Quick-fix plan for failed banks

By RICHARD BRADDELL

Depositors and creditors of a failed bank could end up as shareholders under a proposal the Reserve Bank is considering.

The aim would be to get a failed bank back in business within days, minimising disruption to the financial system.

Deputy Governor Dr Rod Carr said the Reserve Bank had been working on the proposal for 18 months because it was important to provide an alternative to the present choices of nationalisation or putting a failed bank into liquidation, which could take months or years.

The proposal was first outlined by Reserve Bank Governor Dr Don Brash to a conference of Commonwealth central banks this month.

However, Dr Carr said it was not dissimilar to the Government's recapitalisation of the Bank of New Zealand in 1991, in which the $600 million capital injection was eventually recouped along with the brand and franchise value when the BNZ was sold to National Australia Bank for double that amount in 1993.

Under the plan, a bank would be placed in statutory management once it became apparent that it was insolvent or about to become so, because loan losses eliminated its shareholders' funds.

At that point, a "haircut" would be applied across all senior unsecured liabilities, including deposits, other creditors and some off-balance sheet liabilities.

If, for instance, 15 per cent of liabilities was required to get the bank back on its feet, depositors and other creditors would then be given access to the other 85 per cent of their funds once the bank reopened for business.

The new equity would absorb outstanding loan losses and provide new capital. Other parties, including the Government, might also put up equity.

Dr Carr said an important part of the proposal was that banks would be required to maintain computer programs that would enable ready identification of haircut funds so that the recapitalisation could be quickly implemented.

Some banks can do that already, but others with legacy systems may need months to get them in place.

Because the recapitalisation would be undertaken during statutory management, it was unlikely that any additional regulatory or prudential rules would be needed.

Under the present regime, the Reserve Bank and Government offer no guarantees in the event of bank collapse.

In countries where guarantees exist, they usually apply only to retail depositors, and do not extend to institutions and large investors who provide local banks with 65 to 70 per cent of their deposits.

If the recapitalisation proposal was adopted, said Dr Carr, those depositors would be left in no doubt that they might become reluctant shareholders, thus giving them a strong incentive to bring their sophisticated skills to bear in analysing and monitoring the existing bank disclosure statements.