Open Bank Resolution-Broadening the Government's Options to Deal with a Bank Failure

Article excerpt

1 November 2012

Background Feature by Reserve Bank Deputy Governor Grant Spencer.

The global financial crisis has provided a worldwide reminder that banks can fail. It also highlighted the potential size of the financial burden that can be faced when Governments step in to guarantee a nation's banking system. A glaring example of this is Ireland. Bank failures are very rare in New Zealand and we do not expect this to change. In addition, New Zealand's financial system remains stable. Nevertheless, it is important to have robust policies in place to deal with such unlikely, but potentially damaging events.

Open Bank Resolution (OBR) is a process for dealing with a failing bank quickly to enable the bank to re-open for business the next business day.

Without OBR, the options for responding to a bank failure are liquidation, government bail-out or takeover by a competitor. If takeover is not an option, then the Government is left to choose between liquidation and bailout.

Neither option is appealing. Government bailout carries with it potentially huge costs to taxpayers. Liquidation is complex and time-consuming, and results in the bank's customers not having access to any of their money for a lengthy period. In the case of a large bank, this could lead to serious disruption of the wider economy.

OBR works by allowing the failing bank to remain open under the control of a statutory manager. In contrast to liquidation, deposit holders have full or partial access to their accounts, while a long-term solution is worked out.

The first losses of a failing bank are borne by the bank's shareholders and subordinated creditors, as they would under liquidation. Under OBR however, a portion of depositors' and other unsecured creditors' funds are frozen to meet any remaining losses, while the unfrozen part is subject to a government guarantee to give depositors confidence in the re-opened bank. …