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How safe are bank deposits ?

September 27th, 2007

A reader writes

‘Im about to assume duties as Treasurer of my local church and have found that our reserves are not diversified but are with one institution already in the news as possibly suspect. The outgoing Treasurer is convinced that bank (ADI) deposits are guaranteed by the Reserve Bank and is resisting diversification. My reading of the Reserve Bank site, the APRA site and the modified Banking Act suggests that this “protection” was done away with by changes introduced by the Howard Government and that the claimed “protection” is an urban myth. Hence could you, or any of the readers of your blog advise – are deposits with ADIs protected in that someone will repay them in the event of institutional failure? and if not what should church (and club) treasurer’s do to protect these investments (many people in my position fail to realise that they can be personally liable for any losses)?

My response is that there is no explicit guarantee of deposits, although there is a strong expectation that the Reserve Bank would protect depositor. Unfortunatley, it is not entirely clear which deposits would be guaranteed, which makes life tricky for people like my correspondent. I don’t think there ever was an ironclad guarantee but it’s correct to say that the changes associated with the establishment of APRA moved us further away from such a situation. Coincidentally, the editorial in today’s Fin discusses this very topic, noting that Costello has been sitting, for the last two years, on a report recommending an explicit guarantee, limited to $20 000. I must have missed the whole thing, as I don’t remember any movement on this issue since the Wallis Committee.

Here are some thoughts from 2002. An extract

the medical insurance panic would be nothing compared to what might happen if, in the midst of a liquidity crisis at a major bank, one of our socially responsible talk-show hosts suddenly discovered that there was no government guarantee for bank deposits. This happened on a small scale in the 1970s, forcing NSW Premier Neville Wran to take a loudhailer into the streets to stop a run on a building society.

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  1. craigmalam
    September 27th, 2007 at 14:46 | #1

    This review followed the recommendations of the HIH Royal Commission.

    It was a small review conducted mainly back in 2003 by Professor Davis (I remember because I made a submission). I believe the Council of Financial Regulators (RBA, APRA, ASIC and Treasury) has now endorsed the feasibility of such a scheme.

    I don’t think Australia has ever had deposit insurance.

    There is a reasonable argument against such a scheme as it can exacerbate moral hazard – many believe this contributed to the savings and loans debacle in the US.

    I argued that moral hazard is already an issue anyway since the guarantee is implicit, as long as it’s never likely to be politically feasible to let a bank fall over (or insurance company for that matter). Indeed, by making the scheme cover a predefined amount, you might actually sharpen people’s incentives to monitor who they leave their money with, since it makes a clearer commitment NOT to step in for certain levels of loss.

    From what I understand, this scheme will cover insurance policyholders as well as super contributors up to a certain amount, but really represents a more efficient failure management device rather than a broad safety net. I think your correspondent’s money is pretty safe, but some diversification might improve returns.

  2. gandhi
    September 27th, 2007 at 15:20 | #2

    Dear Agony Uncle (LOL)…

    I have a related question about what happens if the bank holding my mortgage collapses. With all the talk of US sub-prime exposure, and people queuing to take money out of UK bank Northern Rock, there has been a lot of finger-pointing at the Adelaide Bank (who hold my mortgage) as potentially over-exposed to risk.

    I recently paid off all my credit cards and refinanced my mortgage on a fixed rate because I expect trouble on the global finance horizon. If I knew the Adelaide Bank was not stable I might have changed to another mortgager, but of course one never hears about these things till it’s too late.

  3. September 27th, 2007 at 16:00 | #3

    My reading of the Reserve Bank site, the APRA site and the modified Banking Act suggests that this “protection� was done away with by changes introduced by the Howard Government and that the claimed “protection� is an urban myth.

    My understanding that deposits with private banks have never been guaranteed by the government or the central bank. However deposits with the Commonwealth bank were guaranteed when it was government owned and this probably accounts for a lingering cultural expectation. When the Commonwealth bank was privatised (by the ALP not the Coalition) the guarantee was withdrawn for all deposits accounts. Term deposits that pre-dated the move to privatisation continued to be guaranteed by the government after privatisation until such time as the term of the deposit expired.

    Australia has only had one Bank failure post federation in which depositors permanently lost their money and that was the Primary Producers Bank of Australia in 1931. Of course other financial institutions (eg HIH) have collapsed.

    My response is that there is no explicit guarantee of deposits, although there is a strong expectation that the Reserve Bank would protect depositor.

    I think this is an expectation that the RBA should periodically discourage.

    And if there is ever going to be any explicit form of deposit insurance offered by the RBA they should insure considerably less than 100% of the deposited funds so that there is meaningful pain associated with any collapse. Also the arm of the RBA that might offer such a guarantee should be separated from the arm that controls the printing press.

    Of course I don’t think that the RBA should offer any guarantee at all but neither do I think the RBA should exist in the first place.

    On the face of it the USA seems to have far more in the way of explicit government guarantees by way of deposit insurance and explicit reserve requirements. Even so it seems to me that they have proportionally more bank failures than Australia.

  4. September 27th, 2007 at 16:02 | #4

    I have a related question about what happens if the bank holding my mortgage collapses.

    The bank liquidators would assume this asset (ie your liability). In reality they would probably sell it to some other bank.

  5. gandhi
    September 28th, 2007 at 07:38 | #5

    Thanks Terje.

    I guess the “probably” depends on the broader environment – what if nobody wanted the “asset”? Would it not then fall to the mortgage underwriters, or could I personally be held liable? Just speculating on worst-case scenarios, you understand.

    NB: The idea that anyone would see debt as an asset is proof positive that economics is a dark art indeed.

  6. September 28th, 2007 at 09:55 | #6

    Being held liable for a debt that you owe hardly seems like a worst case scenerio. If they decided to demand their money back it would be dependent on the original contract terms. If the interest rate was variable they could in theory jack up the interest rate to such a point that you elect to refinance elsewhere. However in the case of a single bank failing it is hard to see it being anything other than an inconvenience.

    NB: The idea that anyone would see debt as an asset is proof positive that economics is a dark art indeed.

    This is more of an accounting issue than an economics issue.

    Surely when you deposit money in the bank you see your deposit account as an asset. In fact I would think that the masses of people who the banks are in debt to in this way will regard this debt as an asset. Thats precisely why the masses get upset if the bank fails.

    “Look mum I have $50 in my bank account” = The bank is in debt to me to the tune of $50 and I regard this as an asset.

    So it is not so much “an idea” that people might see debt as an asset. It is a basic fact that millions of people do regard such debts as an asset.

  7. derrida derider
    September 28th, 2007 at 11:40 | #7

    I reckon if you put your money into one of the big four banks in practice it is indeed government guaranteed in practice, simply because each is too big to be allowed to fail for fear of knock-on effects. Can’t say the same for smaller ADIs though.

    It’s the upside from having an imperfectly competive retail banking sector.

  8. joe2
    September 28th, 2007 at 12:56 | #8

    gandhi , Adelaide Bank is involved in merger plans with Bendigo Bank. You would think that their auditors would be going through the books with a fine toothed comb. But anyway, why fret when you owe a bank money?

    If you fear economic collapse, you should make full use of your credit cards on the chance that they will go bust and take some time to remember, Mr gandhi, who owes them sweet ‘f’ all, in the totality of things.

  9. Bingo Bango Boingo
    September 28th, 2007 at 16:53 | #9

    John,

    Another thing worth mentioning is that one of your reader’s duties “as Treasurer of [his/her] local church” may be a fiduciary duty take professional advice on such matters (rather than, say, requesting informal answers on some blog somewhere). Just something to bear in mind.

    Cheers
    BBB

  10. haiku
    September 28th, 2007 at 21:40 | #10

    Terje, you may need to make clearer to gandhi that your asset is the bank’s debt (and, similarly, your debt is the bank’s asset). So it’s not so much the case that “debt is an asset” as “one person’s liability is another person’s asset”.

  11. October 6th, 2007 at 08:29 | #11

    Haiku – I thought it was pretty clear. But yes the point is that one persons debt is somebody elses asset.

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