Is Your Bank Deposit Really Yours?

BY DAN DENNING

Let’s return to the issue of whether your money in the bank is really yours. The answer is probably ‘yes, but with conditions.’ And the real question, obviously, is whether bank deposits are…as safe as houses. The answer to that is more complicated.

First off, thanks for the many emails and comments regarding this issue. It’s obviously an important one for many people. As such, it needs to be treated carefully, but honestly. Do your own research and ask lots of questions if you’re not sure.

In the meantime, there are three important points to make about the whole subject. First, the best prevention against a banking crisis is a well-regulated industry where authorised deposit taking institutions (ADIs) never put themselves in the position of requiring a bail out or a wind up. That’s ‘Plan A’ for Australia.

By that, I mean that the Australian Prudential Regulation Authority (APRA) hopes to prevent a crisis before one ever happens. It does this by monitoring lending standards and generally keeping a good eye on things. Australia’s banking regulation regime is widely regarded, at least in Australia, as one of the best in the world.

But you don’t plan for crisis by concluding that another one isn’t possible. And if you don’t think a banking/property crisis is possible in modern Australia, do yourself a favour and get a copy of Trevor Sykes’ classic, Two Centuries of Panic: A history of corporate collapses in Australia. The last three chapters are on banks and property. And Sykes published his book in 1988, two years before the collapse of the Pyramid Building Society in Geelong!

APRA’s description of how bank depositors are protected through the Financial Claims Scheme can be read here. There are a couple of important points to note. First, the FCS only comes into effect if an ADI is wound up. You can bet that any government would move heaven and earth to prevent a wind up. But in the event of a wind up, then the FCS comes into play.

Second, if you have a deposit greater than $250,000, any amount over the $250,000 is not insured. Third, the FCS appears to cover you for $250,000 for each account you have with a different ADI. Please note, I’m not certain about that last part. The wording is opaque.

As I said, though, the FCS would only come into effect if an ADI w ere wound up. If you thought the RBA would be involved in a wind up, you’re wrong. It has no obligation whatsoever to depositors in an ADI. It said as much in a 1998 Memorandum of Understanding with APRA (point number 2):

‘The RBA’s role is focused on the objectives of monetary policy, overall financial system stability and regulation of the payments system. It has no obligation to protect the interests of bank depositors and will not supervise any individual financial institutions. The RBA does, however, have discretion to provide emergency liquidity support to the financial system.’

Unless something’s changed since then, don’t expect the Reserve Bank of Australia to print money to bail your bank out. That said, the RBA would clearly be critical to providing liquidity to an ADI in order to prevent a failure that would trigger the FCS. You can imagine the Bank buying heaps of mortgage backed securities from an ADI in a repurchase agreement to ease immediate pressures.

But just to be sure, and to erase any doubt over whether a depositor is also an unsecured creditor, see also the Bank’s March 2011 supplement on covered bonds. In that obscure little piece of research, the Bank writes the following:

‘Currently, Australian ADIs are not permitted to issue covered bonds because covered bondholders would have preferential access to an ADI’s assets, thereby subordinating other unsecured creditors, like ordinary depositors. This would conflict with the Banking Act 1959, which enshrines the principle of depositor preference under which, if an ADI is wound up, all of its assets in Australia are made available to meet the ADI’s deposit liabilities in Australia in priority to other liabilities of the ADI.’

This passage both confuses and clarifies matters. The bolded bit shows that ordinary depositors are, in fact, unsecured creditors. But the principle of ‘depositor preference’ is supposed to ensure that the deposit is treated like a preferred liability, to be paid out ahead of other liabilities. But do ‘other liabilities’ include secured creditors, who would have preference over unsecured creditors, and thus depositors?

It’s a fairly straightforward question. I suspect the answer has been kept deliberately vague. It’s not something the authorities want you to think too much about. The whole point of insurance is to have it but not need it. You know it’s there. But you’re not banking on it. If you have spend any time thinking about the soundness of the banking system, something with the system is very wrong indeed.

At a deeper level, the premise of the regulatory response to a theoretical banking crisis seems to be that there can’t be a crisis anyway. Australian banks are packed to the gills with commercial and residential property assets. For there to be a banking crisis at an ADI, there would have to be a property crash. And for that to happen, interest rates would have to rise quickly and unpredictably (something that seems impossible in a ZIRP world).

The consensus among bank economists is that interest rates won’t rise, property can’t crash, and bank assets are as safe as houses. And even if a smaller ADI got in trouble, APRA and the RBA could get together and perform some behind-the-scenes liquidity operations to avert a solvency crisis. Really, then, only people who enjoy worrying would worry about depositors getting wiped out by a failed ADI.

Well, I sort of enjoy worrying. So let me put it to you this way: T he counter narrative is that you have a banking system — and a whole country — that’s over-invested and over-exposed in an over-priced asset. A generation’s worth of capital and savings has been allocated to non-productive enterprises. When house prices fall, and incomes decline as the mining boom recedes, the conditions for an ADI crisis will be firmly in place.

It will be too late to do anything about it by then, which is why I’m asking the questions now. Trevor Sykes had this to say about it:

‘Banking in Australia developed an image of great stolidity from the 1940s to the 1960s. It has not always been so. Bank collapses were a recurrent feature of nineteenth-century finance, and banks were still unstable until the 1930s. The 1970s saw a wave of fresh banking jitters. It is worth making the point that the deregulated Australian banking system of the 1980s bears a closer resemblance to the system which prevailed here in nineteenth century than the in the 1960s.’

Through most of Australia’s history, the mining sector has been there to pick up the pieces after a banking crisis. Sykes explains:

‘A point upon which I have laid little emphasis is the frequency with which recessions have been eased by the mining industry, particularly gold mining. The deep recession of the 1840s was followed by gold discoveries at Bathurst, and then in Victoria, which transformed the Australian economy. The 1866 crisis in Queensland was swallowed by the discovery of gold at Gympie, then further discoveries at Rockhampton, Etheridge, and ultimately the Palmer River. Even the1886 distress in South Australia was eased by so ephemeral a rush as that to Teetulpa. The eastern woes of the 1890s were not felt in Western Australia, thanks to Coolgardie and Kalgoorlie. Gold was the brightest industry in Australia in the 1930s. The 1961 credit squeeze was forgotten in the mineral boom of the rest of that decade. The property and finance crashes of the 1970s were followed by yet another gold revival in the 1980s. Mining, and gold especially, has rescued Australia economically on repeated occasions.’

Mining can’t save us now, can it? We just had the greatest mining boom in Australian history and came out of it with more debt than ever. All we have to show for it is sky high housing prices and the prospect of a higher cost of living to go with falling living standards. At least the beer is still cold, if not also overpriced.

What would Sykes say about today’s banks? I’d say they’re more 19th century than ever! Another crisis is inevitable as sure as night follows day. The key is timing. Do you have to worry about it now? Sykes tells a sad story:

‘A few months after Cambridge Credit collapsed, an elderly woman rang the Melbourne office of the Financial Review. She had retired the previous year and sunk her life savings — $20,000 — into Cambridge. She asked what the prospects were. When I told her she would have to wait years to get anything back, and would probably never be repaid in full, she said: “ Oh well, I’ve got a heart condition, so I don’t suppose I’ll last that long anyway. ”’

You don’t want to deal with a banking crisis by having a heart attack. It’s not a survival strategy. What about gold? Well, it’s saved Australian mining before. If the world’s central bankers win their war on deflation, they will devalue paper money, and by extension, the savings in your bank account. Maybe gold will ride again. And maybe its day is soon.

Dan Denning+
For The Daily Reckoning Australia

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