RBNZ defends 'no deposit insurance' stance

A deposit guarantee scheme would not work in New Zealand's highly concentrated banking system and the central bank would continue to advise the government against deposit insurance, said Reserve Bank governor Graeme Wheeler.

This is despite a review of the New Zealand Treasury's fiscal policy advice by former IMF director Teresa Ter-Minassian recommending Treasury work with the RBNZ on deposit insurance.

Wheeler, speaking at Wednesday's release of the half yearly Financial Stability Report, said he was not worried about New Zealand being one of the few OECD economies without such a scheme.

"It tends to work well in economies like the US where you have multiple small banks, frequent failure - to be honest - in the US banking system and the funds that can be built up can be used profitably to protect borrowers in that sort of system," Wheeler said.

Wheeler said it would take "several decades" to set up a fund that could "seriously protect the deposits of investors and that creates a sort of tension in the sense that, if a government goes out and says 'OK we're providing deposit insurance, we're going to guarantee depositors in the event of bank failure' but it takes years for that - in fact, decades based on the analysis we've done - to build up a fund, then basically the government's written an explicit contingent liability that it will do that."

He added that the RBNZ worried about creating an incentive for depositors to "aggressively look for the highest returns" and also about the "incentive structures it creates for people in banks, bank managers, in terms of risk taking if they feel that there is this government guarantee."

"And there are also tricky issues about pricing these sorts of guarantees," he said.

"So you would want to set the premium for deposit insurance such that it reflected the credit standing of the institution that you are providing that assurance for. And that's become quite a tricky issue in many countries.

"Often they don't create that differential pricing for credit risk. What you see over time is deposit insurance levels rise, get higher and higher and that imposes more guarantees for the government. So our recommendation for the government on this sort of issue when it does come up is to basically say we don't think it's in the broader public interest to do this."

The Ter-Minassian report to Treasury also recommended Treasury work on better modelling tools to simulate the effects of fiscal policy, and take another look at policy options to lift national savings.