Open Bank Resolution policy FAQs
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 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.
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.