Sunday, October 12, 2008

New Zealand To Introduce Shonky Deposit Insurance

PM Helen Clark has announced the Labour government will now introduce a deposit insurance scheme that will provide coverage for the next two years. Fees for the insurance will be assessed for institutions with $5 billion or more in total retail deposits.

Update: read details released by the Reserve Bank of the "opt-in" deposit insurance scheme here.

Deposits in banks and non-banks such as building societies, credit unions, and finance companies will be covered, but each institution must choose to join.

The voluntary nature of financial institution participation underscores New Zealand misunderstandings of the policy objective of deposit insurance: it is designed to protect the financial system from systemic failure - a run on the banks; it is not designed to protect individual institutions from illiquidity, however much individual depositors may focus on that.

Permitting individual institutions to opt out of deposit insurance coverage is to turn your policy charged with ensuring financial system stability into a very leaky boat.

The major trading banks will very quickly get the message. To fail to join the deposit insurance system will tag their deposits as unsafe and uneasy depositors will start moving funds to insured accounts. Poor policy design, however, will create unnecessary and possibly costly uncertainty at the onset of the scheme. The "loan sharks", however, will be left to prey on unsuspecting depositors.

Thus, deposit insurance is a condition of obtaining a banking licence, not an option. Moreover, with deposit insurance - a socialisation of bank liabilities as the government through the insurance fund guarantees to back bank liabilities - must come tighter asset standards to be supervised by regulatory authorities, otherwise bankers or at least the shadier kind of financier has the incentive to take the depositor's money and run - into more speculative lending practices.

Let's hope someone at the Reserve Bank and the Treasury gets the picture on this and is persuasive enough to turn the policy around on this point.

Update: It appears that the policymakers were either in agreement with the politicians or were overridden because the Reserve Bank has announced the details of the voluntary system that is euphemistically being called "opt-in" insurance.

The National Party, in opposition but leading in the polls, was not consulted on the insurance proposal, according to leader John Key. But Key and National Finance spokesperson, Bill English, have welcomed the proposal. They do, however, expect a bi-partisan process to be followed in designing and adopting the scheme. English will be briefed by the Reserve Bank on Monday.

Given the critical importance of deposit insurance to maintaining the nation's confidence, and that of internatonal lenders, in New Zealand's financial system that is a reasonable and proper course for both political and economic reasons.

Blog comment: this blog pointed out the absence of deposit insurance in New Zealand and the vulnerability of New Zealand's financial system back in July soon after the blog's creation. In recent weeks we've called for deposit insurance to be introduced. Global events have made such a scheme inevitable. It is unfortunate that the insurance system is only a voluntary one. As argued above, carrying deposit insurance should be seen as a duty or obligation of obtaining a banking licence in order to promote the public interest in a sound and stable banking system.
Stay tuned...

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