Option 2 - Extend the DGS (continued)

Fees on total book based on credit rating and expected loss to Crown if default; fees not full commercial pricing but based on market averages in normal times, Treasury bill minus Bank bill differentials and the average rates applying over the 5 years before the crisis with a risk premium attached (see Table 3 in Annex 2); cap lowered to $500K for bank depositors per institution and $250K for non-bank depositors per institution (heading in the direction of pre-crisis, normal time levels); coverage to BB rated and above; CISs excluded to limit coverage.

Increases the economic costs associated with under-pricing risk, makes it harder for non-guaranteed institutions to compete, makes exit harder as it is distant from real market conditions.

Economic costs associated with under-pricing risk. Difficult but not impossible for non-guaranteed to compete:   some firms chose not to join the scheme even though they would have been eligible; non-eligible institutions have tended to keep their customer base but some switching has occurred into guaranteed products. Finance company growth likely to have reached its limit and not continue to expand. However, pre-DGS their deposit base was contracting and a better reflection of risk.

Buys time for restructuring.

Exit decision is just as hard as it is now but pushed out.

As fees are not fully commercial (considered to be over-pricing risk currently) it will be continuing to under-price risk, but to a lesser extent relative to the status quo. Fees are also charged across the book reducing the level of subsidy relative to the status quo and would be in line with what would happen under commercial terms.

Exit decision is easier as the cliff into a non-guaranteed environment is not expected to be as steep.

Less risky firms go forward into an environment where

NDBT sector provides competition to banks and services in area of lending and niche lending not covered by banks.

While there would be no distortions created by any subsidy or ease of other terms, currently risk is overpriced, and rates are unaffordable by most and virtually no, if any at all, demand for the scheme. Even if firms could afford the rates, overpricing of risk has economic costs in that an appropriate level of risk is not taken, with opportunities missed.

 As the commercial price is expected to be unaffordable, then no demand means the option becomes, in effect, the status quo and firms behave as if the scheme ends on 12 October 2010.

Fee revenue decreases due to low or no fees, contingent liability increases.

Possible that asset markets have more of a chance of starting to pick up by end of 2011, and so recovery rates in default situations may be higher.

There may be a disorderly exit and higher fiscal costs as the extension has not promoted adjustment, and pushed out the liquidity wall.  However, the new NBDT prudential regulations will mitigate that to some extent.

Fee revenue higher than under looser terms, but still involves a large amount of subsidy. Coverage of unrated and lower rated entities continues the risk to the Crown.

Possible that asset markets have more of a chance of starting to pick up by end of 2011, and so recovery rates in default situations may be higher.

There may be a disorderly exit and higher fiscal costs as the extension has not promoted adjustment, and pushed out the liquidity wall.  However, the new NBDT prudential regulations will mitigate that to some extent.

Fee revenue higher than under current terms.

[Withheld to avoid prejudice



           ]Banks may opt out as access is not longer factor considered for access to WFGF, but there still may be depositor and competitive pressure to join the scheme.

Contingent liability is reduced by excluding lower rated firms and CISs.

Overall fiscal costs are not expected to increase relative to the status quo and may decrease as some firms that would have exited under the status quo will still exit, with some taking the additional time to reduce their overall riskiness via mergers and restructuring ([Withheld–
to avoid prejudice
                                       ]).

Less likely to have good firms taken down with disorderly exit of firms with no long-term future.

May make more recovery in default situations as defaults are spread and it is possible that asset markets have more of a chance of starting to pick up by end of 2011.

Relative to the status quo, investor flight is less likely.

Scheme will cover institutions that do not comply with NBDT regulations that will be introduced and put into effect over this time.

Non-guaranteed firms are likely to struggle and moral hazard is significantly increased, so there are still some stability problems present.

Liquidity wall gets pushed out another year, and increased in amplitude, with RB regulation beginning to have an effect for non-banks.

Relative to the status quo, investor flight is less likely.

Scheme will cover institutions that do not comply with NBDT regulations that will be introduced and put into effect over this time.

Non-guaranteed firms are likely to struggle and moral hazard is increased, so there are still some stability problems present.

Liquidity wall gets pushed out another year with RB regulation beginning to have an effect for non-banks.

Relative to the status quo, investor flight is less likely.

Liquidity wall is eased with RB regulation beginning to have an effect for non-banks.

Liquidity wall does not resolve. Same as for the status quo where stability concerns would be minor.

Less restructuring occurs as no additional time has been gained. Sector to October 2010 remains as risky as it is currently.