The_Australian_Government_Guarantee_Scheme_for_Large_Deposits_and_Wholesale_Funding

Introduction The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding (the Scheme) was announced by the Prime Minister on 12 of October 2008, similar announcements in a number of other countries such as New Zealand Government, to guarantee certain deposits and wholesale funding of qualified authorised deposit taking institutions (ADIs) which are subject to prudential regulation by the Australian Prudential Regulation Authority (APRA) in accordance with international standards. Both governments also introduced unlimited wholesale bank debt funding guarantee schemes available for new borrowings. These schemes charge risk based fees with the New Zealand charges being generally higher and more risk sensitive (including higher fees for longer maturities) (Davis & Boyle 2009). The purpose of the Scheme is to maintain the stability of financial system and ensure the continued flow of credit during the extremely difficult circumstances in the global financial system. Furthermore, it sustains and aids ADIs to continue to access funding and to ensure that Australian institutions does not experience any difficulties compared to international competitors that can access similar schemes in other countries that have received similar government guarantees on their bank debt (English, 2009). This report examines the reasons for introducing such scheme and discusses the characteristics of the deposit and wholesale funding guarantee scheme. Discussion The Scheme will be applied to Australian owned banks, Australian ADI subsidiaries of foreign banks, credit unions and building societies (‘eligible ADIs’). Additionally, it will be valid to the foreign branches of eligible ADIs but not their foreign subsidiaries (The Economist, 2009). Functions of the Scheme To summarise the principles of the Scheme, it has four main points. Firstly, it can re-build the reliance and confidence among banks, investors and the public efficiently and effectively (RBA & APRA, 2009). Secondly, it reduces and control impact of failed financial institutions on the rest of the market. Thirdly, it avoids and minimise losses to consumers with greater certainty (Lucas, 2009). Finally, it encourages lending transactions and liquidity stream in the international and domestic money and capital market (McCarthy, 2009). In accordance with RBA and APRA (2009), the features of the Scheme are: (a) A strong notice of timely reaction against the crisis by the government; Evidence suggests that although Australia suffered least in terms of the impact of the crisis amongst developed nations, the reactions of the government are more sufficient and effective in dealing with the collisions; (b) A transparent and practical protection approaches from the government; The Scheme is well-designed and precise, it is therefore well-organized; (c) A temporary arrangement which lasts for about three years. The Scheme remains in place until market conditions have normalised, which contains characteristics and variables that may require adjustment in light of market developments. The government will keep reviewing on an ongoing basis and revise it if necessary. The Wholesale Funding Guarantee (WFGs) The process for making applications, issue of Eligibility Certificates and fees are in essence the same as for the guarantee for ADI deposits over AUD$1 million. However, not all wholesale funding liabilities of ADI’s are eligible for the guarantee (RBA & APRA, 2009). The governments of Australian and New Zealand has declared intention of Wholesale Funding Guarantees (WFGs) which was to aid the sustained access of local financial institutions to global financial markets with the overall financing needs of their respective countries. In other words, the WFGs were designed to address short-term funding and liquidity issues, rather than solvency problems such as the negative impacts of the global financial crisis (Davis & Boyle 2009). The introduce of WFGs were due to the liquidity of cash issues occur from the disruption of financing channels in international wholesale debt markets, and were to apply only to the new flow of debt issues (English, 2009). In both countries, eligible financial institutions are charged on a risk-adjusted basis for accessing the WFG. Although the degrees of risk are generally higher, and more risk-sensitive, in the scheme of New Zealand, the prices in both countries are fundamentally arbitrary (Davis & Boyle 2009). However, this is probably necessary as the result of the international financial crisis. There may be positive impact of WFGs on the particular short-term problem they were designed to address, governments are forced to operate in a insurance, which they have no particular expertise or comparative advantage; banks are able to avoid disciplines normally imposed by the market; and institutions not covered by the WFG are placed at a competitive disadvantage, potentially leading to increased concentration in the banking (Davis & Boyle 2009). The wholesale funding guarantee will also promote financial system stability in Australia and assist banks, building societies and credit unions to continue to access funding at a time of considerable market turbulence (Brown, Davies, & Thanrick, 2010). The Deposit Guarantee schemes The existence of has frequently been connected to the economic health and performance of a financial system (Dennis, Sharpe, & Sim, 1998). Diamond and Dybvig (1983) demonstrate that DGSs are essential due to the delicate nature of the contract in banking system. Evidences suggest that it is inclined to bank runs. Depositors have the motivation to line up first, even if they believe the bank to be stable, since the probability of repayment declines with the number of depositors in front of the individual (Demirgüç-Kunt, Kane, & Laeven, 2007). A deposit guarantee, given the guarantee has adequate credibility, eliminates such motivation. The DGSs has guaranteed the deposits in eligible ADIs for a period of three years (RBA & APRA, 2009). For deposits of or under one million dollar, DGSs will be free. For deposits over one million dollar an eligible institution will be able to obtain coverage, in return for a fee. For example, if a person holds one and half million dollar in deposit accounts in an ADI, the first one million dollar would be guaranteed for free and a fee would be payable to obtain the guarantee for the remaining half million dollar. The threshold applies per depositor per institution. That is, the threshold applies to the total amount of funds held by a depositor in (separate) deposit accounts with an ADI. The DGSs apply to deposits held in eligible ADIs by all types of legal entities, including individuals, partnerships, businesses, trusts (including in their offshore branches) and government entities. According to RBA and APRA (2009), DGSs will not apply to: i. Products that are not deposit products with eligible ADIs; ii. Market-linked investment products such as share portfolios or managed funds, as these products offer motivations for investors to pursue superior returns through investments that may involve greater risks, as well as the risk of making capital losses; iii. Retirement income products including annuities. iv. Products offered by non-ADI entities, including non-ADI subsidiaries of Australian ADIs. These entities are not subject to the prudential regulation framework that applies to ADIs, which protects the interests of depositors. Because of this, non-ADI entities are not permitted to offer deposits in Australia v. Deposits held in eligible institutions, regardless of where the depositor resides. vi. Deposits held in any currency. The introduction of DGSs made explicit the implicit guarantee that many depositors in Australia and New Zealand already believed they had, and eliminated the uncertainty of the future claim by governments and assure that they would provide security to depositors (RBA & APRA, 2009). Once guarantees have been exercised in the urgent manner such as financial crisis, depositors are expected that government would use over again. Practically, no return to the claimed caveat emptor pre-crisis situation is possible. Moreover, any attempt to remove the guarantees entirely risks large movement of deposits from minor financial institutions to the “too-big-to-fail” banks, reducing competition and declining stability of system (Davis & Boyle 2009). Application to the International economic background Since July 2007, the extremely severe sub-prime mortgage crisis takes places in the United States, and immediately spread to most of the developed countries, where the capital markets and banking business have been adversely affected (Maximilian, 2009). The list of banks and companies involved in economic failure, administration or other insolvency proceedings grows longer by the day. The most unpredictable aspect is that the list includes previously solid (or widely perceived to be so) blue chip companies such as New Century Financial corporation, Bernard L. Madoff Investment Securities LLC, Lehman Brothers (bankruptcy), Mervyns, and so on. The global nature of means that the Australian economy and many Australian financial institutions and companies were undoubtedly affected as a result of being part of the global financial community (Brown & Davis, 2008). Application to financial environment Wheelock and Wilson (1995) propose that there is a positive relationship between failure rates of banks crisis and financial crisis. In addition, Havokimian and Kane (2000) are convinced that risk-based capital requirements did not avoid large banks—especially inadequately capitalized banks and those with high ratios of deposits to total debt— from shifting risk into the safety net. In contrast, Karels and McClatchey (1999) suggest that the adoptions of deposit guarantee in the decreased the risk-taking of credit unions (e.g., they had lower ratios of non-performing loans after deposit guarantee). According to Demirgüç-Kunt and Detragiache (2002), deposit insurance increases the likelihood of banking or financial crisis, particularly countries with inadequate institutional environments. A growing body of evidence from empirical cross-country studies suggests that the beginning of deposit guarantee systems (as opposite to implicit guarantees) has undesirable effects in countries with low levels of political and economic freedom and high levels of corruption (Hovakimian, Kane & Laeven 2003). In accordance to Gropp and Vesala (2004), alternatively, the introduction of explicit deposit guarantee in Europe diminished bank crisis and financial crisis. Additionally, they disagree that explicit deposit guarantee may have implied a effective reduction in the scope of the safety net by credibly excluding large subordinate debt holders from the previously implicit guarantees. According Brown, Davies, and Thanrick (2010), the short-term impact on the market are: (a) The number of anxious customers reinvested funds into bigger banks has dramatically slowed after the Government announced that it would stick to all Australian bank deposits; (b) Banks suffered a large outflow of deposits previously, now gain trust from customers after the introduction of the Scheme such as BankWest, which was in the process of being acquired by Commonwealth Bank of Australia, (c) The Big Four banks in addition to other main financial institutions, such as Suncorp and Macquarie have adopted the Scheme immediately after it launched. Importantly, Australian domestic banks are borrowing at progressively better rates than before; (e) A number of regional banks which have a lower credit rating and therefore must pay more to use the Government Guarantee are using it less, but some have used it. It is comparatively more expensive for them to use due to the fee structure of the Guarantee. So, NAB, Westpac, Commonwealth and ANZ (the “Big Four” banks all rated “AA”) pay the lowest fee to use it. As a result, these banks are given a competitive advantage to use the Government Guarantee over the minor, lower rated banks such as Suncorp, Bendigo Bank and so on (Black &Hack, 2010). Long-term impact on the financial system The Guarantee Scheme has acted as a protection to smaller and lower rated financial institutions which might otherwise have experienced more difficulties as a consequence of the GFC. The accessibility of the Guarantee Scheme may encourage risk taking behaviours in financial institutions and serve as a discouragement for them to improve their productivity and innovation (Lucas, 2009). As the Scheme only has a limited life span and its existence is against the beliefs of free market, distortion will inevitably result in the market and the impact of which may take years to be remedied (Jonathan, 2008). The cruelness of the degree and the intensity of the current crisis have brought cautions that nobody is capable of predicting precisely how long the financial markets, particularly; the credit market is able to fully recover (Brown, Davies, & Thanrick, 2010). If withdrawal the Scheme at an inappropriate time, it may cause the fall of the less competitive, which would lead negative effect to consumers (Black &Hack, 2010). Conclusion In 2008, the Australian and New Zealand Government Guarantee Scheme for Large Deposits and Wholesale Funding were launched in response to unexpected expansions in the global financial system. The scheme has provided a constructive and essential contribution to the strength and stability of the financial system in Australia by ensuring that institutions sustained the access of capital markets for the duration of the most severe period of the crisis. Additionally, the schemes have guaranteed that the overall accessibility of financial support has not been materially limit on the capability of Australian banks to lend and served to mitigate the large growth of cost to issue debt (Cecchetti & Krause, 2005). The changes of circumstances mean that while Australia and New Zealand have previously expressed some ambivalence about the need for the Scheme, it is probably unavoidable to implement the adaptations of such schemes for the future (Davis & Boyle 2009). Recommendations It should be noted that there is no perfect scheme; there are many possibilities which all involve packages of measures that attempt to offset the known disadvantages of the Scheme of Large Deposits and Wholesale Funding. The Scheme may set their aim at removing the uncertainty about the value of banks’ past investments and providing greater confidence to rebuild and restructure their operations and increase lending in the economy (McCarthy, 2009). Additionally, the Scheme may be maintained until to the market conditions is normalised as it will have significant improvements and eventually benefit the Australian and New Zealand economy and financial systems.