Understanding bank risk in New Zealand: just how informed are retail consumers about the implications of a bank failure?

Publication: Journal of Banking and Financial Services

Publication Date: 01-JUN-05

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COPYRIGHT 2005 Australian Institute of Banking and Finance

Banks are an important part of a modern economy, fulfilling a number of important functions. They provide the infrastructure for the payments system, they act as financial intermediaries--as repositories for depositors' surplus funds and they provide liquidity for the economy as a whole. Potentially, a bank failure can mean that access to these economic benefits is lost.

Because we depend on banks to make and receive payments, the failure of a bank can severely disrupt the payments system. Payments made, whether by cheque or by electronic means, by both private individuals and businesses might be cut off, not because the bank account-holders themselves have no money, but because the bank with which their money was lodged has failed. This may mean that other banks are not willing to rely on promises to pay where the failed bank was a party to the transaction. This could also impact on the wider economy, as suppliers are prevented from receiving payments for the goods and services they have supplied because their purchaser has maintained their accounts with the failed bank.

If a depositor has credit funds in an account with a financial institution that fails, they may lose all or part of the sum involved, which may comprise a significant portion of their personal wealth. People will commonly view their relationship with the banks as special and will forget that they are in the same position as any other creditor when a business with which they have a creditor relationship fails. They may further argue that they ought to be able to put money into a bank account without having to undertake an analysis of the bank's financial strength. This predicament may be aggravated in a banking context because of the relatively...

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