The Reserve Bank's controversial Open Bank Resolution, which could leave depositors facing loss if a bank falls over, isn't the only tool in the kit and gives the government breathing space in the unlikely event a major lender collapses, the regulator says.
Central bank head of prudential supervision Toby Fiennes told the Institute of Directors in Wellington "OBR would not be the only option in a crisis" and it can work alongside other tools.
"A government could still decide to bail out a bank or allow a bank to go into liquidation, if it felt the risks of doing so were small," Fiennes said. "But it is critically important to have a tool such as OBR in the crisis toolkit to maximise options for the authorities of the day."
The OBR scheme would mean a failed bank has to write down the value of the most pressing unsecured liabilities almost immediately, so service could resume a day after an insolvency event or statutory management to allow customer transactions to keep flowing.
The policy's ultimate goal is to place the cost of failure on the shareholders, while providing the flexibility to assign losses to creditors without unnecessarily disrupting banking services.
Fiennes said "its mere existence provides important incentives for bank shareholders and management to minimise the risk of failure."
Where the policy becomes controversial is that customer deposits are at risk if shareholder funds get exhausted in the event of insolvency in much the same way as a standard liquidation.
If a bank does collapse, "it will be very messy, people will lose money and how it is dealt with will depend on circumstances at the time," he said.
Still, Fiennes stressed that New Zealand's banks are "sound and stable" and the risk of failure "very low."
The Reserve Bank sees deposit insurance as "increasing the likelihood of bank failure" by encouraging riskier behaviour in good times and distorting incentives, he said.
Still, OBR can work alongside deposit insurance if the government decided to introduce such a framework.