The Government is committing to introducing a deposit protection regime.

Cabinet has made an in-principle decision to introduce the scheme, designed to protect depositors in the event of their bank going belly-up, under the second phase of the Reserve Bank Act Review currently underway.

The proposal is for the regime to include a limit of between $30,000 and $50,000. This means someone with a $70,000 deposit in a bank that runs into trouble would get up to $50,000 back.

If they had a $50,000 deposit with Bank A and a $50,000 deposit with Bank B, and both banks went under, they would get $50,000 back from each bank, so $100,000 in total. But if they had $100,000 with Bank A, they would only get $50,000 back.

Finance Minister Grant Robertson said the proposed limit would cover 90% of individual bank depositors and 40% of funds in bank deposits in New Zealand.

Who pays?

While the deposit protection scheme's design will be announced in 2020, it is likely to be funded by bank levies, with the taxpayer standing in as a backstop.

Treasury explained: "Deposit insurance transfers the risks and costs of bank failures away from depositors onto an insurance scheme...

"Modern deposit insurance schemes are normally funded by levies on member banks, supported (where necessary) by temporary lending paid for by taxpayers.

"If the insurance scheme is accompanied by a depositor preference, this might also increase banks’ non-deposit funding costs as risks are transferred from depositors onto institutional investors.

"To the extent that depositor protection increases banks’ average costs, this might be passed on to customers through higher mortgage rates or lower deposit rates.

"Alternatively, costs might be absorbed by banks’ own margins and retained earnings. The extent to which costs are shared between banks and their customers depends on competition and contestability in the sector."

Why such a low limit?

Treasury said the $30,000 to $50,000 limit was "broadly consistent" with international schemes in terms of the share of deposits protected (90%) even if the dollar value of the limit was relatively low.

Indeed, Australia has a A$250,000 limit, the UK a £85,000 limit, and Canada a C$100,000 limit, as analysed by David Chaston in this article.

Treasury was conscious of setting the limit at the right level to avoid creating a moral hazard - IE knowledge of a protection scheme causing depositors to take less care when assessing the risks associated with their banks, and banks taking less care with depositors' money.

It said it was a matter of finding the point that would protect most households and small businesses, while leaving large institutional depositors, best placed to monitor bank risk-taking, more exposed.

Treasury also said: "International experience demonstrates that strong regulatory monitoring of deposit-takers’ corporate governance and risk management systems goes a long way to addressing the moral hazard of depositor protection."

Won't banks be safe enough once the Reserve Bank makes them hold more capital?

Treasury recognised the Reserve Bank's proposals to require banks to hold more capital - another move designed to make banks stronger, potentially at a cost to bank customers.

Yet it saw the introduction of deposit protection as a missing part of the "financial safety net".

"Capital tools that help to keep banks safe and sound at the ‘top of the cliff’, must be complemented by robust tools to deal with banks that may still fall to the bottom," it said.

"The OECD and IMF have warned that, without depositor protection, New Zealand is vulnerable to contagious bank runs."

Asked whether the introduction of depositor protection meant the Reserve Bank wouldn't need to go as far as it's proposing with it capital requirements, Robertson said that was a matter for the Reserve Bank to deal with.

“Our banks are safe and sound,” he assured.

"A deposit protection regime will increase public confidence in the banks.

“Overseas experience shows that bank failures can be the result of a few bad decisions that normal bank customers had no influence over and no idea about.”

Robertson said it was yet to be determined whether bank deposits that make up parts of investment funds, like KiwiSaver funds, would be covered by the regime.

The deposit protection announcement was one of three relating to bank regulation from the Government and regulators on Monday after a week of colourful media headlines about ANZ NZ and its recently departed CEO David Hisco.

The Financial Markets Authority and Reserve Bank confirmed that all banks have committed to removing sales incentives from frontline staff and their managers. And the Reserve Bank said ANZ NZ's regulatory capital modelling and director attestation process will be independently reviewed after falling foul of Reserve Bank requirements.

Regulatory regimes for bank and non-bank deposit takers to be combined; Treasury to be the Reserve Bank’s monitoring agent

The Government also announced other in-principle decisions on matters considered as a part of Phase 2 of the Reserve Bank Act Review. These include:

keeping responsibility for all prudential regulation functions with the Reserve Bank

combining the separate regulatory regimes for banks and non-bank deposit takers (institutions that are not registered banks, such as finance companies and building societies) into a single ‘licensed deposit taker’ perimeter

replacing the Reserve Bank’s existing ‘soundness’ and ‘efficiency’ financial policy objectives with a single overarching ‘financial stability’ objective

establishing a new governance board, which will be given statutory authority over all Reserve Bank decisions (other than those reserved for the Monetary Policy Committee)

establishing the Treasury as the Reserve Bank’s monitoring agent

The Reserve Bank Act Review was agreed in the Coalition Agreement between Labour and New Zealand First.

Phase 1 addressed monetary policy. It resulted in an employment target being added to the Reserve Bank’s inflation target, and saw a Monetary Policy Committee established to set the Official Cash Rate, so this responsibility wouldn't be left with the Governor.

Phase 2 considers the Reserve Bank's role as banks' and insurers' prudential regulators.

Cabinet has decided the next consultation in Phase 2 will consider whether the Reserve Bank’s supervisory regime is sufficiently strong. It will also review the enforcement tools the Reserve Bank has, including whether penalties are tough enough to discourage bad behaviour.

Increasing the responsibilities and accountabilities of senior executives on the table

The Government is considering adopting elements of overseas frameworks, which would increase the responsibilities and accountabilities of senior executives for the actions of New Zealand’s banks and licensed deposit-takers.

Australia’s Bank Executive Accountability Regime (BEAR) and the UK’s Senior Managers Regime are two examples of frameworks that assign duties to individual decision-makers at banks, so that if things go wrong the individuals directly responsible can be identified and held to account.

“These regimes go a step further than New Zealand’s current Director Attestation Regime for banks, by also holding senior managers to account for the prudent management of their bank within their area of responsibility,” Robertson said.

More information is available here.