The Cypriot crisis has turned a spotlight on the open bank resolution (OBR) policy the Government and Reserve Bank have been working on, even though, as the bank has been quick to point out, the situations are very different.

The policy is intended to deal with a bank failure. The aim is to minimise damage to the insolvent bank's customers and to the wider economy, including taxpayers, by enabling the bank to reopen for business the following day.

It is in principle a separate question from whether bank deposits should be guaranteed, and if so up to what sum and at whose expense. But the issues are entangled by the fact that an OBR would mean depositors could face a haircut - some portion of their funds would be frozen - if the first losses are not enough to cover the shortfall.

The remainder of the depositors' funds, however, would be immediately available and subject to a government guarantee.


The idea is to keep the bank open for business while a long-term solution is sought, which might be purchase by another bank, bailout by the Government, or liquidation.

Deposits are historically not guaranteed in New Zealand, though they were between 2008 and 2011 and the taxpayer incurred hefty losses over the failure of South Canterbury Finance.

"The Government has looked hard at deposit guarantee schemes and concluded that they [are] blunt incentives for investors and banks to properly manage risks, and may even increase the chance of bank failure," deputy governor Grant Spencer said.

"Deposit insurance is widely used in Europe, including Cyprus, but hasn't prevented banking failures, as we saw during the global financial crisis."

Under the bailout terms planned for Cyprus but rejected by its Parliament, deposits below the "guaranteed" threshold would still have been subject to a haircut.

The Cypriot situation was a systemic collapse and not just a case of one institution failing, Spencer said.

"It must be seen in the context of the broader European sovereign debt and banking crisis. Further, the Cyprus banking system is dominated by a large foreign deposit base, from Russia in particular."

David Mayes, professor of banking at Auckland University and a former chief economist of the Reserve Bank, argues New Zealand should institute a deposit protection scheme, funded by the banks and phased in while they are strong.

"The worst side of having no explicit deposit protection is that during a crisis, the chances are authorities will rush in with a temporary scheme, just as they did in 2008, which will be taxpayer-financed and colossally expensive," he said.

When pressed in Parliament this week by Greens co-leader Russel Norman on why the Government rejected such a scheme, Acting Finance Minister Steven Joyce said, "Well, even if it is not the taxpayers, all [you are] going to do is make the depositors pay insurance every year, forever, against the unlikely event of this actually occurring."