Part 5: Assessing and amending the Scheme

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

5.1
In this Part, we discuss:

the Treasury's assessment of the overall performance of the Scheme;
the Treasury's actions to enhance its powers;
some of the other issues with the design of the Scheme;
the Treasury's work to revise and then extend the Scheme;
the information communicated when the Scheme was revised and then extended; and
our overall views on the Treasury's actions.

5.2
In summary, we consider that the Treasury did not prepare a thorough assessment framework for the overall performance of the Scheme. A thorough assessment framework could have helped to ensure:

that the Government was better informed about how the Treasury was implementing the Scheme;
that the Government was better informed about the effects and performance of the Scheme; and
earlier identification of any issues and challenges with the design and operation of the Scheme (including the tools available for responding to high-risk institutions).

5.3
In our view, the Treasury could have acted sooner to identify and offer advice on suitable tools for responding to high-risk institutions. However, tighter controls, including specific exclusion of interest payments after an institution failed, were put in place with the passing of the Crown Retail Deposit Guarantee Scheme Act in September 2009.

Assessing the overall performance of the Scheme

5.4
Given the importance of the Scheme to the stability of the financial system, and the potential Crown liability, it was important for the Treasury not only to implement the Scheme but also to continually assess the overall performance of the Scheme against its objectives.

5.5
The Treasury's Statement of Intent 2009-2012 highlighted the Scheme as an important response to the financial crisis at that time, explaining that the purpose of the Scheme was to ensure continued confidence in the banking system by guaranteeing money deposited or lent. It considered the management of risks posed by the Scheme, noting the prudential regulation of banks, specific monitoring of NBDTs, and some of the controls imposed on business activities of the NBDTs. The Statement of Intent did not say anything further about the Scheme, its objectives, or the Treasury's processes for assessing and measuring the Scheme's performance.

5.6
In its Statement of Intent 2010-2015, the Treasury indicated that it had the people, skills, and systems in place to:¹⁸

process and make decisions on applications for guarantees by eligible banks and NBDTs;
monitor institutions' compliance with the guarantee deeds;
assess and collect guarantee fees;
manage any claims from depositors in a timely and efficient way in the event of a default; and
report the progress of the Scheme, including provisioning in the Financial Statements of the Government.

5.7
Also in the Statement of Intent 2010-2015, the Treasury explained that it was managing the Crown's exposure to risk related to the initial Scheme through the prudential regulation processes for registered banks and by requiring at least monthly financial reporting and other business controls from NBDTs.

Assessing the effectiveness of the Treasury's powers

New Zealand's approach to intervening in the financial system

5.8
The view long held by governments in New Zealand has been that intervention in the operations of a financial institution should be minimal. This long-standing approach, as explained by the Governor of the Reserve Bank in a speech in 2007, is that "market-based solutions – sometimes with regulatory prompting and encouragement – often result in a better performing financial system".

5.9
The approach is reflected in Part 5D of the Reserve Bank Act which says that "depositors are responsible for assessing risk in relation to potential increments and of their own investment choices".¹⁹ It is also reflected in the Reserve Bank's general requirements for disclosure statements²⁰ for registered banks, and the reliance of the regulatory and supervisory framework for banks and NBDTs on credit ratings. The purpose of disclosures and credit ratings is to arm depositors, creditors, and other parties with information to assess the creditworthiness of the institutions and, in so doing, enforce market discipline. For this purpose, market discipline is about encouraging institutions to behave appropriately on the basis that the depositors, creditors, and other interested parties will monitor the health of those institutions carefully and will choose to invest or lend to the healthiest of those institutions.

5.10
Consistent with this approach, there is no permanent deposit insurance scheme in New Zealand, nor a government guarantee or depositor preference arrangements. The belief is that such arrangements would undermine the incentives for depositors, creditors, and others to monitor effectively, and that this would be detrimental to soundness and efficiency. Moreover, it is believed that regulatory protection of depositors can inadvertently and inappropriately become a form of protection of shareholders, undermining incentives for good risk management and leading to lower-quality financial system performance overall.²¹

5.11
Introducing the Scheme was a significant intervention, and a major departure from previous policy settings. This was recognised in the Options Report of 10 October 2008, when the Treasury and the Reserve Bank highlighted that providing a scheme would fundamentally change New Zealand's approach to financial regulation.

The Treasury's powers under the Scheme

5.12
The Scheme was implemented quickly, and there was no opportunity to fully explore the consequences of the various policy decisions that the Government made at the time. This included the powers given to the Treasury to implement the Scheme. Although the Treasury refined aspects of the Scheme in the weeks after its introduction, the formal boundaries and powers were set once the guarantee deeds were finalised.

5.13
At a level of principle, there are a range of options available for responding to emerging issues within a financial institution. At one end of the spectrum, relatively light oversight could include additional information requests, attestations from directors, or conversations with financial institutions to discuss business strategies. Along the spectrum are several other activities, including issuing directions to restrain activities, commit additional capital, or improve risk management practices (such as managing delinquent loans). At the other end, heavy-handed intervention could include powers to appoint receivers or statutory managers.

5.14
The Government's decisions when the Scheme was designed determined how far along that spectrum the Treasury could go. Within that range, the appropriate response depended on the circumstances of the financial institution. Ultimately, the response had to balance the cost of the intervention, including the risk of triggering the guarantee or of litigation, with the benefits of potentially reducing the Crown's liability. The Treasury's powers and remedies under the Scheme included:

asking for information from the institution or third parties (such as the trustee, auditors, bankers, and regulators);
restricting or prohibiting certain transactions for NBDTs (such as distributions and related-party transactions);
appointing inspectors to NBDTs;
asking for undertakings from directors of NBDTs; and
withdrawing the guarantee.

5.15
The guarantee could be withdrawn if an institution failed to comply with ongoing obligations under the trust deed or failed to provide information requested, or for other reasons such as conducting affairs contrary to the intention of the guarantee.

5.16
The Treasury's ability to withdraw the guarantee was a complicated power. Once an institution was accepted into the Scheme, the Crown was committed to repay the institution's eligible deposit balance, regardless of whether the guarantee was later withdrawn. Withdrawing the guarantee could also have significant implications for the financial institution. The Treasury was reluctant to withdraw the guarantee if doing so would be at odds with the goal of keeping depositor and public confidence. It was possible that an institution would fail as a result of the withdrawal, which would trigger the guarantee (with no reduction in liability). Part 6 includes more discussion about withdrawing the guarantee.

5.17
Overall, the powers that the Treasury had under the Scheme were limited. Treasury officials interviewed had different views about the implications of the Treasury having limited powers. Some officials did not consider the Treasury's lack of powers to be problematic, believing that:

the Scheme was not designed to prevent default or insolvency;
the Treasury's role was to guarantee and pay out in the event of default, not to police the financial institutions covered by the Scheme;
not intervening with institutions was consistent with the more general approach to regulation and supervision; and
becoming involved in the running of an institution removed liability from directors and posed legal risks to the Crown if the institution failed during the period that the Treasury was directly intervening.

Ongoing advice on options

5.18
In our view, the Treasury relied too heavily on the presumption of minimal intervention, at least in its early policy advice. It should have been giving earlier and more thorough policy attention to whether a wider range of powers might help to manage the cost to the Crown while still meeting the Scheme's primary objective. This comment applies mainly in relation to institutions that were involved in activities that were not prudent and thereby posed undue risk to the Crown, but were not yet failing.

5.19
The Treasury extensively analysed its options in the event of an NBDT being in difficulty or failing, including providing liquidity support or placing the institution under statutory management. The Treasury considered, among other management tools, more active management of deposit book growth (such as powers to intervene to prevent continued growth) and requirements that financial institutions get authorisation from the Treasury for any changes of ownership.

5.20
We saw evidence that the Treasury considered potential additional powers in the early days of the Scheme. In a draft internal note titled "Intervention Options for the failure of a deposit taker under the Crown guarantee",²² the range of options included:

no intervention;
payout under statutory management or receivership;
liquidity support;
merger/facilitated merger;
transfer of deposit book; and
recapitalisation or restructuring.

5.21
The paper was focused largely on responses to a failed institution or an institution that was close to failing. It did not appear to consider additional powers to provide directions to a financial institution that was in difficulty, although that is implicit in a facilitated merger. Some of these issues were considered further in an internal discussion note titled "Factors to guide government intervention in NBDT failure under the DGS" (undated, but we understand that it was drafted in August 2009).

5.22
Around the middle of 2009, in response to information provided by the Treasury, the Minister and Prime Minister asked the Treasury to identify additional management tools (steps the Treasury could take before an institution failed) and resolution tools (steps the Treasury could take after an institution failed), regardless of whether the Scheme was extended.

5.23
The Treasury explored other resolution options but appeared to consider the standard resolution mechanisms (that is, payout and receivership) to be adequate.

5.24
The Treasury was concerned to ensure that changes to any management and resolution tools would not undermine eligible depositors' rights under the guarantee.

5.25
The Treasury prepared a "significance test" in August 2009, to help it assess whether the failure of an NBDT would have significant economic or fiscal effects. This was as well as the "systemic" test that the Reserve Bank applied for intervention to support a failing financial institution and maintain the stability of the financial system. The Treasury considered it unlikely that any NBDTs would meet the significance test's threshold.

5.26
Minutes of the monthly financial system issues meeting between the Treasury, the Reserve Bank, and the Minister in September 2009 show that the resolution framework was discussed. The Minister noted that the framework needed to be developed to identify all available options and to ensure that the Treasury and the Government were ready, even though each response would be specific to the situation.

5.27
At this September 2009 meeting, the Reserve Bank indicated that it had been working on a "pre-emptive distressed asset management fund" to avoid paying out under the guarantee. The Treasury noted that it would provide the Minister with additional information on options to recover funds from institutions that failed while in the Scheme.

5.28
In general, there appeared to be a view that recovering funds after a payout and receivership or liquidation was more desirable and less costly than intervening before a failure. However, we did not see evidence of the growing financial risks being considered at a strategic level or informing the Treasury's ongoing policy analysis and advice to Ministers on options. Although there were ongoing discussions with Ministers about policy settings, we did not see evidence of strategic analysis of the range of options alongside the unfolding risks. In particular, we consider the evidence of increasing deposits and liability should have prompted more policy work.

Other design issues that affected the operation of the Scheme

Description of design issues

5.29
Other issues emerged with the design of the Scheme which challenged its implementation. Some of these were predicted on or before the Scheme's introduction. Some emerged only as the Scheme evolved.

5.30
These design issues included:

market distortion;
complicated eligibility criteria for depositors;
how to deal with interest payments after guaranteed institutions failed;
implications arising from the contractual relationship between the Crown and financial institutions; and
a "funding wall" of investments due to mature when the Scheme ended.

Market distortion

5.31
The Treasury recognised early that including NBDTs in the scheme would create distortions in the financial system. Before the Scheme was introduced, the deposit books of many of the finance companies were shrinking. In the months after the Scheme's introduction, the deposits of the finance companies grew significantly (see Figure 9).

5.32
The returns that finance companies paid to depositors before the Scheme were higher than those paid by banks, reflecting finance companies' higher-risk lending. When the Scheme was introduced, some finance companies continued to pay these high returns. This encouraged depositors to invest in higher-returning government-guaranteed (effectively risk-free) finance company deposits. Without regulatory restrictions, the growth in deposits allowed finance companies to continue to engage in higher-risk lending.

Figure 9
Growth in retail deposits with finance companies before and after the Scheme was introduced

Source: Reserve Bank of New Zealand Financial Stability Report, November 2009.

5.33
The Treasury was aware of, and had highlighted before the introduction of the Scheme, concerns about potential effects on deposits and the importance of monitoring deposit flows. Deposit flows were a useful measure of effectiveness. Metrics related to overall deposit volatility were an indication of whether depositors had regained confidence in the financial system. Overall deposit growth measures, as well as measures reflecting changes in deposit levels within and between the banking and NBDT sector, provided the Treasury with information about whether the Scheme was distorting the market. These measures were also an indication of whether some financial institutions were taking advantage of the guarantee to raise large amounts by attracting deposits at higher rates of return to fund riskier loans.

5.34
The design of the Scheme provided some incentive for NBDTs to constrain deposit growth. Deposit growth of more than 10% a year would incur a fee based on the credit rating of the NBDT. However, the Treasury recognised that this did not adequately deter some NBDTs from offering attractive interest rates on deposits.

5.35
The Treasury carried out more targeted analysis in May 2009 of deposits in NBDTs. There were concerns about NBDTs in wind-down mode (as they could have been vulnerable to takeover) as well as those showing high rates of growth. The Treasury decided to send particular NBDTs a letter asking for more information about their business plans and reasons for the high or low levels of growth. The Treasury decided that it could put a cap on the guaranteed amount, carry out closer monitoring, and/or send reminders of prudent business behaviour.

5.36
Letters were sent to a number of institutions in May 2009 asking for further financial information and for a director's certificate. The information obtained was then used to identify where inspectors needed to be sent in to have a closer look at the business operations. When designing the Revised Scheme and Extended Scheme, the Treasury recognised that additional powers to prevent continued deposit growth would be useful.

Complicated criteria for deciding which depositors were eligible for the guarantee

5.37
From the outset, the policy intention was to guarantee retail deposits made with financial institutions. Details issued in the early days of the Scheme made it clear that deposits of New Zealand citizens and New Zealand tax residents were guaranteed, but deposits and other liabilities owed to financial institutions and related parties were not guaranteed. The guarantee also covered deposits held by those who provided trustee or nominee services as a bare trustee.²³

5.38
These definitions were reasonable but in practice were difficult to apply. Moreover, the criteria were not tested until they needed to be used. When an NBDT under the Scheme failed, the Treasury had to decide which depositors would be paid. The criteria were complicated for a number of reasons, such as the definition of financial institution (which included unintended complexities in assessing the eligibility of depositors such as financial advisers and public trusts), the wide range of investor types (including trusts, joint accounts, companies, and deceased estates), and the fact that some of the information required (such as tax status and residency) were not details normally held by the NBDT. These issues did not emerge until Mascot Finance failed and the Treasury had to work out who was to be paid. Eligibility was further complicated by claimants (that is, depositors) often submitting incorrect claim forms to the Treasury.

5.39
The eligibility criteria were refined when the Scheme was revised and when it was extended, to clarify the position of certain investor types. This complicated the criteria further.

Paying interest after a financial institution failed

5.40
The question of how to deal with the payment of interest on deposits between the time that a financial institution failed and the time that the depositor was repaid arose unexpectedly when the Treasury was processing claims for Mascot Finance. The treatment of these interest payments was not clear, so the receivers, the trustee, and the Attorney-General (on behalf of the Crown) sought a court interpretation. The Treasury supported this move and agreed that clarification was required.

5.41
The High Court ruled on 27 August 2009 that the Crown was liable to pay interest on deposits at the interest rate agreed to be paid by the financial institution. The interest accrued from the date the institution failed until the Crown paid the claim.

5.42
This decision meant that depositors could take advantage of the system; they could continue to receive high interest payments at a cost to the Crown by delaying when they submitted their claim forms. There was no deadline in the original guarantee deeds for submitting claim forms.

Use of contracts

5.43
An important early policy decision was to set up the Scheme through a contract between the Crown and the individual institution under the Public Finance Act. Specific legislation to provide the guarantee would have taken time to write and implement. Given the urgency of the situation, and the fact that Parliament had been dissolved on 3 October 2008, legislation was not possible.

5.44
The Scheme was based on opt-in contracts that enabled risk-based fees to apply. The opt-in nature of the Scheme also allowed NBDTs to be subject to monitoring and information requirements.

5.45
However, there were a number of unintended practical consequences that arose from the decision to use contracts. These included the issue of paying interest after an institution failed, difficulties in modifying the contract, issues with the way the Crown recovered funds from failed institutions (as part of the receivership process), and limitations in the powers that the Treasury had (its powers were limited to those set out in the contract or under existing statutes).

Funding wall

5.46
Another effect of the Scheme was the creation of a "funding wall" on 12 October 2010 (the Scheme's original end date). The finite term of the Scheme meant that financial institutions took deposits out to the end date of the guarantee but found it difficult to get deposits beyond this date (investors wanted their investments to mature inside the guarantee period). As a result, there was a significant amount of funding that would mature at the end of the Scheme.

Revising and extending the Scheme to address design issues

Overview of the amendments

5.47
In March 2009, the Treasury started taking steps to revise and extend the Scheme. The problem of interest payments after an institution failed (which was clarified in August 2009 by the High Court ruling) was addressed, in part, by changes to the Revised Scheme and explicitly excluded as part of the Extended Scheme. Problems with the use of contracts were addressed under the Extended Scheme through the introduction of new legislation. The Treasury made several changes to the guarantee deeds under the Revised and Extended Schemes to address problems with the Treasury's lack of powers.

5.48
The main design features of the Revised Scheme and Extended Scheme are set out in Figure 10. In summary, under the Revised Scheme:

some debt products were guaranteed and others were not;
there was a cap on any interest payments after an institution failed; and
the Treasury redefined what a "default" was under the Scheme (that is, what constituted an institution failing).

5.49
In summary, under the Extended Scheme:

fees were based on the risk that an institution posed;
changes were made to eligibility (which institutions would be covered);
the Treasury had stronger powers to manage institutional risk;
the caps on the size of deposits covered were reduced; and
changes were made to the timing and structure of the guarantee.

Figure 10
Comparing the original, revised, and extended phases of the Scheme

Original Scheme	Revised Scheme	Extended Scheme
Guaranteed period
12 October 2008 to 12 October 2010	1 January 2010 to 12 October 2010	12 October 2010 to 31 December 2011
Institutions*
73	63	7
Number of failures
2	6**	1
Guarantee
Includes interest accrued after the failure date	Includes interest accrued after the failure date, but cap applies (claim forms must be submitted within adequate time)	Interest after the failure date is explicitly excluded and claim forms must be received within 180 days
Excluded debt security
N/A	Guarantee does not apply to Excluded Security (entity can offer non-guaranteed debt)	Guarantee does not apply to Excluded Security (entity can offer non-guaranteed debt)
Liability cap
$1 million	$1 million	$250,000 for NBDTs and $500,000 for banks
Fees
Charged if an institution had more than $5 billion in deposits Charged if an institution experienced a more than 10% increase in its deposit book from year to year	Same as for the original Scheme	Risk-based fees apply to all guaranteed debt (not just growth)
Ratings requirement
Minimum credit rating of BBB-	Same as for the original Scheme	Minimum credit rating of BB
Supporting legislation
Public Finance Act 1989	Public Finance Act 1989	Crown Retail Deposit Guarantee Scheme Act 2009
Other notable changes
	Clarifies the treatment of joint account holders and trustees Definition of "default event" provides for 14-day period before guarantee is triggered Expanded reporting requirements (to include subsidiaries) For NBDTs, expanded ongoing obligations and entity to pay for cost of inspector New obligations for NBDTs – adequate disclosure of excluded securities and assistance to the Crown to verify liability and make payments	Carries over the changes to the Revised Scheme, and: extended reporting requirements (to include controlled entities) for NBDTs, new obligation to provide notice and information of changes in control for NBDTs, increased requirement for prior Crown consent for certain transactions new withdrawal power as a result of changes to the Crown's liability

* Number of institutions covered when the Scheme started.

** A large proportion of deposits in failed entities covered by the revised guarantee deed continued to be covered by the original guarantee deed (which was the deed in place when the deposit was made).

The Revised Scheme

5.50
In March 2009, the Treasury began considering options for either exiting from the guarantee (an option soon discounted) or extending the Scheme (which was due to expire on 12 October 2010).

5.51
The Treasury intended to announce the Extended Scheme about a year before the Scheme expired, to provide market certainty and give institutions enough guidance to enable them to make informed investment decisions. The planned extension was designed to continue to maintain public and depositor confidence while at the same time achieving an orderly exit from the Scheme and allowing institutions to revert to their normal business practices.

5.52
At the same time that it was preparing to extend the Scheme, the Treasury was also trying to change the terms of the Scheme to provide more flexibility and address some of the problems noted earlier. Revising the Scheme would also allow a smoother transition to an Extended Scheme by introducing some of the sorts of changes that an Extended Scheme would include.

5.53
There were many problems with the Scheme that the Treasury would have liked to address, including the payment of interest after an institution failed and adjustments to allow institutions to offer non-guaranteed deposits. However, the use of contracts constrained the extent of changes that the Treasury could make.

5.54
The Treasury had a contractual obligation to ensure that the rights of eligible depositors were not undermined. Under the terms of the original guarantee deed, the Crown was able to withdraw its guarantee as long as it provided the guaranteed institution with the opportunity to enter into another form of guarantee on terms that were not materially adverse to the interests of depositors generally.

5.55
On 18 November 2009, the Treasury announced these changes to the Scheme:

Participating institutions would be able to offer both guaranteed and non-guaranteed debt securities (with clear disclosures in their offering documents).
The deeds would provide a 14-day "stand down" period between a potential failure and triggering the Crown guarantee. Without this change, seeking to appoint an administrator, manager, or liquidator would trigger the guarantee. The 14-day period would provide time for the institution to work through its problems and avoid receivership without triggering the guarantee.
The Crown would set a time frame for claims to be made after an institution failed. Although it was not possible to remove the payment of interest, this allowed the Crown to set a limit on its liability for interest payments.

5.56
Other changes in the Revised Scheme included more detail about depositor eligibility (for example, clarifying how different types of depositors – such as joint holders, beneficiaries, and trusts – would be treated), additional reporting requirements (for example, requesting information about subsidiaries), and refined ongoing obligations (see Figure 10).

5.57
The revised guarantee deeds came into effect on 1 January 2010. Institutions had to choose whether to sign up for the Revised Scheme. Replacement deeds that included revised terms and conditions were issued to the institutions that chose to sign up. However, the changed terms affected only new deposits or deposits "rolled over" after 1 January 2010. Existing deposits remained under the terms of the original Scheme.

5.58
The Treasury contacted all institutions participating in the Scheme to inform them of the changes and then to send out revised guarantee deeds. Institutions had until 4 December 2009 to accept the revised guarantee deeds. A list of all participating institutions was kept up to date on the Treasury's website, along with the names of the institutions that did not sign up.

5.59
Six institutions elected not to accept the revised guarantee deeds, representing $84 million of existing deposits. Revised guarantee deeds were issued to 63 institutions, effective from 1 January 2010 for new or rolled over deposits.

5.60
For those institutions that chose to decline the revised guarantee deed, new deposits or those rolled over after 1 January 2010 were no longer covered by a Crown guarantee. However, deposits made before 1 January 2010 remained under the original Scheme until 12 October 2010 (unless they became due and payable earlier). Institutions that did not sign up for the Revised Scheme were not eligible to join the Extended Scheme.

The Extended Scheme

5.61
The Treasury considered it necessary to extend the Scheme to continue to promote depositor confidence, minimise economic distortions that might be caused by the "funding wall" (see paragraph 5.46), facilitate the transition to "normal" arrangements, and minimise potential costs to the Crown. Although the potential cost of the Scheme to the Crown was an acknowledged risk earlier in the Scheme, minimising that risk became an explicit objective when the Scheme was extended. The Treasury was active in assessing options for extending the Scheme and produced a number of analysis papers, both for internal purposes and for the Minister and Cabinet.

5.62
The Government announced on 25 August 2009 that the Scheme was extended and would expire on 31 December 2011. As part of this, some of the Scheme's terms and conditions would change. It was the Treasury's intention to announce the Extended Scheme's details at least a year in advance to provide certainty for investors and institutions. Changes made when the Scheme was extended included:

Risk-based fees were to apply to all deposits covered by the Scheme. It was thought that more risk-based pricing would reduce the potential for market distortions due to the Scheme, be more favourable to lower-risk institutions, and encourage some financial institutions to opt out of the Scheme.
Eligible bank deposits were to be covered up to a maximum $500,000 for each depositor in each institution and eligible NBDTs to a maximum $250,000 for each depositor in each institution (reduced from $1 million). The reduced cap signalled the transitional nature of the Scheme.
The minimum credit rating for institutions wanting to join was BB (institutions rated BB- or below, or unrated, were no longer eligible to join).
Collective investment schemes were not eligible for the Extended Scheme.
Interest payments after an institution failed were explicitly excluded.
The reporting requirements for NBDTs were expanded to include controlled institutions and introduce new obligations about changes in control.
Certain related-party transactions for NBDTs needed the Treasury's prior approval.
New withdrawal powers were introduced (as a result of changes to the Crown's liability).

5.63
Figure 11 sets out the fees (which were charged monthly) for each version of the Scheme.

Figure 11
Fees charged for the original, revised, and extended phases of the Scheme

	Original Scheme and Revised Scheme	Extended Scheme
Guaranteed deposits of more than $5 billion	Annual fees of 10 basis points per annum on amount over $5 billion.	Monthly fees on full guaranteed amount. Fees as per table below.
Guaranteed deposits of less than $5 billion	Monthly fees on cumulative growth in guaranteed amount from 12 October 2008 (growth above an allowance of 10% each year on this amount). Fees as per table below.	Monthly fees on full guaranteed amount. Fees as per table below. Same fees apply whether guaranteed deposits were under or more than $5 billion.
Credit rating	All institutions with guaranteed deposits of less than $5 billion (basis points)	Finance companies (basis points)	Banks, credit unions, building societies, PSIS (basis points)
AA and above	10	15	15
AA-	10	20	15
A+	20	25	20
A	20	30	20
A-	20	40	20
BBB+	50	60	25
BBB	50	80	30
BBB-	50	100	40
BB+	100	120	50
BB	100	150	60
Below BB or Unrated	300	N/A	N/A

Note: A basis point is one hundredth of a percentage point (0.01%). This means that a bank with an A+ credit rating and $7 billion in deposits guaranteed under the original Scheme would pay fees of 0.1% of $2 billion each year, or $2 million.

5.64
Another important change was the use of specific legislation to offer the guarantee, instead of using powers under the Public Finance Act. This had the following advantages:

There was greater certainty about the end date for the Scheme.
It enabled better management of Crown risk.

5.65
On 13 September 2009, the Crown Retail Deposit Guarantee Scheme Act 2009 came into force, providing legislative authority for extending the Scheme. Under the Act, the Minister can specify entry criteria and terms and conditions of the guarantee. It also included provisions to strengthen the Crown's ability to recover funds from the guaranteed institution, including giving the Crown the same priority as creditors. The legislation provided for the granting of a guarantee if the Minister believed it "necessary or expedient in the public interest to do so" (which also applied in the original Scheme under the Public Finance Act).

5.66
Participation in the Extended Scheme was voluntary and by application. Institutions in the original Scheme were not covered automatically by the Extended Scheme. The Extended Scheme was open only to institutions that had been in the original Scheme (except for newly registered banks and merged institutions, at the Crown's discretion). It was important that newly merged institutions be eligible because there was scope for consolidation in the non-bank sector, and the Crown did not want the guarantee to act as a barrier to that. On 18 September 2009, the Treasury released:

Policy Guidelines setting out the factors to be considered in exercising discretion to offer or refuse the extended guarantee;
a notice from the Minister on institutional eligibility;
draft deeds for the Extended Scheme (for banks, building societies and credit unions, and NBDTs); and
an application form (similar to that for the original Scheme).

5.67
The Policy Guidelines were different to those that applied to the original Scheme. Although the "Discretion" and "Overarching Principles" were the same, there were several other changes. The section on "Institutions eligible" was removed because this topic was covered in a separate section on eligibility criteria, and the section on "Relevant criteria" was removed because institutions in the existing Scheme had already met these criteria. There were also changes to the "Other factors to be considered", based on the Treasury's experience of implementing and managing the Scheme. In particular, factors that had proved not to be relevant (such as the size of institution, the number of depositors, and audited accounts) were removed. Other factors were refined or expanded (for example, reference to compliance with the Reserve Bank's prudential requirements and compliance with the trust deed).

5.68
The Policy Guidelines for the existing guarantee period were also revised to be consistent with those for the Extended Scheme. These revised Policy Guidelines would apply to any new institutions with deposits guaranteed until 12 October 2010. Further, the Policy Guidelines were amended to provide for mergers so that a new merged institution with a rating of at least BB would be eligible (previously, new entrants needed to be rated BBB- or better). It was thought that mergers in the NBDT sector might be beneficial for the institutions and could reduce the Crown's risk.

5.69
The Notice from the Minister on institutional eligibility was given under section 5 of the Crown Retail Deposit Guarantee Scheme Act 2009. Banks, building societies, credit unions, and other NBDTs such as finance companies were eligible for the Extended Scheme, but collective investment schemes were not. The criteria required eligible institutions to be already approved under the original Scheme, not be subject to withdrawal or default, and have a rating of BB or better. New banks and merged institutions were also eligible. Existing institutions also had to meet criteria similar to the "relevant criteria" from the original Scheme (that is, to have debt securities on issue, to be in the business of borrowing and lending, to be a New Zealand business, and to not lend primarily to related parties).

5.70
Only eight institutions – all NBDTs – were approved to join the Extended Scheme. Three institutions are still in the Scheme. Four financial institutions merged, one failed under the Extended Scheme, and one (South Canterbury Finance) failed before the Extended Scheme started – see Figure 12.

5.71
Most institutions chose not to join the Extended Scheme. Some institutions were deterred by the cost of participation. Others were performing well and did not need the guarantee. Others did not meet the eligibility criteria (the minimum BB credit rating requirement, in particular).

5.72
Guarantee deeds were signed between March and May 2010. As at 30 April 2011, the four institutions still in the Extended Scheme had guaranteed deposits totalling $1.9 billion.

Figure 12
Institutions approved to join the Extended Scheme

Institution	Date extended deed signed	Comments
South Canterbury Finance Limited	1 April 2010	Did not make it into the Extended Scheme. Receiver appointed on 31 August 2010.
Equitable Mortgages Limited	19 March 2010	Failed. Receiver appointed on 26 November 2010.
Canterbury Building Society	28 May 2010	Merged into Combined Building Society, which was covered by the Extended Scheme from 5 January 2011 (now Heartland Building Society).
MARAC Finance Limited	11 March 2010
Southern Cross Building Society	28 May 2010
PGG Wrightson Finance Limited	1 April 2010	The guarantee was withdrawn on 1 September 2011 after completion of arrangements for acquisition of PGG Wrightson Finance Limited by Heartland Building Society.
Fisher & Paykel Finance Limited	17 May 2010
Wairarapa Building Society	28 May 2010

Note: The NBDTs still covered by the Extended Scheme after the failures, mergers, and name changes are shown in bold type.

Applying for the Extended Scheme

5.73
The application process for the Extended Scheme was similar to that used for the original Scheme (see Part 4). The Reserve Bank was not contracted to provide monitoring services for the Extended Scheme, but applications were processed in early 2010 when the Reserve Bank was still contracted to provide services under the original Scheme. Also, the Treasury was in a better position in 2010 to assess applications, having had two years' experience in receiving financial and other information about institutions covered by the Scheme.

5.74
As well as an assessment against the Policy Guidelines, the application process for NBDTs now involved:

confirmation from the trustee to the Reserve Bank that the institution met the eligibility criteria, could meet its payments, was solvent, and was complying with the trust deed;
advice from the Reserve Bank, confirming that the institution was not in breach of prudential regulations under the Reserve Bank Act, estimating the capital ratio and exposure to related-party transactions, and providing the latest financial details of the institution (along with historical key indicators);
confirmation from the Registrar of Companies about any obligations under the Companies Act, any issues in prospectus registration, any ongoing inspections or notices, and any enforcement activity; and
advice from the Securities Commission on any relevant matters (which had not been required before).

5.75
As before, the Minister delegated responsibility to the Treasury for deciding whether to approve applications. This delegation consent specified more exactly the officials who had authority to approve applications. The consent also required the Treasury to provide the Minister with the details of all guarantees entered into.

5.76
Once institutions signed the new guarantee deed (from March to May 2010), the Treasury was able to call on many of the additional powers available under the Extended Scheme (that is, the Treasury did not have to wait for the official 12 October 2010 start of the Extended Scheme). These powers included:

the requirement for the Crown's prior consent for certain related-party transactions;
additional grounds for withdrawing the guarantee as a result of changes in the institution's circumstances (such as certain material reductions in the institution's net asset position or insolvency);
new obligations to provide notice and information about changes in control; and
expanded reporting obligations to include controlled institutions.

5.77
Two financial institutions that applied and were accepted for the Extended Scheme have since failed. One of these was Equitable Mortgages Limited. The other was South Canterbury Finance, which was accepted into the Extended Scheme but failed while still in the Revised Scheme. The application process for Equitable Mortgages Limited, and its subsequent failure, is considered in Figure 13.

Figure 13
Application process for Equitable Mortgages Limited

Equitable Mortgages Limited is a deposit-taking finance company and part of the Equitable Group. The company invests predominantly in the Equitable Property Mortgage Fund (a group investment fund governed by a trust deed and formed in 2007 to hold most of the Equitable Group's mortgages). This fund in turn invests in loans secured by first mortgages over commercial, industrial, and residential properties. The Equitable Property Mortgage Fund also invests for the other members of the Group. The manager for the Equitable Property Mortgage Fund is Equitable Property Finance Limited (which is also part of the Equitable Group) and the trustee is the same trustee as for Equitable Mortgages (Trustees Executors). At 31 March 2008, Equitable Mortgages had total assets of $177 million, equity of $20.7 million, and debentures of $152.7 million (at 30 September 2008, assets were $136 million and deposits $116 million). The credit rating of Equitable Mortgages was affirmed at BB+ on 11 September 2008 with a stable outlook. A prospectus was registered on 24 September 2008 (and later amended). Equitable Mortgages applied to join the Scheme on 14 October 2008. The affirmation from the trustee was received by the Reserve Bank on 4 November 2008 with no concerns. However, the Reserve Bank said that Equitable Mortgages was not eligible to join the Scheme because it primarily invested in the Equitable Property Mortgage Fund, which is managed by the Equitable Group. It was the Reserve Bank's view that Equitable Mortgages was providing financial services to a related party, which was contrary to one of the main eligibility criteria in the Policy Guidelines. However, the Treasury took a broader view and determined that, because of the trust arrangement and the nature of the transactions, the recommendation of ineligibility from the Reserve Bank was not persuasive. The Treasury concluded that it was in the public interest for a guarantee to be granted, so the application was approved on 4 December 2008. Before entering the Scheme, deposits for Equitable Mortgages had been declining. After it joined the Scheme, Equitable Mortgages experienced significant growth in deposits (to $141 million by 31 March 2009). Deposits continued to increase. The Reserve Bank and the Treasury's monitoring revealed issues with large exposures to individual borrowers, much vacant land or development lending, poor loan book performance, a large funding mismatch, and only modest levels of capital (until a capital injection of more than $4 million in March 2010). However, the institution was profitable and mortgages were first mortgages only, with reported conservative loan-to-valuation ratios. On 27 February 2009, Equitable Mortgages' credit rating was lowered from BB+ to BB with a negative outlook. The Treasury monitored the performance of Equitable Mortgages closely, asking for additional information directly from the company in May 2009 and appointing an inspector in July 2009. The support of shareholders was critical to the viability of Equitable Mortgages, with a shareholder support mechanism and insurance underwriting in place to provide support of up to $20 million. Equitable Mortgages was closely analysed by the Treasury as part of monthly Provisioning Working Group meetings, but the support of the shareholders was a significant factor in the continued view that it would not fail. Its ongoing viability also depended on acceptance into the Extended Scheme. Although a provision was recommended for June 2009 (assuming there would not be an Extended Scheme), there were no provisions in all later months for Equitable Mortgages. Equitable Mortgages continued to be closely monitored, with considerable direct contact, additional information requests, weekly liquidity reporting, comprehensive monthly reports, independent verification of monthly data provided to the Reserve Bank, and meetings with management, the Board, and shareholders. Equitable Mortgages joined the Revised Scheme (from 1 January 2010) and applied to join the Extended Scheme on 5 February 2010. In processing the application, the Treasury received advice from the Reserve Bank on 1 March 2010 (which had advice from the trustee on 24 February 2010). The Treasury also received advice from the Registrar of Companies and the Securities Commission on 9 March 2010. Equitable Mortgages met all the relevant eligibility criteria for the Extended Scheme (including the minimum credit rating of BB), and there were no issues of concern. Having considered the Policy Guidelines and the recommendation of the Reserve Bank, the Treasury concluded that extending the guarantee was necessary or expedient in the public interest. Equitable Mortgages was accepted into the Extended Scheme on 19 March 2010. On 20 August 2010, the rating of Equitable Mortgages was downgraded to BB- with a negative outlook, because of its poor asset quality and its failure to resolve arrears as promptly as anticipated. A new prospectus was registered on 28 September 2010. In November 2010, the Equitable Group was rationalised into a single issuer structure (the Equitable Property Mortgage Fund was terminated) to better position itself to meet the impending Reserve Bank NBDT prudential regulations (effective 1 December 2010). The shareholders injected an additional $10.5 million of capital into Equitable Mortgages. Future business opportunities were also being explored. In late November 2010, Equitable Mortgages told the Treasury that it no longer had a viable business in the current economic climate and would struggle to meet the Reserve Bank's upcoming capital requirements. The shareholders were not prepared to provide any additional capital support beyond the $4 million in uncalled credit support. The failure of South Canterbury Finance on 31 August 2010 had also affected investor interest in non-guaranteed debentures (which, before the failure of South Canterbury Finance, had been experiencing slow but steady growth). On 26 November 2010, Equitable Mortgages was placed into receivership with about $178 million in Crown-guaranteed deposits.

Our assessment of the Treasury's handling of Equitable Mortgages Limited

5.78
Equitable Mortgages met the eligibility criteria for the Extended Scheme, and it appeared to be well managed. The Treasury was vigilant in its monitoring of Equitable Mortgages during the Scheme and met with directors and shareholders, which gave the Treasury comfort in their ability and the inclination of the shareholders to provide any additional support required.

5.79
However, we consider that the Treasury relied too much on implicit additional shareholder support. Throughout the Scheme, Equitable Mortgages was consistently ranked as high risk, with recognised issues with liquidity, capital, loan exposures, and loan delinquencies. Although shareholder support was an important consideration, it should have been only one of many indicators of ongoing viability.

5.80
In our view, the Treasury should have tested the strength of the shareholder support by requesting a written guarantee (of the obligations of Equitable Mortgages) or otherwise analysing the position without this support (on a "what if" basis). Without this explicit support, the financial position of Equitable Mortgages should have been more closely scrutinised and analysed with associated detailed reporting and escalation to senior management in the Treasury.

Communicating information about the Revised Scheme and the Extended Scheme

5.81
The Treasury conducted extensive analysis into the need for an Extended Scheme and the possible design options of such a scheme. Many documents were prepared, in the form of Treasury Reports, aides-memoire, memoranda for Cabinet Committees, and presentation slides for meetings with the Minister and Prime Minister. These documents were dated from April 2009 to September 2009. On 25 September 2009, the Treasury publicly released 22 of these documents. Some of the documents were joint reports by the Reserve Bank and the Treasury. A media statement was issued by the Minister on 25 August 2009 detailing the final changes to the Scheme and providing a link to the Treasury's website for further information.

5.82
The Treasury's website posted the main documents as these were released (policy guidelines, draft guarantee deeds, and eligibility criteria). It also hosted the "questions and answers" statement, which was updated on 12 October 2010 to reflect the Scheme changes. A list of institutions approved for the Extended Scheme was included, along with the guarantee deed for each institution. A Regulatory Impact Statement was issued on 8 September 2009, providing further details on the Scheme's extension.

5.83
In our view, the documents and the information on the Treasury's website provided timely and comprehensive public information about the Government's reasons for extending the Scheme, the implications of the various design features considered, and the final terms and conditions. The information could have been structured better to improve access to the various types of information.

5.84
The Treasury relied on its website to communicate this information. Using more communication channels might have been more helpful for investors to understand the nature of the guarantee. There was evidence from one of our interviews that some investors were confused about the changes to the Extended Scheme and the implications of those changes (in particular, details such as the change in the maximum amount of deposit guaranteed).

5.85
The Treasury provided the Minister and Cabinet with detailed information about the Extended Scheme. The Cabinet agreed to the design of the Extended Scheme (including timing, coverage, fees, caps, tools, and use of legislation) on 17 August 2009. The terms of the Extended Scheme were debated in Parliament on 26 August 2009, and the Crown Retail Deposit Guarantee Scheme Bill 2009 was introduced on 8 September 2009. In our view, the disclosures to the Minister and Cabinet were timely, effective, and of a high quality.

5.86
The changes made when the Scheme was revised were not as significant as they were when the Scheme was extended, so there was less to communicate. The Treasury issued a media statement on 18 November 2009, setting out details about the changes as part of the Revised Scheme and the need for institutions to sign replacement deeds if they wanted to stay in the Scheme. The general "questions and answers" statement on the Treasury's website was updated to reflect the changes. Further media statements were issued on 18 December 2009 and 24 December 2009 (to say how many institutions were covered under the Revised Scheme and that six institutions had opted out).

Our views on the Treasury's actions

5.87
In our view, the Treasury should have prepared a thorough assessment framework for the overall performance of the Scheme. If such a framework had been prepared, it is likely that many of the activities that did not begin until March 2009 or later would have taken place sooner.

5.88
Most importantly, the framework might have helped to ensure that the Government was better informed about the effects of the Scheme and established which aspects of the Scheme the Minister wanted to be alerted about. We make this comment having reviewed diary notes of some of the discussions between the Treasury and the Minister after the failure of Mascot Finance. In these discussions, it was apparent that the Government could have been better informed.

5.89
It is clearly in the best interests of the Treasury to ensure that the Government understands how the Treasury is implementing government policy, the effects and performance of the policy, and any issues and challenges faced. A performance assessment and reporting framework for the Scheme could have included, for example:

measures to assess and report overall Scheme effectiveness (such as deposit volatility and public awareness and confidence);
measures of overall fiscal risk;
an issues register for emerging policy design issues;
an issues register for concerns with individual financial institutions covered by the Scheme; and
a stronger project management approach to the Scheme, including an issues register to catalogue implementation concerns, such as resourcing.

5.90
In 2009, many of the activities supporting the above components were taking place within the Treasury. For example, the Treasury was aware of, and had highlighted before the introduction of the Scheme, concerns about its potential effect on deposits and the importance of monitoring deposit flows. We have seen evidence that the Treasury looked closely at deposits from March 2009 to determine how the Scheme was affecting the financial sector and individual financial institutions. The deposit growth of financial institutions in the Scheme was considered each month as part of the monitoring of individual financial institutions. We have not seen evidence that this analysis was taking place before March 2009. Moreover, we have not seen evidence that the analysis was reported and escalated within and beyond the Treasury.

5.91
The Treasury was also actively considering possible revisions to the Scheme in response to emerging policy design issues and considering its powers to act in the event of an issue with a particular financial institution. The Treasury carried out much research into ways to improve the Scheme and was assessing various aspects of the Scheme's performance. We did not see evidence of these two areas of work coming together. The policy or design work did not appear to be informed by information on the emerging level of financial risk.

5.92
We saw evidence that, from March 2009, the Treasury was trying to work out how it could quantify how much money the Crown could lose if a financial institution covered by the Scheme failed (see Part 6). The Treasury had prepared a report for the Minister that discussed fiscal risk and estimated possible payout amounts, but we have not seen any evidence that the Treasury updated these amounts between October 2008 and March 2009.

5.93
We also saw evidence that, in July 2009, the Treasury was beginning to consider how it could increase the amount that the Crown could recover from a failed institution. This issue was discussed at the financial system issues meeting in November 2009 and a number of analysis papers were produced (including papers in January 2010 and June 2010).

5.94
We have evidence of discussions with Australian counterparts in the lead up to the Scheme's introduction and in mid-2009. We have not seen evidence that the Treasury's considerations to design or improve the Scheme included discussions with any other offshore counterparts. In our view, if the Treasury had talked to counterparts in additional jurisdictions more familiar with deposit insurance schemes, it is likely that some of the design issues that later emerged could have been identified. We understand that interest payments after an institution fails, for example, is one aspect of deposit insurance addressed under the United States' deposit insurance arrangements.

5.95
As well as the Treasury's extensive analysis about desired changes under the Revised and Extended Schemes, the Treasury also analysed:

options for dealing with South Canterbury Finance (see Part 6);
intervention options for institutions that were expected to trigger the guarantee;
the possible introduction of permanent deposit insurance;
exit options for the end of the guarantee; and
weekly liquidity analysis for higher-risk institutions to gauge the potential effect of the "funding wall".

5.96
Overall, the Treasury carried out much research in 2009 into ways to improve the Scheme. In our view, the Treasury's process was comprehensive and carefully deliberated but could have benefited from a structured approach in keeping with a monitoring, escalation, and reporting framework. Although changes to the Revised Scheme were limited, many of the problems with the Scheme were remedied in the Extended Scheme.

Reviewing the Extended Scheme

5.97
In November 2009, the Treasury reviewed the lessons it had learned from offering the Extended Scheme. The review gathered and analysed views from all teams with responsibility for aspects of the Scheme (including communications, policy, operations, and legal teams). The lessons covered the co-ordination and communication between teams, as well as internal processes and stakeholder engagement.

5.98
From all accounts, the review was a useful exercise. We were told that the review was initiated by a relatively junior staff member, and we are unsure of the extent of escalation of the findings of this review. Another useful review was commissioned about the failure of Mascot Finance. This review was completed in May 2009, with the aim of improving Treasury's ability to anticipate and manage operational risks under the Scheme. The findings of the review were escalated broadly, including to the Secretary to the Treasury, and a summary of the lessons learned was circulated widely within the Treasury. The Treasury also carried out a supplementary review to consider decision-making.

5.99
In our view, the Treasury could usefully carry out reviews of this type after it implements all significant policy initiatives. Such reviews would best be sponsored by a senior official or senior committee within the Treasury to ensure that the reviews are thorough and that findings are implemented.

Recommendation 3
We recommend that the Treasury carry out a formal post-project review after it implements any significant policy initiative. The review should be timely, independent, and sponsored by a senior official or committee within the Treasury. The findings of the review should be discussed and implemented where appropriate.

18: Of these, Part 3 discussed the changes that the Treasury made to the Scheme’s draft design soon after its announcement on 12 October 2008. Part 4 discussed the applications process. Parts 6 and 7 consider the monitoring, provisioning, and payout processes.

19: Reserve Bank of New Zealand Act 1989, section 157F(2)(b)(ii).

20: Reserve Bank of New Zealand (2011), Registered Bank Disclosure Statements (New Zealand Incorporated Registered Banks) Order (No. 2) 2011, Wellington.

21: Bollard, Dr A and Ng, T (September 2003), Financial system regulation in New Zealand, paper presented during a speech to the Finance Sector Ombudsman Conference and reproduced in the Reserve Bank of New Zealand Bulletin, Reserve Bank of New Zealand, Vol. 66, No. 3.

22: Undated, but according to the Treasury’s document management system it was drafted in February 2009.

23: Bare trustees are sometimes called naked trustees or simple trustees. They have no duties other than conveying the trust’s assets to beneficiaries, according to the trust’s provisions.

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