Joint Submission from the RBA and APRA to the Inquiry into Bank Funding Guarantees 2. The Australian Guarantee Arrangements in an International Context

There are two aspects to the Australian guarantee arrangements.

Under the Financial Claims Scheme (FCS), all deposits under $1 million with Australian banks, building societies and credit unions and Australian subsidiaries of foreign-owned banks are automatically guaranteed by the Government, with no fee payable.

Under the Guarantee Scheme (GS) for Large Deposits and Wholesale Funding, eligible ADIs can, for a fee, obtain a government guarantee on deposits greater than $1 million, and wholesale funding with maturity out to 5 years. Unlike the FCS, the GS is also available, with some restrictions, to branches of foreign-owned banks.^[1] To obtain the guarantee under the GS, eligible ADIs must apply to the Reserve Bank which administers the scheme on behalf of the Government. This involves assessing applications from ADIs, issuing guarantee certificates to successful applicants, administering and reporting monthly fee payments, monitoring guaranteed liabilities and maintaining a website with relevant information about the scheme and the liabilities that have been guaranteed.

Guarantee fees vary by credit rating, but not by the maturity or the currency denomination of the debt (Table 1). In setting the premiums on the guarantee the Government considered a range of factors, including international settings and the need to ensure that the arrangements did not continue indefinitely. The fees were set at a level between the then current risk spreads – the product of very stressed conditions – and spreads likely to prevail in more normal market conditions. This was to provide the basis for a natural exit mechanism, with the expectation that at some point investors will no longer be willing to accept the lower yields on guaranteed paper and banks will therefore no longer seek to insure their debt.

The Australian arrangements share many common features with those introduced in other countries although, on balance, the range of parameters are generally at the more supportive end of those internationally.

2.1 Deposits

In Australia, the combined effect of the schemes is that there is no limit on the size of deposit that can be guaranteed, although for a guarantee on deposits over $1 million per customer at eligible ADIs a fee is payable. The Australian arrangements for the FCS were announced with a termination date of three years.

As mentioned, many governments responded to heightened uncertainty by increasing the monetary cap on the amount of deposits guaranteed under pre-existing schemes, but there is significant variation among countries both in terms of the starting point and the subsequent increase. For example, the cap was increased on a temporary basis to $250,000 from $100,000 in the United States, the minimum cap in European Union (EU) countries was raised to €50,000 from €20,000 previously, and some EU countries went further to introduce unlimited caps (Table 2). Many countries that introduced increases, particularly those with an unlimited cap, nominated a set period for the arrangements to apply, typically around two years.

2.2 Wholesale Funding

Details of wholesale funding schemes also vary considerably across countries in structure, fees, the eligible maturity of debt covered and the period of availability of the guarantee.

Most schemes are structured to allow private financial institutions to issue governmentguaranteed debt, but some countries (France and Austria) established a separate state controlled agency to raise funding and on-lend to eligible private institutions.

The fees charged for the government guarantees on wholesale funding are typically based on the credit rating of the issuer, credit default swap premiums or a combination. In the United States, the fee charged is dependent on the term of the instrument but not the rating of the issuer. The fee structure adopted in the Netherlands and New Zealand also depends partly on the term of issuance.

At the time the Australian GS was introduced, the pricing was similar to that in the United States, but below that in the United Kingdom. Since the original announcements, the United States has raised its fees on bank long-term issuance from 75 basis points to up to 125 basis points, as part of its strategy for exiting from the current arrangements. In contrast, schemes with fees at the higher end, including the United Kingdom, have decreased their fees, partly due to concerns about the competitive implications for their banks of charging high fees. As a result, the range of fees has narrowed (Graph 1). Given the changes that have taken place elsewhere, the pricing of the Australian guarantee for long-term debt now looks relatively low for AA rated banks. Internationally, fees on comparable schemes have converged at around 90 to 110 points, above the 70 basis point charge for AA rated Australian banks.^[2] The Australian fee structure also has a relatively large differential between banks with different ratings. Further details are provided in the Appendix.

The GS permits a maximum eligible maturity of a rolling 5 years. In comparison, most governments nominated a maximum maturity date, beyond which debt would not be guaranteed (Table 3). This date has of necessity, been extended in a number of countries, including the United States and United Kingdom, such that most schemes have a fixed maturity limit of sometime in 2012 or, for some, 2014 (i.e 3 to 5 years since the introduction of the schemes). The rolling 5 year maturity eligibility of the Australian GS has the advantage for ADIs of accessibility to a less crowded part of the yield curve, and avoids bunching of refinancing risk around specific dates.

The Government announced that the GS would remain in place ‘until conditions normalise’. In comparison, most other countries nominated a fixed date by which debt had to be issued. Given the continuation of difficult conditions, however, a number of countries – including the United States, United Kingdom and Canada – have subsequently extended the cut-off date (Table 3).

Footnotes

The differing treatment to foreign bank subsidiaries reflects that, unlike the subsidiaries, foreign bank branches are not separate entities incorporated and independently capitalised in Australia – they are part of the foreign bank incorporated overseas. [1]

The only scheme where the fee appears to be lower is the French scheme where debt is issued by a centralised borrowing authority and fees partly reflect the centralised borrowing authority's cost of funds. [2]