Studies conducted by The Financial Stability Forum (“FSF”) working group of G7 Finance Minsters and Central Banks have identified three broad categories from its public-policy objectives for deposit insurance schemes: Firstly, to contribute to stable financial system, secondly, to protect less sophisticated depositors and thirdly, to enhance the ability of regulators to achieve other related policy objectives. (Financial Stability Forum, 2000)
4.1 Enhancing Financial Stability
Cameron, L. et. Al (2007) highlighted that the level of development in NZ’s financial system is mixed, where on one hand we have large and dominating group of efficient foreign banks and on the other the Non-Bank Financial Institutions (“NBFI”), private funders and venture capital which are small in size and have limited access to cost effective capital. NBFI are deemed important as they cater to a segment of market that are not traditionally the business of the large foreign banks. NBFI, especially the finance companies, credit union and building societies are major credit funder for vehicles financing, equipment and chattel financing for small businesses, consumer goods ie. LCD TV, Fridges, Computers, personal loans and other direct lending such as property development and purchase of business. These NBFI primarily take term deposits and issues short term debentures or debt securities as their funding source. The mismatch of short term funding and lending long remains the major inherent risk faced by NBFI, which can be devastating in times of financial crisis and market dislocation. This inherent liquidity risk problem is evident in the series of failures of NBFI and finance companies since 2006. The impact of NBFI failures is significant and have resulted in wider failures across other sectors such as property development, car sales and consumer goods. The problems faced by NBFI are further compounded by the lack of ability to raise efficient capital. The large banks dominates the marketplace for the same funding source, hence creating a “non-level playing field” for the others. In the recent Treasury’s Regulatory Impact Statement (“RIS”), The Treasury acknowledges the fragility of the NBFI sector, in particular the difficulty for finance companies to fund on its own and their need to depend on the DGS to secure funding in the market. Although, NBFI (Refer: Annex 2) are faced with more regulations going forward, the huge gap between themselves and the large foreign owned banks is a major disadvantage. In this regard, NBFI facing funding problems and higher compliance cost would simply go out of business and, results in further shrinkage to the sector. They are a threat to the financial stability of the system, when credit supply to their market becomes costly and in short supply. Therefore, an extension of the current DGS to an Explicit Deposit Guarantee Scheme (“EDGS”) with clear guideline is sensible in addressing the inherent liquidity risk of NBFI. This measure in future will provide the time for NBFI to re-balance their assets to it’s liabilities in time of stress.
4.2 Protecting Small and Unsophisticated Depositors
Despite, having a regulatory regime based on market discipline approach in operation in NZ for quite some time now, research have shown that depositors still lack the capacity to exercise market discipline principles and have difficulty in making choices on which bank to invest their deposit. Unlike the more advanced financial market, the lack of a secondary market information available in the NZ marketplace is a disadvantage for market discipline monitoring to be effective. A recent NZ survey research indicates that depositors rely directly on information supplied by the institutions in making investment decisions, often lack understanding of the risk involve and oblivion to their right to disclosure information. The survey also shows depositors mostly rely on news media and analysis from the newspaper for information. It is unlikely for market discipline to be effective for these diverse group of uninformed retail investors. (Wilson, W.R. et. al. 2007)
4.3 Market Expectation and Why an Explicit Deposit Guarantee
Blanket guarantees are essential in stopping the systemic effect of crisis and flight of capital from perceived weaker institutions to stronger ones. In the case of NZ, it has certainly created the desired effect of stemming potential shift of deposits from NBFI to the large foreign owned banks at the time. However, once blanket guarantees have been used and later withdrawn when crisis recedes, the market would come to expect that such guarantees to be available in future crisis, therefore creating a moral hazard in itself, and undermines market discipline. (Demirguc-Kunt, A. et. Al. 2006) . Schich, S (2008a), argues that politically it will be more difficult for government to resist supplying deposit guarantees to bailout retail depositors, as trend shifts in risk allocations as more deposits are placed towards household retirement savings in the system. Blanket guarantees buys time and should be used effectively to solve gaps within the system, the failure to reform or address deficiency in the financial system is costly and worst, if blanket guarantee remains entrenched. (Financial Stability Forum, 2001)
Explicit insurance scheme helps to define and demarcate the perimeter of the financial safety net. Using the Singapore’s explicit insurance as an example, guarantee is limited to specific creditor type which are essentially small depositors whilst leaving depositors with larger exposure, creditors, shareholders and managers to monitor the limit how much risk should the bank be taking. (Schich, S 2008a:61) Explicit deposit scheme can be use to scale back the size balances covered by government’s blanket guarantees issued during times of crisis. (Demirguc-Kunt, A. et. al. 2006:5) Therefore, a well design Explicit Deposit Guarantee Scheme (“EDGS”) will not only help to do the job of protecting depositors but can be scaled accordingly and reduce effects to moral hazard.
To summarize our arguments, there are merits to implementing and designing a suitable EDGS, to mitigate the following issues:
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Addressing inherent liquidity risk in NBFI and promote financial stability;
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Protect small, uninformed and unsophisticated retail investors;
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As an “exit” strategy of current “blanket” guarantee DGS;
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Explicitly define and demarcate limits for deposit guarantee, and reducing moral hazard;
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Complements the market discipline approach and ongoing regulatory reform.
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