Report: Treasury and Crown Retail Deposit Guarantee Scheme
The Treasury: Implementing and managing the Crown Retail Deposit Guarantee Scheme.
On Sunday 12 October 2008, at the peak of the global financial crisis, the Government decided that it needed to implement a form of retail deposit guarantee scheme to avoid a flight of funds from New Zealand institutions to those in Australia. It needed to do this urgently: the Crown Retail Deposit Guarantee Scheme (the Scheme) was designed and announced that same day.
The Scheme offered a Crown guarantee over the money that people deposited or invested with financial institutions – specifically banks and “non-bank deposit takers”, which is a group that includes finance companies and savings institutions (such as building societies and credit unions). If a financial institution in the Scheme failed, the Crown would repay all of the money that eligible people had deposited or invested, up to a cap of $1 million each.
This was a major decision in both financial and policy terms. In financial terms, this decision resulted in the Crown guaranteeing up to $133 billion in investor funds. In policy terms, it was a significant departure from the longstanding setting in New Zealand of minimal state intervention in the market. However, the Government considered the Scheme necessary to maintain depositor and public confidence in our financial markets.
I considered it important to tell the story of this Scheme, because it was so significant to our economy and because it was designed and implemented with such speed. After any crisis, there is value in pausing to reflect on how the response was managed and what lessons can be learned.
Our report does not question the policy choices made by the Government as the Scheme was developed. Nor does it look at how private sector finance companies were managed. That is not the Auditor-General’s role. My focus is on the work of public sector organisations. We therefore carried out a performance audit of the Treasury’s implementation and management of the Scheme that the Government had decided on. Inevitably, for something this complex and urgent, we found a mixed picture.
Overall, the Scheme achieved its goal. No banks in New Zealand failed, and there was no run on banks. Many of the other finance institutions also survived the global financial crisis. The economy was stabilised.
However, there have been costs. Nine finance companies in the Scheme failed, causing the Crown to pay out about $2 billion to depositors. It will be some time before the various receiverships are completed and the total amount recovered from the finance companies is known. Expected recoveries are currently estimated at about $0.9 billion.
At a practical level, implementing the Scheme proved to be challenging. It was a major project, and a significant change from the Treasury’s usual work. The speed with which the Scheme was introduced, the scale of it, and its importance to the country’s economy all demanded a disciplined project management approach.
The early months of the Scheme were undoubtedly busy, and the first few weeks were hectic. The initial focus was on getting the application system up and running, and starting to process applications. This task was important for instilling confidence in the economy quickly. The Treasury’s work to put the Scheme in place, quickly and under significant pressure, is commendable.
However, this task was done at the expense of setting up good governance arrangements for the overall management of the Scheme and planning for the rest of the work that would be needed. In my view, the Treasury should have been doing both. Those early and very busy months were also when stronger governance frameworks, escalation procedures, and strategic management were needed most.
The lack of overall governance meant that there was no coherent strategic overview to inform the evolving thinking and work on individual tasks. This affected:
• the practical work needed for the successful operation of the Scheme;
• the approach taken to managing the Scheme’s major risks, and
• how and when the hastily put-together Scheme was reviewed and refined over time.
Practical work needed
Most of the practical challenges that arose, and required swift responses, were predictable. Some had been identified as a need in early notes or meetings, but had not been picked up and turned into a stream of work. Others could have been identified if the Treasury had made contact with its overseas counterparts that had substantial experience in running such schemes.
For example, at a very early stage the Treasury had identified operational matters it would need to address, such as how to resource and manage the claims process, monitoring successful applicants, the Treasury’s own monitoring and reporting requirements, the payout process, and how the Crown might recover funds from failed financial institutions. However:
• Planning for payouts did not start until late February 2009, only one week before the first finance company failed. Many people told us the Crown was lucky that this first failure was not a large finance company.
• The Treasury waited for monitoring data to arrive from the Reserve Bank of New Zealand rather than planning for its arrival and working out what to do with the information once it arrived. The Treasury should have prepared a monitoring work stream to run concurrently with the application process.
In essence, the Treasury remained in a reactive mode for too long, responding to needs as they emerged, rather than systematically anticipating and preparing for the next eventuality.
Managing the Scheme’s risks
From the outset, the advice from officials recognised that the decision to include finance companies in the Scheme carried significant risk. Once deposits with these companies were guaranteed, depositors could safely move investments to where they would get the highest return, irrespective of the risk of company failure. The finance companies also had less reason to minimise risk in their investment activity. The Crown was carrying much of this risk.
During 2009, the Treasury watched some of that behaviour eventuate. Deposits with finance companies under the Scheme grew, in some instances significantly. We saw one example where a finance company’s deposits grew from $800,000 to $8.3 million after its deposits were guaranteed. At South Canterbury Finance Limited, the deposits grew by 25% after the guarantee was put in place.
From mid-2009, the Treasury was closely monitoring these changes and the individual companies that were identified as being at risk. However, it was largely doing so to prepare for potential payouts. It did not see itself as able to interact with a finance company to attempt to moderate that behaviour, even when it could see the Crown’s potential liability increasing markedly. The view appeared to be that it was better to recover what funds it could after an institution failed, than try to influence events before a failure.
In my view, this approach relied too heavily on the presumption of minimal intervention and gave insufficient weight to the need to manage the overall potential cost to the Crown. The presumption of minimal intervention had already been weakened when the Crown introduced the Scheme. Although the Scheme’s primary objective was to secure depositor and public confidence, and it was accepted that this would involve a significant cost, financial prudence should still have been a significant consideration. There was still some capacity to manage risk within the Government’s policy settings.
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.
We saw the same approach in how individual applications were considered. In our view, further enquiries could have been made of some financial institutions as part of the application process. The Treasury and the Reserve Bank of New Zealand did not seek additional information in the early days of the Scheme, because they were squarely focused on the objective of depositor confidence. At that time, managing the size of the Crown’s potential liability was not the primary concern.
Although we cannot say definitively that more immediate close monitoring would have reduced the overall cost to the Crown, closer monitoring could have helped identify risks for earlier consideration and possible management.
Reviewing and refining the Scheme
Problems began to emerge as the Scheme was implemented. Some were caused by constraints when the Scheme was introduced, such as having to use contractual guarantees under the Public Finance Act 1989 rather than new legislation. Other problems had not been foreseen at the start, such as that the Crown would be liable for interest that continued to accrue on deposits after a finance company had failed and before payouts were made.
Problems were to be expected for a Scheme that was put together with such haste. In my view, the Treasury should have recognised this from the outset, and established an ongoing work stream for identifying problems and providing advice on options for addressing them. This work did not begin until 2009. However, the Treasury did then take steps to improve the effectiveness of the Scheme. It was later modified twice in ways that addressed many of the problems.
Our overall conclusion
All entities, at some point or another, are faced with unexpected situations that necessitate a crisis response and major change. When these situations occur, the challenge is to respond to the immediate operational needs while at the same time setting up the strategic oversight and governance arrangements that will carry the entity through the rest of the crisis and its aftermath.
With the Crown Retail Deposit Guarantee Scheme, the Treasury repeatedly responded well to the immediate operational needs. It achieved this despite difficult circumstances, including the fact that Parliament was dissolved for a general election, there was a change of government, and it was simultaneously responding to other aspects of the global financial crisis. However, it did not appreciate how important it is to “get ahead of the wave” as quickly as possible, to maintain a clear and comprehensive view of the strategic picture and start to plan and manage accordingly. The Treasury tells me that it has learned from the experience, and is now taking a more structured approach to crisis situations.
I thank the Treasury and the Reserve Bank staff for their co-operation during this performance audit. I would also like to thank the individuals in other organisations who contributed to our work. Although the views in this report are those of my office, I would like to acknowledge the substantial assistance provided by Promontory Financial Group Australasia with this work.
Controller and Auditor-General
29 September 2011
[Full report: crownretaildepositguaranteescheme.pdf]