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31 May, 2017: One of the reasons being suggested for a new levy on Australia’s five largest banks is that it is compensation for the Federal Government’s implicit guarantee. The rationale is that these banks are so important to the domestic financial system that their failure would cause significant disruption, and therefore in a crisis the Government would provide financial support to prevent these banks collapsing.
This seems to assume that there are other banks which the Government would allow to fail, which is unlikely.
Banks play a unique role in the community. Irrespective of the current concern over conduct and culture, Australians trust their banks to keep their money safe and to provide a reliable return on shares. The Government knows that the failure of any bank to repay or service its debts would affect confidence in the whole system and so they have put in place structures to preserve stability.
The Australian Prudential Regulation Authority exercises tight control over all aspects of the operation of banks, including capital levels, holdings of liquid assets, and exposures to risks.
The Reserve Bank provides a liquidity facility to all banks under which they can obtain very substantial funding at short notice.
In addition, retail deposits up to $250,000 held in all banks in Australia – large and small – are guaranteed by the Federal Government under the Financial Claims Scheme.
During the depths of the GFC there was a three and a half week period when the Australian Government guaranteed all liabilities of all banks for no fee. This means the whole system was supported, not just the major banks.
In 2008, a fee structure for the guarantee of large deposits and wholesale funding came into effect. In the end, no bank was bailed out but the Government earned $4.5 billion in fees from banks.
To understand the political reality of maintaining confidence in the financial system we have to put ourselves in the shoes of a Federal Treasurer faced with the financial difficulty of any of Australia’s banks. Could he or she afford to allow any bank to default on its debt obligations or to close its doors? That is doubtful because the contagion effects through the rest of the financial system are unpredictable.
The last bank failure in which Australian depositors lost money was a trading bank, the Primary Producers Bank of Australia, in 1931. Since then, governments have sought to resolve bank difficulties without losses to the public.
Ratings agencies should take these considerations into account when determining bank ratings.