Kiwis with money in the bank could see their nest eggs and savings dwindle in a government move the Greens say is a "Cyprus-style solution" to help out failing banks.
New Zealand banks are readying their IT systems for Open Bank Resolution, a Reserve Bank policy that in extreme cases like insolvency would see a bank's losses shouldered in part by its shareholders and creditors - including everyday depositors.
The Reserve Bank has the power to freeze bank deposits but up to now has lacked the technical infrastructure to implement it - hence their requirement for banks with retail deposits of more than $1 billion to change their systems and meet their requirements by July 1.
Under the policy, which can only be activated by the Minister of Finance, if a bank fails a statutory manager is appointed to calculate the bank's liabilities.
The statutory manager can then freeze a percentage of customers' bank deposits to cover those liabilities before it reopens the next trading day.
But the Green Party's co-leader Russel Norman said OBR was a "Cyprus-style solution" that would see small depositors suffer to fund big bank bailouts.
"Bill English is wrong to assume everyday people are able to judge the soundness of their bank," he said. "Not even sophisticated investors like Merrill Lynch saw the global financial crisis coming.
"If he insists on pushing through this unfair scheme, small depositors can be protected ahead of time with a notified savings threshold below which their savings will be safe from any interference." Dr Norman questioned the Government's insistence on pursuing OBR when virtually no other country in the OECD used it.
He said most OECD countries run deposit insurance schemes that protect people's deposits up to a maximum ranging from $100,000 to $250,00.
"A deposit insurance scheme is a much simpler, well-tested alternative to Open Bank Resolution. It rewards safe banks with lower premiums and limits the cost to taxpayers of a bank failure."
Prime Minister John Key said the OBR policy was a "last-resort facility" and when told that few people seemed to know about it he responded that it was unlikely to be used.
"The basic principle is, what would you do in the event of a catastrophe, how would you recapitalise the bank and it's reasonable logic to say that is one way through that.
"This is really in the event a bank was in such a terrible mess that it fell over and had to start again," he said.
When asked about deposit insurance, Mr Key said there were significant costs involved. "The argument is it is so unlikely to happen that this is a cheaper way through it."
Auckland University Professor of Banking and Financial Institutions David Mayes said OBR was an efficient and simple method to deal with failing banks that would not see chaos caused in the banking system or costs passed on to the taxpayer.
New Zealand Bankers Association chief executive Kirk Hope said an IMF report showed New Zealand had a strong, stable and well-capitalised banking system with plenty of liquidity and Kiwis could feel confident.
What is open bank resolution?
Reserve Bank policy to ensure the losses of a failing bank are taken on by its shareholders and creditors - including depositors - rather than taxpayers, and to ensure the bank is open for business the next trading day. If a bank fails it can be closed for 24 hours while a statutory manager is appointed to calculate liabilities and then freeze a percentage of customers' bank deposits to cover liabilities.
Why have it?
In the absence of the OBR policy, the options for responding to a bank failure are limited to liquidation, government bail-out or takeover by a competitor. If a private sector solution is not available the government must choose between allowing the bank to enter the liquidation process, or providing public support.
Which institutions are covered?
All locally incorporated banks with over $1 billion of retail deposits are being required to participate.
Why aren't deposits guaranteed?
The Government placed temporary guarantees on retail deposits. But in 2011 the Minister of Finance announced that further guarantees would not be provided following the expiry of the existing scheme.By James Ihaka Email James