Gareth Hoole: Raise the bar on deposit scheme

Gareth Hoole. Photo / Supplied

The Government's Retail Deposit Guarantee Scheme should be further refined and become a permanent fixture on the investment landscape in order to minimise the cost on taxpayers and provide a measure of protection to investors.

The scheme was introduced last year as a way of protecting investors after the collapse of a significant number of New Zealand finance companies.

Deposit-taking institutions which qualify are charged a fee to be included in the scheme and, should they fail - placing depositors' funds at risk - the Government provides indemnity to those depositors up to a specified level.

The Government has announced an extension to the scheme which ends in just over a year. The new scheme will apply only to deposit-taking institutions that have a credit rating of BB or higher. Those with a lower, or no credit rating, will not be eligible.

There has also been a change in the cost structure, with a graduated scale of fees that reflect the credit rating and type of organisation. This stands to reason - the lower the risk, the lower the cost and that risk profile is reflected in the level of the credit rating.

Some may argue that the present credit rating mechanism is not without flaws but in the absence of a better alternative, it is the only gauge available to potential depositors in assessing the financial strength of the custodian of their savings.

The introduction of the scheme - at the height of what was arguably the biggest banking crisis the world has seen since the Great Depression - was really unavoidable, yet was a bold step for what was then a newly elected Government.

Obviously a measure such as this comes at a cost when a deposit-taker fails and the Government has to pay out the affected investors. That cost is carried by the taxpayer.

We are unlikely to see the same proliferation of finance companies for a long time and the few that remain will hopefully not go the same way that so many others have gone. It must be accepted that about $4 billion of investor money has been lost and hopefully some salutary, albeit expensive, lessons have been learned by the investing public.

New Zealanders are being exhorted to commit themselves to a culture of saving but they need reassurance that if the custodian of those savings fails, they may have recourse. Even some of the largest banks in the world have not been immune to the vagaries of the credit markets.

It appears that the Government hopes to remove the scheme altogether after December 31, 2011.

It is my view the Government should continue to provide a guarantee but should raise the bar, offering the scheme only to deposit-taking institutions which meet even stricter criteria.

Investors who place their funds into only the safest of institutions should be rewarded for their caution, so that if the financial institution fails against all odds, they will be protected.

Those investors who are seeking a higher rate of return than is on offer by the mainstream banks and other more cautious deposit takers must realise that with greater returns comes greater risk.

The cost of belonging to the Government's scheme will undoubtedly be passed on to the depositor in the form of a bank charge, but that is a small price to pay for peace of mind.

The cost to the taxpayer should, theoretically, be minimised as the risk of failure of institutions which meet the coverage criteria should be vastly reduced.

It has been argued that a guarantee scheme was essential given the lack of regulatory control over the finance company sector.

That is all changing and investors who choose to place their funds in a finance company which does not meet the guarantee criteria should in the future have a great deal more information available to them upon which to base their investment decision.

This way the prudent investor is rewarded with a safety net at minimal cost to the taxpayer and investors, who have a more aggressive risk profile, will know what they are potentially diving into and can assess their own risks.

* Gareth Hoole is director of corporate advisory services at Staples Rodway.