Is Your Bank Safe?

The uncertainties in the global financial markets have reached a dramatic climax in September. Venerable names in investment banking and insurance have collapsed. The UK has also seen several banks flounder, leading the government decided to nationalise four giant banks including Halifax Bank of Scotland (HBOS).

With giant companies in banking and insurance collapsing all over the place, you might be wondering if your bank is safe. Should you be worried?

You can look at two aspects of the situation.

The Condition of Australian Banks

The Australian Prudential Regulatory Authority (APRA) is one of the most stringent financial regulatory authorities in the world. It has set policies that induce Australian banks to be prudent and to adopt conservative approaches to lending and investments.

A very important result from this careful regulation is that Australian banks did not share the fervour of many banks in the US and Europe to buy mortgage-backed securities. For a while, these investments were very profitable but they were also anchored on shaky foundations: subprime mortgages, which are loans to people with relatively weaker credit ratings.

Subprime mortgages are at the very core of the current financial crisis. Australian banks have been fortunate not to have invested heavily in the securities backed by these mortgages. This only means there is very little chance that any of them will lose money in the enormous amounts you are seeing in the US and UK today.

The result of careful regulation has been solid balance sheets among banks which fall under the oversight authority of APRA, financial positions made robust by safe investments and performing loan assets.

While the banks remain fundamentally strong, what may be affected is liquidity or the availability of cash or near-cash assets (such as short-term borrowings from the money markets). Liquidity is important because it is what allows you and businesses to borrow money for your personal needs and for their working capital.

There has been a sharp spike in the cost of borrowing in the international credit market. It is now more expensive for banks all over the world to borrow money from each other, and this will undoubtedly have an impact on Australian banks.

The decision of the Reserve Bank of Australia on the official interest rate will have important bearing on domestic borrowing costs. The government has set up a short-term deposit facility to infuse liquidity into the banking system. It can well afford to do so because Australia is one of the few countries where the government does not have much debt. There is a considerable amount of budget surplus.

The Status Of Your Deposits

On the slim chance that a bank should fail, what would happen to deposits?

The Australian banking system does not have any deposit insurance at the moment. If a bank failed today, the deposit holders would have to wait until its assets are liquidated and line up in a queue to claim their share of the cash. Note that the procedure is to pay off the largest accounts first, so small customers will be at the tail-end.

New legislation has been proposed that would establish a Financial Claims Scheme, which would give back up to $20,000 per individual for deposits held in all deposit-taking institutions. This will exclude superannuation funds and deposits at banks not regulated by APRA. This means about 80 per cent of all deposits will be immediately paid back — no need to wait in line.

If your bank is APRA-regulated, this proposed deposit insurance scheme will give you more certainty. In any case, you can take comfort in the strength of Australia’s well-regulated banking system.

Disclaimer:

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