In our previous update (available here) we discussed what may have happened if the Deposit Takers Bill had been enacted and Silicon Valley Bank had been a New Zealand bank.
Since then, Swiss bank Credit Suisse has been taken over by its rival UBS in a rescue package hurriedly put together by the Swiss regulator FINMA.
So what would have happened if the Deposit Takers Bill was passed in its current form and a New Zealand bank required an urgent rescue along the lines of Credit Suisse? Credit Suisse was not in resolution when it was taken over by UBS, so we have focussed on the Reserve Bank's pre-resolution powers in the Deposit Takers Bill.
Sale of a bank or its assets
Normally, a sale of shares in a bank, or the transfer of a substantial part of a bank's assets, would require the purchaser to obtain a number of regulatory approvals. Under the Deposit Takers Bill the Reserve Bank's consent must be obtained before a person obtains control over a bank or acquires all or a material part of a bank's business. This is similar to the current non-objection requirements contained in BS9 and BS15. Separate to the Deposit Takers Bill, a purchaser may need to obtain consent under the Overseas Investment Act (if the purchaser is an overseas person) or clearance from the Commerce Commission (if there are concerns about competition being lessened), or both. Obtaining these approvals can be a time-consuming process.
Going through the normal process would not be an option if a rescue package was required for a failing bank. The transaction would need to be done very quickly to minimise contagion risk and to attempt to restore confidence in the financial system. UBS's takeover of Credit Suisse was done over a weekend.
The Deposit Takers Bill gives the Reserve Bank broad powers to give directions to a bank if a bank is in severe financial difficulty. The Reserve Bank also has the power to give directions to a shareholder of a bank in limited circumstances. These powers are similar to the Reserve Bank's existing powers under the Banking (Prudential Supervision) Act, and can be exercised prior to the Reserve Bank putting the failing bank into resolution. Directions can be given without having to obtain the approval of the Minister. The direction powers do not explicitly refer to the sale of shares or assets in the bank, but the Reserve Bank can give a direction to require the bank (or shareholder) to take action "to address any circumstances of financial difficulties" and to implement all or part of the bank's recovery plan.
While these statutory rights would provide the Reserve Bank with considerable power, the details of any rescue package would depend on the circumstances of the affected bank and be a matter of negotiation between the various stakeholders (some of whom would have significantly more leverage than others).
The Reserve Bank also has the power under the Deposit Takers Bill to approve a sale of the whole or part of the capital or business undertaking of a bank that is in severe financial difficulty. If that approval is given, the Deposit Takers Bill provides that the provisions of any legislation or instrument requiring any consent, licence, permission or clearance or other authority do not apply as a condition of the legality or validity of the sale. This would likely be the basis on which an urgent rescue package would be forced through without having to obtain the usual regulatory approvals described above. Emergency legislation was also passed in Switzerland in the case of the Credit Suisse transaction.
Write-off of regulatory capital
Part of the Credit Suisse transaction involved FINMA writing-off US$17 billion of additional tier 1 bonds that had been issued by Credit Suisse. Holders of those bonds have complained that their bonds should not have been written-off before shareholders had first borne the loss (shareholders in fact will receive US$3.25 billion from UBS).
Additional tier 1 capital is going concern capital, and so from a distance the bonds appear to have operated as intended, with bondholders absorbing losses before the bank became non-viable. But the devil can be in the detail, and the bondholders and their advisers no doubt will be reviewing the terms of the bonds and FINMA's reasons for writing-off the bonds very carefully.
New Zealand banks are required to hold regulatory capital, and part of that can be additional tier 1 capital. Additional tier 1 capital in New Zealand must take the form of perpetual preference shares. This is different to the approach in other jurisdictions (including Switzerland) where perpetual subordinated debt securities can qualify as additional tier 1 capital.
Another difference is that additional tier 1 capital in New Zealand cannot include a conversion or write-off feature. So the write-off of additional tier 1 bonds that occurred with Credit Suisse would not happen in New Zealand under current rules. But while the preference shares would remain on foot, holders of those shares would have no voting rights and it is not likely they would receive any returns on the preference shares for a very long time (if ever).
However, it is possible that New Zealand banks will be issuing securities with conversion or write-off features in the future. The Reserve Bank has the power under the Deposit Takers Bill to issue bail-in standards. A bail-in standard can require a bank to issue bail-in instruments. A bail-in instrument is a security or loan that is required to be converted into ordinary shares or written-off if a specified bail-in trigger event occurs. The powers of the Reserve Bank to give directions discussed above include a specific reference to a bank taking action that is necessary or desirable for the conversion or write-off of a bail-in instrument to occur.
No detail is available yet on what the bail-in trigger events will be. However, we would expect the bail-in instruments to form part of the bank's gone concern capital, with instruments being bailed-in in accordance with the usual hierarchy in a liquidation. This would mean the experience of Credit Suisse's bondholders absorbing losses before shareholders is not likely to occur.
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Disclaimer
The objective of this article is to highlight some important changes to be introduced by the Deposit Takers Bill, by reference to what has happened to Credit Suisse. Information on Credit Suisse has been sourced from publicly available information and we have not verified it.