Unexpected Consequences Guaranteed

The Age
24 November 2008
VANESSA O'SHAUGHNESSY

IF YOU had more than $1 million in the bank today, you'd be preparing to pay the Federal Government to insure it.

It is the new world of bank deposit guarantees. In Australia, they are free for people with less than $1 million, but for those with more, a fee will apply from this Friday.

Of course, that's as long as you haven't opened a few new accounts and distributed your money among them.

And it assumes that, having observed the global economic downturn, you have decided that a guarantee is worth paying for.

Early last month Prime Minister Kevin Rudd announced an unlimited guarantee on deposits held in Australian banks - free.

The decision was widely applauded. And it brought Australia into line with other Organisation for Economic Co-operation and Development (OECD) nations, many of which were boosting their existing deposit guarantee schemes.

But the move, which was meant to prevent a run on an Australian bank and inspire confidence in the Australian financial system, has resulted in some unintended consequences.

Many mortgage fund managers froze redemptions after the guarantee was announced.

They said members were withdrawing their money to obtain the deposit guarantee, thereby threatening the funds' liquidity and stability. But their calls for equal treatment went unheeded. Using a term that the mortgage funds disliked, the Government said it was unable to guarantee "market-linked" products.

There have, of course, been some alterations to the deposit guarantee scheme.

And some believe those alterations - such as the decision to impose a fee on accounts holding more than $1million - may also have unintended consequences.

Martin McGrath, a partner at audit, tax and advisory firm KPMG, says regional banks may miss out on much-needed deposits because of the variable costs imposed on banks with different credit ratings.

For example, anyone with a deposit of more than $1million held at the AA-rated Commonwealth Bank, ANZ, Westpac or NAB, will pay 70 basis points a year.

But someone with a deposit of more than $1million that is held at an A-rated bank will pay 100 basis points. And for anyone else, the fee will be 150 basis points a year, or 1.5 per cent of their balance above $1 million.

Analysing bank performance, Mr McGrath says the regional banks have performed remarkably well over the past full year.

For the purposes of his study, regional banks included the Bendigo and Adelaide Bank, Suncorp, Bank of Queensland, Elders Rural Bank and the recently swallowed St George.

Together they increased deposits by 16.9 per cent, slightly above the 16.4 per cent average growth recorded by Australian banks on the whole.

"That's a good story, but a good story that they had to have," Mr McGrath said.

But regional banks face challenges. They have lower credit ratings than their larger counterparts, and therefore have to pay more for wholesale funding.

And Mr McGrath suggests the variable fee to guarantee large deposits will add to the majors' dominance.

"There's still fierce competition for deposits," he said. "To the extent that people are prepared to pay the guarantee, (regional banks) are at a disadvantage."

Melbourne business school senior lecturer in finance Ning Gong says that over the past year the smaller banks have attracted deposits by offering higher interest rates.

But as global conditions worsened, the perception that size was strength favoured the bigger banks.

Despite the issues associated with the variable fee for balances above $1million, Dr Gong believes the Federal Government's deposit guarantee has levelled the playing field somewhat.

But Dr Gong says that a free insurance scheme, for those with less than $1million, has encouraged banks to take greater risks.

To improve the system he suggests the Government ask for payment for all guarantees, and limits the guarantee to about $100,000.

"After the crisis is over, we have to think about how to design a proper deposit guarantee system," he said.

Last week Treasurer Wayne Swan declined to speculate on whether the Government would redesign its deposit guarantee scheme ahead of the three-year deadline announced last month.

Professor Robert Brooks, from the Monash University econometrics department, says the decision to guarantee deposits was a confidence-restoring measure, on which the Government probably did not expect to act.

But he suggests the purpose of the deposit guarantee was to protect the investment wealth of middle-class households, not to guarantee funds for richer households, which had been benefiting from a higher risk-return premium from their investments.

Hence the fee for the deposit guarantee for people with more than $1million, whatever its unintended consequences.

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