Big banks weigh up benefits of new retail deposit guarantee

Chris Lee

The major banks will take their time deciding whether to participate in the extended retail deposit guarantee unveiled last week, but the new scheme has provided some certainty to the finance company sector even if it is the almost certain demise of many smaller players, say commentators.

The extended scheme, which runs for a further 14 months after the present one expires on October 12 next year, requires institutions to have at least a BB credit rating and at the lowest couple of levels of qualifying rating, imposes hefty fees.

Under the existing scheme, many smaller finance companies have been able to gain coverage without paying anything, essentially free riding at the expense of the major banks who have contributed virtually all of the $64 million plus in fees collected by Treasury so far. The banks have so far not indicated whether they would be likely to participate in the extended scheme under which they would pay double the existing scheme's fees.

"I think they're probably going to take some time to decide what they're going to do," said Claire Matthews of Massey University's Centre for Banking Studies.

"They've got to weigh up the cost of going into the extended guarantee - it is a substantial cost - against how much they believe customers are actually relying on it, and how much they are depositing with the banks because the guarantee is there. It's going to be a balancing act and will involve keeping an eye on things and seeing what the market is doing. I think it will possibly be the middle of next year before they make up their minds."

Unofficial comment from bank insider suggests that in the fierce competition for retail deposits, especially as the banks work towards complying with new Reserve Bank prudential liquidity requirements, means that guarantee coverage is a selling point they will not give up lightly. Whether competition for deposits is as acute in a year's time may be a significant factor the banks' decision.

Matthews, says the new scheme looks a lot better than the hastily drafted original, especially when it comes to non-bank deposit takers, particularly finance companies. "The increased cost, the fact that there's no exemptions for smaller institutions as there was in the original scheme, and the requirements for credit ratings, I think those improvements are substantial and very appropriate because there has been some criticism of some of the original scheme's design features and that reflects the fact it was rushed in."

"With the extension they've been able to take some time and think about what they want to do, the changes make it a better more appropriate scheme."

However, the improvements aside, Matthews believes the new scheme to a large extent merely buys time and doesn't fully answer questions around how or if it is unwound.

"It doesn't totally get around the orderly exit issue because it still has a finite expiry date, there's still the question that when you get to December 31, 2011 is it simply going to drop off or is it going to need a further extension with another ratcheting down of the details."

However, Kapiti Coast financial advisor and outspoken finance company commentator Chris Lee says the new scheme, while not setting the bar so high that no finance companies survive, sends a clear signal to smaller weaker ones. "Going through another 14 months will be the signal to all the little tiddly ones to get out of the industry. I think that's necessary."

Lee says smaller companies that would be unlikely to get a qualifying credit rating are getting no new money from investors and face stark choices.

"They should be doing one of three things, either asking whether they could survive on shareholders' funds and money from family and maybe some bank borrowings. If not, the best thing they can do from everyone's perspective is close down, pay everyone out and go and do something different. If they can't pay everyone out, then the next best thing they can do is hand the keys to Treasury.

"That would mean Treasury would have to employ Deloitte and others to liquidate maybe two or three dozen piddling little companies they've guaranteed, paying everyone out, collecting the loans as they come and wearing any shortfall."

That shortfall, Lee estimates, might be $100 million at most, "and the revenue they're going to get from this will exceed that easily".

The demise of these companies will not be much of a loss, he believes, after a decade when there were "essentially more finance companies than the country every needed".

"We just won't have all these people who thought there was easy money to be made and the public would feed them cash however badly they were structured."