Wednesday, 30 November 2011

Banking: An important warning

Bank Failures – Could they happen in NZ? The Reserve Bank thinks so

29 November, 2011

Last week we were reading this Zero Hedge article with the rather long headline “Futures Plunge As Fed Discloses New Stress Test: Fears US Banks Will Need To Raise Tens Of Billions In New Capital”.

It outlines how the US Federal Reserve is intending to stress test 6 large US banks against a “hypothetical” market shock (or should that have said a highly likely market shock!?), including a worsening of the European situation.  Zero Hedge surmises that the banks will likely have to raise tens of billions in capital as a result of this.  In short the big US banks are under capitalised.

This got us thinking (not for the first time), could a bank failure occur here in New Zealand?

Could a bank failure occur here in New Zealand?

This Herald article from earlier in the month paints a fairly rosy picture of the NZ banking environment, as you can tell from the headline “NZ banks well placed to cope with Greek crisis”.

However even this article confirms that 35% of our bank funding must come from offshore.  Granted this is down from what it was in 2008 but it still means we are reliant upon “the kindness of strangers” so to speak for capital.  Our Government borrowing may not be as bad as some other nations.  New Zealand public – i.e. Government – debt is around 33% of GDP (Source). 

However add in private borrowing and we’ve seen numbers that blow out to over 100% of GDP.  The point is we as a nation owe a lot of money and we need to keep borrowing to keep the balls in the air.  Not too dissimilar to most other nations.

However the key factor to consider we believe, is the interconnectedness of the global financial system.  2008 taught us that a decent sized market shock (like the one the Fed is “testing” for perhaps) can reverberate around the globe.  The system was only hours from falling over in 2008.  So if there is a credit freeze, then the 35% funding we require from offshore suddenly looks like a big number.  And remember that the very nature of the modern fractional reserve banking system means that it doesn’t take much for a bank run to occur as banks are leveraged at least 10 to 1 on deposits.

Well, it seems this fact is not completely lost on the Reserve Bank of New Zealand (RBNZ).

RBNZ prepares for bank failures with “Open Bank Resolution”
This November 14th article in the Herald outlines the RBNZ Open Bank Resolution Policy (OBR):“NZ banks wary of new Reserve Bank rescue rules”.

OBR basically means if your bank were to fail it could be shut down by the RBNZ and then immediately reopened but with deposit holders taking a “haircut” on a percentage of their savings.  The theory being that “it beats the alternative, which potentially involves depositors losing access to their entire savings, not just a proportion of them, if a bank’s doors are shut for good.  They say the key thing about OBR is that Joe Public would gain almost immediate access to at least a part of his savings if the bank failed. It would also allow the bank to keep its doors open, and lessen the chances of the taxpayer having to step in to prop it up.”

If you feel the urge you can read a 6 page “Primer on Open Bank Resolution” at the RBNZ website.  In this document the writers Kevin Hoskin and Ian Woolford conclude “While rare, bank failures can happen, and can be enormously costly and disruptive. The global financial crisis has renewed the focus on finding resolution mechanisms to deal with failed banks that do not involve heavy recourse to the taxpayer (i.e. taxpayer-funded bail-outs).“

Not surprisingly the banks are non committal on OBR.  From the above Herald article…

You really have to wait until the rest of the world also determines how it deals with bank failures,” Westpac NZ chief executive George Frazis said.”If you are not aligned you can get yourself unstuck. Our view is continue consulting until we see what comes out.”….ANZ New Zealand’s chief executive David Hisco, … said the ANZ was still “working through the issues” with the Reserve Bank.”We understand the logic behind it. We just need to make sure that New Zealand is not disadvantaged in relation to other countries, such as Australia,” he said.”Investment capital is mobile. If New Zealand becomes a place that is harder to invest in than other countries, then it may work against us.”

So you could wake up one day and find there’s been a “Bank Holiday” (and not the kind where you get a day off work and a long weekend!) and your savings have been cut by say 20%.

Aren’t NZ bank deposits government guaranteed?

But aren’t my bank deposits now government guaranteed you may be thinking?

You might be surprised to learn that this was only the case until a year ago.  Prior to October 2008 we actually had no bank guarantee scheme but as Australia was about to announce a government guarantee of their banking sector we were pretty much forced to follow suit.  However, the guarantee was only for a set period.  Since 12 October 2010 it has been voluntary and none of the major NZ banks have elected to go into the scheme.
Hat tip to our friend Louis Bolanger who first brought our attention to the expiry of the bank guarantee when he published this in the Gold Standard Institute Journal earlier this year.  (By the way go and sign up for the GSI Journal, it’s free and a great read every month

In his article, Louis commented that the banks might have chosen not to participate in the scheme for a couple of reasons:

1. Because they think the government will step in if necessary just like they did in instituting the original guarantee in 2008.

2. Because by electing to do so would be to admit they need it.

Can’t argue with either of those theories!

Don’t leave all your eggs on one basket

Regardless of the reason, the fact remains that your bank deposits are no longer guaranteed.  Meanwhile… the Reserve Bank of NZ  is busy canvassing the banks and planning for how to handle a bank failure using OBR a.k.a. a haircut to depositors savings…  The Federal Reserve is stress testing it’s major banks…  and Europe continues to teeter with it’s banks heavily indebted to the likes of Greece Italy, Spain and Portugal.

So maybe not leaving all your eggs in the one basket is a good idea?  Of course as always we can be accused of “talking our book”.  You could argue we would say that since we sell gold, the only asset on the planet that is not at the same time someone elses liability.  But with all the above going on, having all your savings purely in paper money in a bank seems like too high a risk to us.

Perhaps a good question to ask yourself is how safe is my money?  Or as we heard Eric Sprott say recently at the Gold Symposium  “be very concerned about where you have your money.”

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