Guarantee a prudential problem

New Zealand's Reserve Bank yesterday described the "transition" away from the just-introduced guarantee on retail and wholesale liabilities of banks, and also non-bank institutions, as "an important objective of prudential policy". The RBNZ discussed some of the issues surrounding the guarantee in its half-yearly review of financial stability.

Eight banks (though still, not, formally, ANZ National) have opted into the retail deposit guarantee, as have three building societies, one credit union and five finance companies. Presumably scores more, if not hundreds of tiddlers, will do so.

The guarantee lasts for two years, to October 2010 and as in Australia (where the scheme runs for a year longer) banks and finance companies face delicate issues in managing the shape of their liabilities in the run up to the expiry of the scheme. Some pundits wonder if the scheme will in fact become permanent.

The RBNZ wrote in the review that "such guarantees create distortions and can disadvantage some borrowers and lenders since they cannot cover all financial contracts and institutions.  

"Both the retail and wholesale guarantee schemes are being structured in a way that attempts to reduce these distortions as much as possible by using risk-based pricing and other features.  Regulatory oversight will also need to be very alert to the moral hazard that can arise in the presence of guarantees."