ$15 billion, are being asked to pre-position.

An open bank resolution is an option whereby the bank is open for business on the next business day after its temporary closure following an insolvency event or an event that triggered putting it under statutory management, and is able to provide customers with full or partial access to their accounts and other bank services.

The key feature of the policy is that creditors are able to access a portion of their funds immediately after the bank fails and is placed in statutory management. The bank can then quickly reopen with the unfrozen or accessible portion of funds guaranteed by government to avert a further run by creditors. Additional funds can be unfrozen at later dates as the final losses are determined.

The Reserve Bank says the policy is intended to act as a resolution tool that places the cost of bank failure primarily onto a bank's shareholders and creditors rather than taxpayers, thus minimising moral hazard and providing a continuity of core banking services. The policy, previously known as Bank Creditor Recapitalisation, was developed after a review of the central bank's crisis management policies and instruments following the 1997 Asian financial crisis.

The Reserve Bank says its outsourcing, local incorporation and governance policies were all designed to facilitate the implementation of the OBR policy. Now, the pre-positioning of banks' internal systems represents the next stage in the process.

The central bank recently pushed out the deadline for consultation on its planned pre-positioning requirements for the OBR policy by three months to September 30 at the behest of the banks.

A consultation document on the proposals was released in March. The Reserve Bank wants detailed implementation plans by January 16 next year and full operational capability from the banks by the end of 2012.

In May Moody's downgraded its credit ratings on ANZ, ASB, BNZ and Westpac by one notch to Aa3 from Aa2 citing New Zealand's subdued economy, the banks' exposure to offshore wholesale financial markets for funding, and similar downgrades of their Australian parents.

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