Interest.co.nz chats to RBNZ Deputy Spencer about the challenges in weighing up the IMF's call for deposit insurance or a pre-stated 'de minimis' option against the reality of having to wait to see how big a hole you're dealing with if a bank fails

By Alex Tarrant

“There are always challenges around these things.”

Reserve Bank Deputy Governor Grant Spencer, on resumption of the debate on what happens if a NZ-registered bank fails.

Ask the bloke beside you on the bus tomorrow morning what he thinks of the RBNZ’s Open Bank Resolution policy.

In the perfect Interest.co.nz world, he’ll give you an opinion on moral hazard, whether government actions during the GFC led New Zealanders to believe there’s an implicit State guarantee of the banking system, and how a deposit insurance scheme might affect bank and depositor behaviour.

In reality, he’s more likely push the stop button and get off early.

He shouldn’t. He should ask what on earth you’re talking about and then take great interest as you launch into your own opinions on how well-protected bank depositors should be in this country.

The IMF recently recommended New Zealand adopt a deposit insurance scheme. Simply, if a bank fails, the government would bail out regular term depositors up to a certain limit.

Finance Minister Steven Joyce was clear that the government doesn’t like that idea, following a long-running stance held by John Key and Bill English. But he has said that tweaks were being considered to the Reserve Bank’s playbook of what would happen in the case of a bank failure in New Zealand.

Get used to the term, “de minimis”. Not because we’re expecting any action on the bank failure front, mind – far from it. This is just a topic we should all be aware of.

De minimis is not the latest Italian rap sensation. Rather, it regards the subject of ‘minimal things’. And in the present context it relates to whether a small portion of your deposit in a bank would be ring-fenced for you to still have access to if that bank went belly up.

The RBNZ’s Open Bank Resolution system is basically what it says on the tin. It is a method to try and keep a bank open after a failure event, while the central bank tries to resolve whatever has led to that failure.

I sat down with Reserve Bank Deputy Governor Grant Spencer on Thursday to discuss the Bank’s thoughts on the IMF recommendations, and to see if he could add to Joyce’s teaser that changes were being worked through to the OBR regime.

The regime already has scope for a ‘de minimis’ to be declared, Spencer explains. At point of failure, the Finance Minister can declare that $X in every depositors’ account will remain accessible.

Now, the IMF doesn’t want people to have to wait until after the fact to know how much of their money will be accessible. It wants the government to have an already declared $10,000 ‘di minimis’, arguing this is the next-best option to a deposit insurance scheme.

And here’s where Spencer’s quote about the difficulties comes into it. You can’t know the size of the hole that led to a bank failure before the fact. So, it’s hard to promise how much of someone’s deposit will remain accessible.

“You can’t make it too large or it may not be fundable,” Spencer says.

“And it creates a preference – it’s sort of like depositor preference, which the Aussies have. In a failure, depositors [there] are all covered first, whereas in our regime a depositor is just another senior, unsecured creditor standing in line with wholesale creditors as well.”

That’s another thing to remember. Bank depositors are one of a number of sources of bank funding. Some banks have a greater proportion of funding sourced from retail deposits, some less.

“If creditors overall are taking a haircut, but every [retail depositor is] guaranteed $10,000, that means that potentially other creditors have to take a bit more [of a haircut],” Spencer says.

“The government’s not paying this,” he reminds us. “This is not…a deposit insurance or a bail out where the government comes to the party. This is really who gets paid first and who’s front of the queue and how much you get.”

If it comes to it, a small de minimus would be much more manageable. “If it gets too large, it gets more difficult, particularly if you’ve got a bank that is very much retail funded,” Spencer warns.

“Those are the sort of challenges you get in designing such a regime.”

The IMF reckons pre-establishing a de minimis amount in legislation rather than leaving it to be addressed on a case-by-case basis could provide the same certainty to depositors as a deposit insurance scheme.

“This could mitigate against runs,” the Fund says. “It could also contribute to consumer education, as it is a simple message to communicate that deposits will be protected only up to the de minimis limit. The greatest certainty would be provided through a clear legislative framework including depositor preference for the de minimis amount.”

But again, that leaves the problem of the RBNZ and Finance Minister not knowing what kind of hole you’re going to find in a failed bank.

“Under the current OBR policy…when it’s all happening, the Minister comes out and declares what you’re going to keep [aside] to protect small depositors by saying you get $1,000 or whatever. But it would be in the context of how big a hole, the nature of the bank, the conditions of the day,” Spencer says.

“We recognise that’s not particularly satisfactory from the point of view of small depositors. Most other countries have these fantastic deposit insurance schemes with large amounts [covered by government].

“We’re saying, ‘well can we enhance/make it better for depositors here [with the OBR] without going to that full-blown deposit insurance type thing?’.

“That’s the challenge.”