N.Z Banks: How Safe is your Money?

N.Z Banks: How Safe is your Money?

Most of the developed countries of the world operate some form of retail deposit guarantee scheme designed to protect deposits in the event of a bank collapse. Many had been in existence for some years prior to the 2008 GFC and those countries that didn’t have them quickly implemented them as the crisis developed.

I briefly mentioned the N.Z Retail Deposit Guarantee Scheme back in June, in my post ‘Don’t be a Rabbit in the Headlights’ http://kiwiblackers.blogspot.co.nz/2012/06/dontbe-rabbit-in-headlights-as-we.html

 Here’s a quick reminder-

In New Zealand, the Retail Deposit Guarantee Scheme that was introduced during the depths of the 2008 crisis has now been wound down. It was brought in out of necessity because Australia had already done the same thing and if NZ had not followed suit there would have been a mass exodus of funds across the ditch.

The sole reason the schemes were rushed into being around the globe was to restore investor confidence and prevent a ‘bank run’. Were a serious bank run to occur and the banking system collapse, neither the NZ Government nor many other Governments have the necessary financial muscle to actually guarantee the deposits in their banking systems, it would effectively bankrupt the country. The banking sector is simply too large.

The fact that the guarantee has lapsed has not been an issue over the last few years. During this period N.Z has experienced relative calm after the shock felt during the initial stage of the GFC, so the fact that savings could be lost in the event of a bank collapse has not been a matter for concern in the minds of depositors.

Meanwhile the Government and the Reserve Bank have been working to improve New Zealand’s ability to withstand another shock to the financial system and their solution is the Reserve Bank’s Open Bank Resolution (OBR) policy.

This policy was flagged some months back and is designed to act as a new tool in the case of a bank failure.

In general terms the process works like this –

•      A statutory manager is appointed 

• All means of depositing or withdrawing money are frozen, as are all of the bank’s liabilities.

•      A portion of customer accounts are frozen and all other creditor’s claims are frozen in full (the amount frozen will be determined by the size of the bank’s losses plus a certain degree of slack).

These processes occur immediately, and are completed on the day the bank folds, then the following morning,

•        Bank reopens for core transaction business and to allow depositors to access all bar the frozen portion of their funds.

After that, once the final assessment of losses is known, additional funds will be distributed if available.

There are undoubtedly some good aspects to this policy, especially the quick ring-fencing of liabilities, allowing people swift access to the majority of their funds, but the inclusion of customer deposits in the assets that could be frozen will come as a shock to most people.

Many New Zealanders wrongly think that their savings are still guaranteed should a big bank go under, in spite of the expiry of the N.Z Government’s scheme, and as a consequence are more trusting of the banking system than they probably should be.

Even with the addition of the OBR policy, should a bank get into trouble I believe things will play out in a very similar fashion to previous ‘bank runs’.  

•       Once the OBR policy is triggered, depositors will become aware for the first time that some of their funds are at risk

•        As awareness of the implications of OBR policy become known, depositors will immediately start withdrawing their funds from banking entities with the same risk.

•      This will in turn create a problem for these institutions likely resulting in another OBR event with another bank, and so on.

•        Depositors will be desperately searching for a safe home for their funds and at this point, the Government will have no choice but to once again underwrite the entire banking system or face a massive exodus of funds from N.Z to the many jurisdictions that do have a retail deposit guarantee, creating a system wide banking collapse.

I fail to see what good the OBR policy will do as we will inevitably get the same end result. It seems more of a crisis management tool, designed in part to move some of the risk onto depositors, and little to do with making the banking system more robust and less likely to fail.

Rather than playing  ‘pass the buck’ and just focusing on the management of the next crisis, why don’t they instead look to ways of making the system more balanced, less exposed to risk and therefore less prone to a crisis in the first place?

Let’s have a look at some of the more obvious things that Government and the Reserve Bank could do:

•      Work to decrease our massive reliance upon Australian owned banks.

They currently account for around 90% of New Zealand’s banking sector, a situation that is virtually unprecedented anywhere else in the world. Aside from the fact that our balance of payments problems are exacerbated because so much of their profit is generated in N.Z but returned to Australia , the very fact that so much of our banking is foreign owned and therefore subject to problems within the Australian banking system, increases the risk within our own.

•       Legislate to prevent banks from offering mortgages on ridiculously high Loan to Value ratios (LVR’s).

Banks have repeatedly shown themselves unable to self regulate when it comes to mortgage lending. When the housing market is running hot they chase the perceived ‘easy money’ by offering higher and higher leverage until the obvious happens and the bubble bursts, disrupting the entire banking system. If these LVR’s were capped it would both deprive the housing boom of the fuel it needs to flourish, and stop the imbalances developing in the system in the first place.

•        Raise the risk profile of mortgage lending on the banks books. This will stop them pumping money into the over-inflated and under-productive housing sector

By making mortgage lending ‘riskier’ to the banks, it restricts the volume of mortgage lending they can undertake, and increases the relative attraction of other forms of lending. Over time this will result in a rebalancing of the banks’ lending profile which decreases their overall lending risk, and drives more capital into the business sector where jobs and profits are ultimately generated.

•         Curtail the banks ability to access the wholesale funding markets, forcing them to pay more for domestic savers funds.

Currently the banks are sourcing approximately 30% of their funding from the overseas wholesale market at cheap interest rates. This allows them to offer lower rates to domestic depositors because they are not so dependent upon these funds. This high dependency on overseas money dramatically increases the systemic risk, as should this money flow suddenly dry up things would get very ugly, very quickly!

 This is particularly pertinent as the overwhelming majority of money in the wholesale markets originates from the euro-zone, and when the next leg of the GFC hits, it is there that the impacts will be most felt, with wholesale markets freezing up and likely remaining so for some time.

By restricting their access to overseas funds, you force the banks to chase domestic savings. This will drive up the rates offered on domestic deposits, benefiting savers, and decrease our reliance upon this riskier overseas money. It will also benefit our balance of payments as the interest payments will be staying in the country rather than going overseas.

None of these solutions are in themselves a silver bullet, but implemented as part of a broader strategy might help to make our system more robust, less prone to external shock and with a better lending balance.

It is possible to have a banking system we can rely upon in times of global strife rather than one with obvious weaknesses that will more likely be an ‘Achilles heel’.

Unfortunately the chances of any meaningful change are remote. In his inaugural speech, the new Governor of the Reserve Bank Mr Graeme Wheeler seemed to agree with the pre-existing orthodox approach of his predecessor Mr Bollard, and suggested that although new measures might be introduced they would be more tinkering around the edges than a fundamental overhaul of the system.

It would appear therefore that the fallout from the 2008 GFC didn’t frighten the powers that be sufficiently to undertake any meaningful change. They seem content to tweak the system rather than undertake the required action (like rearranging the deckchairs on the Titanic), and as a result the safety of deposits during a serious banking event will remain questionable.

I would be very careful where you hold your savings, and be ready and able to move them should the storm clouds start to gather.

The Government and Reserve Bank may be quite sanguine about the risks, believing that the prospects for the global economy are improving and that another risk event like 2008 is quite a remote possibility.

 I don’t share their enthusiasm.