Swan's $20,000 Promise Is Ready Cash But Not Full Protection

The Age

Tuesday June 3, 2008

Tim Colebatch - Tim Colebatch is economics editor

The Treasurer has helped some investors but passed others by.

MOST Australians, a survey tells us, think their bank deposits are safe because they are protected by a government guarantee. Well, most Australians are wrong.

The government doesn't guarantee a cent of our savings. But that's about to change. After long argument between the regulators and the banks, Treasurer Wayne Swan has agreed to write into a law a limited government guarantee of bank deposits for up to $20,000.

Twenty grand, you say? Yes, this is a very limited government guarantee. It's designed to meet one need: the demand for ready cash by depositors and insurance policy holders who have invested their money in four types of institutions: banks, building societies, credit unions and general insurance.

It is not designed to help those with substantial investments, whether in term deposits, life insurance or superannuation. Even if you have $2 million invested in term deposits, if the bank goes bust, the Government will give you only $20,000 in ready cash. And money invested in life insurance and superannuation will carry no Government guarantee: political pressure would be your only weapon if your fund goes bust.

So what is the Government aiming at? Its Financial Claims Scheme (FCS) is a relatively small step that will give depositors legal certainty that some of their money is safe. Swan emphasises that when financial institutions have collapsed in recent times, such as HIH, the problem for depositors and policyholders has been not so much to get their money back, but to get their money back when they need it - rather than waiting years for the liquidators to dig it out.

That is what this scheme aims to do. Suppose the Bank of Sweet Dreams has made so many bad loans that it goes bankrupt. The Reserve Bank could lend it money if it believes the bank is solvent (that is, its problems are due to a lack of cash rather than to owing more than it owns). Or it could force it into a shotgun marriage with a sturdy institution, as we saw in 1990 when the State Bank of Victoria was merged into the Commonwealth Bank, or a decade earlier when Westpac absorbed the failed Bank of Adelaide. But if that fails, depositors in the Bank of Sweet Dreams now have no legal recourse. They could demand a government bailout, with a good chance of success. The Cain government in 1990 had to bail out depositors in Pyramid Building Society after it failed. The Howard government eventually did the same for policyholders in HIH. But, legally, no government is obliged to pay you anything.

In the new scheme - devised in 2006 by the Council of Financial Regulators - Sweet Dreams depositors would get instant compensation for small sums. Within a week, the government would step in and pay out up to $20,000 to depositors. The Australian Prudential Regulation Authority says this would pay out 80 to 90% of depositors in full.

What of the other 10 to 20%? That's the problem. More than half of banks' deposit funds are in fact reasonably large amounts in term deposits. They will not be guaranteed beyond $20,000 in the new scheme, and insofar as it removes the implicit government guarantee assumed to operate until now, they will be arguably worse off.

This is one of the reasons the banks don't want this scheme. The other is that, while Swan tells us the Government will normally be able to recover all the money it has given to depositors over the long term from the liquidators, if there is still a gap, it would raise the money through a levy on the surviving institutions.

The banks think it's unreasonable that well-run banks should be required to make good, in part, the losses of badly run ones. But assuming they pass the levy on to consumers - and they are pretty good at that - then it's other depositors bearing the cost, rather than taxpayers.

Seems fair enough to me: that's the way insurance works.

A more serious problem is that the scheme will not apply to superannuation or life insurance. The Government's rationale is that it does not want to provide a safety net for risky investments. But that logic fails: a guarantee of $20,000 for superannuation or life insurance is so minimal that if anything, it would underline the need for trustees to play safe. Super is too important an investment class not to need some form of protection, whether it's this scheme or some other.

But don't believe the conspiracy theorists who tell you Swan is doing this because one of the banks is about to go bankrupt. The idea that any Australian bank could fail to protect its interests is too ludicrous for words.

Tim Colebatch is economics editor.

© 2008 The Age

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