Why the Reserve Bank expects savers to start spreading their money across banks and other deposit takers

Finance Minister Nicola Willis will decide which institutions will pay what to fund a new deposit compensation scheme. Photo / Mark Mitchell

Savers are expected to start opening new accounts at banks, credit unions, building societies and finance companies once a deposit compensation scheme gets off the ground.

From mid-next year, savers will have the first $100,000 of their deposits insured by the industry-funded, government-backed scheme.

So, if an individual or business had $200,000 deposited at a credit union that collapsed, they’d get $100,000 back.

If they spread their $200,000 evenly between two institutions that both collapsed, they’d get $100,000 back from each one.

The idea is that if people know they’ll get at least some of their money back in a collapse, they’re less likely to rush to withdraw it, causing a run on an institution, during a crisis.

Even though deposit takers must hold much more capital now than they did around the time of the 2009 Global Financial Crisis, the confidence provided by a deposit compensation scheme should strengthen the financial system.

The Reserve Bank (RBNZ), in responses provided to questions by Herald, said it expected the arrangement to incentivise people to spread their money across deposit takers. This way, more of their funds would be guaranteed.

It also believed people would deposit more money at higher-risk institutions, like finance companies, that pay higher rates of interest, knowing they’d be reimbursed up to $100,000 if that institution failed.

That said, the RBNZ hasn’t modelled how much money will likely be moved around once the deposit compensation scheme becomes operative.

It recognised the scheme could create a moral hazard – people could take on more risk than they otherwise would by putting their money with a risky institution, because they know they’ll get at least some of it back in a failure.

But with around two-thirds (or less, if there is a lot of deposit-splitting) of the country’s deposits likely to remain uninsured, it believed enough market discipline would remain.

The RBNZ was also of the view there was enough international experience to draw on to design the scheme in a way that minimises unintended negative consequences.

Key to this was the RBNZ’s belief that it’s important to ensure the levies deposit takers pay to fund the scheme are risk-based.

In other words, institutions more likely to run into trouble, such as finance companies, should pay higher levies relative to their size than lower-risk institutions, like the big Australian-owned banks.

The riskier players may need to pass on the costs to their customers by paying savers less, for example.

This should narrow the difference between what a depositor can receive for putting their money with a higher versus a lower-risk deposit taker, making the higher-risk one less attractive than would otherwise have been the case, decreasing the chances of it being over-run with customers.

While the RBNZ has been working with the Treasury on designing a scheme for several years, on the back of advice from international organisations like the International Monetary Fund, Finance Minister Nicola Willis will have the final say on how levies are set.

She will consider the RBNZ’s view, which is based on its role to maintain financial stability, alongside that of the Commerce Commission, which is tasked with supporting competition.

The commission is worried risk-based levies could cost smaller deposit takers too much, helping the big banks get even more market share.

It suggested, in the final report of its banking sector market study, that deposit takers are charged a flat-rate levy relative to their size in the first years of the scheme until its costs and benefits are better understood.

Willis told the Herald she was mindful of striking the right balance between promoting competition and financial stability.

She hinted she supported risk-based levies, but was considering whether to have levies a little less risk-based than the RBNZ proposed.

“There’s a gradation there. With risk-based pricing, there could still be gradations of how much of a ratio there is of risk that is borne,” Willis said.

“Where a financial institution is riskier, then there is pricing and prudential regulation to reflect that. You do need some reflection of that in your financial system.

“What we also need to balance that with is the significant incumbency advantage that the big four banks have. They’ve managed to develop scale and therefore stability over time through favourable regulatory settings.”

With the deposit compensation scheme to become operational mid-next year – a year later than originally intended, Willis will soon have to announce exactly how it’ll be funded.

She will do so, as the spotlight remains on banking sector competition and profitability, with a parliamentary select committee inquiry under way.

ANZ’s chief executive and board chair were the first of a string of bank bosses to appear before politicians on Wednesday for a grilling on how they do business.

Jenée Tibshraeny is the Herald’s Wellington business editor, based in the parliamentary press gallery. She specialises in government and Reserve Bank policymaking, economics and banking.