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.