Important
for all New Zealanders
to read.
With
thanks to Gold Survival Guide
What’s
Wrong With the RBNZ’s Bank Failure Plans?
21
November, 2012
What happens if a bank fails in New Zealand?
If
your bank failed tomorrow, what would happen? Who knows is the
current answer. If it was a small bank the government may leave it to
the statutory managers and so depositors might get wiped out
completely if the bank was devoid of assets. But, if it was one of
the big four Aussie owned banks the government might well step in and
bail it out to avoid the major flow on effects to the rest of the
economy, not to mention the backlash from a sizeable portion of the
populace who would be deposit holders.
So
will this change when the Reserve Bank implements it’s Open Bank
Resolution (OBR) policy next year?
The
short answer is it’s not really clear.
But,
in case you haven’t read about the OBR before though, let’s start
from the beginning with a bit of background.
What is the Open Bank Resolution?
In
simple terms it means a potential “haircut” for deposit holders
of a failed bank.
There
isn’t currently a government guarantee of bank deposits in New
Zealand. As we’ve written about previously (Bank
failures could they happen in NZ: The Reserve Bank thinks so) and
unbeknownst to most kiwis the hastily set-up bank guarantee of 2008
expired in October 2010.
Under
the planned OBR, banks with over $1 Billion in retail customer
deposits will be required to set up their computer systems so the
RBNZ can, at the flick of a switch, freeze a portion of the banks
funds and then reopen the next day. This way the statutory manager of
the failed (or distressed as the RBNZ puts it) bank can continue to
trade while working out just how much or little the bank has in
assets. The banks shareholders would be hit first, but if there were
still insufficient funds then depositors would also potentially take
a cut on their deposits i.e. a haircut.
Why is the RBNZ implementing OBR?
According
to the RBNZ’s recently released mouthful of a report the Regulatory
Impact Assessment of pre-positioning for Open Bank Resolution (OBR),
the liabilities of the New Zealand banking system account for around
180% of national GDP. And the 4 major banks would account for the
vast majority of this. So if one of the big four banks were to fall
over and the government were to bail them out, like Iceland, Ireland
et al, New Zealand would be in a lot of trouble. So the aim of OBR is
to avoid putting government and therefore taxpayers on the hook for a
bailout of a major bank. Here’s the reasoning direct from the RBNZ:
The
costs associated with bank failures can create pressure on the
government to provide public support. One of the key lessons of the
financial crisis was the potentially enormous fiscal costs associated
with supporting troubled banks.
Some governments that chose to
guarantee their banking system’s liabilities are now faced with a
sizeable public debt burden, which can have serious consequences for
their sovereign credit rating and the availability and cost of
accessing international financial markets. The
liabilities of the New Zealand banking system account for around 180%
of national GDP.1
Whilst
shareholders have incurred significant losses during the financial
crisis, one of the outcomes has been that the risks that depositors
and wholesale lenders (particularly subordinated lenders) should
rightly have borne have fallen instead on taxpayers. As identified
above, without special resolution tools it is costly to impose losses
on creditors meaning governments feel pressure to bailout. The
resulting ‘moral hazard’ can damage incentives on bank management
to operate in a prudent manner, and reduce the incentive for
creditors and depositors to scrutinise their bank’s affairs,
distorting decision making and encouraging too much risk. Ultimately,
this can result in an increased probability of failure.
When will OBR take effect?
According
to the above mentioned Regulatory
Impact Assessment report
the
banks will undertake detailed design work, implement system changes
and carry out the necessary tests to ensure that they are able to
carry out an OBR according the requirements specified by the Reserve
Bank by
30 June 2013.
So
in just over 7 months banks should have made the necessary system and
IT changes to be able to flick a switch when required by the RBNZ and
freeze all ATM, internet banking and branch transactions for a day,
and be ready to reopen the next day.
What other options for handling bank failures were considered?
The
RBNZ looked at 4 options which were:
- Option 1: the status quo (including adoption of Basel III to strengthen resilience of banks);
- Option 2: significantly enhanced capital requirements;
- Option 3: introduction of living wills; or
- Option 4: introduction of OBR.
Option
1 is
what we have now, but with some tweaks made to line us up with the
coming BASEL III banking changes. So no absolute guarantee of
deposits, but the government and Reserve Bank would appoint a
statutory manager for a troubled bank and then decide what to do
depending on just how bad it was.
An
RBNZ consultation paper from October outlines what the RBNZ does and
doesn’t intend to implement in terms of BASEL III changes. From
what we could see the RBNZ says that the significant changes of BASEL
III in terms of capital ratios, are already met by our banks. Ratings
agency Fitch have confirmed this
is the case.
The
Reseve Bank notes that according to the new Basel III banking rules
(which were due to be implemented 1 January 2013, although
looking likely
to be delayed now)
the “minimum
for total capital is 8% of risk-weighted assets (RWA) comprising:
common equity tier 1 at 4.5%; total tier 1 of 6% and total capital at
8%. “
So
at first read you would think that means the minimum capital a bank
must have on hand is 8%. But the interesting thing here is that
banking regulations mean that banks don’t need to hold capital
against all their assets, but only “Risk-weighted assets”. We
just read a Bloomberg
story last
week outlinging how Frances 3rd largest Bank Credit Agricole has
a supposed Tier 1 capital ratio of 9.3%. However, “Total
assets at Credit Agricole were 1.9 trillion euros as of Sept. 30.
Risk-weighted assets, however, were a mere 298.3 billion euros. In
essence, we’re supposed to believe that 84 percent of Credit
Agricole’s assets were riskless, even though that obviously is
impossible.
Give
blame where
it’s due: The Basel
Committee on Banking Supervision is
the body that writes these rules, the objective of which is to make
too-big-to-fail banks’ capital seem
more robust than
it really is.
For
a more realistic capital ratio, take tangible shareholder equity
(which excludes intangible assets such as goodwill) and divide it by
tangible assets. At Credit Agricole, the figure was 1.4 percent as of
Sept. 30, which translates into leverage of about 73-to-1.
The
financial crisis isn’t over by a long shot.”
So
when we read these reports of banks having to hold increased capital
against their risk-weighted assets this story indicates we need to
dig plenty deeper to see just what their total assets are, and
therefore what their actual reserve ratios are.
Option
2 would
involve cranking up significantly the reserves banks would be
required to hold. The theory being that the risk of failure would be
reduced enough that the government would be prepared to cover the
circumstances where a failure could still occur.
Of
course we’d point out that these first 2 options assume that the
intellectuals running Central Banks can determine an appropriate
percentage of capital for banks to hold as reserves. As this article
we wrote back in August outlines (Why
Fractional Reserve Banking is Not the Problem),
originally bank reserves (ie. the portion of a depositors funds that
they needed access to and didn’t want lent out) were determined by
the depositors themselves, not by the banks and certainly not by
decree from a central bank. The very nature of the current system
means that if the depositors all want their money back at the same
time, even their “on call” funds, no bank will have sufficient
reserves. As we pointed out in the above mentioned article “on
call” funds should in fact earn no interest as they shouldn’t be
lent out, that’s why they are called “on call”!
Option
3 –
living wills – is merely planning to manage and reduce the overall
impact of any failure, so nothing in place to limit the likelihood.
So the RBNZ has gone for option
4,
the introduction of OBR, as the other options all leave open the
likelihood of the government being pressured into having to bail out
a bank in the event of a failure..
How will OBR work in the RBNZs opinion?
Here’s
a bit more detail from the riveting Reserve Bank report that put us
to sleep all weekend:
Undesirably,
bailouts protect shareholders and quasi-equity holders from suffering
full losses. OBR is an example of a creditor loss sharing mechanism
and puts in place systems to enable creditors to share the losses
associated with resolving bank failures, in addition to shareholders
assuming the burden of first loss.
Under
OBR, a bank would be open for (full-scale or limited) business within
one business day from occurrence of an insolvency event and be able
to provide depositors with full or partial access to their accounts
and other bank services…
The
key processes of OBR can be broken down into the following phases:
○ imposition
of statutory management;
○ closure
of access channels and freezing liabilities;
○ freezing
a portion of pre-positioned customer accounts and freezing all other
creditors’ claims in full (overnight process);
○ bank
re-opens for core transaction business and allows customers to access
the non- frozen portion of their funds;
○ release
of an equivalent portion of all other liabilities in due course;
○ release
of additional frozen funds, if available, following more accurate
assessment of losses; and
○ decisions
on the bank’s final resolution…
Under
OBR, unsecured liabilities that rank equally among themselves
(including deposits) will have a portion frozen. There is therefore a
large base, which eventually could be used to recapitalise the bank.
The initial freeze represents the portion of the claim that is
expected to be required to cover losses plus a conservative buffer.
However, the final losses to creditors only crystallise at the end of
the resolution process, for example through transfer of the business
to a bridge bank or another entity or when the bank or its bad assets
are liquidated.
How will OBR affect you?
In
short, if your bank fails and OBR is implemented then if there are
insufficient shareholder funds, you face the risk of getting a
“haircut” on your deposits.
But
in the latest report the RBNZ states “The
OBR is intended to represent an option for the government to use in a
failure event if it is considered the appropriate response, rather
than as a default option.”
So
our reading of this is that there is still the chance that the
government could choose another option, such as a taxpayer backed
bailout.
“Although
the OBR policy does in some way signal that the New Zealand
Government might not fully support a distressed bank in the future,
this policy does not eliminate the option for the Government to
extend extraordinary support to a bank.”
The
existence of a resolution regime would not indicate that a government
would let a highly systemically important bank fail in the future.”
However
the S&P analyst also commented that “All
this said, the existence of a resolution regime might make it more
difficult for authorities to defend the use of public funds to
support distressed banks.” We
reckon the clamor of affected depositors would be plenty loud
enough to convince the government to bail out a bank, much like they
chose to in bailing out AMI Insurance after the Canterbury
Earthquakes.
Why won't OBR work in our opinion?
So
it seems OBR may not achieve that which it is meant to. That is
because a bailout isn’t expressly excluded anywhere, the major
banks may still quite likely believe the government will step in if
necessary and bail them out. So the “moral hazard” that the
RBNZ mentioned OBR is meant to avoid, seems to us likely to still be
in play. And the fact that banks
are again lending up to 95% on residential property would
seem to back this up.
Now
if the government decides to backstop any losses, (albeit even though
the existence of an OBR might make it harder to argue why they should
in S&P’s opinion), the government and by extension taxpayers
potentially face being on the hook for a chunk of money. With the
liabilities of the New Zealand banking system accounting for around
180% of national GDP, if one of the big 4 Aussie banks go down that
could be a big ole chunk o’ money.
With
an existing budget deficit how would the government fund this?
Our
guess is much like everywhere else – through currency devaluation
and money printing. So if your bank fails you likely lose either way:
1.
Your savings take a haircut if OBR is implemented.
2.
Your savings are eroded by currency devaluation if your bank (or
anyone else’s for that matter) is bailed out instead of OBR
implementation.
So
with these 2 factors along with record low interest rates it’s no
wonder more and more people are turning to hard assets such as
property and precious metals as a hedge
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