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Cash & Term Deposits - Not what they used to be...

Cash & Term Deposits - Not what they used to be...

Introduction

The global financial crisis highlighted the enormous fiscal cost governments can incur in providing financial support for troubled banks. A major challenge for policy-makers is how to limit the disruption of a bank failure on the economy whilst minimising the overall cost to the taxpayer. At the same time, it is important that resolution options do not erode market disciplines on bank creditors to act prudently in their dealings with the bank. The Reserve Bank first began considering options for responding to a bank failure following the 1997 Asian financial crisis. This work led to the development of the Open Bank Resolution (OBR) and other supporting policies.

OBR is a tool that would enable the failure of a large bank to be managed by using ‘unsecured creditors’ (i.e. cash and term deposits) to prop up the bank. Recent banking legislation changes mean you cannot access your term deposit immediately, and would need to wait a minimum of 32 days, the reason for this is to stop a ‘run on the bank’, whilst the issues are being addressed.

The OBR policy

The Reserve Bank’s OBR policy is an important part of the toolkit for responding to a bank failure in New Zealand. It is designed to allow a distressed bank to be open for business on the day after the bank is placed under statutory management. A bank may be placed into statutory management on the advice of the Minister of Finance following a recommendation of the Reserve Bank. This reflects the reality that placing a bank into statutory management deprives the owners of control of their business. Moreover, while the OBR is a Reserve Bank policy, bank failures often involve risk to the taxpayer and their resolution – of whatever shape or form –tends to take on a ‘whole-of-government’ dimension. The reasons for making such a recommendation are prescribed in the Reserve Bank of New Zealand Act and include a bank being insolvent, or being operated in an imprudent manner, or that its circumstances pose a threat to the soundness of the system. Essentially, the Reserve Bank wishes for the creditors (i.e. your deposits) of the bank to bail the bank out, rather than the government and taxpayers. Unlike Australia, there is no government guarantee to New Zealand bank deposits. 

In summary:

Prior to the global financial crisis, the governing documents around cash and term deposits made it difficult for governments to use those funds to prop up a failing bank. With the new Open Banking Resolution (OBR), you as an ‘unsecured creditor’ can have part or all of your bank accounts and term deposits frozen and allocated to the banks funding lines, without prior notice. The irony here is that during times of uncertainty, having your money in the bank could be the worst place to be. 

Solution.

Instead of having your money in the bank (in cash or term deposits) where it can be frozen; and part or all of it taken from you, look towards the New Zealand bond market to provide you with diversification and liquidity. If you are feeling particularly cautious, New Zealand Government Bonds offer the safest level of protection. There are also a number of good quality investment grade corporate bonds, which offer attractive interest rates and most importantly, liquidity (i.e. they can be sold on the market). Talk to your adviser to find out what is appropriate for you and your portfolio, as unfortunately cash and term deposits are not what they used to be.

 

This article was edited by Jeremy Sullivan – Authorised Financial Adviser at Hamilton Hindin Greene Ltd. The article represents general information and does not constitute personalised financial advice. If you would like to know if the investments mentioned are suitable for you please contact your investment adviser.  Original article by Kevin Hoskin and Ian Woolford. Reserve Bank of New Zealand: Bulletin, Vol. 74, No. 3.

 A secondary disclosure statement is available on request & free of charge by going to www.hhg.co.nz or by calling 0800 10 40 50.

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