Gareth Vaughan says the NZ Super Fund's Portuguese stoush is a timely reminder of how messy things can get when a bank fails

By Gareth Vaughan

The New Zealand Super Fund's donnybrook with Portugal's central bank is a timely reminder of how messy things can get when a bank fails.

Super Fund CEO and ex-Reserve Bank Deputy Governor Adrian Orr is clearly none too pleased at losing US$150 million of future retirees' money in a situation where he believes the Super Fund, as a senor debt holder in Banco Espirito Santo, was treated "unequally and unlawfully."

Cynics may suggest that by teaming up with Goldman Sachs Orr was swimming with a shark, or a vampire squid as Goldman was famously described by Rolling Stone's Matt Taibbi, and should have expected to be bitten.

But from a broader perspective there are numerous lessons here.

One is that there's still plenty of uncertainty and risk in global financial markets. Banks can fail and when they do things get messy.

Hopefully Orr's plight will raise more than eyebrows among his former colleagues at the Reserve Bank who need to be as well prepared as possible for any potential bank failure on their watch. In such a scenario, that hopefully we won't face anytime soon, there are masses of issues to deal with. An important one is ma and pa bank depositors.

The Reserve Bank was caught on the back foot in 2013 when the Greens and Labour used haircuts for Cypriot bank depositors to highlight the potential for New Zealand depositors to face haircuts if the Reserve Bank's Open Bank Resolution (OBR) bank failure policy was ever actually implemented.

What the average bank depositor understands about the OBR policy, if they've even heard of it, when written down would probably fit on the back of a postage stamp.

The ignorance of many New Zealanders on such issues was starkly highlighted last October in a survey conducted for the Financial Markets Authority. The results showed 52% of respondents erroneously thought New Zealand bank term deposits were guaranteed. And 42% of respondents, also erroneously, believed KiwiSaver was guaranteed. The reality is neither have a government guarantee. New Zealand's an outlier in the OECD in not having a government guarantee on bank deposits.

Doubtless some of the confusion relates to the Crown retail deposit guarantee scheme that was in place from October 2008 until the end of 2011. It incorporated the infamous bailout of investors in Alan Hubbard's South Canterbury Finance with the thick end of $1.6 billion of taxpayers' money, about half of which was never clawed back.

Some sort of public education campaign on what would happen with deposits if the proverbial hit the fan and a New Zealand bank, or banks, failed could help enlighten at least some of the public. It could serve as an exercise in understanding risk. Because no investment comes without risk no matter how small that risk may be. And this is one of, if not the, most important thing to understand when investing.

The Reserve Bank tends to talk tough about how it would deal with a bank failure, telling me a year ago no New Zealand bank is too big to fail. But the OBR policy is only one potential response to a bank failure, with a liquidation or taxpayer funded bailout of, what after all will be voters' money, also still possible.

As I said earlier hopefully a bank failure in this part of the world is not something we'll have to deal with anytime soon. But it pays to never be too complacent because as this Reserve Bank paper on NZ bank crises demonstrates, we have had bank failures in New Zealand before.

Also see: How the RBNZ's OBR might work.

This story was first published in our email for paying subscribers. See here for more details and how to subscribe.