Banking on banks
Your savings might not be as safe as you think.
BREXIT is rattling the European Union, a pantomime villain is racing toward the White House, and Auckland home-hunters have to hand over their firstborn child to get a foot on the property ladder. We live in interesting times.
If the brown stuff hits the metallic whirring thing, what happens to the banks at the centre of the financial system?
Readers may take some comfort from the Reserve Bank’s ‘‘stress tests’’, which found that even if house prices fell 40 per cent, our major lenders would survive the bloodbath.
New Zealand banks are indeed among the strongest in the world. The bad news is that unlike the practice many countries, they don’t have an insurance scheme protecting your cash. Despite what most people assume, the Government isn’t protecting you either. It bailed out the BNZ in 1989, but there’s no guarantee that’ll happen again.
Under a recently introduced system, the Reserve Bank can also ‘‘take a haircut’’ from your account to try to keep a failing bank above water. If no-one steps in, depositors like you and me are near the back of the queue when it comes to recovering any money.
This means it’s a good idea to take an interest in your bank’s financial health. The most useful metric is the credit rating, found in its quarterly disclosure statements or on the Reserve Bank website. Just like your school report, the ratings range from an outstanding A to a dismal D, with pluses and minuses along the way. The more letters the better; an AA is stronger than an A.
The levels estimate the probability of default over a fiveyear period. A gold-plated AAA rating means a bank has about one chance in 600 of going under, while any institution marked with a ‘C’ is in imminent danger, with a 50 per cent chance.
At the time of writing, ratings agency Standard & Poor’s had given an AA- rating to our four biggest banks, ASB, ANZ, BNZ and Westpac. That translates to a one in 150-300 chance of default over five years.
The smaller local banks tend to pay more generous interest rates, but usually have weaker ratings. For example, Heartland has a BBB rating from Fitch, which indicates a 1 in 30 chance of failure over five years.
While the big three ratings firms employ an army of brainiacs to trawl through bank financial statements, they haven’t exactly covered themselves in glory in recent years.
In the lead-up to the global financial crisis, Wall Street firms packaged up toxic mortgage securities into new bundles to sell on to investors. Fund manager Steve Eisman memorably described them as ‘‘three levels of dog s... lower than the original bonds’’, but the ratings agencies assigned glowing AAA ratings. The rest is history.
Of course, trying to rate complex newfangled financial instruments is a different ballgame to bog-standard deposits and loans. Credit ratings are still worth paying attention to.
Doing so would have saved a lot of grief during the collapse of the finance company sector, for example. Investors hungry for higher returns put their life savings into companies with ratings hovering on ‘‘junk’’ status. In some cases the risk of failure was 30 times higher than the bank, and all for the sake of a slightly higher interest rate. Of course, there was criminal activity going on too. Credit 123rf ratings only give us one small clue, but that’s a lot better than going in blind.
The bank is undoubtedly one of the safest places you can put your money. Just remember – there’s no such thing as a completely risk-free investment. Got a money question you’ve been struggling with? Want to send a bouquet or a brickbat? Email Budget Buster at , or hit him up on Twitter at.