The OBR is not meant to be a replacement for deposit guarantees

By Matt Nolan 29/03/2013

I’ve noticed an interesting interpretation of the Open Bank Resolution going around New Zealand, and the world, where it is seen as a replacement for the lender of last resort function and deposit guarantees.

This has caused outrage among some – even I’ve received some emails and facebook messages from people on it.  But the OBR and implicit/explicit deposit insurance are actually two incredibly different issues.

The OBR is a scheme that helps to ensure that, when a financial institution fails, it is wound down in an orderly fashion – it is like an addition to standard bankruptcy law specifically for financial institutions.  The OBR takes the fact that, if debt has “gone bad” there are a range of creditors, and the loss needs to be attributed between them.  This is great, it makes what is going on transparent, and helps reduce the interruptions associated with the collapse of a large financial institution!

But it doesn’t say anything about the government’s willingness to allow depositors to lose out from a failure.  Any implicit government guarantee that existed still exists.  In Table 1 of the RBNZ’s recent bulletin article on the OBR this is made relatively clear – the idea of inherent insurance is not applicable to the scheme.

Now I think the logic people are taking onboard is as follows:

  1. When it is clear how a bank will be shut down, it is more likely that the government will do so instead of bailing it out.
  2. Therefore, by setting all this up, it is less likely depositors will be bailed out.

While this is true, I think that it inherently misses the point for extremely large financial institutions – such as the big banks in NZ.  Governments have an incentive to bail out depositors, and there may well be a presumed “social preference” for a risk free place to save that doesn’t lose value which is where this is coming from (given that the value of cash depreciates over time).  If we really want the government to be able to commit to not bailing out deposit, and we want society to be comfortable with it, we need to face these issues – which are separate issues from the appropriate focus of the OBR.

Personally, I think the OBR is great – I just think people’s view of its “purpose” has been stretched out of proportion.