Comment: Deposit insurance remains unfunded

Banks in Australia have won a free kick from the Government, with plans for one form of a funded system of deposit insurance now abandoned.

The International Monetary Fund was the only real champion of a conventional system of deposit insurance in Australia and even then it only ever made a muted case for a shift in the mid 2000s, citing the work done by Australian regulators to explore such a system.

In Australia the context for that work was the 2001 failure of a large commercial insurer, HIH, which became the catalyst for a study of financial guarantees.

Kevin Davis led that study, producing a discussion paper in early 2004 that made no direct recommendation but simply reviewed overseas experience with deposit insurance schemes, which exist in virtually all industrial economies.

The IMF's Financial System Stability Assessment of Australia, published in 2005, did not give much emphasis to the merits of, or even make a case for, deposit insurance.

Australia's Council of Financial Regulators (a talking shop of APRA, RBA, Treasury and ASIC) had been gingering for a system of deposit insurance, and parallel guarantees for insurance policy holders.

The Reserve Bank of Australia, perhaps reluctantly, had outlined the framework of the scheme regulators favoured at the time. The regulators proposed a pay-later scheme, with any immediate distributions funded by Treasury via APRA, and with banks chipping in premiums equal to a few basis points of insured deposits to restore the balance of the nominal deposit insurance fund over time.

The IMF described the banks' opposition to the proposal as "not surprising given that all parties currently have the benefit of an implicit unlimited government guarantee."

The review went on to observe that "in the absence of a credible alternative, however, it will be difficult for government to withstand the pressure for a continuation of official bailouts in future failures."

The financial crisis inevitably added to the pressure to introduce a deposit insurance system, with the former Labor government finally embracing such a scheme in the second half of 2013.

Public sector budget conventions no doubt added to the interest of the last government, as it did to the tentative interest of the present coalition government, which included a bank deposit levy in the most recent Budget.

But a noisy campaign by banks branding the levy as a tax, where in reality it is an insurance premium, helped swing the argument against it.