Recap Essay Example

International Banking—Recap 6

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International Banking—Recap

The most important issue in this case us not what Australian Bankers Association opines about the introduction of Financial Stability Fund and a levy. Instead, the issue needs to be looked at from the perspective of the depositor or the society at large. Prior to this, the Financial Stability Forum on Enhancing Market and Institutional Resilience report of April 20081 stressed on the importance of effective compensation arrangement for depositors. That is, a need for authorities to find a solution on the international principle for effective deposit insurance systems. This report has been highlighted owing to the argument by Australian Bankers Association that no Australian depositor has suffered from a bank failure since the 1890s. While this remains skeptical claim, the association needs to realise that depositors need to be protected against a run on the bank.

In agreement with Australian Bankers Association, it is true that unlike other countries, depositors in authorised deposit-taking institution (ADIs) benefit from considerable number of layers of protection aimed at ensuring their funds are safe in the banks. Furthermore, as ABC chief executive Steve Münchenberg notes, Australian banks have systems that regulate and supervise activities of the banking system to ensure that problems of ADIs are rare. While these remain to be hardcore facts, the banking systems are not merely to benefit banks. First, the interest of the general public must be given consideration and this is why the introduction of Government Deposit Guarantee Scheme in October 2008 was to stabilise the Australian economy and stimulate investment (Australian Prudential Regulation Authority, 2011). On different note, Münchenberg claims that,

Australia is also unusual compared with the rest of the world in that it has a system of legislated depositor preference,” ABA chief executive Steve Münchenberg said.  This means that depositors get preference over other unsecured creditors if an ADI fails. In the event of insolvency, banks would have to burn through all their profits and capital, and nearly half of their assets, before deposits were even touched — that is a very unlikely scenario.2” 

While this statement is true, it needs to be noted that introduction of Financial Stability Fund goes beyond deposit protection. It also looks to cover protection against a run on the bank as well as stabilisation of the economy. For instance, deposit protection is extended in the United States through Federal Deposit Insurance Corporation (FDIC). In fact, in one of his articles Jesse Eisinger notes that the economy is clearly weaker and weaker than expected and housing prices are falling thus eroding bank asset values (Cornish, 2012). He adds that federal government in many ways has profoundly subsidised and protected banking industries. The case is similar in United Kingdom where Financial Service Authority (FSA) serves the role. This kind of protection is extended to other countries with specific terms on levy depending on the country and the type of account.

Australian Banks are also supposed to act as a mechanism through which the society or depositors express economic policy. This is so especially as fiscal stimulus has been eliminated as an option. The result is what Eisinger (2011) terms as, ‘the government pays a “vig” to banks in order to reach its policy goals’ (p.1). This translates that the Australian regulator has the mandate to limit risk taken by the banks so as to protect taxpayers and depositors. In the event of doing this, a levy of 0.05% on government guaranteed deposits less $250,000 should not be refused by Australian Bankers Association.

Advantage Australian depositors have compared to other countries is that they have priority claim on the assets of a failed ADI ahead of other creditors who are not secured (depositor preference). The introduction of Financial Claims Scheme (FCS) in 2008 further strengthened depositor protection arrangement under which the government has been guaranteeing timely repayment of deposits up to a defined cap. This was temporarily set as $1 million per individual per ADI. However, the global financial crisis has given many, including banks, lenders of the last resort and depositors a lesson to learn. As stated earlier, a levy asked for is not much compared to the confidence and safety of the depositors. The effectiveness of deposit insurance system in maintaining financial stability and protecting depositors was tested therefore speedy adoption of Financial Stability Fund is required to enhance depositors’ confidence. Basically, this is what is happening in other parts of the world. United States being the first country among FSB to introduce deposit insurance (back in 1934), they have been levying banks certain percentage of the guaranteed deposits irrespective of whether financial crises will affect them. As a matter of fact, Australian Treasury (2011) explains that majority of FSB members have been levied by their lenders of the last resort with exception of Saudi Arabia, China and Australia.

Münchenberg further argues that in the event of insolvency Australian banks “would have to burn through all their profits and capital, and nearly half of their assets, before deposits were even touched — that is a very unlikely scenario.3” He further argues that, “the unfortunate effect of the levy is that banks may pay less interest to savers and others with deposits, such as small businesses.4” It needs to noted that Münchenberg’s statement is one sided and in so saying, does not factor in events such as provision of essential banking services. Besides, ADIs are exposed to a number of different risks, including liquidity risk, credit risk, market risk and operational risk—critical aspect of an ADI’s risk management is its assessment of its capital needs based on its risk profile. It therefore naïve to believe that since Australian banks manipulated financial crises they are immune against the above risks. To concretise this claim, Eisinger (2011) notes that when federal reserve (The Reserve Bank of Australia plays that role here) lowers interest rates to help boost the economy during slowdowns, first beneficiaries are the banks. This is because banks borrow cheaply and lend out for big profits—a classic monetary policy applied across FSB jurisdictions. It therefore unjustifiable for Australian Bankers Association to object the levy because in so doing, deny the society more financial opportunities and or benefits.

References

APRA (Australian Prudential Regulation Authority) 2011, ‘Implementing Basel III Capital Reforms in Australia’, Discussion Paper, September.

Australian Treasury (2011), ‘Financial Claims Scheme – Consultation Paper’, May. Available at http://www. treasury.gov.au/documents/2025/PDF/CP_Financial_ Claims_Scheme.pdf

Cornish, S. (2012), ‘Prudential Regulation and Supervision’, in The Evolution of Central Banking in Australia, Reserve Bank of Australia, Sydney, pp 79–91.

1
See http://www.financialstabilityboard.org/publications/r_0804.pdf

2
http://www.bankers.asn.au/About-Us/The-ABA/The-ABA