Is Your Money Safe in the Bank?

Is Your Money Safe in the Bank?

Joseph Darby

Will New Zealand banks weather the storm?  

In 2023, the second and third largest bank failures in United States history happened within three days of each other! To this day, this still makes people nervous worldwide – the US is the world’s largest economy and is home to many global companies, after all – and thrown up inevitable questions about the safety of savings in the bank.

The safety of banked money isn’t usually something many of us think about, but during such a time it’s perfectly normal to consider the worst-case scenario. If too many people were to try and withdraw money from the same bank within a short period of time, a bank run ensues. In years gone by, when gold-backed banknotes were our currency, bank runs would literally drain bank’s cash reserves and force them out of business. Today, bank runs are more likely to be “silent” — marked by numerous electronic funds transfers into other accounts. They can still spell doom for affected banks though, as recently happened overseas.

The good news is we have some of the most regulated and robust banks in the world. In fact, your money is probably far safer in the bank right now than if you were to hold it as cash stored in or around your home, where it’s vulnerable to theft, flood, fire, and other troubles.

Guaranteed Banked Savings

The last time the public was surveyed about this, 75 percent of respondents believed their New Zealand bank deposits were guaranteed (Financial Markets Authority 2014 survey). These respondents were wrong.

All OECD countries except New Zealand have some form of bank deposit insurance or government guarantee.

In other words, all or part of bank deposits are insured or guaranteed in most countries but New Zealand bank depositors are not shielded from losses when a bank fails.

When you think about it, it is understandable why taxpayers are keen to guarantee the stability of the banking system: the economy relies crucially on the ability of our savings to be converted into loans via trusted intermediaries (i.e., banks). We are much more likely to park cash in a bank deposit if it is guaranteed to be risk-free. If we don't save and make cash available via deposits, there will be no loans for businesses and households to borrow. And the economy suffers.

Moral Hazard

Believe it or not, there’s a good reason why New Zealand doesn't guarantee bank savings, including term deposits. It’s called moral hazard, which is when one party in a transaction gets involved in risk-taking activities but they do not bear the full costs or potential downside of that risk – these are usually carried by the other party.

Use of the term ‘moral hazard’ usually implies immoral behaviour, or even fraud.

For example, over recent days US regulators moved quickly to stem fears the failure of Silicon Valley Bank would ripple through the financial system, announcing that all depositors would have access to their funds.

Betashares chief economist David Bassanese said US authorities had acted even more forcefully than he expected. "It's been a huge step - in the wrong direction with regards to moral hazard but it's been a great step in terms of limiting near-term contagion… I guess the answer is, whenever they face that trade-off between moral hazard and contagion, they'll stop the contagion at the risk of creating more moral hazard," he told AAP.

This is similar to the GFC, when many of the largest financial institutions were bailed out by taxpayers (governments) all over the world. There was a comparable outcome: the major financial institutions, and those who deposit or invest funds with them, were shielded from the consequences of risky behaviour which can inadvertently encourage even more risk-taking.

Sometimes, Failure Is Good

In stemming losses to depositors, the government regulators "…. took another step towards demonstrating that they are unwilling to allow free markets to sort themselves out," said Toronto-based independent proprietary trader Kevin Muir. In other words, they stopped a natural and seemingly-deserved failure of two banks engaged in risk-taking behaviour.

Business failures and recessions are like wildfires. A painful, but necessary part of the financial ecosystem.

How? Wildfires are now accepted by most ecologists as nature at work. In every wildfire there are the seeds of rebirth, renewal, and rejuvenation. Some species cannot even seed without the intense heat of flames! Painful as a bank failure will be for many (and acknowledging the very real impacts on some individuals and families) failures should nearly be celebrated for the opportunities they present. Such failures correct economic imbalances and excesses, to help reallocate human effort and other resources to more productive ends. A business failure or recession can be a powerful necessity that drives businesses and individuals to find new and better ways of doing things.

It's early days, though it seems both the US failed banks were highly concentrated in risk-taking behaviours which would be unheard of in the New Zealand or Australian banking systems (noting our biggest banks are owned by their Australian parents). One of the US banks was cryptocurrency-dependent, while the other was remarkable because it did not adhere to the usual banking business model of lending out most of its US$173 billion in deposits to mortgage customers, and instead had nearly 60 percent of all assets invested in financial market securities, most of which are considered “safe”.

How Safe Are New Zealand’s Banks?

New Zealand banks are amongst the safest in the world when we look at the credit ratings provided by Standard & Poor’s. The four largest domestic banks, ANZ, ASB Bank, Bank of New Zealand and Westpac are among the top ranked banks out of over 2000 that are rated by Standard & Poor’s, which have an AA rating or better.

That means failure of a major New Zealand bank is highly unlikely. The last time it happened was 1990, when BNZ, our largest bank at the time, needed to be bailed out by the government.

Banks in New Zealand are regulated by the Reserve Bank. They are subject to Reserve Bank supervision and are required to have a high level of disclosure, something that was clearly lacking when nearly all of New Zealand’s finance companies failed around the time of the Global Financial Crisis (GFC).

In the wake of the GFC, financial regulators the world-over increased the amount of capital (or shareholder’s equity) that a bank must have. While this is the most expensive form of funding, it is also the lowest risk. Just as with a regular company, high levels of equity (and therefore lower debt) mean a safer bank which is more able to withstand adverse economic conditions, like we’re currently experiencing.

But, if recent times have taught us anything, it’s that we all know sometimes that "what can't happen" occasionally does.

What Happens if a New Zealand Bank Goes Bust?

New Zealand doesn't have deposit insurance or bank guarantees, but the Reserve Bank has an established system called Open Banking Resolution (OBR).

Under OBR, the Reserve Bank will undertake an initial assessment of the health of a troubled bank.

Following this assessment, the procedure is:

  • The Reserve Bank may make a recommendation to the Minister of Finance that the bank be placed under statutory management
  • If the Minister of Finance decides to go down the OBR path, then a proportion of the bank's funds, including individual deposits, are frozen to cover the estimated losses. The bank opens for business the next day, with depositors able to get access to their unfrozen funds, although individuals with term deposits will have to wait until these mature
  • These unfrozen funds are subject to a government guarantee

The OBR process allows a bank to close temporarily and then reopen while a long-term solution to its problems is developed. This contrasts with the finance company failures of the GFC, when all funds were immediately frozen and depositors had to wait a long time before they got any money back, if at all.

Frozen funds are determined on the following basis:

  • The OBR has been designed to ensure the owners and shareholders bear 100 percent of the initial loss due to a bank failure
  • Subordinated creditors also take 100 percent of their cut after that
  • The remaining frozen funds are allocated proportionally among unsecured creditors, mainly domestic sourced deposits and wholesale deposits from large international financial institutions

The OBR system has been introduced in New Zealand because it reduces "the pressure for government to provide a bail-out to a failed bank". The Reserve Bank goes on to state that "the OBR might also help to strengthen incentives on bank management to operate in a more prudent manner, and on creditors to provide greater external scrutiny, helping to mitigate the moral hazard concerns that arise when an assumption of implicit government support prevails".

In theory, the OBR has great merit because a failed bank could be open within 24 hours with the unfrozen funds available and subject to a government guarantee.

However, the Reserve Bank and Ministry of Finance would probably freeze more funds than necessary, to ensure this government guarantee isn't called on. This could create considerable depositor discontent.

The main issue in fact is the Reserve Bank's ability to carry out a proper process, to make quick and decisive decisions and to ensure that the investing public, both depositors and shareholders, are fully informed.

Does the Reserve Bank Have the Expertise to Deal With a Troubled Bank?

CBL Insurance was not a household name in New Zealand, but did do some local insurance business, and was once valued at $750 million. CBL insurance had former Prime Minister Jenny Shipley as a director when it failed in mid-2019.

The insurer was regulated by the Reserve Bank, so it’s only fair that since that failure, questions were raised about the capacity of the Reserve Bank to regulate, or indeed then handle the failure, of a major bank.

Should You Withdraw Money From Your Bank?

No – it’s almost certainly a bad idea to withdraw money from your bank due to fears over the economy and media headlines about overseas banks – unless you would have done so during normal times.

You should only make withdrawals from your bank if you need to spend it or reinvest it. Or, if you’re truly that worried about your bank savings, withdraw some to spread it among a few different banks so you don’t have “all your eggs in one basket”.

Alternatively, if you can afford to do so, you might want to add to your bank account balance – with one or more banks if you so feel the need. Padding an emergency fund is wise protection against unemployment or unexpected expenses, which you’re more likely to face during the current economic downturn.

Why Bank Savings?

Banks are really only a place to put short-term money; wages before regular expenses are paid, short-term savings to buy a big item, savings for a house deposit or renovation or as somewhere to keep an emergency stash.

Most of us can’t afford to keep large sums in the bank over any long timeframe, such as a couple of years or more. This is because savings are slowly eaten away by inflation, so instead we need to invest it to try and grow our nest egg and stay ahead of the long-term inflation rate.

The Bottom Line: Are Your Banked Savings Safe in a Recession?

Don’t hold your breath waiting for the banking system to collapse, regardless of what happens overseas. In any eventuality, the bank is still the safest place for your money.

In New Zealand, despite the lack of a deposit guarantee, we’re fortunate we have a well-capitalised and well-regulated banking system that is better placed than that of most countries to handle any shocks or recession.

It’d be the pleasure of one of our trained professionals to help you work through any of the topics mentioned above, so get in touch today.

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