The saving of us

by The Listener / 01 May, 2013
If our banks are sound, why do we need new regulations aimed at protecting deposits?
Europe’s various banking traumas are a stark reminder of what could conceivably happen here.

Customers descend on a Cyprus bank hoping to get access to their money. Photo/Getty Images

New Zealand survived the 2008 global financial crisis pretty well, largely, we’re told, because our mainly Australian-owned banks were strong and not too exposed to a property boom that triggered the demise of many finance companies.

So why is the Reserve Bank pushing for reforms, christened Open Bank Resolution (OBR), if there’s only a remote chance of our banks collapsing?

This proposal is not a recent idea. The bank has been looking at it since the 1997 Asian banking crisis. The proposal would allow any bank that collapsed to reopen immediately. Customers could access small amounts of cash but larger deposits would be frozen.

This is a bit like what has happened in Cyprus. Eventually the banks reopened and larger depositors took a haircut – their money was used to recapitalise the banks once shareholder funds were used up.

Iceland’s experience a few years before is not directly comparable. There, the Government let the banks fail because it couldn’t afford to bail them out, and the economy has paid a heavy price in the value of its currency, high unemployment and the crippling cost of repaying foreign debt. The chances of major banking failure happening here are small. But reader Mike Cowell wants to know if the OBR is a good idea.

He argues the average Kiwi is not equipped to tell a good bank from a bad one. It’s simple, however, if you apply the old adage about risk: ask yourself why finance companies offered the highest interest rates in the market.

Cowell wonders whether savers should spread even relatively small deposits across a range of banks. I don’t think it’s necessary, but spreading, say, $20,000 across four banks won’t make any difference to the interest you receive. And keeping track of your accounts will take more time.

What about banks formally separating riskier investment operations from basic saving and lending operations, Cowell asks. That’s part of a wider question. The key to having a stable and robust banking system is making sure it is well managed.

Our banks operate under the international Basel standards, which set minimum capital requirements to cover credit, market, operational and other risks and also focus on disclosure.

Cowell also questions whether talk of the changes will be enough to make depositors panic. I suspect the OBR discussion will escape most people given our stable environment.

But what it does raise is the issue of deposit insurance. New Zealand is unusual in not having it and some think it would be a good idea to protect small investors. The Government says it would be a cost for all. The Reserve Bank argues insurance distorts behaviour, encouraging risk-taking. It would rather address the primary issue – keeping the risk of failure low through regulation.

The tiny chance of a bank failure would be the financial equivalent of the Canterbury earthquakes. The insurance industry is generally good at providing disaster cover for individuals, but inevitably is stretched when dealing with thousands all facing similar problems.

Cowell worries that if bank deposits are made to look riskier, property might once again be the default investment option. In reality, property is not a viable investment option for small investors. Investment funds, for their part, spread money across a range of assets (property, interest-bearing deposits and equities), varying the proportions to meet the risk requirements of customers.

The OBR proposal might influence a few wealthier investors. But they should have the smarts to realise, in the unlikely event of a bank collapse, that big flow-on effects will hit the wider economy, including the value of property.

So, my assessment is the proposal will add to the set of tools for the bank to manage the financial system. The bank has had many years to think through the issues and has the benefit of some recent examples of what happens in a crisis.

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