Treasury Estimates Costs of Financial Institution Failures

Highlights:

• Non-Bank Deposit Takers at Risk: Treasury estimates non-bank deposit takers are the most likely to fail, with potential costs ranging from $800 million to $1 billion, reducing to $100 million to $400 million after recoveries.
• Deposit Guarantee Scheme Details: The scheme, starting July 1 next year, will guarantee individual deposits up to $100,000, funded by levies on financial institutions and supported by a government backstop loan.
• Medium-Sized Bank Failures: A failure of a medium-sized bank could initially cost $1.5 billion to $3.5 billion, with net costs potentially reduced to $100 million to $700 million after asset recoveries.

Non-Bank Failures Most Likely

The Treasury estimates that the most probable financial institution to fail would be a non-bank deposit taker, potentially triggering the new deposit guarantee scheme. Initial costs could range from NZ$800 million to NZ$1 billion, with recoveries likely reducing the net cost to between NZ$100 million and NZ$400 million. This estimate was outlined in the Treasury's statement of funding approach (SoFA) ahead of the scheme's launch on July 1 next year.

Scheme Details and Funding

The deposit guarantee scheme will protect individual deposits up to NZ$100,000, funded by levies on financial institutions. The fund will be built up to 0.8% of protected deposits over 20 years, with the government providing a backstop loan if necessary. The scheme is designed to ensure stability and confidence in the financial system.

Costs for Medium-Sized Bank Failures

A medium-sized bank failure could cost between NZ$1.5 billion and NZ$3.5 billion initially, with recoveries potentially reducing the cost to between NZ$100 million and NZ$700 million. For context, TSB, the largest of the smaller banks, had $7.43 billion in total assets as of March 31, while the smallest, Co-operative Bank, had NZ$3.12 billion.

Big Four Banks and Kiwibank

Treasury did not estimate upfront costs for failures of the big four Australian-owned banks or Kiwibank, due to the low likelihood of liquidation. Losses after recoveries for these institutions would likely range from zero to NZ$300 million, representing the maximum contribution the deposit compensation scheme (DCS) would make.

Levy and Fund Management

The Reserve Bank of New Zealand (RBNZ) will set the levy each institution must contribute and will manage the fund on a cost-recovery basis. The average target size of similar funds internationally is about 1.1% of guaranteed deposits. However, in New Zealand, a higher target could risk levies exceeding the expected cost of failures over time.

Future Uncertainty

Treasury notes significant uncertainty about the likelihood of deposit taker failures over the initial five-year period of the SoFA. Recent history shows few deposit taker failures, aside from finance company collapses during the global financial crisis. Additionally, banks are being strengthened by increased capital requirements, which will be phased in by June 30, 2028.

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