Deposit Insurance: dealing with the wholesale ramifications

The original policy, as announced on 13 October, stated unambiguously that to ensure that taxpayers are not disadvantaged by this guarantee, the Australian Government will charge financial institutions for providing the guarantee. The charge will be similar to an insurance premium.

That particular clause, i.e. charging the protected deposit institutions for the guarantee, has still to be formally announced.

In the meantime, the Government is still dealing with the complications at the wholesale level. It recently decided that up to 1 million dollars will be free. Tim Colebatch warns that the threshold is so high as to be meaningless. He adds that there is there is only one way out — eat humble pie, admit error, fix it and move on.

There are three ways out of this mess assuming it is not all due to the global financial system and that deposit insurance has a strong influence on events in the wholesale market.

One way is to lower the lower the guarantee threshold, as Colebatch implies.

A second way of averting the backwash would be for the Government to aim for competitive neutrality where anyone could play in it, including investment in mortages.

There is a third possibility. When the Government looks again at the premium on all new deposits, it could insert another modest modification. At present, it is authorized to charge a different initial premium on all new institutions, depending on their rating. Why not make this clause also subject to scale? For very small deposits, no charge. But as the investment gets bigger, the fine grows a little up to the 1 million dollar mark. Beyond the million mark, the old figures will apply (adopt the original fee for all maturities up to 60 months – i.e. AA 50, A 100; and BBB and unrated 150).

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Paul Frijters
13 years ago

Fred,
agreed that the current position looks untenable, but never underestimate the power of wanting to save face. It is hard to keep admitting mistakes if you are trying to ‘restore confidence’.
In terms of content my suspicion is – but I do not know – that some of the biggest questions about this deposit guarantee have to do with exactly what kind of deposit is guaranteed. For instance, what about foreign currency holdings, are they guaranteed? If so, I can call in any debts from overseas and park them here on an interest-bearing deposit, and wait for the storm to blow over before I re-invest. The disruption of such choices may well be enormous.

I can think of many other disruptions the price fixing is causing. The interest rate differential is still enormous and the exchange rate looks out of sinc. There is thus an incentive to borrow in the US and invest here in ‘guaranteed’ off-set accounts with the prospect of double-dividends (higher interest rates and the likelihood of exchange rate increases). That would be a normal market reaction via which the guarantee and the end of the carry trade would increase the exposure of risk of our economy to banks in the US.

And god help us if the central banks and everyone else decides to sell their US government bonds and/or their dollars. The only logical reaction of the Fed to that would have to be to either default or engineer an inflation bubble to tax away the foreign holdings.

Robert Merkel
Robert Merkel
13 years ago

Yep, that sounds like what they should have done in the first place.

Nicholas Gruen
Admin
13 years ago

Fred,

What measures do you take to stop people splitting accounts to avoid guarantee fees?

I’m not sure what is wrong with an opt in guarantee – for which the government requires a fee.

Thersites
Thersites
13 years ago

Nicholas,

If the threshold is low enough as suggested by the RBA Guv this aint a problem? Splitting is more likely among HNW and corporates. If the threshold was $50k before a fee (what i reckon it should be) are you telling me that someone with $2mill will go to the trouble of splitting this into 40 accounts at different institutions to get the guarantee? Surely not hard to legislate against anyway?

Your own bias in favour of policy that favours your mortgage business backed by other associates is increasingly showing mate?

JC
JC
13 years ago

I think you may actually stop it moving too, Jacques, which is something you don’t want either.

The insurance thing was badly thought out. The Fed’s move was the right one if the action was not going cause more trauma. The very action of the government will cause a reduction in lending as the banks capital requirements prevent them from lending to all the disadvantaged players. Amazing.

Sinclair Davidson
Sinclair Davidson
13 years ago

I’m inclined to agree with Fred – the government could (and should) have quickly said ‘our bad – stuff-up, but let’s all calm down and move quickly to plan B’. By the time the next election rolled around everyone would have forgotten. The best thing would have been to do nothing, and follow the Bagehot principle (lend at penalty rates to good collateral) if need be. Following that they should have gone for something along Jacques lines (although JC identifies the problem here) but how about the government gaurantees up to $x that was in an institution at 12 am the night before the announcement. But that is still very much a second best alternative. As both Mr Rudd and Mr Swan said, and I agree, Australian banks (at least the big 4, plus one) are sound – so the Bagehot principle would have worked well in our context.

Australia would have been buffeted by an international crisis, but this is now a domestic stuff-up that will undermine domestic confidence. The other problem is that it has taken the $10.4bn spending package off the frontpage. Unlike Nick – who had an interesting piece in the Fin last week (and republished here) – I am not as sanguine about that decision. Ken Henry has had a torrid week and I don’t want to pick on him more than necessary (the government should not turn public servants into political footballs and then complain when they get kicked) but last year he was, rightly, talking about the 3Ps – population, participation and productivity. They haven’t gone away just because there is a crisis on. The ‘go hard, go early, go household’ slogan is all well and good subject to the 3Ps.

What we now have is a policy whereby the banks have a subsidy from government that they will share between their shareholders and customers (John Hewson had a good op-ed in the Friday Fin on this, but he ignored the customers). So my mortgage rate has come down again, and I’m happy with that, but it is at the expense of the taxpayer and those who’ve had their savings frozen (as an individual that suits me – at last some value for my tax dollar – but bad policy is always problematic.

pedro
pedro
13 years ago

And now Jacques, the next side effect is that Perpetual and the others are being encouraged to turn into banks. Way to save face guys!

Sinclair is right, Rudd should have done a Beatie. You can apologise for stuff ups and increase your vote if you do it right.

This morning I heard about a survey result showing 40% of the lump sum payments will be saved. The extension of the FHOG for used houses isn’t going to do much useful stimulating either, but perhaps the idea is to support the prices of cheaper houses and thus minimise flow on effects from negative equity phobia.