THE recent collapse of two US banks and the almost collapse of Swiss bank Credit Suisse have shown how quickly things can get out of hand. These crashes happened so fast because withdrawal of deposits is now a mouse click away.
There was a run on these three banks, and the difference with the traditional bank run was that it happened, literally, with the speed of light. It happened online.
What does this mean for Australian pensioners and retirees with money in the bank?
The Australian bank deposit guarantee
The federal Government’s guarantee on bank deposits offers reassurance. This means that the Government will pay up to $250,000 per account-holder per authorised deposit-taking institution (bank, building society or credit union). If an Australian bank collapses, that’s what the Government will pay individual account holders.
While this guarantee is adequate for most depositors, there are retirees who have more in the bank. They are, of course, well-advised to open accounts with other institutions, so that they do not have deposits exceeding $250,000 with any one institution.
Banks impose daily withdrawal limits on their customers, and this offers some protection against a bank run, or at least the speed with which it happens. But businesses and certainly big business do not necessarily have low daily withdrawal limits. And as the case of Silicon Valley Bank shows, depositors frantically clicked to try and withdraw $US42 billion on a single day. It meant the end of Silicon Valley Bank.
An unlimited guarantee is applied
The US federal Government also provides a $250,000 guarantee (in US dollars, obviously) but this did not prevent the run on Silicon Valley Bank. There were too many depositors with balances higher than US$250,000.
Similarly, Swiss bank Credit Suisse suffered a digital deposit run. This one was triggered by hedge funds. These hedge funds had borrowed bank securities, sold them and were hoping to buy them back for cheaper, thus making a tidy profit.
In the event of the run on Silicon Valley Bank, the US Government extended its bank deposit guarantee to unlimited. No matter how big the deposit, the US Government would guarantee it. Unfortunately, this came too late for Silicon Valley Bank.
The Swiss Government went about it another way. It gave Credit Suisse and related entities 150 billion Swiss francs of cheap loans and a 9 billion Swiss francs guarantee to the bank who took over Credit Suisse for any future losses. In the process, Credit Suisse shareholders lost 90 per cent of their money (deposit holders were fine).
Clearly, extending government bank guarantees to cover any size deposit is an effective and, on-the-face-of-it, cheaper solution.
The German Government certainly thought so, because it did just that when it got a whiff of trouble involving hedge banks targeting Deutsche Bank. It stopped hedge funds in their tracks.
The problem with unlimited bank deposit guarantees
Unlimited bank deposit guarantees can be problematic in their own right.
To start with, they are a form of insurance benefitting financial institutions. It’s insurance provided by the taxpayer. While unlimited guarantees are effective against bank runs, there are plausible scenarios where they would be triggered. In other words, like any type of insurance it should attract a premium, payable by financial institutions (who pass on the cost to their customers).
There is also the issue of moral hazard. Banks could think they can do whatever they feel like and write risky loans in the knowledge that if things go wrong, government will bail them out.
The question is, what would the insurance premium be for unlimited bank deposit guarantees? To be realistic and cover banks going belly-up, it would have to be in the stratosphere, that is, unaffordable. The question is: isn’t an unlimited bank deposit guarantee just a bluff, something that could not possibly be honoured in a real crisis involving all banks?
Perhaps, that’s why the Swiss Government didn’t go down the road of unlimited bank deposit guarantees, and why the German Government only applied a one-off unlimited guarantee for Deutsche Bank.
What does it mean for Australian pensioners and superannuants
Those Australian retirees fortunate to have more than $250,000 in the bank should keep spreading their risk over as many financial institutions as it takes. There’s no unlimited bank deposit guarantee on the Australian horizon, so having multiple $250,000 guarantees in place is the next best thing.