Treasury outlines likely costs of financial institution failures

That's Treasury's estimate in its statement of funding approach (SoFA) published ahead of the scheme scheduled to start from July 1 next year.

The scheme will guarantee individual deposits up to $100,000 and will be funded by levies on financial institutions.

Treasury says the fund size will be 0.8% of protected deposits and will be built up over 20 years with the government providing a backstop should any institutions fail in the first 20 years or should losses from any failure exceed the fund's resources.

The backstop would be in the form of a loan that the fund, the deposit compensation scheme (DCS), would be expected to repay over time.

The next most likely failure would be of a medium-sized bank and that would cost an initial $1.5 billion to $3.5 billion with recoveries from liquidating that bank reducing the cost to between $100 million and $700 million.

To put that in context, largest of the smaller banks, TSB, had $7.43 billion in total assets at March 31, according to the Reserve Bank's bank financial strength dashboard, while the smallest, Co-operative Bank, had $3.12 billion in total assets.

Treasury doesn't attempt to estimate the likely upfront costs of one of the big four Australian-owned banks or the government-owned Kiwibank failing, “given the low expected likelihood that liquidation would be used over resolution.”

But it does say that the losses after recoveries would likely be between zero and $300 million. “The upper end is the estimated maximum contribution the DCS would make to a resolution of a deposit taker,” Treasury says.

The actual amount of levy each institution will be required to contribute will be set by RBNZ which will also invest and manage the fund, which it expects to run on a cost recovery basis.

Treasury says the average target size of equivalent funds internationally is about 1.1% of guaranteed deposits.

“However, in New Zealand a higher target would risk levies being higher than the expected cost of failure events over time, taking into account recoverings that would likely be made from a failed deposit taker,” it says.

“There is significant uncertainty about the likelihood of deposit taker failures over the period of the SoFA,” which covers the initital five years.

“With the exception of finance company failures during the global financial crisis, there have been very few failures of deposit takers in recent years that would provide data to estimate the likelihood of failures,” Treasury says.

It also noted banks are in the process of being strengthened by RBNZ's increased capital requirements which are being phased in over the seven years ending June 30, 2028.