Update on the Guarantee of Australian Banks

by Stubborn Mule on 22 October 2008 · 7 comments

Treasury Secretary, Ken Henry, appeared before a Senate Estimates Committee today to provide some clarity on the nature of the consultation between the Government, Treasury and the Reserve Bank prior to the 12 October announcement that the Government would provide guarantees for all Australian banks. This followed yesterday’s article in The Australian which claimed that the Reserve Bank and Treasury were at odds on the question of providing an unlimited guarantee. Opposition leader Malcolm Turnbull tried to capitalise on the issue in Parliament the same day and, despite scoring some initial points, he lost the upper hand when he appeared to question Henry’s integrity.

Despite repeated attempts by opposition members of the Senate Committee to extract damning comments from Henry, they had chosen the wrong target. Henry was firm and clear, adamant that the Reserve Bank and Treasury were in full agreement on the question of the guarantee. The day before, Reserve Bank Governor, Glenn Stevens, had perhaps shown a little less unanimity during questions following a speech to the Trans-Tasman Business Circle, indicating that the Bank supported the guarantee but that there were still details under discussion. One of these details is the question of a “cap” or “threshold” on the guarantee for retail deposits. Initially it was widely understood that the guarantee would be unlimited, but now the Government is changing the legislation to impose a guarantee fee for balances over $1 million. The Opposition was at great pains to characterise this as a cap and thereby a backflip on the unlimited plan. Ken Henry replied that it was simply a matter of clarifying the distinction between “retail” and “wholesale”. By my reading of the original announcement*, it seems fairly clear that “wholesale” referred to securities and “retail” to bank accounts and the matter of a fee was only mentioned in relation to the wholesale guarantee. Nevertheless, Henry’s impressive performance clearly closed the issue in favour of the Government.

Despite the events of the last two days, much remains murky in relation to the guarantee. We now know that large retail deposits will attact a fee, but we do not know the size of the fee. Nor do we know the fee for the wholesale guarantee and how widely this guarantee will be taken up. There are already concerns that the retail guarantee will result in a mass exodus from cash management trusts and other investments which are not guaranteed. Significant sums have already started to move, leading some mortgage fund managers to freeze redemptions on their funds.

Retail cash management trusts predominantly invest in short-term bank securities and, while the funds themselves will not be guaranteed, knowing whether or not these bank securities are guaranteed is likely to be a deciding factor for many investors on what to do with their money. Even if the securities are not guaranteed, if the fee on large retail deposits is high enough, some of the tide of money may be stemmed. The major banks would be the likely beneficiaries of any shift to deposits, but smaller banks who rely on money market funding may find themselves in some difficulty. Macquarie Bank, which has already seen its cash management trust shrink somewhat is also likely to suffer both through the loss of fees on their fund and because the trust is almost certainly a significant investor in Macquarie Bank securities.

While there may not be too many people out there shedding tears for Macquarie Bank, the confusion surrounding the guarantee is a good example of the unintended consequences that can follow policy on the run. The Government was right to step in with the guarantee and it has doubtless provided some stability for a financial system that remains jittery, but the sooner the details are sorted out, the better.

* The original announcement has been pulled down and replaced with this one. While it lasts, the original can still be found courtesy of Google’s cache.

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{ 3 comments… read them below or add one }

1 AJ October 24, 2008 at 12:34 pm

Henry looked ready to headbutt that prize furball Coonan into tomorrow didn’t he? Aussies cannot be very deserving if this is our political representation. Further, Turnball picked the wrong battle at the wrong time. Nuff said.

2 Mrs V Fisher January 29, 2009 at 1:38 pm

Could I ask a question please about the Government guarantee on bank accounts in Australian owned Bank? If one had a cheque account (no interest earned) then the Government guarantee protects the money in that account. If one had a savings account that earns interest I understand now that the money earning interest is subject to a reduction in interest rate (.7%) if one elects to keep the Governement guarantee on funds earning interest. One can elect to earn .7% more interest but those funds are not Government guaranteed. Any clarification would be much appreciated. Thanks Val

3 stubbornmule January 29, 2009 at 2:41 pm

@Mrs V Fisher: my understanding is that “retail balances” of under $1 million dollars are guaranteed regardless of the interest rate paid on the account. For accounts of over $1 million, it is necessary to pay a fee of 0.7% to have the benefit of the guarantee. Again, this is the case regardless of the interest that the account earns, although you can think of the fee as a reduction in the interest rate. So if you had over $1 million in a cheque account that earned no interest (probably not a good idea!), if you wanted to have the money guaranteed by the Government, you would effectively be earning a negative interest rate of 0.70%. Note also that the $1 million applies to the total across all your accounts with a given bank, so you can’t get around it by opening up a number of accounts with the same back. You could, of course, split it across a number of banks.

Hope that all makes sense. The upshot is that it doesn’t make any difference whether the money is in a cheque account or a savings account.

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