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


In October 2008, at the peak of the global financial crisis, the Government needed to very quickly implement a form of retail deposit guarantee scheme or risk a flight of funds from New Zealand institutions to those in Australia. The Crown Retail Deposit Guarantee Scheme (the Scheme) was designed during the course of, and announced in the evening of, Sunday 12 October 2008.

The Treasury and the Reserve Bank of New Zealand (the Reserve Bank) were jointly responsible for advising Ministers on the design of the Scheme. The Treasury was responsible for implementing and managing it.

The Scheme offered a Crown guarantee over the money that people had deposited or invested with financial institutions – specifically banks and “non-bank deposit takers” (NBDTs), which is a group that includes finance companies and savings institutions (such as building societies and credit unions). The Scheme was originally set up to last for two years, but revisions to the Scheme have meant that it now ends on 31 December 2011.

Financial institutions that were eligible for the Scheme needed to apply to the Treasury. If an institution accepted into the Scheme failed during the term of the Scheme, the Crown would repay depositors of that institution. The Crown would then rely on receivership processes to recover funds from the failed institution.

We carried out a performance audit of the Treasury’s implementation and management of the Scheme, given its economic and financial significance. Introducing the Scheme required the Treasury to play a larger operational role than it had historically played.

We considered all types of financial institutions covered by the Scheme when reviewing the Treasury’s implementation of it. However, we spent the most time reviewing the implementation as it related to finance companies. Including finance companies in the Scheme was controversial, and more complex than for other types of financial institution, because of their higher risk profile.

In terms of achieving the Scheme’s objectives, we record that:

  • Ninety-six institutions were accepted into the Scheme (60 NBDTs, 12 banks, and 24 collective investment schemes).
  • No banks accepted into the Scheme failed, and there was no run on the money in banks.
  • No building societies or credit unions accepted into the Scheme failed.
  • Of the 30 finance companies accepted into the Scheme, nine have failed since the Scheme was introduced.
  • The Crown has paid out about $2 billion to more than 42,000 depositors, and depositors received 100% of their entitlements up to the date of failure. The Crown expects to recover about $0.9 billion after the receiverships and liquidations of failed companies are resolved.
  • Investor confidence was maintained or improved during the term of the Scheme.

A recurring theme of our audit findings is that the Treasury should have started planning for the necessary implementation and operational activities in the weeks after the Scheme’s introduction.

About finance companies

Although finance companies hold less than 3% of the assets in the financial sector, they are considered important to the economy because they service sectors of the economy not serviced by other types of institutions.

Many finance companies experienced significant problems in the years leading up to the introduction of the Scheme. Their problems were compounded by the funding pressures and investor uncertainty that characterised the global financial crisis.

The Government had recognised, before the Scheme was introduced, that finance companies and other NBDTs needed a stronger regulatory framework. Several changes have occurred during the past few years to increase the regulatory oversight of finance companies, including the appointment of the Reserve Bank as regulator and the introduction of prudential requirements. These changes have been phased in since September 2009.

Comparisons with other countries’ guarantee schemes

Before the global financial crisis, New Zealand was the only country in the Organisation for Economic Co-operation and Development (OECD) without any sort of statutory depositor insurance or depositor preference arrangement. Introducing a deposit guarantee scheme represented a material departure from New Zealand’s long-standing approach to supervision and regulation – an approach that favoured minimal intervention in the financial system and market-based solutions, supported by good disclosure requirements.

To the extent that it made sense to do so, we used international benchmarks and principles to carry out this audit. However, given New Zealand’s unique minimal interventionist approach, no set of international benchmarks provides an adequate frame of reference against which to assess the Treasury’s implementation of the Scheme. New Zealand applied a less intrusive and disclosure-based regime to banks than did most other OECD countries.

Introducing the Crown Retail Deposit Guarantee Scheme

By October 2008, several other countries had already responded to the global financial crisis by guaranteeing deposits in their countries. On 10 October 2008, the Treasury reported to the Government that such a scheme was not needed here, but the Treasury would continue to work out what might be needed should circumstances change. Two days later, Australia said that a scheme there was imminent. Officials here believed that, if the Government did not act quickly to implement a similar scheme, depositors would transfer funds from New Zealand to Australia, adding to the difficulties faced by New Zealand financial institutions and the broader economy.

The Treasury and the Reserve Bank had to work with Ministers to finalise the design of the Scheme quickly. Some work had been done already (to produce the 10 October 2008 report), but there was limited opportunity to fully explore the consequences of the various policy options available – such as which types of financial institutions would be offered the guarantee, and how much they would pay the Crown for the guarantee. The Treasury would later discover that the design of the Scheme presented some challenges for its implementation.

As part of the initial design, the Government decided that the Scheme would cover all banks and all NBDTs that met some basic eligibility criteria. It was recognised that including NBDTs would increase the potential cost to the Crown and the likelihood that the guarantee would be invoked. It could also encourage depositors to shift deposits from banks to NBDTs, where rates of return and risks were higher. Although the NBDT sector was small enough that it was unlikely to significantly affect overall confidence in the economy, excluding them would trigger a flow of funds from NBDTs to the banks. The Government’s thinking was that this might cause the failure of a sector that was important to the diversity of the financial system. Including NBDTs meant that the Scheme guaranteed a broader range of financial institutions with a higher risk profile than most guarantee schemes elsewhere in the world.

Although the Scheme was broadly designed and announced on October 12, detailed design matters were refined in the weeks that followed to ensure appropriate Scheme coverage, pricing, and obligations on NBDTs. Policy Guidelines were also issued, setting out the criteria that might be considered by the Treasury when assessing applications for the Scheme.

The design of the Scheme saw the Crown acting as a guarantor. The Crown assumed the responsibility for repaying investors’ deposits if financial institutions covered by the Scheme failed. The Scheme did not guarantee the solvency of those financial institutions.

The purpose of the Scheme was to maintain the confidence of depositors and the public in the financial system. There was no explicit reference to the need to minimise the Crown’s liability. Including this as an explicit objective could have contradicted the urgent need for depositor and public confidence.

However, we consider it reasonable to assume that the Crown’s liability was an important long-term consideration for the Treasury, because the Treasury manages the Crown’s finances. Fiscal prudence was explicitly addressed in the design of the Extended Scheme, because many of the changes were aimed at minimising the Crown’s liability (such as excluding interest payments after a guaranteed financial institution failed, and reducing the liability cap).

The Treasury faced a challenging environment in the early period of the Scheme. Parliament had risen; there was a general election then new Ministers and a new government. Work on a wholesale scheme was also under way, and there were lots of uncertainties in international financial markets.

Planning and governance and reporting frameworks

The work the Treasury did to put the Scheme in place quickly, and under significant pressure, is commendable. It met the objective of maintaining public and depositor confidence. However, we consider that the Treasury should have carried out formal and documented planning early in the Scheme to ensure that all of the necessary processes and activities were rigorously developed and implemented. This should have included planning for processing applications, monitoring the financial institutions in the Scheme, monitoring the Scheme’s performance, and payout processes. Formal, documented planning for many of these activities did not start until March 2009. Even then, much seems to have been done reactively and in response to immediate needs.

The Treasury did not start to intensively monitor individual financial institutions until March 2009. Earlier and intensive monitoring would have helped with earlier provisioning (being clear about the potential cost of paying out depositors of institutions that were considered likelier to fail) in the financial statements of the Government and understanding of the Crown’s risk.

Similarly, planning for payouts started a week before the failure of Mascot Finance Limited in March 2009. The Treasury’s analysis of possible payout solutions should have happened in late 2008, instead of being finalised in late 2009. Planning the communications that would be needed if an institution failed should also have been done earlier. The Crisis Response Plan that was written in late 2009 should have been prepared before the first financial institution failed.

In our view, the Treasury should have established stronger governance and reporting frameworks for the Scheme. We found no evidence of formal senior management oversight, such as a steering committee, to provide senior strategic direction and to ensure that all aspects of the Scheme’s implementation were addressed. More formal frameworks would have included clear roles and responsibilities for implementation and clear accountabilities for making decisions.

We expected a gap in documentation in the hectic early weeks after the Scheme was introduced, but the documentation deficiencies continued for too long. Some initial planning took place, but we saw little evidence of formal implementation planning discussions or documentation of important decisions and processes.

The Treasury told us that it is now taking a more structured approach in its response to crisis situations (such as its work on government support for AMI Insurance Limited).

Processing applications

The focus for the Treasury in the first few months of the Scheme was processing the applications from individual financial institutions. The applications process was well defined and well documented, with input from the Reserve Bank and the trustee of each financial institution but with the Treasury deciding whether to approve or decline an application. The criteria to assess applications were documented and in line with the policy decisions about the Scheme’s introduction.

However, there was some confusion about the interpretation of certain aspects of the criteria. The Policy Guidelines provided for “other factors” that could be considered in exercising discretion to off er the guarantee (including size, creditworthiness, related-party exposures, and business practices). These “other factors” could be used to decline an application. There was some initial confusion about how to apply these “other factors”.

Some financial institutions were declined because they failed to meet the criteria. For example, some applicants were not deposit-takers, had complex structures, or were in a moratorium (that is, they were suspended from activity as part of a creditor arrangement). However, no applicant was refused in the first few months of the Scheme based on the “other factors”, such as creditworthiness or business practices.

Although we accept the need to process applications quickly, we consider that the Treasury should have made further inquiries about some financial institutions before accepting them into the Scheme. We did not see evidence that the Treasury sought additional information in the early days of the Scheme, even though there may have been some indications in the material considered that additional review was warranted. We are not suggesting that these institutions should have been immediately declined, but further review would have placed the Treasury in a better position to understand the risks presented by these institutions.

Although it was consistent with the supervisory model, we were surprised by the degree of reliance on the advice of trustees.

Applications processed after the failure, in March 2009, of Mascot Finance Limited were more closely considered in terms of riskiness of the institution. The “other factors” became more of a focus and a number of institutions were declined based on their higher probability of failure. The Treasury told us that this change in focus reflected the fact that, by this time, the remaining applicants were generally higher-risk institutions.

At this time, there was an easing of external conditions and the Treasury started to receive reports on individual institutions from the Reserve Bank. The need to minimise the cost to the Crown also began to be emphasised within the Treasury. Although this change in emphasis was probably warranted, we consider that it was a change that should have been actively discussed, formally documented, and reported to the Minister.

Assessing the performance of the Scheme

During the course of the Scheme, design issues emerged that made its implementation difficult. A small number of these were predicted on or before the Scheme’s introduction. Most design issues emerged only as the Scheme evolved. These issues included market distortion (significant growth in NBDT deposits), complicated depositor eligibility criteria (which depositors would be paid as part of the payout process), payment of interest after a financial institution failed, use of contracts, lack of Treasury powers, and the funding maturity wall (at the end date of the Scheme). Starting in 2009, the Treasury carried out much research into ways to improve the Scheme and was assessing various aspects of the Scheme’s performance.

We have not seen evidence that this research included discussions with overseas counterparts. Before the Scheme was introduced, New Zealand had neither depositor protection nor deposit insurance provisions. It would have been useful for the Treasury to contact its overseas counterparts, such as in the United States of America or the United Kingdom, about their experiences in implementing a deposit insurance scheme.

The Treasury’s process for reviewing Scheme changes was otherwise comprehensive and carefully deliberated but, as noted earlier, could have benefited from a more structured approach. For example, the Treasury did not analyse NBDT deposit growth until March 2009, and we saw no evidence of the analysis being reported and escalated. Deposits with many of the NBDTs increased significantly in the first few months of the Scheme (deposits of South Canterbury Finance Limited increased by more than 25% to February 2009 before levelling off ). A well-defined monitoring framework would have ensured that the Treasury was aware of this growth and the consequential risk exposure, and that the issue was reported and escalated.

The Treasury’s powers were consistent with a policy against direct involvement in the management of guaranteed institutions. This was in line with New Zealand’s longstanding minimal intervention approach to regulation and supervision. The strongest power was the ability to withdraw the guarantee. However, the use of the withdrawal power had to be carefully considered and it affected only deposits made after the date of withdrawal (deposits made up to the date of withdrawal continued to be covered by the guarantee).

The Treasury was responsible not only for implementing the Scheme but also for giving ongoing policy advice to Ministers on possible ways of enhancing the Scheme. 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. For example, early in the Scheme, the Treasury could have considered whether it might need additional powers to ensure the effectiveness of the Scheme. These might have included powers to issue directions, restrain activities, require extra capital, or improve risk management practices. We understand that imposing constraints on weak institutions to stop them making their financial exposures worse was a common feature of deposit guarantee schemes in other countries.

Decisions about any powers the Crown wanted to have available, and the level of intervention in the market, were policy choices that needed to be carefully considered. It is not our role to form a view on whether more or less intervention was appropriate. However, we were concerned that we did not see evidence of detailed policy analysis informed by overseas models and assessments of the emerging risks.

We note that there were some changes made to improve the effectiveness of the Scheme and the terms and conditions of the Scheme were twice modified (by way of the Revised and Extended Schemes). The problem of the Crown needing to pay interest to depositors after an institution failed was addressed in part by changes to the Revised Scheme, and fully addressed by being explicitly excluded from the Extended Scheme. Similarly, issues with the use of contracts were addressed in the Extended Scheme through legislation. A number of changes were made to the (Revised and Extended) guarantee deeds to address concerns with the lack of Treasury powers under those deeds. The Extended Scheme introduced risk-based fees for all deposits and a lower liability cap.

Monitoring individual institutions

One of the Treasury’s important roles was monitoring the individual institutions covered by the Scheme. The Reserve Bank was contracted to help the Treasury by providing regular reports based on information it was receiving from the institutions (through the trustee). The Reserve Bank prepared templates to collect this information and models to analyse the results. The Reserve Bank provided the Treasury with reports that included a risk-ranking report, sector reports, and detailed individual analysis for higher-risk institutions.

The Treasury also reviewed information from other sources, including financial accounts, prospectuses, ratings reports, and general intelligence from regulators and market participants. The Treasury and the Reserve Bank worked collaboratively and were in frequent contact. Ultimately, the Treasury decided what an institution’s risk ranking was and what the Treasury’s response should be. The Treasury also asked for additional details from individual institutions as well as other third parties (such as auditors and trustees). From March 2009, the Treasury began to request additional details from a number of high-risk institutions and directors were asked to attest to the financial positions by providing directors’ certificates.

The Treasury could, under the guarantee deed, appoint an inspector and would use this option if it had concerns about the information it had received or required additional detail. The first short inspection was in March 2009, with six more comprehensive inspections carried out during June and July 2009. During the Scheme, 12 institutions were inspected. The Treasury’s use of inspectors was effective and the Treasury maintained close contact with inspectors.

The monitoring framework eventually implemented by the Treasury, which included reporting provided by the Reserve Bank, inspections, and the Treasury’s analysis from other sources, was for the most part effective. It provided the Treasury with sufficient financial details on individual institutions to assess which institutions should be asked for additional information. Most of the institutions that triggered the guarantee were identified by the Treasury as having a high risk of failure at least three months before they failed. From March 2009, the Treasury was proactive in its analysis and review of the institutions and its search for additional evidence. The Treasury used a wide range of information sources and did not rely solely on the Reserve Bank’s monitoring reports.

Monitoring under the Scheme had only just started when the first failure occurred in March 2009 (almost five months after the start of the Scheme). As soon as the Scheme was announced, a monitoring work stream should have been prepared to run concurrently with the application process. There was a long history of finance company failures and another failure was, in our view, predictable. If the monitoring process had started earlier, inspectors may have been appointed earlier and resulting actions potentially brought forward. Although we cannot say definitively that more immediate close monitoring and careful management of risk exposures would have reduced the overall cost to the Crown, closer monitoring could have helped identify risks for earlier consideration.

A similar comment applies to the quantification of the Crown’s potential exposure for the purpose of including provisions in the financial statements of the Government. Once started, the provisioning process was well defined, with sufficient governance and amounts carefully analysed. However, this process started too late, both in terms of disclosure and in terms of active analysis of the institutions that had a high likelihood of failing.

The Treasury had several difficulties when monitoring. These included data accuracy (often addressed by the appointment of inspectors) and delays in receiving information (this improved as the Scheme progressed). The Treasury relied heavily on the models developed by the Reserve Bank. In our view, there should have been stronger governance processes for the use of those models within the Treasury, including independent review and validation.

Payout processes

Nine finance companies accepted into the Scheme have failed, the first in March 2009, another in April 2009, six in 2010 under the Revised Scheme, and one in 2010 under the Extended Scheme.

There is evidence that planning for payouts had started in the week before Mascot Finance Limited failed in March 2009, but not earlier (although we were told that this was discussed in late 2008). Once the Treasury was aware of the pending failure, it responded quickly to ensure that the payout process was smooth. Several issues complicated the claims processing, including complex depositor eligibility criteria and the payment of interest to depositors from the date that the institution failed. Although the Treasury contracted in additional resources and payments were timely, if a large institution had failed in March 2009 the Treasury would have been caught unprepared and it would have taken significant effort to produce a workable solution.

In our view, the Treasury learned valuable lessons from the experience of the Mascot Finance Limited payout, and applied this knowledge successfully to improving the outcomes for future payout processes. The Treasury’s experience with Mascot Finance Limited highlighted the need for a more robust and scalable payout solution. The Treasury comprehensively analysed what was needed and explored a number of options. An outsourcing arrangement was set up in late 2009 for Computershare Investor Services Limited to set up adequate systems and then process any claims as they occurred. All payouts after the first two failed institutions were made using this outsourcing model. The use of the outsourcing model was a sound decision and contributed to an efficient payout process.

South Canterbury Finance Limited’s failure on 31 August 2010 presented more challenges because there were so many deposits and the potential for interest payments to significantly increase costs. effective monitoring of South Canterbury Finance in the months leading up to its eventual failure provided ample warning of the failure and an opportunity to analyse and consider alternative payout approaches. The Treasury used this early warning to extensively analyse how to simplify the payout process and reduce the Crown’s liability. A decision was made to pay both eligible and ineligible depositors in full on the day of the receivership (through the trustee) and to pay prior-ranking creditors to simplify the funds recovery process. Ineligible depositors of all institutions that had failed already were also paid in full. The Treasury’s analysis was comprehensive and the outcome effective, likely resulting in significant savings to the Crown.

Communicating information about the Scheme

In the early weeks of the Scheme, there was considerable effort to ensure that the public was aware of the Scheme and the policy decisions made to refine its design. There was a call centre and regularly updated information on the Treasury’s website. In our view, this disclosure was adequate and timely.

Information about later aspects of the Scheme was also made available through the Treasury’s website, including:

  • a list of institutions approved under the Scheme, along with their guarantee deeds;
  • details about changes to the Scheme for the Revised and Extended Schemes (in particular, timely and comprehensive information about the reasons for extending the Scheme, the implications of the various options, and the final design features); and
  • details about institutions that had failed under the Scheme, the process for making a claim, progress with payouts to depositors, and the amount of repayments made.

In most instances, the amount and quality of information provided was useful and timely, but it was not always well organised or easy to find.

Information to Parliament (through the Minister of Finance) in the early weeks of the Scheme was comprehensive, providing adequate and timely background details and supporting analysis for the various policy design issues as they emerged. We did not see evidence that this level of disclosure was maintained between the early weeks of the Scheme and the first failure under the Scheme. However, we accept the Treasury’s assurance that the Minister was kept informed, and note that Parliament was dissolved for the general election for some of this period.

Information to the Minister of Finance and Parliament on the options for an Extended Scheme was timely, effective, and of a high quality.

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