29th October 2013
People often fail to remember that a bank deposit is little more than a loan that you make to the bank.
That is, you lend the bank some of your money with the expectation that you will get it back with interest sometime in the future.
The banks then use the money that they borrow from you (the depositor) in order to lend it out again (in the form of loans) to businesses and other people hoping that they will repay the bank with interest sometime in the future. One of the ways banks make money is by borrowing money from you (i.e. your deposits) and then taking ‘risk’ with that money by lending it out to try and earn a higher interest rate return above the interest rate they need to pay you on your deposits.
The banks also use the money borrowed from you in order to finance other activities that they pursue (besides traditional lending) in order to try and make a profit. Banks typically raise money to fund their business in two main ways:
(1) they borrow money from people and institutions in the form of deposits and bonds (a bond is basically a standardised loan that the bank is given from its investors),
(2) they raise equity capital from shareholders usually on the share market.
The Difference between a ‘Bail-out’ and a ‘Bail-in’
“A bail-out is when outside investors rescue a borrower by injecting money to help service a debt. Bail-outs of failing banks in Greece, Portugal and Iceland were primarily financed by taxpayers.
By contrast, a bail-in, a term first popularised in the pages of The Economist, forces the borrower’s creditors to bear some of the burden by having part of the debt they are owed written off. (In the case of Cyprus, the creditors in question were bondholders, and depositors with more than €100,000 in their accounts.)
…But one thing is clear: bail-outs will now be accompanied by bail-ins. All-encompassing rescues are becoming a thing of the past.”
…The Economist, 7th April 2013 (link)
We now live in a world where deposits in banks have been deliberately raided in order to pay for the troubles of banks and/or the countries they are in… and if you think such things can only happen in Europe – e.g. in Cyprus over the last 12 months depositors lost up to 47.5% of the cash deposits they had in the bank – then you would be surprised to be informed that the legislative frameworks and policy pressures are being established in more and more countries around the world. From this perspective, Cyprus would have appeared to have been a ‘test run’.
Although still in its infancy, even in Australia and New Zealand we are seeing the early stages of similar policy frameworks being drafted and legislative capabilities progressing in these directions.
Countries around the world have been either bringing measures into legislation or preparing the way for it that include ‘bail-in’ provisions to address a possible future banking crisis or similar.
As far back as 2010, G20 leaders (which includes Australia’s Finance Minister and Central Bank Governor) agreed to work towards implementing frameworks in their respective countries that enable the bailing out of banks using depositor’s money. It appears that they have been working towards this objective ever since.
Australian Prudential Regulation Authority (APRA) Budget Statements
“In 2013-2014, APRA’s main strategic objectives are to:
- …
- consolidate the prudential framework by enhancing prudential standards where appropriate, in line with the global reform initiatives outlined by the G20 and overseen by the Financial Stability Board;
- …”
…page 134, Portfolio Budget Statements, APRA, Australian Government Budget 2013-14.
The world after the 2008 GFC is changing in more ways than people realise. Should we undergo another crisis of similar or greater magnitude to the GFC, then the simple term deposit at the bank may not be as safe as it once was.
But aren’t Deposits up to $250,000 in Australian Banks insured by the Government?
Trying to find a ‘free lunch’ in life has always proven an elusive endeavour…
There is no doubt that the guarantee… has facilitated the stampede into term deposits.
…But the question is whether the stampede would be slowed if bank customers read the fine print of the guarantee.
How many of them would know, for example, that the standing appropriation to meet any initial payout of deposits is limited to $20 billion per failed bank?
It might seem like a lot, but it pales when compared to about $200bn in eligible deposits for each major bank.
…The Australian, 14th March 2012, ‘Limited Guarantee Fuelling Deposit War’ By Richard Gluyas
What can you do to protect yourself from this growing trend?
Clearly, there are more issues at play here than can be covered by a simple blog article, but nonetheless the world continues to change at a rapid pace and the directions it is heading in are not very reassuring with regards to the long-term safety of our cash deposits at the bank.
Navigating such a world places a premium on good advice, knowledge and broad awareness of what is going on. If you are not willing to thoroughly educate yourself as to these things, then make sure you have capable advisors and well-informed professionals in your world that understand the issues at play. There are contingency strategies that an investor can undertake should the risks of bank deposit confiscation ever escalate in this country – however the nature of the strategies that can possibly be pursued will vary immensely in relation to the context of events that are unfolding.
The following is a recent comment made by a Chief Investment Officer and Chairman of a large investment company in the US, we find it is quite a pertinent closing thought on this issue…
“We are sensitive to credit risk. If we think there is trouble, we want to run fast. The idea is that pressured governments cannot rely on other governments to bail them out. The bailout era, with tons of money thrown precipitously at problems, seems to be drawing to a close. The difference between “bailout” and “bail-in” is a shift of responsibility. Lehman-AIG triggered a bailout. In the next round of trouble, bail-in will mean that risks have risen for the investor. The investor has to perform the risk management now, because the government will not save him or her from the errors that our system is prone to repeat.”
…David R. Kotok, 22nd October 2013
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