Taxpayer takes it in the team

Last weekend Wayne Swan announced a new permanent guarantee of bank deposits up to $250,000 under the Financial Claims Scheme (FCS).   The existing scheme, introduced during the financial turmoil of October 2008, guarantees bank deposits up to $1million, and will expire when the new scheme takes over on 1 February 2012.

We now, in theory, have a permanent protection against an It’s a Wonderful Life-style bank run.

This new Australian scheme appears to be a very close replica of the deposit guarantee operating under the US Federal Deposit Insurance Corporation (FDIC).  I say this because the FDIC insures deposits up to the magic number of $250,000 (after increasing the limit from $100,000 in 2008).

But there is one main difference.  The new Australian FCS will be funded from general government revenue.  In the US, the FDIC is funded by premiums paid by banks for the insurance it provides.  Our new scheme appears to embed a great deal more moral hazard on the part of banks than the US scheme.

It is interesting to note is that during the financial crisis of 2008, the FDIC itself was getting low on funds.  It also needed to broaden its insurance coverage substantially during the crisis.

You see the problem here is that the FDIC raised money to covers losses by charging banks a premium – just like any insurer.  But they themselves need to do something with that money to earn interest and avoid erosion of the value of the pool of insurance funds.

So perhaps they could put the money needed to insure banks in… a bank?

The reality is that this insurance funding pool needs a safe haven, and that probably comes in some form of US government debt. In any case, the FDIC’s pool of insurance funds itself needs some form of government guarantee.

Why then are Australian banks are being offered free insurance by the taxpayer?

The answer is that they aren’t, technically.  The new Australian scheme requires the government to pay guaranteed deposit holders upfront.  But it also has a provision that allows the government to apply a levy on banks to make up any shortfall should money for guaranteed deposits not be available in the process of winding-up the failed bank.   It a strange type of insurance where the failure of one bank triggers the other banks to pay a premium to cover the insurance claim of the failed bank.  It is still a major moral hazard for each bank individually, with risks being shared with surviving banks.  Assuming there are surviving banks in a time of such financial upheaval and that the government is willing to force them to pay an insurance levy.

While the scheme appears a little odd when we think in these terms, when analysing its effect we need to keep in mind that it is primarily a public relations exercise.  The government was always going to guarantee deposits in some form whether it was formally enshrined in legislation or not.  By placing this $250,000 limit now, and providing the ability to levy surviving banks to recover the costs, it actually allows them to reduce the obligation they might otherwise, politically, have had.

Comments

  1. So it’s a mechanism by which a failure of one of the big four will drag down the other banks, and then the Australian government’s financial situation too??

    That’s how it looks to me. One bank fails, leads to government asking for huge levy payments from the other banks so that they can bail out the first bank’s creditors. If things have reached the point where one bank has failed, I doubt the others will be able to afford the levy. So then the government has to front up the whole amount.

  2. A good summary Cam but an examination of the Banking Act will disclose that its a lot more complicated than has been made out by the government or APRA.

    There is only provision $20bn to be available to meet depositor requirements in the case of an ADI insolvency. APRA would set how much is to be paid out to each depositor. The government would only make a shortfall after liquidation. How long could that be?

    The “guarantee” does not cover the interest payable on a deposit. APRA sets an interest rate that it may pay on deposits held until liquidation is finalised.

    The “guarantee” is truly a reliance of last resort mechanism. Nevertheless banks should be paying for it now. Its very dumb risk management for that not to be occurring.

    • yep the delay in payment is how other schemes operate as well, its not an instant thing and happens alongside a liquidation process. And as a result, overseas experience shows there is sometimes limited value in a guarantee containing a bank run. people who understand what its all about still want their money immediately, esp if they are relying on that cash.

      Its also per depositor per bank, so multiple accounts get aggregated.

      Completely agree that there should be a fee for it now; the banks benefit from the guarantee being there, in use or not. They should have to calculate the amount under guarantee on their books and pay a fee for that facility.

  3. Risk off, and the tax payer will bail out the banks if any of them fail. This might also reflect the rising CDS of the big four? I guess spread the $1M over four banks, and manage it that way.

    • immediate funds (20b) equals to ~1k per person. For remaining balance- good luck and patience 🙂 After 10y of liquidations and adjusted by supressed CPI in real terms it would be…(let’s put it mildly)not as valuable

      and almost certainly limits per person will be applied also- be it 10 accounts or 20 in different institutions.

  4. This does little to reduce the moral hazard – it actually enshrines it. And as Avid Chartist says, it’s unlikely that the current government (or any other for that matter) will have the political will to actually enforce the levy on the remaining banks. Therefore, it looks to me like it will 100% payable by the taxpayer.

    As long as the idiots don’t rush in with another round of first home buyers boosts as soon as the SHTF, I’m relatevely content.

  5. FDIC was created during The Great Depression, under the Glass–Steagall Act – a desperate measure during a desperate situation (solely created by banksters wearing top hats).
    .
    What is the need to create the FCS, when the official Treasury/APRA/RBA narrative/meme is that our banks are well-regulated, well-managed and survived the GFC without a scratch?
    .
    We don’t need a “black swan” event. We have a white one as Treasurer – a turnip would be better qualified to become the Treasurer.

    • That’s pretty funny Mav, I was think a goat not a turnip 🙂 How do we explain away the CDS … I love to hear your view?

    • +1

      As long as that turnip could not constantly blurt out lines about strength and confidence and a sound economy.

      Every time I hear him talk that BS it is like fingernails on a blackboard.

    • Speaking of Glass Steagal, there was a guy at Parramatta Station this morning campaigning for its restoration. He had a placard and everything.

      It was quite impressive if a bit bizarre.

      A rather esoteric subject to be greeting the morning commuters in the ‘burbs’.

  6. Would it be cheeky to suggest that the main beneficiaries of this guarantee are bank depositors and they are already paying for it indirectly, since bank deposits are taxed more than alternate investments? So maybe it’s actually kind of fair?

  7. This is actually the way the superannution assitance works as well (so APRA is repeating a “successful model”)

    The super system has rarely been called upon, but when Bill Shorten and Swan started saying how generous they gov’t was being by giving the Trio investors 100% of losses I was unimpressed- that money is coming from my super balance- and it wasn’t that small! Yes and advantage for being in an SMSF BUT the SMSF investors in Trio were wiped out and have no acces to the APRA scheme- so there are losses to.

    • Dont get me started on SMSF investors in Trio. The “SM” in SMSF stands for “self-managed”, for crying out loud!
      .
      On the topic of Super assistance, I think we should take up Peter Costello on his offer of raiding the Future Fund and top up any private non-SMSF super losses. 🙂
      .
      But the money in the Future Fund (now $75 billion) is not owned by public servants. Public servants did not pay any money into it. It was built by budget surpluses. That money belongs to all of us and not just to us, but to future generations.

      • That’s interesting. Looking at the act from 2006 it says:

        3 Object

        (1) The main object of this Act is to strengthen the Commonwealth’s long‑term financial position by establishing the Future Fund.

        (2) The Future Fund will make provision for unfunded superannuation liabilities that will become payable during a period when an ageing population is likely to place significant pressure on the Commonwealth’s finances.

        I took people’s word that the Future Fund was for politicians and PS, but not so according to the act. It might have been altered since then??

        I expect none of this will stop it from being raided however.

        Thanks for the tip Mav.

        http://www.comlaw.gov.au/Details/C2009C00043/Html/Text#param3

        • I took people’s word that the Future Fund was for politicians and PS, but not so according to the act.
          .
          That is just a play of words to avoid having to use the words “public servants” – i.e. pollies and Fedcrats – and use the nicer sounding “people” instead in the act itself.
          .
          The operating words here are “unfunded superannuation liabilities of the Commonwealth”. Does the Commonwealth have a legal obligation/liability to fund and manage your super and mine? Nope. We have to fund it ourselves and are at the mercy of the AMPs of the world to manage it.

          • Thanks for the clarification Mav. Well I went down the AMP path for 15 years and they ripped me off so I do my own SMSF now, and doing a lot better.

  8. It’s the bank depositor who receives the free insurance, not the banks. The bank will still go under. The scheme is a pragmatic approach. The average depositor cannot wait 7 years to get their money back, however that’s how long bankruptcy can takes. As an example, after 10 years, the bankruptcy of OneTel is STILL ongoing!!

    Then again, does anyone here believe that the Australian government will let any of our banks go under?

  9. Its a liquidity backstop for retail depositors. Rather than having Joe Blow waiting 3-6 mths to get his money out of a failed ADI while APRA appoints adminstrators / inspectors and conducts a fire sale of the business and/or twists the arm of one of the other big 4 to take the business on – Joe Blow gets his money straight off the bat (well quicker then what he normally would). It has turned what was always an implict guarantee into an explict guarantee.

    The danger is if this then becomes a guarantee for unsecured bank bondholders and shareholders. Then its pure moral hazard!

    But like other posters I disagree with how they intend on funding it A levy on surviviing banks I don’t think is the go – I would like something more akin to a liquidity provision charge based on an ADIs level of retail deposits. This charge should be paid to either RBA or APRA to administer and not be raided by Government (Hmmm we seem to be entrusting pots of gold to the future fund so maybe them instead) so that it becomes a self insurance mechanism for ADIs.

  10. As Rumple essentially says, it’s political marketing with unhealthy side effects should this particular new law ever get tested.

    These are the depths our politicians have sunk to.

    These is the cotton-wooled state that our “free market” has devolved into.

    I need a drink.

  11. Guys, this isnt about protecting depositors, its about maintaining confidence in the banking system. The banks are the primary beneficiary, even though it is depositor money that is “guaranteed”.

    Thats the reason the guarantee was established in the first place, it wasnt to underpin any deposits, it was to ensure that people didnt get spooked and cause a run on one of our banks. And the rationale was “other countries are doing it so we have to as well”.

  12. Please excuse my ignorance…does the guarantee apply only to Aus citizens or to foreign depositors as well?

    • As far as i can see it doesnt distinguish between foreigners and citizens. Could be wrong though and happy to be corrected.

  13. Flawse – guarantee applies to AUD deposits in ADIs. No distimction between citizens and foreigners. Guarantee dosen’t apply to branches of foreign banks operating in Oz.

    Mav – public servants DO contribute to their super. I myself contribute 10% in after tax dollars. Its a defined benefit fund where the lump sum payout is based on your final salary times a multiple. The multiple is determined by the number of years you contributed for and a what % level you contributed at – with the multiple capped at 10.

    Now I could have placed my contributions into a SMSF and gotten a better return or maybe not but that is the benefit of a DB fund – it pushes the market / investment risk from the small employee to the large employer!

    Basically the reason for the future fund is that for several generations fed govts decided not to contribute any money towards their employee’s super. Now with all the BB.s retiring they were found short.

    • public servants DO contribute to their super.
      .
      Sorry, I wasn’t aware of that. I misunderstood PC’s comment when he said “Public servants did not pay any money into it.” He was referring only to the Future Fund.

      • Understand – but its a bit underhand of Pete. Any other employer that was the sponsor of a DB fund that was underfunded to the extent that the Commonwelath Govt had underfunded their super schemes what have had APRA all over them like a rash. Funny enough commonwealth govt funds are specifically excluded from APRA regulation.

        I think the catalyst was the change a couple of years ago to the accounting standards where companies had to account for any deficits to DB funds they where the sponsor of to their balance sheet.

        • Christ can’t spell at the moment!

          should have been “super schemes would have had” and “deficits to DB funds they were the sponsor”

    • Almost all DB funds require that the employee make a contribution as well- it is somehting that many younger workers are not interested in.
      Federal Gov’t is not the only one that shirked their responsiblities- most of the states did too- that’s why there are no open federal or state DB funds anymore.
      Qld was the last to shut the gate- but they have been fully funded since the days of Joh (who wanted to play with the money) and a clever public servant walling the money off from him.

      Even corporations are not immune -Telstra took a 3 or 4 year “contribution holiday” in the mid 2000’s when investment returns pushed the balance of the funding pool up enough to cover benefits!

  14. Lets face it, it was the ‘Irish what done it’, if theirs was the only banking system offering a guarantee, where would your money be now?