Bryan Gould: Cyprus outrage not too far from home

Protesters demonstrate outside Parliament in the Cyprus capital Nicosia. Photo / AP

Our own Reserve Bank is well-advanced in developing just such a measure that could present a similar threat.

We have grown accustomed to treating crises in the euro zone as having little to do with us. So, there will be a restrained response to the news of yet another crisis, even one that has provoked "outrage and panic" in Cyprus, where it has arisen. But we should perhaps take a closer look on this occasion, because what has happened in Cyprus could - in essence - happen here as well; and, if it does, we too would respond with outrage and panic.

This particular crisis does of course involve issues that are specific to Cyprus. Like many other eurozone economies, Cyprus is in urgent need of a bailout; and, as a condition of that bailout, European finance ministers are proposing that a somewhat unusual contribution to the cost of the bailout should be made by those who have placed their cash for safekeeping in Cyprus banks.

European finance ministers have announced (after markets closed last weekend) that the $25 billion bailout (Europe's fifth) will come with a huge twist - a levy of 6.75 per cent on deposits in Cyprus banks of less than $190,000 and 9.9 per cent on deposits greater than that. The measures will raise, from those with deposits in Cyprus banks, about $10 billion.

The finance ministers are playing a dangerous game. They have their eye on the huge deposits kept in Cyprus banks by Russian oligarchs who apparently (but not for much longer) see Cyprus as a safe haven where not too many questions are asked. But the risk they are taking is huge. If depositors find that their savings are not safe in Cyprus banks, there will not only be a mass withdrawal of funds from those banks (as is already happening), but from banks in other "bailout" countries as well. The eurozone crisis is on track to return with a vengeance.

What has this got to do with New Zealand, you may ask? The answer may surprise you. Our own Reserve Bank is well-advanced in developing just such a measure that would, in certain circumstances, present a similar threat to New Zealand depositors as well.

The "Open Bank Resolution" policy being proposed by the Reserve Bank is an attempt to settle in advance the question of who should bear which liabilities in the event of a banking collapse - whether of a single bank or on a much wider scale.

As David Mayes pointed out yesterday, the current absence of a deposit guarantee scheme (and, one must assume, the Government's unwillingness to provide one) means that the options in the event of a bank failure are limited - liquidation, Government bailout or takeover by another bank.

The post-GFC history of the impact on government finances of bailing out failed banks has obviously reduced the appetite for such operations, and in most such cases there will be few institutions willing to take over the failed entity.

The remaining option - liquidation - however, is politically unattractive since it would immediately threaten the security of customers' deposits.

The Reserve Bank argues that in these circumstances the main priority should be to keep the failed bank afloat. They therefore propose that the bank should close for just 24 hours while a statutory manager is appointed and the bank's financial position is assessed.

A calculation should then be made of the proportion of customers' deposits with the bank that would be needed to cover the bank's liabilities and that proportion would then be frozen. The bank would then reopen, but the frozen deposits would be retained for the statutory manager's use so that the bank's financial situation could be stabilised. Any unused portion of the deposits could then be returned to the depositors. Similar processes would be applied to shareholdings in the bank.

This proposal for what is popularly called a depositors' "haircut", on which the Government and commercial banks are currently being consulted and which is intended to take effect this year, is presented as a response to the failure of a single bank. But the measure would have its most significant impact in the event of a banking sector meltdown, such as might be triggered by a renewed global financial crisis - and who would bet against that?

As in the case of Cyprus, the New Zealand proposal is an astonishing assault both on the property rights of depositors and on confidence in the banking system. The mere fact that such a proposal is even being contemplated should ring alarm bells, even for a typically complacent New Zealand public - and if they were, like the Cypriots, actually denied access to their savings as they disappeared into the banks' coffers, that would certainly be enough to trigger Cyprus-style "outrage and panic".

The supposed need for such a draconian measure arises entirely because banks not only enjoy the unique privilege of creating money out of nothing but are also entitled to use customers' deposits for their own trading purposes. There can surely be no more compelling case for a fundamental review of the way banks operate in our economy. Shouldn't we know more about this proposal and be consulted about it before it is too late?

Bryan Gould is a former UK Labour MP and former vice chancellor of Waikato University.