KEY POINTS:
Last year the sight of anxious Brits queueing at Northern Rock branches in a desperate bid to recover their savings sent shockwaves around a financial world already reeling from the sub-prime and credit crisis.
The safety of money New Zealanders have in their bank accounts, and to lesser extent the wealth they have accumulated in their homes, are a couple of things they have probably taken for granted in recent years.
Softening prices, however, will probably have forced many of us to rethink housing as our primary means of building up wealth and the failure of Northern Rock raises the spectre of a far more damaging economic catastrophe.
Aruguably, the prospect of futher bank failures overseas and by extension here in New Zealand - where more than 90 per cent of the banking system is owned by foreigners - is more likely than it has been for years.
Northern Rock is not the only recent bank failure in developed economies.
In the United States four banks have failed in the last 12 months and Federal Reserve chairman Ben Bernanke recently unnerved financial markets when he predicted his country's economic downturn meant more would likely follow.
"Banks on occasion do get into trouble, and probably more often than is commonly thought," Reserve Bank Governor Alan Bollard pointed out a few years ago, in what were happier, safer times.
There have been several crises over the past 30 years. National Australia Bank, the owner of the Bank of New Zealand, got the wobbles in 2004 following a A$360 million ($416 million) foreign exchange trading scandal, and in the late 1980s and early 1990s both the State Bank of Victoria and the State Bank of South Australia failed. Westpac found itself in a "parlous condition" as a result of exposure to commercial property investment firms. In New Zealand the Government was forced to bail out the BNZ in 1990.
The early 90s also saw systemic banking collapses in Sweden, Finland and Norway and the Asian financial crisis in the late 90s resulted in Indonesian, Korean and Thai banks all needing financial rescue.
The disruptive upheavals currently playing out in global financial markets come hard on the heels of - and indeed are inextricably linked to - a period of unprecedented growth in the amount of debt taken on by households and businesses across developed economies in the last five years which has now topped out.
"Banking pressures are often linked to the upper turning points of business cycles," says Susan Schroeder, senior lecturer in business and economics at Auckland University of Technology.
"Given the close relationship that New Zealand banks have with the Australian banking system, a key risk to New Zealand's banks is for the Australian economy to reach the peak, or upper turning point, in its
business cycle." Schroeder points out that the Australian economy is still healthy, but the word recession is being nervously mentioned with increasing frequency.
The four big Australian banks' subsidiaries here - ANZ National, ASB Bank, BNZ and Westpac - utterly dominate the New Zealand market, holding well north of 80 per cent of the industry's assets.
Despite work by the Reserve Bank to ensure New Zealand is quarantined from any home market strife, any problems suffered by their parents would surely be felt here.
The impact of sub-prime and the credit crunch has clearly been greater in Australia than in New Zealand.
Australian stocks, particularly those of the major banks, have been hit far harder than the New Zealand sharemarket, and a number of sizeable, complex investment firms have gone spectacularly awry as a result of tighter credit conditions.
But apart from a few pockets of exposure, the impact so far has hardly been disastrous.
"The Australian banks, whether it's good luck, good management or good supervision, have avoided the direct exposure to the sub-prime crisis and all of the things that came as a result of that," says Professor Kevin Davis, director of Melbourne's Centre for Financial Studies.
There have been some losses. ANZ, for example, may lose US$200 million ($245 million) on its exposure to a US bond insurer.
But the biggest sub-prime-related problem for the big Australian banks, and their New Zealand subsidiaries, has been the resulting increase in the cost of money on international wholesale markets.
"That has a negative effect, except to the extent that they can pass it on to their customers which they are trying as hard as they possibly can to do," says Davis.
Significant recent increases in mortgage rates over and above what the central banks in both Australia and New Zealand have been doing are the painfully obvious result.
But the increase in the cost of money has also had a dramatic effect on some Australian businesses leading to a situation with some striking similarities to the events which caused problems for Australian banks in the late 80s and early 90s.
Back then, following deregulation, the banks lent large sums to what Davis describes as "very complicated companies that were highly leveraged" in the commercial property sector. "They were just being a bit bloody stupid."
This time around the banks have taken on a significant exposure to very opaque, complicated and also highly leveraged investment companies, some of whom, the likes of MFS, Allco and Centro, have come spectacularly unstuck.
What's different now is that the relative size of the banks' exposure is smaller, and the trouble comes after a period of great profitability for the banks who are now extremely well capitalised and in far better shape to cope.
Top Australian banks' exposure to these types of companies was recently estimated at A$5.5 billion ($6.35 billion).
But there is another area of potential trouble, and one which the big Aussies share with their New Zealand subsidiaries - the housing sector.
"We know that household leverage is the highest it's ever been and it's very unequally distributed," says Davis.
"There are some households with no debt outstanding but some groups, significant pockets of households in outer suburbs, are highly leveraged, with high loan to value ratios and high repayment to income ratios, and everything's probably going against them at the moment. There are some risks that are going to crop up in bank portfolios there."
Having said all that, Davis again points out Australian banks have been "enormously profitable" for quite a few years.
"While you wouldn't expect to see their profit rates staying where they are, because they'll obviously have to book some provisions for various losses, I don't think anybody would be expecting they'd be even making losses let alone getting into problems of losing capital." Davis's observations about the Australian housing market hold true for the market here, where banks' exposure is probably even more concentrated in housing.
Two years ago, then-Reserve Bank Deputy Governor Adrian Orr in one of the bank's twice-yearly Financial Stability Reports commented on the fact that New Zealand's banks were enjoying "a robust historical period" with the lowest levels of non-performing loans across the sector seen in recent decades.
That was due to the increasing concentration of lending into the housing market, which traditionally has low levels of defaults. But as much investment literature points out, past performance is no guide to future results.
The Reserve Bank was not without concerns that the banks' high levels of housing loans left them vulnerable to simultaneous shifts in house prices and unemployment.
"We're working closely with the banks to ensure that they're adequately capitalised for those sorts of events to be able to buffer through it.
"The issue we always have to think about is if things turn bad they can go quite quickly and you can have quite significant turnarounds."
It now seems inevitable that house prices will fall, indeed they have already, but it remains to be seen how deep and fast they will decline from here.
The more pessimistic predictions talk of a 30 per cent drop.
A possible contributor to such a fall could well be an intensification of one of the main forces that has already ended the housing boom and driven prices lower - higher interest rates.
It now looks likely that the Reserve Bank has finished raising the official cash rate, and indeed may even cut it sooner than expected if New Zealand catches a dose of the economic malaise now clearly taking hold in the US.
However, there are few signs that the sub-prime-related credit market problems which have driven substantial mortgage rate increases will ease soon, and indeed there is talk from the banks the pressure could intensify.
Should unemployment, currently at historical lows, rise quickly and significantly at the same time as such a housing bloodbath, the local banks could have real problems, says Massey University head of banking studies David Tripe.
He qualifies that with the observation that it's difficult to gauge the quality of banks' mortgage books.
"The figure for the amount of lending to first-home buyers with low equity could be only 10 per cent of their bank loan portfolios, in which case they're probably not exposed to any great risk. But we don't know enough about their portfolios to know if that's true," he said.
There are already some early signs that the quality of banks' mortgage books is starting to deteriorate.
Their most recent General Disclosure Statements reveal a sharp increase in the number of borrowers unable to make payments on time and some increases in their provisioning, the money they set aside to cover bad loans.
However these increases were off a very low base and are nowhere near danger levels yet.
Still, the impact of the most recent interest rate increases have yet to flow through to New Zealand homebuyers, who are also under pressure from rising fuel and food prices.
There's little so far to suggest unemployment is about to take off in New Zealand. Should that change though, for those New Zealanders with mortgages, big problems for their bank could pale in comparison with their own financial woes.
Time to insure against banks' failure: experts
New Zealand and Australia remain the only two OECD countries that do not have some form of insurance to protect depositors' cash should their bank go belly up.
Deposit insurance has two main functions, to reduce the risk of a bank run during a period of stress for the financial system, and to allow depositors to get access to their cash, or most of it, should their bank fail.
The Reserve Bank's view is that it is not clear that deposit insurance is the best way of achieving this.
It argues that deposit insurance may actually increase the risk of a bank failure because, depositors secure in the knowledge they won't lose should their bank go under, are not incentivised to monitor their bank's behaviour.
Banking expert Professor George Kaufman of Chicago's Loyola University spent time in New Zealand in 2004 examining issues around the Reserve Bank's financial stability regime.
He pointed out that "requiring mandatory public disclosure of financial and risk related information will be of limited effectiveness unless there are investors, creditors, or financial analysts who make use of it".
None of New Zealand's large banks are listed on the sharemarket here therefore, apart from second hand coverage from Australia, there are no analysts paying attention to their local performance.
Meanwhile, it's safe to assume the banks' General Disclosure Statements, which they are obliged by the Reserve Bank to produce every quarter, are largely ignored by their customers.
"It's clear the public doesn't read General Disclosure Statements and haven't embraced the concept," ANZ National chief executive Graham Hodges recently told the Business Herald.
Moreover, Kaufman made the point that while New Zealand had no "explicit" deposit insurance, "it is arguable that there is implicit deposit insurance".
"This stems from the presumption that many depositors are likely to have that the government would not allow depositors to lose money in a bank failure situation."
That perception was probably fuelled by the Government bailout of the Bank of New Zealand in 1990 which cost $635 million, albeit money that was eventually repaid with interest.
Still, this implicit state guarantee could potentially give rise to future bail outs at huge cost to the taxpayer.
That implicit guarantee is probably even stronger for Kiwibank, which is in effect owned by the government through New Zealand Post.
Kaufman argued that a limited insurance scheme, principally designed to protect retail deposits up to a predetermined but modest amount, funded by the banks would be preferable.
Auckland University of Technology business and economics lecturer Susan Schroeder also believes deposit insurance is needed, perhaps even for non-bank financial institutions.
"If such a scheme were in place, depositors would be less apt to retrieve their funds when their institution comes under pressure, giving an institution a better chance of surviving a rough patch."
