Status Quo

Reasons for introduction of current deposit guarantee scheme

9. The current retail deposit guarantee scheme (DGS) was put in place on 12 October 2008 to maintain depositor confidence in New Zealand given, at the time, the extreme stresses in international financial markets and the actions being taken internationally to introduce broad deposit guarantees, including by Australia.

10. Given the strong financial sector and corporate interconnections between New Zealand and Australia, Australia's policy reaction to these financial market stresses was very important as potentially significant parts of New Zealand's retail deposit base might have moved to Australian banks to take advantage of the Australian guarantee. This would have made New Zealand banks more dependent on wholesale markets which, also at that time, had been severely disrupted.

11. A wholesale funding guarantee facility (WFGF) was introduced in November 2008 to help improve access to international funding markets for investment grade New Zealand financial institutions. The WFGF has no explicit end date and is outside the scope of this RIS.

12. New prudential regulations for non-bank deposit taking institutions (NBDTs) were due to be phased in during 2009-2010 to promote the maintenance of a sound and efficient financial system and avoid damage to the financial system that could result from the failure of a NBDT. These regulations were not considered sufficient at the time to address the perceived risks to depositor confidence. The regulations will continue to be implemented throughout the current scheme and any extension. Clearly the regulations are not the means of exit from the scheme: they help to create and shape the environment into which firms will be required to manage long term. However they will encourage firms to take actions to reduce their own riskiness or to exit the sector.

Key features of existing DGS

13. The DGS is voluntary and will lapse on 12 October 2010. Eligible financial service providers pay a fee to enable their depositors to be covered by the scheme. Features of the current DGS are:

• Eligibility: The current DGS covers retail deposits up to $1 million per depositor per institution (including deposits, term deposits, current accounts, bonds, bank bills and debentures) in banks and non-bank deposit taking institutions (building societies, credit unions, finance companies, the PSIS and collective investment schemes who meet the eligibility criteria). For the purposes of the Scheme, retail deposits include deposits made by anyone other than financial institutions, related parties and in the case of non-banks people who are neither New Zealand citizens nor New Zealand tax residents. Policy guidelines set out the types of institutions eligible for the DGS and what criteria and other factors may be considered by officials when assessing an application, including whether the inclusion of an institution meets the relevant public interest test.

• Fees: Institutions which choose to opt in to the current DGS pay risk based fees depending on their credit rating, the size of their deposit book (if over $5 billion), or the expansion of the deposit book (if under $5 billion). The fee structure involves an element of subsidy from taxpayers to guaranteed depositors and deposit taking institutions, particularly in the non-bank sector.

14. Annex 1 shows the coverage of institutions at the moment.

Costs of existing DGS (sunk costs)

15. [Withheld - commercial sensitivity ]

16. [Withheld - commercialsensitivity ]^[1]

17. To date, fees collected under the current fee structure are approximately $87.4 million per annum ($81.9 million from banks and $5.5 million from non-banks).

18. However, the net costs of the Scheme extend beyond just fiscal: there are also economic costs. As a result of under-pricing of risk due mainly to the subsidised fee schedule, the current DGS has created distortions in financial and capital markets. Economic distortions include encouraging guaranteed depositors and deposit taking institutions to make riskier investment decisions since the gains from these riskier decisions will be accrued by the depositors and deposit taking institutions, while potential losses to depositors (of up to $1 million per depositor per institution) will be borne by the taxpayer. This is referred to as a “moral hazard” problem.

19. An example of this “moral hazard” problem within the current DGS is that finance companies, which tend to be involved in higher-risk and higher-return lending, have grown their deposit books by approximately $880 million (19%) since the guarantee was introduced in October 2008. Before the guarantee, the deposit books of many finance companies were shrinking.[2] In some cases, finance companies have used retail funding to replace their bank funding lines.

Objectives

20. The Government seeks a stable and economically efficient financial sector that supports growth in economic activity by minimising economic distortions while not exposing the Crown (and thus, taxpayers) to undue fiscal costs or risks. This requires a diversity of innovative financial service providers that are prudent in their lending decisions, can adapt to changing circumstances, and investors in these institutions that understand the risks involved and can price these risks accordingly. This reduces moral hazard, ensuring well-priced credit markets. Ensuring a viable non-bank sector in the future is important to this end, particularly as it provides competitive pressures upon banks and provides services in areas not otherwise provided.