Six years after HIH, financial guarantees unresolved

As Northern Rock, a British regional bank, implodes into a colourful curiosity of the repercussions of the US sub-prime crisis, there may be a lesson or two for bank regulators in Australia.

What on earth are the relevant rules for a bank failure? What alternative rules are under discussion?

Australia's government - a colourless curiosity of a different kind - is stumbling towards the end of its current parliament (its fourth in all). And what has the government gotten up to in the realm of financial services supervision during this term?

Nothing of any consequence is one answer.

In the in-tray of the lazy Treasurer, Peter Costello - to personify a deeper bureaucratic problem - is the proposal by the Council of Financial Regulators (made public in November 2006) for a system of financial guarantees. The proposals largely follow the recommendations arising from the work of Kevin Davis (of the University of Melbourne) in his study of financial system guarantees, published in March 2004.

The Davis report followed the muddle created by the collapse of HIH Insurance in 2001 and the need to devise a system to compensate some policy holders in the wake of that collapse.

The Council of Financial Regulators (comprising ACCC, APRA, ASIC and RBA) proposed a scheme that would apply to deposit taking institutions (banks, building societies and credit unions) and also to life insurers, friendly societies, and general insurers (defined to include "limited superannuation products" whatever that means).

The scheme would cover only "capital certain" promises, including deposits, claims on insurance policies, guaranteed life insurance savings and annuity products. The scheme would not cover managed investment schemes and market-linked products, including ordinary superannuation products.

The proposed coverage limit would be around $50,000, with "tightly defined discretion" for the scheme administrator to pay higher amounts in "specified circumstances". The regulators propose that initial payouts be for only 90 per cent of any claim (up to the cap) with the balance paid only when the liquidator of a failed bank or insurer had the assets available to pay the balance. The regulators describe this as a co-insurance premium.

The scheme would be restricted to liabilities in Australia, with initial funding via budget appropriation and loans from the Reserve Bank, with payments and scheme costs recovered from the sale of assets of the failed entity.  Industry levies would apply to cover the cost of any shortfall.

What's the fate of this scheme? And what's the government's position?

Who knows.

What is known is that banks oppose it and the government and its agencies have, deliberately or otherwise, let it drift. Banks and the ABA don't like it, and really prefer the status quo, which is a mix of ignorance and confusion over what sort of support would be available in the event of a banking crisis.

And banks could point to contradictions now evident in Britain where the Chancellor of the Exchequer, Alistair Darling, overnight said early in the day deposits of Northern Rock are "backed by the Bank of England" when the actual deposit insurance system only guarantees deposits up to 37,500 pounds.

By later in the day, the position of Britain's government shifted. Darling said later that "should it be necessary, we and the Bank of England will put in place arrangements that guarantee all the existing deposit arrangements" at Northern Rock.

So apparently unconditional and potentially unlimited government guarantees are in place in other markets.