Bank Intervention Is A Risky Business For Governments

Sydney Morning Herald

Saturday October 25, 2008

ELIZABETH KNIGHT

If governments have learned anything over the past six months, and in particular over the past six weeks, it is that the unfettered capitalism model has failed abysmally at pricing risk. But can Kevin Rudd do a better job?

The Federal Government's decision to intervene in this market - by guaranteeing bank deposits over a certain amount for a fee - is another way for it to impose a price on risk.

Those depositors whose funds fall under the new fee-free deposit threshold of $1 million will clearly push money into bank deposits, because there is no financial penalty for the gift of a sovereign guarantee.

Already we have seen bank deposits surge. The word is that over the past week they have grown by 6 to 9 per cent - against the normal rate of growth of about 11 per cent in a year - as depositors seek the security of the Government guarantee and safe non-bank organisations experience a run on their deposits so large that they have had to freeze redemptions.

These non-bank institutions such as Perpetual and AXA are of high quality, but the depositors that remain can no longer access their money, and this is a serious problem.

Those who choose safety pay this risk fee - more aptly described in this environment as a "fear fee".

The rationale behind the Government's move was logical enough because the public was starting to panic that even their bank savings were not safe: the instability that this could cause an economy is incalculable.

The whole idea of risk-weighted investments, be it in bank deposits, government bonds or shares, is that the riskier the investment, the greater the return. A risk-free deposit should attract a lower return than one that has some element of risk. Thus the Government's decision to allow some bank deposits a return that does not reflect this security distorts the market - and 99.5 per cent of deposits are less than $1 million.

The once-level playing field gets tipped in the banks' favour to some extent. As the average bank deposit falls under the Government-imposed risk-free threshold, the banks are receiving a very large kick.

But there is also a downside for banks. There will be investors with larger deposits, be they corporate, institutional or just private high net worth investors, who do not want to pay a fee on their bank deposits and who would rather take their money to a reputable non-bank deposit taker such as Perpetual to get a better return.

For that reason, banks would prefer larger depositors had a choice about whether they pay a fee for the guarantee.

The heads of the major banks met the Government on Thursday night to air their views, but they came away with the impression that Canberra was just opinion shopping.

Indeed, within the banking sector there were diverging views.Those with large non-bank wealth management businesses, such as NAB's MLC, were keen that that sector of the market was not disadvantaged.

There is no easy solution. The Government's move is set to disadvantage many commercial enterprises. However, too much of the debate over the past week has been tied up with the politics of security.

Whether Glenn Stevens at the Reserve Bank warned the federal Treasury that the bank guarantee was a good or a bad idea, or whether it should be refined, is not particularly important.

And whether the Treasurer, Wayne Swan, was premature is making his sweeping guarantees and has had to amend his words is equally unimportant. The attempt by the Opposition Leader, Malcolm Turnbull, to capitalise on these will not be viewed well by history.

The decision has been made and all that remains is for the casualties, be they non-bank financial institutions or foreign banks operating in Australia, to be dealt with.