The Reserve Bank has published its latest consultation paper on the detailed regulations to implement the Depositor Compensation Scheme (DCS).
The Reserve Bank is seeking feedback on the final policy proposals for:
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the methodology for calculating levies payable by deposits takers;
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the scope and coverage of the DCS, including the types of eligible products that will be covered and the entitlement conditions;
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the types of accounts that will be relevant arrangements whereby protected deposits held on behalf of eligible depositors will receive "look-through" treatment;
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the treatment of in-flight transactions to determine the aggregate balance of eligible depositors' protected deposits at the quantification time; and
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a proposed exemption for branches of overseas banks, which is not unexpected following the publication of the branch policy review decisions.
The consultation paper contains final policy proposals following the initial consultation in July 2023 and industry workshops. This consultation is separate to the Treasury's consultation on the statement of funding approach, which addresses matters such as the target size of the Depositor Compensation Fund.
Below, we summarise the Reserve Bank's final policy proposals. The consultation closes on 10 May. Please contact one of our experts if you wish to discuss any aspects of the proposals or the DCS more generally.
Background to the consultation
The Deposit Takers Act 2023 (DTA) received royal assent in July 2023. Once fully implemented, it will modernise the Reserve Bank's regulatory and supervisory powers and combine the regulation of banks and non-bank deposit takers into a single regime. One of the most significant changes introduced by the DTA is the establishment of the DCS under which eligible depositors will be protected up to $100,000 per depositor, per deposit taker.
The DTA leaves much of the detail needed to operationalise the DCS to be prescribed by regulations. The content of the regulations is constrained by mandatory considerations that the Reserve Bank must have regard to when making its recommendations to the Minister of Finance.
There are several matters that the DTA leaves to be prescribed by regulations which are not included in the consultation paper. This includes: the rules that will apply to temporary high account balances; record keeping requirements for accounts held by two or more persons; the process to pay out compensation to eligible depositors; and the methodology for calculating a person's share of protected deposits.
Another matter that is still to be addressed is how the DCS and the Open Bank Resolution (OBR) policy will work together. OBR is intended to provide customers of a failed bank with continued (but limited) access to their funds, and applies on a "per account" basis; while the DCS will entitle depositors at a failed bank to compensation for their protected deposits, and applies on a "per depositor" basis. Section 214 of the DTA provides for regulations to prescribe how the amount of compensation available under the DCS should take account of any amount that a depositor withdraws, or that is available to be withdrawn, after the bank has failed but before compensation is paid. It is in this period that OBR would be expected to apply, and customers should have some continued access to their accounts.
Later this year the Reserve Bank is expected to consult on a DCS preparedness standard which will be a "core" standard under the DTA. The standard will prescribe the pre-positioning requirements for deposit takers for the DCS, including system and data requirements to enable the Reserve Bank to form a "single customer view". The standard will be issued in January 2027 and come into effect in July 2028.
Summary of the final policy proposals
Levies
The DTA provides that the costs of the DCS are to be fully funded by levies paid by deposit takers. Levies are to be calculated as a percent of the amount of protected deposit held by each deposit taker.
The DTA provides that levies should apply to different classes of deposit taker and must take into account the likelihood of a compensation event occurring in relation to each class of deposit takers. In July 2023, the Reserve Bank consulted on three approaches to setting levies: using a flat rate, using credit ratings and using a composite risk indicator. The Reserve Bank's preferred approach is to use a composite risk indicator to reflect the likelihood of a compensation event and mitigate any moral hazard risk that may arise from introducing the DCS. Under the risk indicator approach, each deposit taker would receive a risk score and be allocated to one of four risk "buckets" which would determine the levy the deposit taker pays. In this consultation, the Reserve Bank is seeking feedback on a simplified suite of risk indicators (and consequential changes to weightings and boundaries).
In the draft report into personal banking services published last week, the Commerce Commission noted the potential for smaller deposit takers to be disadvantaged by the composite risk indicator approach and the potential negative implications this may have for competition. The Commerce Commission is proposing to recommend that the Reserve Bank articulate how it is applying the purposes and principles of the DTA when it makes its recommendation on levies to the Minister of Finance.
Scope and coverage
The DCS will cover all protected deposits held by an eligible depositor at a deposit taker, up to the $100,000 coverage limit.
The consultation paper provides that regulations will ensure that protected deposits include everyday bank products that New Zealanders commonly use: current accounts, savings accounts and term deposits. It will also cover products that have the same economic substance as deposits, but are called something else (for example, mutual deposit takers issue redeemable shares rather than deposits).
In the consultation paper, the Reserve Bank seeks feedback on the following proposals:
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Debentures may be eligible provided they are not readily tradeable or sellable by the depositor;
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Credit balances of specific borrowing products (eg credit cards, revolving loan facilities) would be eligible given these often have the same economic substance as deposits;
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Only the most senior tranche of deposit-like products such as redeemable shares issued by mutual deposit takers would be eligible; and
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Limiting the entitlement to compensation for deposits held on trust to express trusts only, with the additional eligibility condition that the trustee must provide additional documentation to prove eligibility for compensation.
Relevant arrangements
Under the DCS only eligible depositors will be entitled to compensation. An eligible depositor is a holder of a protected deposit or a person on whose behalf a protected deposit is held under a relevant arrangement (subject to specific exclusions, such as government agencies and other deposit takers).
Relevant arrangements will receive "look-through" treatment meaning only the beneficial owner of a deposit held via a relevant arrangement is entitled to compensation and not the account holder. Deposits that are beneficially owned by an eligible depositor must be included when determining the depositor's entitlement to compensation.
A "relevant arrangement" is defined as a "client money or property service" within the meaning of section 431W of the FMC Act and other arrangements prescribed by regulations. The Reserve Bank is proposing that client accounts operated by the following persons be prescribed as relevant arrangements:
Bank-sponsored PIEs will also be prescribed as relevant arrangement on the basis their economic substance is a deposit held at a deposit taker.
In-flight transactions
In-flight transactions refer to partially completed payments to or from a deposit taker at the quantification time. These are payment instructions that have been initiated by the sender, and may even have been received by the deposit taker, but have not yet settled.
How in-flight transactions are treated will determine the aggregate balance of eligible depositors' protected deposits and hence their entitlement to compensation. The DTA provides for regulations to be made to account for in-flight transactions.
The Reserve Bank proposes to follow the same approach that is used by its existing OBR policy (except when it comes to card payments):
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"On us" transactions, which involve transactions between accounts held at the same deposit taker, will be settled before balances are determined;
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Inter-bank payments that use the Reserve Bank's exchange settlement accounts will only be taken into account if settlement has been completed as at the quantification time; and
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Card payments will only be taken into account if the transaction has been settled as at the quantification time (under OBR the statutory manager has discretion as to how these settlements are to be treated).
Exemption for branches of overseas banks
Last year the Reserve Bank published its final decision to restrict the business of branches of overseas banks in New Zealand to wholesale customers only (meaning branches will not be able to take deposits from, or offer products and services to, retail customers). See our previous insight here.
The Reserve Bank is proposing to exempt wholesale-only branches from the DCS on the basis that the financial stability benefits are limited relative to the costs of complying (ie the $100,000 coverage limit is small relative to the size of wholesale deposits).
The Reserve Bank's branch review decisions will not be implemented until 2028, when the DTA standards commence. However, the DCS will commence in mid-2025, at which time some branches may still hold retail balances. The Reserve Bank is proposing that branches that have not wound down their retail deposit book by the time the DCS commences will be included in the scheme until such time as they have fully divested and qualify for the wholesale exemption.
Timeline for DCS implementation
Following this consultation, the key milestones to implement the DCS include:
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Consultation on DCS preparedness standard: The Reserve Bank expects to consult on the DCS preparedness standard in May 2024.
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Advice to Minister: The Reserve Bank expects to provide its advice on the DCS regulations to the Minister of Finance once the consultation ends on 10 May 2024.
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Issuance of DCS regulations: Subject to the Minister's decisions, the Reserve Bank expects the regulations will be issued by the end of 2024.
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Consultation on statement of funding approach: Treasury intends to undertake a second round of consultation on the statement of funding approach.
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Commencement of DCS: The DCS is expected to commence mid-2025.
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Issuance of DCS preparedness standard: The Reserve Bank expects to issue the DCS preparedness standard in January 2027.
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Commencement of DCS preparedness standard: All DTA standards, including the DCS preparedness standard, will commence July 2028.
This article is intended only to provide a summary of the subject covered. It does not purport to be comprehensive or to provide legal advice. No person should act in reliance on any statement contained in this publication without first obtaining specific professional advice. If you require any advice or further information on the subject matter of this newsletter, please contact the partner/solicitor in the firm who normally advises you, or alternatively contact one of the partners listed below.