ANALYSIS: The New Zealand Government's plan to introduce deposit insurance is a welcome step. Last week, finance minister Grant Robertson announced a new deposit protection regime to make the banking system safer for customers and to strengthen accountability for banks' actions.
Worldwide, 143 countries have deposit insurance schemes, and New Zealand has long been an outlier. It is high time one was introduced.
HOW DEPOSIT INSURANCE WORKS
Currently, if a bank fails in New Zealand, depositors could lose all or some of their savings.
Deposit insurance would change that and protect depositors' savings. It operates like other types of insurance. If disaster strikes and a bank fails, depositors' savings would be repaid up to a set limit.
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According to Reserve Bank data, New Zealand households store about NZ$177.98 billion of their cash resources in banks. The proposed plan is important for all New Zealanders. Most people with a bank account are retail depositors and may be unaware of the vulnerable position they could find themselves in.
Under the Reserve Bank's controversial open bank resolution policy, if a bank is distressed and under statutory management, part of a retail depositor's savings may be frozen and used to recapitalise the bank, if shareholder and subordinated creditor funds prove insufficient.
Essentially, New Zealand retail depositors would have to bail out their banks, unlike retail depositors in other countries who are protected by deposit insurance up to a set limit.
Apart from protecting depositors, the insurance helps to maintain stability in the financial system. It operates primarily to stop bank runs where depositors, afraid that they will lose their money, all demand repayment at once.
Images of people lining up outside banks and at ATM machines all trying to get their money out were a feature of the 2007-2008 Global Financial Crisis (GFC).
If people are confident that they will get their money back quickly from deposit insurance, they do not need to “run” on their banks.
BANKS OWN THE MONEY YOU DEPOSIT
Typically, banks will lend this money to individuals and businesses (for example, through mortgages), making a profit by charging interest. In return, depositors get the right to repayment of their savings on demand.
Banks have fragile business models because they borrow short (through deposits which are repayable on demand) and lend long (through mortgages and other loans that are repayable at a fixed date in the future). Banks do not hold sufficient funds to repay all, or even most, of their depositors at once.
Bank regulation provides some protection because banks are required to maintain certain levels of capital and liquidity, but if depositors panic and enough of them demand r
