The liquidation of FE Investments with $55 million in regular Kiwis' savings shows the value of deposit protection.
Banks are shaping up for a stoush over who picks up the tab – an estimated $200-400 million a year – for the Government's new deposit protection scheme.
New Zealand is to join most other OECD nations in providing insurance of sorts, for the eventuality of the collapse of a credit union, building society, finance company or – harder to conceive – a bank.
Finance Minister Grant Robertson has announced that if you have money in the bank or another register deposit-holder, a new scheme will protect the first $100,000. That is double the $50,000 he had initially planned, and ensures 93 percent of depositors will be fully covered.
It comes after the previous government cobbled together a temporary deposit protection scheme at haste in the Global Financial Crisis, which was needed when South Canterbury Finance and several smaller finance firms collapsed. That scheme was paid for by a levy on the four big banks – not the small, high-risk institutions. But it was those small-timers that went under, at a cost of about $1 billion to bail out the unfortunate ma-and-pa investors who'd stashed their savings in the finance companies.
The grim irony, as critics point out, is that the security of the deposit guarantee scheme encouraged more and more people to take their money out of the bank and deposit it with companies like South Canterbury Finance – where Allan Hubbard famously kept handwritten ledgers.
This time, the Government is taking more time and care to set up a scheme that is less likely to actually contribute to the problems. ACT leader David Seymour, for one, isn't convinced.
“The Government’s deposit insurance scheme is the kind of moral hazard madness that led to the GFC,” he said. “This is the socialisation of banking. The Minister of Finance is saying 93 percent of bank customers don’t care about bank stability because the taxpayer will bail them out."
Somewhat perversely, the decision to set a higher guarantee was, essentially, to encourage people to deposit their money with the smaller, riskier institutions. When the Government put the proposal out to consultation, small banks, credit unions, building societies and finance companies warned that a lower $50,000 limit posed a threat to their stability and liquidity, as it could prompt some depositors to shift uninsured funds (above the coverage limit) to the large banks, given their perceived greater stability.
Some argued the limit should be higher still, in line with the A$250,000 cap on the Australian scheme.
The Government admits the scheme could face losses in the event of institutions failing, and says it will also have ongoing operational costs. These costs will be covered by levies on all deposit takers – and those costs may be passed on to customers in the form of lower deposit rates or higher lending rates.
The collapse of finance companies is neither hypothetical nor merely historical. Last month, EY completed the liquidation of FE Investments, an investment and lending firm that was a strong player in the fishing industry.
The New Zealand company, which is owned by a Sydney parent company, was first put into receivership a year ago, with term deposits of $55 million. It was one of the Non-Bank Deposit-Takers that was supervised by the Reserve Bank, but by law, wasn't required to have a credit rating.
One worried depositor told the NZ Herald he had hundreds of thousands of dollars with FE Investments. The term deposit was due to expire and he should get his money back with substantial interest, but he feared the worst. "My main question is how much can I expect to get back but maybe there are some bigger questions for government," he said.
Smaller finance companies deserved support, he said. "I knew FEI were struggling," he said. "So I planned to reduce my exposure as soon as my term deposits expired. But that wasn't going to be until later this year and I guess Covid-19 was too much of a hit for them on top of their existing issues."
It is collapses like these that causes the big banks to argue such entities should pay a bigger levy towards the scheme, to reflect their higher risk.
As the retail banks point out, most of them have A or AA credit ratings. That's not the case for the building societies, credit unions and finance companies.
The table below shows that that they have B credit ratings, as best – and many aren't required by law to even have a credit rating.
“One issue that will need working through is how the levies to fund the scheme are applied to participating entities," said Roger Beaumont, chief executive of the NZ Bankers’ Association. "We support a risk-based approach to setting levies where lower risk entities, such as banks, pay lower levies because they are less likely to call on the scheme."
Professor David Tripe, who specialises in banking at Massey University's School of Finance, said he had been cautious about the "moral hazard" of deposit protection schemes in the past. But after the GFC and the collapse of firms like South Canterbury Finance, his view had changed.
"There's been some discussion of the levy being risk-rated," he said. "That's probably not going to work, because it would fall very heavily on the small institutions, and that's probably not the desirable outcome. So it's probably more straight-forward to impose a flat levy for everyone."
This time round, it would be important to avoid a repeat of South Canterbury Finance, where investors moved their money to the riskier firms, knowing they were backed up by a taxpayer guarantee.
"That will require more significant controls on financial institutions and what they do," Tripe said.
"There will be a levy from the beginning so people aren't incentivised to pile the deposits on at no cost. And I think there's going to be much more oversight by financial system regulators as well. So it won't just be open slather."
