KEY POINTS:
When British mortgage bank Northern Rock got into financial difficulty last year, the Government moved quickly to guarantee that savers would not lose their deposits. There was already a bank-wide scheme to protect savers' deposits, but only up to certain levels, and they rushed to withdraw money.
The British Government has since announced plans to beef up its bank deposit protection scheme.
In New Zealand, there is no such scheme. If a bank were to collapse, depositors would be in the same position as all the investors who have lost millions through the collapse of finance companies: waiting in the queue with creditors.
The Government would almost certainly come under pressure to assist if a bank got into difficulty, but the outcome would depend on the circumstances.
New Zealand authorities have looked at the pros and cons of a deposit protection system, says David Tripe, director of the Centre for Banking Studies at Massey University.
"I don't have the feeling they have come to a satisfactory answer," he says.
Tripe says the major problem with such schemes is that they provide no incentive for people to invest prudently.
Because there is no scheme in New Zealand does not mean there should not be one in future. But Tripe points out that these schemes are not simple to operate and someone has to pay. That could be savers, through lower rates of interest.
In Britain, the run on Northern Rock happened despite the existence of a deposit protection scheme, reinforcing the view that deposit protection is not a panacea. In New Zealand, there's an added complexity to grapple with: the fact that the four major banks - ANZ, BNZ, Westpac and ASB - are owned by Australian parents. Who would pay and how?
The approach in this country is for banking regulation to take the strain; encouraging investors to assume that the banks will be policed in a manner that prevents collapses.
Tripe says one of the consequences of having no deposit protection scheme is that it encourages people to look at credit ratings attributed to banks by internationally recognised agencies such as Standard & Poor's. Credit ratings are not a perfect indicator of safety or a guarantee, but at least they give some clue to strength. "There is a huge margin between double-A and double-B," says Tripe.
But, as he concedes and as recent events in the international banking industry confirm, there are no cast-iron guarantees. Northern Rock was hit hard and fast by the international credit squeeze and its crisis appeared to take everyone - regulators and management included - by surprise.
In New Zealand, the fallout from the credit squeeze has had an impact on finance companies and some smaller lenders, but banking analysts and financial advisers believe it is unlikely that there will be major difficulties for New Zealand banks. Their businesses are confined mainly to Australia and New Zealand, and exposure to higher-risk lending and overseas markets is limited.
But one of the features of the international banking crisis is the uncertainty over the exposure of large international banks to the problems in the United States mortgage market. This is because of the complexity of the financial products related to US mortgage lending.
Tripe says: "What you shouldn't do is put your money with someone and go to sleep.
"A lot depends on circumstances. It's quite different when there is no problem on the horizon [than] when there is [even] some vague possibility of problems arising."
Banks in New Zealand are seeing large inflows of deposits from savers at present, as investors take fright over the collapses among finance companies. The falls in share prices since the turn of the year are also likely to encourage a flight to cash.
In the absence of any sort of deposit protection scheme in this country, and the problems in the international banking market, how should cash investors reduce their risk?
Tripe says: "People who have multiple millions impose limits on the amount they will expose themselves to [with] any one bank."
For someone with $50,000 it may not be worth splitting between banks but with $50 million, you would probably want to.
Financial planner Greg Moyle, of New Zealand Financial Planning (NZFP), says that having a multitude of small deposit accounts adds complexity to your financial affairs.
This does not mean that investors should not diversify. But risk and diversification involve decisions about how to invest as well as with which institution.
Moyle's firm runs a cash fund for clients, overseen by an independent trustee, where money is pooled and invested across a range of large banks. Clients are recommended to have one bank account for day-to-day living expenses.
Holding large cash deposits long term is not the aim of the fund. For financial planners such as Moyle, cash is part of a wide spread of investments that can weather gyrations in financial markets.
Over the long term, returns from cash are not high enough to justify holding large sums on deposit, and portfolios run by NZFP generally hold around 2 per cent of their value in cash, with the remainder in equity and other funds, depending on the client's need for growth or income.
Moyle says: "When it is time to get out of the banks and put it somewhere else, no one is going to ring a bell."
Financial planners say that investors often have a poor grasp of what risk management and diversification involves. Susanna Stuart, of Stuart & Carlyon, says: "People thought they were diversified by investing in a lot of finance companies."
Her clients also have diversified portfolios. She generally tries to limit exposure to any one company or institution to 10 per cent. For clients who are sitting on cash after selling a business or property, she normally recommends spreading it between two or three banks.
If you are relying on interest from bank deposits for income, she recommends a range of terms as well as banks.
* Maria Scott is a Christchurch journalist who specialises in personal finance.
