Treasury advised to revisit work on deposit insurance

Wednesday 12th November 2014

A review of the Treasury's fiscal policy advice has recommended the government's financial adviser revisits its work on deposit insurance in tandem with the Reserve Bank, saying the issue remains a concern in the unlikely event of a major bank failure.

The government agency's advice was generally found to be consistent with sound principles and practices for responsible fiscal management and has been effective in influencing fiscal policy, with the main areas open to improvement in macroeconomic modelling the impacts of policy, analysis and management of fiscal risks, and the information needed to strengthen the monitoring of the Crown's assets, according to a report by Teresa Ter-Minassian, a former director of the fiscal affairs department at the International Monetary Fund.

Among those recommendations, Ter-Minassian said the Treasury, in consultation with the Reserve Bank, should revisit its advice to the government on adopting some form of limited bank deposit insurance. New Zealand's government has been reluctant to take on such a scheme, despite its adoption by other nations such as Australia, which is seen as encouraging lenders to take on more risk on the expectation that they won't bear the full brunt of the consequences.

"The absence of a limited deposit insurance mechanism and the degree of concentration of the banking system still give cause for concern about the fiscal risks of a potential failure of one or more banks," Ter-Minassian said in her report. "These concerns are reinforced by the precedent of the blanket deposit guarantee extended by the Government in the wake of the global financial crisis."

Last month, the Reserve Bank's head of prudential supervision Toby Fiennes said the central bank's task to manage system wide risk meant that it was willing to allow individual entities to fail to avoid risks posed by moral hazard, where a party will take more risk as it won't bear all of the consequences, and inefficiency.

At a media conference following the release of its six monthly financial stability report, central bank governor Graeme Wheeler today said the bank recommended against deposit insurance because the scheme doesn't tend to work well in jurisdictions such as New Zealand with a high concentration of banks, and was better suited to places like the US, which have a large number of smaller lenders and a relatively high rate of failure.

"It would take decades to set up a fund that could seriously protect deposits of investors," Wheeler said.

Other recommendations in the Ter-Minassian report were that the Treasury should consider proposing time limited legislation mandating a reduction in net public debt, develop better modelling tools to simulate the effects of fiscal policy, revisit analysis of policy options to lift national savings and consider advising the government to commit to saving any favourable revenue surprises, and to strengthen its analysis of general and specific fiscal risks.

The report commended the Treasury's adoption of the living standards framework, which seeks to include less tangible measures than simple economic production in informing policy, which aligns New Zealand "with a growing group of countries and international institutions that are focusing on the quality, inclusiveness and sustainability of economic growth, not just its speed."

Other considerations recommended were for the Treasury to undertake more analysis of the magnitude and possible mitigation of risks to New Zealand's farming sector, and to lift attention to rising debt of some local government authorities.

Treasury chief economist Girol Karacaoglu welcomed the report's findings, which were generally positive on the department's framework and general quality of its advice, and that the department will progress a number of its recommendations in the months ahead.

The Treasury's response to the report said work has already begun on further detailing the department's views on fiscal policy settings relating to its mix with monetary policy and targets for net debt, including more extreme scenarios in economic and fiscal updates, conducting more systematic analyses of fiscal risks, developing and integrating new models, and engaging with other departments to improve sustainability, efficiency and the effectiveness of operating and capital spending, and of the Crown's assets.

BusinessDesk.co.nz

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