Chapter 3
The bill
Background - the Financial Claims Scheme
3.1
The Financial Claims Scheme, or 'deposit guarantee' as it is more
commonly known, has been the subject of a recent report by the Economics
References Committee.[1]
3.2
At present the Scheme offers a 'free' guarantee on all deposits up to $1 million.
There is an optional guarantee (under the 'Large Deposits Guarantee Scheme')
for larger deposits at a fee equivalent to that charged for the guarantee on
wholesale funding. However, this broad coverage reflects the extraordinary
circumstances of the current global financial crisis. The Government has
announced it will only operate until October 2011.
3.3
The scheme envisaged before the crisis struck, originally known as an
'early access facility', was to only apply to deposits up to $20,000.[2]
It has not yet been decided to what level of deposits the permanent scheme will
apply.
3.4
Such 'deposit insurance' schemes are common around the world. It has
been noted that:
An IMF survey has referred to average coverage levels in
(pre-crisis) deposit insurance schemes being around one to two times per capita
GDP... Given Australia's GDP of over $1 trillion and population of over 20
million, in round terms, one to two times per capita GDP would translate into a
range of $50 000 to $100 000 as a coverage limit.[3]
Should the banks face obligations in exchange for
the deposit guarantee?
3.5
It has been suggested that the bank funding guarantees provide a
substantial benefit to the banks at a potential cost to the public purse and
that it is therefore reasonable to expect the banks to provide something in
return. For example, the Finance Sector Union suggest:
...such conditions should include measures to safeguard
Australian jobs against practices such as off-shoring, maximise Australian employment,
lend responsibly and effectively to all market segments and require the
observation of social obligations ensuring that banks do not withdraw services
to disadvantaged communities or groups.[4]
3.6
Another example of a possible obligation is to accept some restraint on
their mortgage interest rates as envisaged by this bill.
3.7
On the other hand, the banks argue that no obligation should arise as
the deposit guarantee is underwritten by the banks collectively rather than
taxpayers.[5]
This is presumably a reference to the industry levy proposed for the original
financial claims scheme with the $20,000 cap.
3.8
Professor Sathye was the only witness to give (qualified) support to the
bill. However, he argued the requirements should be tied to the temporary
wholesale funding guarantee rather than to the ongoing Financial Claims Scheme:
...I support the bill where the public wholesale funding
guarantee is provided. This means that there needs to be a full pass-through of
the quantum of the OCR [official cash rate] reduction.[6]
Impact on monetary policy effectiveness
3.9
An argument for tying movements in bank lending rates to those in the
official interest rate is that it makes monetary policy more effective. The
bill would mean that the Reserve Bank would know that the movement it chooses
to make in its official rate will be fully reflected in the interest rate
affecting household spending decisions (although deposit rates which also
affect households' decisions to spend or save, credit card interest rates and
business loan rates would still not be tied to the official rate).
3.10
This is the basis for Professor Sathye's qualified support for the bill:
The OCR, the official cash rate, is reduced to push more
credit into the economy and raised to curb credit expansion. I would particularly
support the bill when the OCR is being reduced to kick-start the economy. When
banks do not do a full pass-through, the monetary policy, in my opinion, gets
stunted...[7]
3.11
However, Professor Sathye is less supportive of the bill in an
environment where the Reserve Bank is increasing interest rates, which most
commentators expect to be the case for the foreseeable future:
However if it is the other way around and the OCR [official
cash rate] is being raised in order to curb credit expansion in the market and
the banks end up trying to raise their lending rates above the OCR, then
probably the monetary policy objective is being achieved through the banks’ actions.... [when interest rates are rising the bill] is probably not very
desirable in the sense that we do not want to go to a system of prescribed
interest rates.[8]
3.12
Under section 18F a bank cutting mortgage interest rates in the
absence of a cut in official rates, or failing to pass on (in full) an increase
in official rates would not have to send an explanation to the treasurer, even
though this is also going against the policy intentions of the Reserve Bank.
3.13
The Reserve Bank itself does not seem particularly perturbed about banks
not always exactly following its movements in official interest rates.
...the banks’ overall funding costs have not come down quite as
much as the cash rate has, so the overall rates that they have to earn off the
whole portfolio of loans were not going to come down as much as the cash rate
did. Of course, we took account of that in deciding how far down to go on the
cash rate.[9]
Of course, in setting the cash rate, the Reserve Bank has
taken account of these shifting relationships, just as it does shifts in other
relationships in the monetary transmission mechanism.[10]
3.14
Home loan lenders believe the bill would not be helpful to monetary
policy as by requiring the treasurer's assent to some bank decisions it would
'politicise' interest rates:
The bill politicises interest rate setting by giving the
Treasurer the power to determine bank product prices through interest rate
control. This is a form of price control which is inconsistent with a market
based economy and has been rejected by the last two major inquiries into
Australia’s financial system, the Wallis inquiry in 1997 and the Campbell
inquiry in 1980. One of the reasons why the Campbell inquiry rejected price
control was that it ultimately proves unfair to low-income earners.
Politicisation of interest rate setting is inconsistent with sound monetary
policy, whereby it is recognised that interest rate setting should be
independent of the political arm of government. This is why the government has
exchanged letters with the Reserve Bank assuring the central bank that it
should act independently in setting official interest rates. The same principle
should apply to retail rates.[11]
Price intervention in response to a highly political and
public issue will compromise the Reserve Bank’s ability to act independently
and sets a very dangerous precedent for the wider community. It has always been
government policy that interest rates are set independent of government. We do
not support government intervention in rate setting in the manner proposed in
the Bill.[12]
Coverage and definitions in the bill
3.15
The bill only covers standard variable rate mortgages, which are the
majority of home loans. It would have caused a problem if it also referred to
the rate charged on new fixed rate mortgages as these rates are generally set
based on deposit rates of a corresponding maturity, which reflect the expected
official rates over the term, rather than the current official rates.
3.16
The bill uses the term "bank" to refer to 'an authorised
deposit-taking institution to which Division 2AAA applies'. As their industry
body, Abacus, notes, this means it covers building societies and credit unions
as well as banks.[13]
This could prove an administrative problem if a large number of credit unions
wanted to move rates around the same time (in the absence of a move in official
interest rates) as there are over 100 credit unions.
3.17
Under section 18D, 'movements in official interest rates' are those
announced 'following meetings of the Reserve Bank board'. It might be argued
that the bill would not apply to cases where the board had given the Governor
limited discretion to act between meetings, or decisions were taken by a more
informal contact between board members.
3.18
Under section 18F, the bill applies to three cases;
- a bank not making a corresponding cut to its mortgage rate
(within five business days) when the Reserve Bank cuts the official rate[14];
- a bank increasing its mortgage rate when the Reserve Bank has not
moved the official rate; and
-
a bank increasing its mortgage rate by more than the Reserve Bank
has increased its official rate.
3.19
The bill is unclear whether a bank making such a move must automatically
send an explanation to the treasurer (as implied by s18B(2)(b) ) or whether it
is up to the treasurer to request in writing such an explanation (as implied by
s18G(1) ).
3.20
If the bank fails to provide a satisfactory explanation to the
treasurer, the treasurer can tell the bank to set its mortgage rate at a
different level and/or declare that the bank's decision is 'contrary to the
public interest'. This term has been criticised by a submitter:
I find the term public interest too vague and that it will
give ample occasion for greediness to find a way through.[15]
3.21
If the bank fails to comply with the treasurer's direction, then the
treasurer can determine that the Financial Claims Scheme will cease to apply to
that bank. (The treasurer can later revoke such a determination.)
3.22
It is not clear whether this would mean that the Scheme would not apply
to new deposits or also to existing deposits. It may be argued that it is
unfair to depositors that have placed funds in a term deposit on the understanding
that they would be covered for that guarantee to be withdrawn before the
deposit matures. It could also undermine the aim of the scheme which is to
support confidence in bank deposits:
...when you give a guarantee and then you withdraw the guarantee,
the decision of the investor who invested the money at the time when the
guarantee was in place is now affected because of the withdrawal of the
guarantee. The investor will not know at the time when he invests the money how
the bank will comply with the requirements of the government. Another thing
that can happen is that it will impact the fundraising by other banks, because
investors may then be wary as they may not know whether these banks will also
be complying with the government rules or not and whether there is a risk of
the guarantee being withdrawn. So in my opinion this is likely to affect the
investor decisions. And from that perspective I feel that, instead of giving
the signal to the market, it is always useful to keep it internal and impose a
financial penalty rather than a withdrawal of the guarantee itself.[16]
3.23
It is also unclear whether the bill applies to deposits of over $1
million, for which a fee is being paid for the guarantee. Professor Sathye has
commented that the reference to 'funds' in s18B(1) of the bill needs to be
clarified.[17]
Is the penalty credible?
3.24
Doubts have been raised about whether removing the deposit guarantee
from a bank is a credible threat:
Such a power in my opinion would be hard to exercise in
practice. Withdrawal of deposit guarantee for whatever reason would result in a
run on that financial institution which the government could ill afford. A bank
may not set mortgage interest rates in line with the official cash rate
as it knows that the government can’t revoke guarantee due to financial
stability considerations. The proposed Amendment then is ineffective and is
only a paper tiger![18]
3.25
As the Professor argues, the withdrawal of the guarantee from one bank
may remove the confidence-inspiring effect of the guarantee on other banks. He
suggests as an alternative:
An alternative could be to insert a penalty provision which
could require erring banks to pay to the government a penalty equivalent to
(official cash rate minus the actual rate charged by the bank) multiplied by
the total loans and advances outstanding.[19]
Impact on banks' rate setting
3.26
It is possible that the bill could discourage lenders cutting mortgage
interest rates in the absence of a cut in official rates, as the bill would
prevent them later (even partially) reversing such decreases. Similarly, the
bill may discourage a lender refraining from passing on (in full) an increase
in official rates, as if they leave it more than five days the bill would not
allow them to 'catch up'.
Mutual ADIs have frequently reduced their interest rates
outside of changes to the RBA cash rate for the benefit of their members. This
Bill would place pressure on institutions to limit their mortgage rate changes
to movements in the cash rate – this would not necessarily be of benefit to
consumers.[20]
3.27
Home mortgages amount to about half of banks' loans. If banks are
restricted from raising interest rates on these loans, it might be argued this
would put upward pressure on interest rates on personal and business loans:
The proposed Bill applies only to mortgage rates and
therefore poses the risk that other forms of credit will become more expensive
or that fees will rise. Younger people, who rely on personal loans and credit
card debt, will find themselves subsidising those who hold a mortgage; a poor
outcome for consumers.[21]
3.28
Alternatively, there is a risk that the bill will make mortgage lending
less profitable than other forms of lending and so lead to a return to the
credit rationing that occurred when interest rates were heavily regulated in
the 1950s and 1960s. There were also 'hidden charges' such as banks only
lending to customers who had shown 'loyalty' (some would say 'fealty') by
placing funds for a long period in low-interest deposit accounts:
The Australian financial market was substantially deregulated
in the 1980s. Before this the interest rate which a bank could charge for a
home loan was controlled. Quantitative lending controls placed ceilings on
interest rates that could be charged to borrowers. In this period, access to housing
finance for many consumers was limited. The regulatory restrictions on the
price of credit caused a restricted credit supply. As a result, only customers
with a very good credit record and high income or savings were able to obtain a
home loan without needing to resort to supplementary forms of finance.[22]
3.29
When the ABA appeared at the hearing, they referred to the Campbell
inquiry, which found that interest rate controls disadvantaged low-income
earners:
...if you have a control and you are restricting the bank in
recovering costs then the bank looks for other ways to cover those costs, such
as doing more business with those who have got high levels of collateral or who
have got higher offsetting balances in deposit accounts. These tend to be
people who are wealthier.[23]
Confidentiality of bank affairs
3.30
Under section 18I of the bill, the treasurer can require APRA, ASIC or
the Reserve Bank to provide information 'including a matter relating to the
affairs of a bank'. This could involve the disclosure of commercial-in-confidence
information.
Committee's conclusions
3.31
The committee is not convinced of the merits of the bill. In particular,
it is concerned that the bill may discourage banks from competing in reducing
interest rates, could lead to higher bank fees and/or reduced lending to
homebuyers, could raise doubts about the deposit guarantees and so reduce
confidence in the safety of bank deposits and could be perceived as
politicising the setting of bank interest rates.
3.32
The goal of increasing the accountability of banks could be better
achieved by increasing information as addressed in the first recommendation.
The goal of discouraging banks from unduly increasing interest rate margins at
the expense of homebuyers can be better achieved by measures to make the market
more competitive, such as the recent initiative by the Government to facilitate
customers moving between banks.
Recommendation 2
3.33 The Committee recommends that the Senate not pass the bill.
Senator Annette Hurley
Chair
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