Thanks Matt,

The main reasons we dematerialize our “real” money by placing it in banks is to facilitate efficient payment transactions, or for safekeeping. The banks hold real money (same day funds issued by the RB) to cover their daily obligation to pay other banks (intraday if necessary) so I don’t see why these cheque account funds can’t easily be secured funds. Offering customers “real” accounts (same day funds) has been proposed at various times but the banks are not keen as they want the free use of those funds. They should not in my view as these funds are different.

When we give money to brokers for security transactions they are required by the regulator to hold it in trust. This is effectively in a bank account which cannot be overdrawn, cannot be used as an offset by the bank against other obligations and cannot be used without the client’s (or their broker’s) specific authority. These are effectively secured funds but I doubt they are regarded as such in the Bank’s accounts and brokers clients will not be happy if they get a haircut under OBR because the broker’s bank fails!

We are now moving to required managed funds to have trustees and custodians for holder’s assets. Why have we forgotten to secure the funds at the point of dematerialization for these transactions.? When customers choose securities or assets (including savings accounts) that put their funds at risk for return, it is only fair that the OBR haircuts their holdings in these unsecured accounts to facilitate resolution. When they haircut transaction balances which should be secured, that looks a lot like a regulatory tax.

I think the arguments for securing transaction accounts are compelling. If this is done, then under OBR any discussion of deposit insurance becomes an option for holders of unsecured accounts to choose or not as they wish. Everyone wants the government to guarantee their risky investments but there is no justification if their real money accounts in their banks are completely protected by securing them with the RB.

Yes the moral hazard issue is broader. The relevant point for OBR (not clear in their explanatory papers) is just whether ALL unsecured creditors suffer the haircut and have those funds frozen, or if there are exemptions. Do the board, executives and employees have their unpaid unsecured assets which are liabilities of the bank (wages, holiday pay, bonuses etc) subject to the haircut as well?

Hi William,

Interesting stuff. I can’t imagine that the cheque account funds are a significant source of funding – but I do agree they are inherently different. They are purchasing a “service” off the bank for holding their funds. I should look into some data at some point for this.

The OBR is definitely about the operation of winding down a bank, rather than a direct way of dealing with the full range of moral hazard. That is a broader issue which I am trying to touch on in the post – having a deposit levy doesn’t cover moral hazard, but it does go in the right direction. It is a “second best” style of solution.

I 100% agree with your interpretation, I feel the same way. I wasn’t meaning to criticise the OBR, just point out that we need to think about the implicit insurance as well. This point must not have come through correctly – so I’ve written a post to flesh it out!

In talking about OBR, deposit insurance and guarantees, it appears most people have forgotten the obvious….. secured transaction deposit accounts. Currently cheques account and deposit account funds are all treated as unsecured by banks. Some points I have been making recently are as follows:

The recent proposal to tax depositors to support a bailout of Cyprus has drawn attention to the Reserve Bank(RB)’s Open Bank Resolution (OBR) policy, due to take effect from 1 July this year. When a bank fails, OBR involves taking a “haircut” on balances in depositors accounts, to ensure continuity of operations while the bank’s finances are resolved.

As Deputy Governor Grant Spencer argues, the situations are not the same, and the RB policy makes sense – keeping banks operating when they fail so transaction flows are not stopped and there are less potential flow-on or systemic problems. RB arguments about reducing moral hazard in the bank and avoiding taxpayer funding when banks fail are also good – BUT – given the current lack of distinction between types of unsecured creditors this policy looks unnecessarily unfair to cheque (transaction) account holders, who are currently regarded as unsecured. If the OBR policy is implement this should be reviewed.

Since the effective dematerialisation of cash money, we all rely on registered banks to hold our cash in safe-keeping so we can process payments through cheques and electronic transfers. Banks cheque and EFT-POS systems are approved by the Reserve Bank and the RB is the regulator of those banks. We all use these systems and rely on the RB to ensure they operate properly and efficiently and are available when needed.

Cash or cheque accounts (transaction accounts but generally and here referred to as cheque accounts) earn typically no interest and we pay transaction fees. These monies are, and should be regarded as, different from deposit accounts which earn interest and where the bank has to put that money to use to earn more interest to pay depositors (i.e. savings or term deposits for example).

Cheque account monies should be regarded as fully secured funds and held in trust for their owners, with 100% capital protection by the bank providing security. They should not be put at risk by the bank to earn income.

In order to provide confidence and protection of the money transaction system, banks can be easily required to have sufficient funds (approved securities) on deposit with the RB at all times to ensure all cheque account monies are protected. This will cover real money (same day funds) provided by the RB to the bank to ensure all transactions of cheque account holders between banks can be completed.

Some categories of savings accounts also could be made fully secured in the same way, though these would necessarily earn less interest (dependent on what the RB pays the bank for those deposits).

Transaction operations of the bank could continue unimpeded while the financial situation of the bank was resolved and holders of secured funds would not have any haircut under the OBR. The argument for any guarantee for depositors is eliminated (since people choose to have their monies in secured or unsecured accounts), and political pressure for any taxpayer bailout of creditors is much diminished.

An interesting arguably unrelated but good moral question regarding the OBR is why not haircut or freeze bank board and executive and employee remuneration, as well as creditors/depositors funds? They are also unsecured creditors. That would certainly reduce the moral hazard risk in the bank!

The reality is that the Aussie banks are “too big to fail”. Westpac, ASB, BNZ and ANZ each make up around 20% of the market – I can’t conceive of a situation where one of them falls over and it not resulting in a run on the other three. The government would not be willing to let 80% of the banking sector ‘resolve’ using OBR – they would be forced to bail out.

Kiwibank is an SOE and on this basis already has an implicit state guarantee. A Labour government would bail them out and Bill English would take great pleasure in selling them if they got into trouble.

But there is a third tier of small NZ owned banks (SBS, TSB, Coop and Heartland). They have poorer credit ratings than the big four and also have a customer bases with a strong regional (TSB,SBS) or industry (Heartland) bias which might make them vulnerable to shocks in their particular market.
Each of them has at least a couple of billion in deposits and are all growing fairly fast. Any one of them falling over in the next few years would blow a hole in the government accounts that would make South Canterbury Finance look like a walk in the park.

As I see it the purpose of OBR is to allow the small NZ owned banks to fail and be ‘resolved’ (get sold to the Aussie giants) at no direct cost to the taxpayers. The sale of AMI to IAG is the kind of approach they are after – NZ owned insurer with a strong local Chch bias goes under and is handed off to Aussie company without cost to the NZ taxpayer.The four big banks will continue to have their implicit government guarantee.

Cheers.

“My wider reading informs me that it is the retail banks, rather than
central government, that create much of the new money entering our
society. And that central banks no longer have effective means by which
to regulate/limit the money supplied by banks. People with access to
the new money naturally (driven by greed/envy) want to spend it and it
is this that has led to the GFC.”

The central bank provides intra-day liquidity at the OCR, so that retail banks can meet investment demand at the interest rate implied by the OCR and rates markets. Money is “created” in a way that is pegged to the inflation target, and underlying demand for investment.

Banks in this case are an intermediary, and we have to look at how they function to figure out what is going on. Calls to “greed” or “too much money” aren’t a full description of what is going on.

“I am sure it is not that simple. But my point is that an open bank
resolution plan and/or deposit insurance scheme is akin to an ambulance
at the bottom of the cliff ”

This is a fair point. The idea is that if depositors realise that there is risk, they will incorporate that in the rate of return they demand from banks – as a result, when banks go to loan they will recognise that borrowing is more expensive than it was previously. In this case, they will lend out less, and use proportionally more equity funding.

Now note that the central bank provides intra-day lending facilities – but the retail bank needs to match assets and liabilities … it can’t just sit there borrowing off the Reserve Bank forever. As a result, the cost of credit on this side matters as well.

So by doing this, the RBNZ gets banks to take into account the risk of default more when they are loaning out – and that is why the OBR makes sense. I like it as a principle, but I am not sure whether a government would let a bank fail, and so I fear that there is a big hole in this when it comes to thinking about what will happen.