Last Friday in California, Silicon Valley Bank (SVB) was shut down by its local regulator and the Federal Deposit Insurance Corporation (FDIC) was appointed as receiver. Urgent regulatory action to prevent systemic risk in the USA and UK has followed.
In late 2022 in New Zealand, the Deposit Takers Bill had its first reading and is now before Select Committee. The Deposit Takers Bill, if enacted, will make significant changes to how banks are regulated in New Zealand. This includes introducing a Deposit Compensation Scheme or "DCS", and giving the Reserve Bank more powers if a bank fails.
So what would have happened if the Deposit Takers Bill was passed in its current form and SVB had been a New Zealand bank?
Receivership and resolution
SVB was placed in receivership by FDIC, which meant control of SVB passed to FDIC. Under the Deposit Takers Bill, the Reserve Bank could put a failing New Zealand bank into "resolution". The Deposit Takers Bill requires the Reserve Bank to have a resolution plan for each bank, designed to facilitate dealing with the bank in an orderly manner if it enters resolution. Resolution is similar to New Zealand's existing statutory management regime. If a bank is put into resolution, the resolution manager (the Reserve Bank) would take control of the bank and would have broad powers to deal with its assets and liabilities. The Reserve Bank would aim for the bank to be re‑opened within 24 hours on a limited basis under its Open Bank Resolution or "OBR" policy. SVB is a closed bank resolution.
The US has a deposit insurance scheme under which up to US$250,000 of a person's deposits at a bank are insured. Deposit insurance is intended to contribute to financial stability by making it less likely that depositors withdraw their funds if they have concerns about a bank.
In the case of SVB, the US deposit insurance scheme might have worked as intended for depositors with balances of up to US$250,000 – ie for retail depositors. However, the run on the bank was caused by uninsured depositors (ie wholesale depositors) who very quickly withdrew their funds once they became concerned about SVB. Reports have suggested up to US$42 billion worth of withdrawals were made on 9 March 2023.
The Deposit Takers Bill will introduce a similar deposit protection scheme to New Zealand. Under the Deposit Takers Bill, up to NZ$100,000 of a person's deposits at a bank will be covered by the DCS.
The SVB experience highlights the limitations of a retail deposit insurance scheme. Retail deposits tend to be sticky anyway, whereas wholesale deposits can be substantial and can be withdrawn very quickly without depositors having to form a queue at a branch. Which leads to the question – will our proposed DCS meaningfully contribute to financial stability in a way that the US scheme did not appear to with SVB?
Perhaps the job of the insurance scheme in the case of SVB was made more difficult because of SVB's particular make-up of depositors (predominantly wholesale) and because SVB was not subject to Basel's liquidity policy, which is designed to prevent a timing mismatch in the maturity of assets and liabilities. New Zealand banks are not subject to Basel's liquidity framework but must comply with the Reserve Bank's liquidity policy (BS13), which broadly is designed to achieve the same outcomes. BS13 is under review by the Reserve Bank, including to consider whether the Basel approach should be adopted.
FDIC extended deposit insurance to all of SVB's depositors, regardless of their balances. While the NZ$100,000 deposit compensation limit can be extended to a temporary higher balance limit, we would not expect regulations to permit the limit to be abandoned entirely. FDIC has said that the cost of extending the deposit insurance will be borne by the banking industry, through levies, and not by the taxpayer. However, it is possible that the cost of these levies (in part at least) may be passed on to taxpayers who are customers of those banks.
The Reserve Bank can use the DCS fund to support a resolution measure if it is satisfied that protected depositors would receive no less favourable treatment than if they had been paid compensation and the total amount paid out of the fund does not exceed the maximum amount that would have been paid to protected depositors. This would not appear to allow the Reserve Bank to extend the scope of deposit protection to all depositors as FDIC did with SVB.
Transfer of liabilities
FDIC established the Deposit Insurance National Bank of Santa Clara (DINB) and transferred all SVB's deposits to DINB. The Reserve Bank would have similar powers under the Deposit Takers Bill to transfer the liabilities of a bank in resolution to a new entity.
FDIC's actions left SVB's bondholders as unsecured creditors to claim in SVB's eventual winding up – ie to bear the losses along with shareholders. We would expect those bondholders to rank behind FDIC's claim for the amount it pays out to insured depositors under the deposit insurance scheme. New Zealand's deposit compensation scheme does not include a preference feature which would give the DCS priority above unsecured creditors for the reimbursement of amounts paid to protected depositors. The DCS would rank equally with other unsecured creditors, including bondholders.
A "no creditor worse off" (NCWO) principle is to be introduced with the Deposit Takers Bill. The NCWO principle provides that no creditor should be worse off in a resolution of a bank than it would have been had the bank been liquidated. The NCWO principle recognises the very broad powers that a resolution manager has, including to ignore the usual rankings amongst creditors. If a creditor can establish that it is worse off, then it is entitled to compensation.
In a liquidation of a bank in New Zealand, bondholders would rank equally with deposit holders, regardless of whether they were protected by the DCS. In a resolution of a bank in New Zealand, if a group of creditors (eg wholesale depositors) were given preferential treatment over another group of equally ranked creditors (eg bondholders) the creditors who were disadvantaged potentially would be able to obtain compensation under the NCWO principle.