Submission to the Inquiry into Competition within the Australian Banking Sector 8. Regulation

8.1. Financial Crisis Responses

Financial Claims Scheme guarantee for deposits up to $1 million

The Australian Government's guarantee arrangements for deposits and wholesale borrowing were introduced in response to extraordinary developments in the global financial system in the second half of 2008. They were designed to support confidence of depositors in ADIs and to help ensure that these institutions had continued access to capital markets, at a time when governments in many countries were announcing similar measures.^[11]

Under the Financial Claims Scheme (FCS) – one of the two key aspects of the Australian guarantee arrangements – all deposits under $1 million with locally-incorporated ADIs are automatically guaranteed by the Government, with no fee payable.^[12] Deposits at foreign-bank branches are not eligible. The FCS will remain in place in this form until October 2011, though the longer-term structure of depositor protection arrangements is currently under review.

The announcement of the FCS, and the arrangements for large deposits and wholesale borrowing, helped to maintain public confidence in the Australian banking sector. In many ways, however, it only served to reinforce existing trends. Deposit growth had been increasing over 2008 as risk aversion increased, but following the announcement deposit growth picked up further (Graph 36).

While deposit growth was boosted by the flows of funds from the less regulated sector, including deposit-like products at mortgage trusts, the trend of outflows from the less regulated sector was evident from early in that year – a large mortgage trust had suspended redemptions as early as March.

Wholesale Funding

(i) Guarantee Scheme for Large Deposits and Wholesale Funding

Under the Guarantee Scheme (GS) for Large Deposits and Wholesale Funding, the Government provides a guarantee, for a fee, on deposits greater than $1 million, and wholesale funding with maturity out to five years. Unlike the FCS, the GS also guarantees, with some restrictions, issuance by foreign-bank branches. The GS closed to new issuance in March 2010, though debt previously issued under the Scheme continues to be covered until it matures.

The fees of the GS are risk-based and, as the major banks have higher credit ratings than most other domestic ADIs, they pay lower guarantee fees (Table 4). 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 that were considered likely to prevail in more normal market conditions. This was designed to act as a natural exit mechanism, so that when pricing of risk improved, the yield spread between unguaranteed and guaranteed debt would narrow to below the guarantee fee and it would become cost-effective for issuers to return to unguaranteed issuance.

Smaller and lower rated institutions were the largest issuers of bonds under the GS relative to their previous limited bond issuance history (Graph 37). When the GS closed to new issuance in March 2010, the non-major Australian banks' guaranteed liabilities accounted for 19 per cent of their eligible debt, compared to roughly 6 per cent at the major banks. The foreign banks were also significant users of the guarantee. Over the course of the GS it became economic for larger banks to issue unguaranteed and avoid paying the guarantee fee, but for smaller ADIs it remained cost-effective to issue through the GS.

8.2. Prudential Framework

The Basel Committee is in the process of finalising its package of reforms for the global banking system, ‘Basel III’. The reforms focus on the appropriate level of capital, liquidity and leverage and are described in detail in the submission by APRA. The reforms will have the effect of making intermediation more expensive than would otherwise be the case, but their primary purpose is to ensure that the global banking system is more stable in the future. Given the extended transition period for implementation of the reforms, the effects on the cost of intermediation are likely to occur only gradually.

Footnotes

For further details, see Schwartz C (2010), ‘The Australian Government Guarantee Scheme’, RBA Bulletin, March. See also Australian Prudential Regulation Authority and Reserve Bank of Australia, (2009), ‘Inquiry by the Senate Economics References Committee Into Bank Funding Guarantees’, Submission, July. [11]

In the event of failure, the Government would provide initial funds to depositors and then recover funds through the wind up process, with the option of an industry levy if there is a shortfall. [12]