Open Bank Resolution (OBR) policy – Q&A
The Open Bank Resolution policy is a tool for responding to a bank failure. It allows the bank to be open for full-scale or limited business on the next business day after being placed under statutory management (as a result of, for example, an insolvency event). This means that customers will be able to gain full or partial access to their accounts and other bank services, whilst an appropriate long-term solution to the bank’s failure is identified.
In the absence of the OBR policy, the options for responding to a bank failure are limited to liquidation, government bail-out or take-over by a competitor. If a private sector solution is not available the government must therefore choose between allowing the bank to enter the liquidation process, or providing public support. The liquidation process can be complex and time-consuming, during which time customers of the bank would not have any access to their funds or banking services. This has potentially significant implications for the wider economy, and can create pressure on the government to provide support. By providing a mechanism through which liquidity can be provided to customers whilst the resolution of the failed bank is being worked out, the OBR mitigates some of the risks that banking failures pose for the wider economy.
In reducing the pressure for government to provide a bail-out to a failed bank, the OBR might also help to strengthen incentives on bank management to operate in a more prudent manner, and on creditors to provide greater external scrutiny, helping to mitigate the moral hazard concerns that arise when an assumption of implicit government support prevails.
Furthermore, one of the key lessons emerging from the financial crisis is the potentially enormous fiscal costs associated with supporting troubled banks. Some governments that chose to guarantee their banking system’s liabilities are now faced with a sizeable public debt burden. By increasing the likelihood of bank shareholders and creditors shouldering the losses of a failing bank, the OBR can help to mitigate the risk of New Zealand being placed in such a position in the future.
The OBR policy is designed to ensure that first losses are borne by the bank’s existing shareholders. In addition, a portion of depositors’ and other unsecured creditors’ funds will be frozen to bear any remaining losses. To the extent that these funds are not required to cover losses as more detailed assessment of the position of the bank is completed, these funds will be released to depositors. At a high level, this outcome replicates the outcome that would apply in the event that a failed bank was liquidated. The primary advantage of the OBR scheme, however, is that depositors would have access to a large proportion of their balances throughout the process. This contrasts with what would happen under a normal liquidation, where depositors might not have access to any of their funds for a significant period.
During the recent global financial crisis the government took the decision to put in place a temporary guarantee on retail deposits. On 11 March 2011 the Minister of Finance announced that further guarantees would not be provided following the expiry of the existing scheme. Furthermore, the Minister ruled out the possibility of introducing a compulsory deposit insurance scheme. In coming to this conclusion the Minister noted that deposit insurance is difficult to price and blunts incentives for both financial institutions and depositors to monitor and manage risks properly. The full statement from the Minister can be accessed at http://www.beehive.govt.nz/release/maintaining-confidence-financial-system
All locally incorporated banks with over $1 billion dollars of retail deposits are being required to participate in the scheme. This means that these banks will have to put in place the necessary systems to allow the OBR to be carried out within the necessary timescales. This is referred to as pre-positioning. All other registered banks have the option to opt-in to the scheme voluntarily if they wish to do so.
The OBR is not intended to be the only option in the event that a registered bank gets into difficulty, rather it is designed to be an option that is available to the government if required. There may, for example, be circumstances in which a private sector solution is available.
The Reserve Bank will undertake an initial assessment of the health of a troubled bank. Following this initial assessment it may make a recommendation to the Minister of Finance that the bank be placed under statutory management. The Minister of Finance is responsible for taking the decision to place the bank under statutory management, and whether to apply the OBR. As part of any recommendation for statutory management, the Reserve Bank will be available to provide advice to the Minister on the appropriateness of activating the OBR policy.
The first stage of the process is to freeze all access channels to the bank and establish the balance of each account at the point at which the bank was placed under statutory management. A high-level assessment of the bank’s losses will then be undertaken, and a conservative portion of account balances frozen.
The frozen funds are then set aside to cover any losses beyond what the bank’s capital position could absorb. The frozen funds are not cancelled or written off, and the depositors and creditors continue to hold a legal claim to these funds. To the extent that all or some of these funds remain available after all losses have been covered, they will be returned to depositors and creditors.
Once the bank is placed under statutory management and all access channels have been temporarily closed, the Reserve Bank will make an initial assessment of the scale of losses incurred by the bank. It is not necessary for this assessment to be precise. What is initially required is a high-level calculation that is expected to ensure that a sufficient amount is frozen so that final losses do not exceed the frozen funds set aside.
It is expected that the size of the portion to be frozen will be issued to the statutory manager as a direction from the Reserve Bank, following consultation with the Minister of Finance.
The bank will re-open for ordinary transaction business on the next business day after it is placed under statutory management. At this point, depositors will have full access to the unfrozen portion of their accounts. These funds will be subject to a government guarantee.
The full assessment of the condition of the bank and the identification of the appropriate long-term solution to the failure are likely to take a number of days or even months to work through. Additional frozen funds may be periodically released to depositors during this time, to the extent that it becomes clear that they will not be required to cover the losses that have been incurred.
No. A key element of the policy is that no additional funds will be frozen once the bank re-opens. The initial amount frozen is expected to be sufficiently conservative to ensure that the losses of the bank do not exceed the level of funds available in the frozen portion of account balances. All funds that are not frozen will be subject to a government guarantee to ensure that all participants in the financial system are able to engage with the re-opened bank with confidence that any transactions will be honoured.
The first stage of the OBR process will see the failing bank placed under statutory management. From that point on the statutory manager is empowered under the Reserve Bank of New Zealand Act 1989 to carry on the business of the registered bank. In doing so, the statutory manager is required to comply with any directions given in writing by the Reserve Bank. Once the bank is placed under statutory management, it is unlawful for any of the bank’s previous management to conduct the business of the registered bank except with the permission of the statutory manager.
One of the key features of the OBR policy is that creditors are able to access the majority of their funds immediately after the bank fails and is placed in statutory management. This means that depositors and small businesses have on-going access to banking facilities, mitigating the risk that urgent liquidity concerns dictate how losses are allocated between shareholders, creditors and perhaps government.
The OBR is therefore not designed to determine how the bank failure should be resolved in the long term, but to create time for a full analysis of the appropriate course of action to be determined. In practice, the OBR is consistent with a range of long-term solutions, including sale to new owners, restructuring to become a stand-alone bank, repurchase by a parent group, government recapitalisation or liquidation.
Banking failures are infrequent, reflecting the low risk nature of the business that New Zealand banks undertake relative to many other financial institutions. This is reflected in the high credit ratings held by the major banks in New Zealand. The Reserve Bank does not expect the risk profile of banks to change significantly in the future, and as such would not anticipate an increase in the likelihood of a registered bank failing. However, banking failures can and do happen. One of the key objectives of the OBR scheme is to reduce the costs of allowing a bank to fail, and minimise access to taxpayer funds or bailouts.