Understanding bank risk in New Zealand

Warwick Hale and David Tripe, Journal of Banking + Financial Services, June/July 2005

In this article, the consequences of a bank failure in New Zealand, the issue of depositor protection, and the key findings of a risk awareness survey are discussed.

The potential disruption to the banking system from the failure of a bank includes the inability for individual and business customers to make and receive payments (and the knock-on economic effects of this, such as the refusal of supply), the loss of depositors' funds, the costs to customers of re-establishing facilities with other providers, and the failure of other banks from the breakdown of inter-bank arrangements (which could result in a general economic liquidity crisis).

Depositor protection

This article explains that such potential consequences are used to justify regulatory intervention in the banking sector. For instance, some jurisdictions offer a system of deposit insurance in the case of bank failure (up to a limited amount), which is intended to promote financial stability by warding off a "run" on a bank in the event of a rumoured or impending failure.

No formal deposit insurance system in New Zealand

The authors describe the reasons for the absence of such a system in New Zealand as being the substantial cost involved and the risk that the promise of reimbursement discourages management from good risk management and also discourages depositors from monitoring and influencing the bank's position.

In place of this, banks in New Zealand are required to make public disclosures about their financial positions, with the objective that the responsibility is with each bank's customers to assess the risk of failure. This assumes, however, that depositors are aware that their funds are potentially at risk.

Risk awareness research

The article describes some "exploratory research" undertaken in Palmerston North in 2003 by way of a door-to-door survey in which questions were asked about people's understanding of these issues. The authors point out that the results are potentially subject to bias.

The strongest views expressed through the survey's key findings were:

1. money was safe, very safe or extremely safe in a bank (99% of respondents);
   
   
2. it was important, very important or extremely important to be told about the safety of bank deposits (93%);
   
   
3. the Government was either not very clear or extremely unclear in relaying to the public how safe people's bank deposits were (81%);
   
   
4. people did not know if the Government insured bank deposits (70%);
   
   
5. people did not know if the Government guaranteed bank deposits (59%);
   
   
6. people thought that their bank guaranteed that bank deposits were safe (55%); and
   
   
7. people did not know if the Reserve Bank had a function to protect depositors in the case of a bank failure (50%).

As the authors point out, the important lesson from this research was the number of "don't know" responses. The absence of an understanding by ordinary bank customers of the risks of their bank deposits may be an argument in favour of deposit insurance.

The article also suggests that further research may suggest a need for a public education campaign about these risks in the absence of a deposit insurance scheme.

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