Part 1: Introduction

The Treasury: Implementing and managing the Crown Retail Deposit Guarantee Scheme.

In this Part, we set out:

On 12 October 2008, the Government announced that it was setting up a Crown Retail Deposit Guarantee Scheme (the Scheme) to assure the public that the money eligible people had deposited or invested (up to a $1 million cap each) with particular financial institutions was safe. If the financial institution failed, the Crown would repay the money that people had deposited or invested. The Crown would then try to recover funds from the failed institution as part of the receivership or liquidation process.

We carried out a performance audit of the Treasury’s implementation and management of the Scheme, given the Scheme’s significance for our economy at the time and the amount of money involved.

The Scheme was introduced in response to the uncertainty caused by the global financial crisis and a risk that the public could lose confidence in New Zealand’s financial institutions. The Scheme was an emergency measure, implemented quickly at a time when the risk of our financial system ceasing to operate effectively was high and there were concerns about cash being withdrawn from New Zealand banks.

The Scheme covered banks, collective investment schemes, and non-bank deposit-taking institutions (NBDTs). It was to run until 12 October 2010 (that is, for two years). At the time of its introduction, banks and NBDTs in New Zealand held about $140 billion in retail deposits.1

The Scheme was set up as an “opt-in” agreement between the Crown and a financial institution. Financial institutions could apply to join the Scheme and had to meet certain eligibility criteria to be accepted.

The Scheme was revised on 1 January 2010 to make it more flexible and manage risks to the Crown. It was extended under more stringent conditions on 12 October 2010, to ensure that no institutions failed because the Scheme ended too soon. The Scheme now runs until 31 December 2011. These changes are sometimes important to the discussion in this report, so in places we refer specifically to the Revised Scheme (between 1 January 2010 and 12 October 2010) and the Extended Scheme (between 12 October 2010 and 31 December 2011).

The Treasury and the Reserve Bank of New Zealand (the Reserve Bank) were jointly responsible for advising Ministers on the design of the Scheme, including its objectives. The Treasury was responsible for the Scheme’s overall implementation, and for accepting financial institutions into the Scheme. It was also responsible for monitoring the institutions that were in the Scheme. The Treasury contracted the Reserve Bank to monitor financial institutions and report relevant matters to the Treasury. The Reserve Bank was also contracted to advise the Treasury whether institutions applying for the Scheme met the criteria set by the Minister of Finance (the Minister).

To date, nine NBDTs – all finance companies – accepted into the Scheme have failed (see Figure 1). At the time of writing, the Crown had paid out about $2 billion to more than 42,000 depositors. The money recovered after receiverships or liquidation was estimated in April 2011 to be $0.8 billion. Recoveries were estimated at $0.9 billion as at 30 June 2011. Depositors received the full amount of their entitlements. As at 30 June 2010, the Crown had collected $237 million in fees from institutions covered by the Scheme.

The focus of our performance audit

Because of the technical nature of the material considered, we sought the help of specialist advisory services firm Promontory Financial Group Australasia, which is based in Sydney.2 We chose an off shore firm because all specialist advisory firms with offices in New Zealand had potential conflicts of interest in commenting on the Scheme. Promontory Financial Group had no involvement with the Scheme.

We have examined how effectively and efficiently the Treasury has implemented and managed the Scheme, including how well the Treasury:

  • identified and monitored the risks to the Crown posed by financial institutions covered by the Scheme;
  • identified and assessed how well the Scheme has met its objectives;
  • attempted to improve the Scheme based on the findings of its monitoring and policy advice; and
  • explained the purposes and functions of the Scheme to Parliament and to the public.

Figure 1
Failures of nine finance companies covered by the Crown Retail Deposit Guarantee Scheme

Company Date of entry Date of failure Amount paid out to date*
Allied Nationwide Finance Limited 19 November 2008 20 August 2010 $131.0m
Equitable Mortgages Limited 4 December 2008 26 November 2010 $140.2m
Mascot Finance Limited 12 January 2009 2 March 2009 $70.0m
Mutual Finance Limited 13 November 2008 14 July 2010 $9.2m
Rockforte Finance Limited 20 February 2009 10 May 2010 $4.0m
South Canterbury Finance Limited 19 November 2008 31 August 2010 $1,580.3m
Strata Finance Limited 18 December 2008 23 April 2009 $0.5m
Viaduct Capital Limited 13 November 2008 14 May 2010 $7.6m
Vision Securities Limited 5 December 2008 1 April 2010 $30.0m
Total     $1,972.8m

Source: The Treasury.

Note: As at 30 June 2011. The Treasury expects to pay out a further $37.3 million.

* Includes interest payments after the institution failed and ineligible deposits. Note that some small payments remain outstanding because some deposits are yet to mature and some depositors cannot be traced.

An important aim of our audit was to provide Parliament and the public with an independent record of the history of the Scheme. Therefore, we have included in this report information about the origins of the Scheme, the important decisions that were made, and the main activities that the Treasury, the Reserve Bank, and the Government have carried out so far.

Although we considered all types of financial institutions covered by the Scheme, we focused on finance companies because of the significant payouts made under the Scheme in response to the failure of nine of these financial institutions.

How we carried out our audit

To carry out our audit, we considered the main aspects of the Treasury’s implementation and management of the Scheme:

  • Processing applications – we looked at how the Treasury applied the criteria used to decide whether to accept an institution into the Scheme.
  • Assessing and improving the Scheme – we looked at whether the effects of the Scheme were effectively assessed against its objectives and whether the Treasury took steps to improve the Scheme as a result.
  • Monitoring of financial institutions – we considered whether the Treasury effectively monitored financial institutions and whether the Treasury’s response to the results of the monitoring was adequate and timely.
  • Payouts – we looked at payout processes to assess whether these were efficiently managed to minimise Crown liability, as well as whether they facilitated timely and accurate payouts to maintain public confidence in the Scheme.
  • Disclosure – we considered the adequacy of explanations of the Scheme’s purpose and functions to the public and to the Minister. We reviewed documents prepared by the Treasury and sent from the Minister to Cabinet. We also considered the Treasury’s explanations about claims processes and payouts made under the Scheme.

We have not “benchmarked” the Treasury’s performance against that of similar agencies overseas, because those other agencies were operating in quite different circumstances. Most comparable countries already had a form of guarantee or insurance scheme (several of which explicitly exclude interest payments after the date of any company failure) and had tighter regulation and monitoring of vulnerable institutions. In contrast, New Zealand officials have described the stance here before the Scheme was implemented as “non-interventionist” with a reliance on market factors to guide depositors’ investment decisions.

1.16 We reviewed key documents, including:

  • policy documents, media statements, and other documents that are publicly available on the Treasury and the Reserve Bank websites;
  • information releases on the Treasury and the Reserve Bank websites about South Canterbury Finance Limited (South Canterbury Finance);
  • monitoring reports provided by the Reserve Bank to the Treasury;
  • important internal Treasury documents such as guidelines, analysis and discussion papers, management reports, payout data, email and other correspondence, and service agreements; and
  • Scheme application files containing documents about financial institutions applying to join the Scheme.

We also interviewed more than 20 current and former officials from the Treasury and the Reserve Bank as well as representatives of:

  • trustee companies;
  • Computershare Investor Services Limited (Computershare);
  • New Zealand Companies Office (the Companies Office);
  • Securities Commission;
  • consumer groups and similar associations;
  • financial institutions accepted into the Scheme; and
  • other relevant parties involved with the Scheme, including advisors, receivers, liquidators, auditors, and investigators.

What we did not audit

We focused on how the Treasury implemented and managed the Scheme. We did not consider in detail the financial and liquidity positions of financial institutions covered by the Scheme, the information they provided, or the risks that any individual financial institutions posed to the Crown. We also did not assess the risk measurement models used by the Reserve Bank and the Treasury to monitor these financial institutions, but we did consider how the Treasury used these models and the governance arrangements for them.

Our audit did not consider whether the Scheme was the most appropriate response to the global financial crisis as its introduction was a Government policy decision. We considered the Treasury’s actions to suggest improvements to the Scheme, consistent with the Treasury’s role as administrator of the Scheme, policy advisor to the Government, and guardian of the Crown’s funds. These roles do not include directly making government policy decisions.

Although we considered the Treasury’s actions to monitor the Crown’s liability, we did not consider whether the provisions for payments of guarantees in the financial statements of the Government were adequate. We have already assessed and reported on this aspect of the Scheme through our annual financial audits of the Treasury.

We have not reviewed detailed operational matters, such as the accuracy of payout amounts, any prices financial institutions were charged to be part of the Scheme, or the processes set up to receive those fees.

Our Office has no mandate to audit private sector companies, so we have not examined in detail the finances of any of the financial institutions discussed in this report.

We have not examined the Wholesale Guarantee Scheme in any detail, but we mention it briefly in Part 3.

Structure of this report

In Part 2, we describe the financial landscape and regulatory and supervisory framework in place before the Scheme was introduced. We focus on the experiences in the finance company sector leading up to the Scheme’s introduction and the way the regulatory and supervisory framework for NBDTs has evolved in the light of these and other events.

Part 3 discusses the Scheme’s introduction, providing some context for the initial policy decisions that were made. We describe the Scheme’s objectives and look at why and how the Scheme was introduced. We also explain the changes that were made to the initial policy design during the first few weeks of the Scheme and set out our views on the Scheme’s initial implementation.

In Part 4, we describe how financial institutions applied to be included in the Scheme, the criteria the Treasury used for accepting financial institutions into the Scheme, and the extensive work carried out to process the applications.

In Part 5, we describe some of the challenges presented by the policy design of the Scheme. We set out our views on how the Treasury assessed the overall performance of the Scheme against the Scheme’s objectives. We also describe the changes that the Treasury made to the Scheme when it was revised and extended.

In Part 6, we consider the Treasury’s monitoring of the financial institutions accepted into the Scheme and disclosure of the Crown’s liability, and provide our views on the effectiveness of the monitoring process.

In Part 7, we look at the payout process the Treasury used to pay the depositors of the financial institutions that failed while under the Scheme.

The Appendix sets out a timeline of major events and decisions before and during the Scheme, and is followed by a Glossary of terms.

1: "Retail deposits" means money held on behalf of individuals, in contrast to “wholesale deposits”, which means large deposits typically received from corporations, governments, or other financial institutions. See the Glossary for fuller explanations of the terms used in this report.

2: Promontory Financial Group is an international organisation that provides expertise in a range of financial and regulatory fields, including consultation on regulatory requirements, risk management, and implementing global and national financial services regulatory policy. The consultants we used have expertise in risk management, financial regulation, and central and other banking.

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