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Opinion: What happens when banks fail?

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Associate Professor David Tripe

By Associate Professor David Tripe

New Zealand’s Reserve Bank has quietly moved forward with its plan to implement a policy of Open Bank Resolution (OBR). That might not sound very interesting, but it should be. It is the Reserve Bank’s plan for managing the failure of the country’s major banks. And its intentions were released at the end of last year with barely a murmur.

The essence of the OBR policy is that if a bank gets into difficulty, the government can appoint a statutory manager immediately, which takes control away from the owners. The aim is “to keep the bank open for business while placing the cost of the bank’s failure primarily on the bank’s shareholders and creditors, rather than the taxpayer”.

This could ultimately include the bank’s depositors. Under OBR, bank customers will have a portion of the money in their accounts frozen through a process called a ‘haircut’, and these funds will be available to the bank’s statutory manager to bring the bank back into solvency.

For someone like me, who has some concerns about the OBR policy, the consultation process has been rather frustrating. The Reserve Bank’s consultation paper, released in early 2011, was focused more on how best to implement OBR rather than asking if the policy itself was a good one. When it responded to submissions, it was with a mere eight-page document that gave scant attention to critics of the scheme.

So, what are my concerns?

The Reserve Bank has yet to release much of the detail of its OBR plans, even though the policy could be implemented as early as mid-2013. There are many questions that need to be answered, including how overdrafts and accounts with uncleared deposits will be treated, and whether the haircut will be applied to small depositors.

For those with only a small amount of savings, having funds frozen could easily mean simple EFTPOS transactions, like buying groceries at the supermarket, are declined. If the policy is implemented, it is important that it applies only to balances over a specified minimum.

With OBR the government is rejecting the blanket insurance of banking deposits – but how many small depositors are really in a position to determine whether or not they are with a dodgy bank? The Reserve Bank would say New Zealand has a wonderful disclosure regime, but it is just too complicated for a layperson to understand what a bank is actually doing.

It may even be too complicated for a banking expert to understand. The idea behind OBR is that distressed banks are able to reopen quickly after a crisis and give customers access to at least some of their funds, instead of staying closed while assets are realised. But given the complexity of modern banking, I believe it would increasingly difficult for any statutory manager to assess the position of a bank within hours, as is envisaged under the policy.

The Reserve Bank has been working on its OBR plans since 1999, but the world has changed since then. It seems it has not taken notice of the significant experience that has been gained by regulators and central banks internationally in the wake of the global financial crisis.

All other OECD countries that have seriously considered the issue of bank failure have opted for some form of deposit insurance. The Reserve Bank is alone in rejecting this and preferring its OBR approach, which requires depositors to recapitalise banks.

While I am willing to concede that deposit insurance schemes have their own issues, I do not accept that it is prudent to implement OBR without more extensive discussion on whether it is the best way of dealing with bank failure. At the moment New Zealand’s approach looks both unusual internationally and very, very brave.

Associate Professor David Tripe is the director of Massey University’s Centre for Financial Services and Markets.

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