Australian Banks Get A Government Guarantee

by Stubborn Mule on 13 October 2008 · 6 comments

In the latest instalment of the Global Financial Crisis (“GFC”), following the lead of Ireland and other countries, the Australian Government has taken the extraordinary step of guaranteeing all deposits with Australian banks, building societies and credit unions as well as locally incorporated subsidiaries of foreign banks. The guarantee can also extend to wholesale debt (if banks pay an as yet undetermined guarantee fee), which allows protection of bonds issued by Australian banks offshore.

This move followed a week of very bad news in global financial markets with a wave of problems with European banks, including the collapse of all of Iceland’s banks, and huge falls across stock markets. In this environment, it had become extremely difficult for any banks, even the relatively strong Australian banks, to borrow in global money markets, while closer to home retail depositors were starting to worry about the safety of their savings. As I noted in an earlier post on AIG, when it comes to banking, if enough people think you have a problem, then you do have a problem. In a banking version of the prisoner’s dilemma, as an individual it makes sense to take your money out of a bank you are worried about, but if others think and act the same way, everyone is worse off. The actions of the Government are aimed squarely at shoring up confidence to break this dilemma.

Local banks are currently working their way through the implications of the Government’s move. For example, they will probably decide that it doesn’t make sense to pay for a guarantee on locally issued bank bills as that market is not as broken as global money markets. Overall, however, it is good news for banks who still need to raise significant sums of money offshore on a regular basis, and it is good news for every depositor who was wondering whether to move out of a credit union to one of the big four or even whether their money would be safe there.

There is likely to be more bad news emerging from the GFC, including longer-term economic consequences, and Government action can help but probably not cure the problems. But for now, the market is taking heart and the Australian share market is up around 3%.

UPDATE: I have posted an update on the guarantee following a week of parliamentary skirmishing about whether or not the Government consulted Reserve Bank before acting.

Also, the Government appears to have pulled down their original list of banks covered by the deposit guarantee, so I have republished the full list.

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{ 4 comments… read them below or add one }

1 Michael Michael October 14, 2008 at 2:06 pm

OMG, WTF with this GFC?

2 Lefty February 7, 2010 at 8:51 pm

“Overall, however, it is good news for banks who still need to raise significant sums of money offshore on a regular basis,”

This is one thing have not understood regarding MMT – if banks require only credit worthy customers to make loans, then why do they need to raise large sums from offshore? This seems to completely contradict MMT. If they do not need to take deposits and then on lend them, why would they need to borrow from anyone else? Obviously I have missed something . Would you be kind enough to tell me what it is?

cheers

3 Stubborn Mule February 8, 2010 at 12:16 pm

Lefty: that is an excellent question. So much so that I think it is worth a blog post of its own. The “short” answer is that while the canonical MMT “loan creates deposit” scenario is accurate, this is only one possible transaction a bank may have to facilitate. The thing to ask is “what next”? If I borrowed money from the bank to buy, say, a car then the loan (bank’s asset) is matched by a deposit (bank’s liability). If the car seller banks with my bank then that’s all there is for now. But if the seller banks elsewhere, my bank has to make a payment to the seller’s bank. If my bank has insufficient funds in its account with the central bank it will have to borrow the money. If no-one is prepared to lend to my bank then is has a problem. If it could simply reverse the original loan, collapsing assets and liabilities rather than creating them, then there would be a way out, but most loans the bank makes have a term of a year or more and so it cannot ask me to repay my loan (yet). It is this mismatch between the term of loans and deposits that creates the potential problem for the bank (so called “liquidity risk”) and one way to mitigate this risk is for the bank to issue bonds in order to borrow in the wholesale markets. You can think of this process as swapping at call (i.e. extremely short term) deposits for longer-term liabilities to come a little closer to matching the term of assets and liabilities. Having said that, no bank every fully matches the term of assets and liabilities which is why liquidity risk is one of the most fundamental risks associated with banking.

4 Lefty February 8, 2010 at 1:27 pm

Thanks for that Sean!

That question has bugged me for some time.

With no formal economics training at all, I never cease to be surprised by the sheer number of things that seem to defy all logic and commonsense until you get your head fully around them.

cheers

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