OBR summary

• What is the OBR and its aims?

• How does it fit into a broader regulatory framework?

• Any suggestions or questions?

Important areas for clarity, questions

Broad debate on financial policy

• Current RBNZ policy: Mismatch ratios, core funding ratio, capital-adequency ratio
• Keister (2010): Combine moral hazard and bank run models - introduce a short term liability tax
• Admati and Hellwig: Ramp up equity requirements
• John Cochrane: Full reserve banking

• Better information of how an event that utilises the OBR will impact upon depositors.
• If systemic episodes are the only times when one of the big four will be bailed out (and also fail), isn't there still an implicit subsidy?
• Policy needs to be based on the expectations that households and firms will form - not the ones we want them to form (eg information insensitivity regarding risk of savings).

These debates are useful - but are largely separate of the usefulness of the OBR as an organisational tool

Need more context

Bank runs and deposit insurance

Moral Hazard

Diamond-Dybvig (1983).

Kareken and Wallace (1978)

We can't think about the OBR without adding thoughts around financial market regulation as a whole.

• What sort of "market failure" is being solved here?
• Why do we need regulation?

• Banks match short-term deposits to long-term assets (maturity mismatch).
• Increases allocative efficiency, but creates risk of self-fulfilling bank runs.
• Multiple Pareto-ranked equilibrium depending on expectations of depositors.
• Deposit guarantees solve this

• Without bailouts, depositors preference for a risk-free asset met by competitive banking sector creating a risk-free portfolio - no bankruptcy.
• Introduce deposit insurance, depositors treat banks as riskless.
• Banks take on excessive risk to maximise shareholder value - taxpayer subsidising risk.
• Having shareholders take on loss doesn't remove result.

To do this, will follow down Thomas Sargent's (where to draw the line: stability vs efficiency, 2010) path, and see where it takes us

When banks are forced to "fire-sell" assets, broader principal of bank bailouts appears (systemic event).

Policy conclusion, ex-ante bailouts of depositors lead to excessive risk taking

Policy conclusion, ex-post bailouts of depositors have value.

Open Bank Resolution

Aims

Works by ...

Statutory manager comes in and stops the bank operating.

Keeping a bank open for payment and transaction services

Orderly wind-down of insolvent banks

Bank reopened the next day, to ensure households and firms have liquidity for day-to-day transactions.

Placing the burden of bank failure on those involved with the bank - not the taxpayer

Burden is determined, and the losses attributed between owners, creditors, and debtors.

The case against moral hazard

Other cases for deposit guarantees

The moral hazard argument is compelling, but not necessarily true!

OBR as communication tool

There is a broader case for deposit guarantees

The 2008/09 Global Financial Crisis kicked off with a 'bank run' in repo markets - Gary Gorton (2009)

The OBR intends to communicate to depositors in no uncertain terms that they bear risk from bank lending.

• Political incentive to renege on "no bailout" - implicit guarantee from time inconsistency.
• Social preference for a risk free rate of return - redistributional policy
• The nature of systemic events

These were risk management professionals - but even so, without a guarantee they were "information insensitive" most of the time ...

By doing this, the RBNZ is taking the logic of the Kareken and Wallace (1978) model and trying to stand against moral hazard.

... until they weren't

OBR exists as good policy OUTSIDE of all these justifications for deposit guarantees.

Behaviour based on step changes between treating assets as information "insensitive" to "sensitive" is not moral hazard unless a bailout adjusts the incentive to get information

This leaves room for bank runs. However, by reducing the cost of failure to depositors, and placing unsecured creditors ahead of shareholders, the OBR hopes to minimise the chance of bank runs occurring happening.

The question of whether, and how, society should guarantee deposits is separate from the existence of the OBR.

Some of what looks like moral hazard is just the behaviour of market participants, irrespective of bailouts!