Deposit Takers Reform Series: Article 3
Consultation on the prudential framework for deposit takers and depositor protection
Submissions close on 23 October in the next round of consultation by Treasury and the Reserve Bank on the prudential framework for deposit takers and depositor protection. In this briefing, we focus on chapter 7 of the consultation document – resolution and crisis management, and we'll discuss other chapters in future briefings. In the meantime, please contact one of our experts if you wish to discuss any aspects of the proposals in the consultation document. See a link to the paper here and our previous briefings on the consultation document here.
If a bank failed in New Zealand, at present the Reserve Bank's management strategy would be based on its Open Bank Resolution (or OBR) framework and the statutory management process. The consultation paper notes that crisis management regimes that have been developed in other countries and the IMF's recommendations for New Zealand's framework suggest there would be benefit in the Reserve Bank having a wider range of tools available.
Cabinet's in-principle decisions
It is not surprising therefore that Cabinet has made in-principle decisions to provide the Reserve Bank with more options. Those decisions are:
to explicitly designate the Reserve Bank as the resolution authority for deposit takers
to specify statutory objectives to be achieved by the Reserve Bank in performing the resolution authority function
to enable management powers that currently reside with a statutory manager to be able to be exercised directly by the Reserve Bank
to provide the Reserve Bank with a statutory bail-in power
to require resolution to be conducted in a manner that respects the creditor hierarchy, and for this to be supported by the introduction of the "no creditor worse off" (or NCWO) principle.
Conditions for placing a deposit taker into resolution
The consultation document proposes that there should be both a non-viability test and a necessity test that are required to be met before a deposit taker is placed into resolution. The Reserve Bank would determine whether these tests have been met. Non-viability is proposed to be a narrower concept than the meaning given to it in the regulatory capital context - it will require the deposit taker to be balance sheet or cashflow insolvent, or to have contravened a prudential requirement in a way that could lead to the deposit taker being de licensed. Necessity refers to there being no reasonable prospect of the failed deposit taker being remedied outside resolution. The conditions are more clearly framed and targeted than the grounds on which a bank presently can be put into statutory management.
Some might be surprised to see the proposal to introduce statutory bail-in given the Reserve Bank's rejection of conversion and write-off as effective loss absorption mechanisms in its recent capital review. However, bail-in to resolve a failed deposit taker has a different purpose to loss absorption in capital instruments. The purpose of conversion or write off in capital instruments is to attempt to prevent a failing deposit taker from becoming non-viable, whereas bail-in is a tool used to restore solvency to or recapitalise a failed deposit taker. The concerns the Reserve Bank had in the capital review that the conditions for write-off or conversion in capital instruments would be triggered too late - meaning the loss absorption would not prevent the bank from becoming non-viable - are less likely to arise, therefore, in the context of statutory bail-in.
Liabilities that would be subject to statutory bail-in
A key question for submitters is what liabilities should be subject to statutory bail-in. As a starting point, we can expect that secured liabilities and insured deposits would not be subject to statutory bail-in. Different options include having an explicit list of excluded liabilities (as per the UK approach) or an explicit list of included liabilities (as per the Canada approach). There could also be a bail-in hierarchy where certain liabilities (such as uninsured deposits) are given a preference by featuring later in line for bail-in.
There should not necessarily be an expectation that uninsured deposits would be excluded or treated more favourably than other unsecured liabilities. Under OBR, for instance, deposits in a failed bank at the moment can be partially frozen, which may eventually lead to depositors not being repaid the frozen amount.
Another approach could be for a certain class of liability (such as subordinated debt) to be designated as the primary form of liability that would be available for bail-in. This could mean that other types of liabilities (including uninsured deposits) would technically be able to be bailed-in, but in practice would not likely to be. Giving an effective bail-in preference to a class of liability (eg if subordinated debt was bailed in first, and uninsured deposits last) could have implications for deposit takers, by increasing the costs of obtaining non-preferred debt.
Bail-in does give rise to some complicated issues. However, the recent experience in New Zealand of banks issuing hybrid securities should mean that market participants (including regulators) are well placed to contribute to developing an appropriate framework.
Credit unions and building societies
The consultation paper acknowledges that building societies and credit unions present particular resolution challenges because of their capital structure. The consultation paper is proposing that the Reserve Bank has the power to demutualise a failing credit union or building society.
In our next briefing, we will discuss chapter 6 of the consultation paper: Supervision and enforcement powers. See the Deposit Taker Reform Series here.
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.