A flood of criticism that broke the levy

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BY Dr Andy Schmulow (Principal, Clarity PRC Pty Ltd, Visiting Researcher, Oliver Schreiner School of Law, University of the Witwatersrand, and CIFR researcher) and Dr Pat McConnell (Honorary Fellow, Centre for Applied Finance, Macquarie University)

The Federal government announced this week that it will not proceed to introduce a deposit levy on Australian bank customers. Just as well. As ideas go it was both ill-advised and unnecessary. 

 First of all, Australia does not have a high rate of savings (http://www.afrsmartinvestor.com.au/p/market-intelligence/the_illusion_of_saving_zRhaQ2nfLpABaDUEr4CB4N). Taxing savings is hardly sending the correct message, therefore. And especially from a government whose core philosophies are belt-tightening, paying off debts, and living within our means. In fact as messages go, this one was to be deeply counter-productive. 

 Secondly, it was not needed. Not even for its stated purpose of funding a depositor bail-out fund. Australian depositors will not, in all likelihood, need taxpayers to bail them out in the event that an Australian bank becomes insolvent, and for two reasons.

A good starting point is the Banking Act of 1959, in particular s 13A, which provides that in the event of insolvency, an Australian bank (referred to as an authorised deposit taking institution, or ADI) is required to reimburse Australian “protected” depositors before settling claims by international creditors or offshore depositors.

Section 4 of the Act defines a protected account as:

An account, or covered financial product, that is kept under an agreement between the account-holder and the ADI requiring the ADI to pay the account-holder, on demand by the account-holder or at a time agreed by them, the net credit balance of the account or covered financial product at the time of the demand or the agreed time (as appropriate).

Effectively therefore, protected accounts are all demand deposits. That is to say, deposits where the owner of the funds can withdraw their funds at any time.

The University of Melbourne’s Professor Kevin Davis has run the numbers, and his findings are that in the event of insolvency, no Australian bank would be so bankrupt that it would not, at least, be able to reimburse Australian depositors.

If Australian depositors are protected as preferential creditors (which they are), and if at current capital adequacy levels no Australian bank would be unable to refund domestic depositors, then the obvious question is why did we need this levy?

Next, the notion that this is some kind of “user pays” scheme is disingenuous. Today in Australia it is almost impossible to exist, in any meaningful economic sense, without a bank account.

That means any deposit into an account in any of the big four – drawing a wage or conducting any kind of business – would have been covered by this levy. So as nets go, this one would have caught something like 80% of all deposits.

In theory, the monies collected by the levy would have been held in (that is, hypothecated to) a new entity, the Financial Stability Fund (FSF). Other than its name, little was known about this new fund. It was obviously meant to be a long-term mechanism as it would take many years - the exact timing being dependent on the levy rate chosen - before the fund would cover even a small percentage of potential pay-outs to depositors.

However, the fund was not designed to cover all pay-outs to depositors in the event of a bank failing, but only any amounts not recovered by other means. Calculating the size of the levy was always going to be problematic and would have to have taken account of other measures, particularly the amount of capital that banks hold.

In suggesting that a so-called “ex-ante” levy be introduced to promote financial stability, the IMF also recommended that additional capital, in the form of so-called Higher Loss Absorbency (HLA), be required for “systemic” banks (which in the case of Australia would be the Four Pillars).

This recommendation has been accepted by banking regulator APRA and, from January 2016, the big four banks will be required to hold an additional 1% HLA capital buffer. This additional 1% capital, which APRA admits is at the low end of international levels, must be met through so-called Tier 1 Equity capital, which helps to explain the current capital raising efforts of the banks and the negative impact on their share-prices.

Since it is expected that a bank’s capital should be sufficient to withstand all but the most severe shocks, it is a moot point whether the belt-and-braces approach of collecting an additional levy would have added much towards ensuring financial stability. As it was not known how much of a buffer the new levy would actually provide over time, and no mechanism was created to manage the monies collected, the decision to go ahead with the levy appeared to be a path of least resistance (blame it on the previous government) rather than well-considered public policy.

In particular, the use of a fixed levy (of the order of 0.05% of deposits) was not in line with international experience, where a risk-adjusted fee is often used, and may have been more appropriate to the Australian banking system.

The Murray inquiry went so far as to reject the idea of a deposit levy in favour of requiring Australian banks to be “unquestionably strong” and in the top tier of international banks as regards capital. 

It appears that by cherry picking recommendations from the IMF and the Murray inquiry, the government was in danger of increasing the costs of banking in Australia without improving the stability of the system. Who would have guessed? 

In light of the lack of necessity of the scheme, why did the Abbott government not abandon it sooner? Could it be that it was tipped to raise $500 million a year in extra revenue? In which case, the jettisoning of this scheme is not to be lamented. It was not needed for a stronger banking sector. It certainly was not needed for depositor protection. It would not have added to the competitiveness of our banks. It was simply a revenue grab. Nothing more. 

What is worth discussing though, is an emergency liquidity fund to refund depositors immediately, in the event of bank insolvency - purely to dampen depositor panic cum contagion. What would be even more helpful would be creating such a fund with a levy that is risk-of-insolvency sensitive. In other words, a levy that goes up and down as the risk of a bank’s insolvency goes up or down. 

But wouldn’t that bring us back to where we were at the beginning of this piece? Taxing savings? The answer is yes and no. If the premium payable fluctuates with risk, then the cost (tax) to depositors fluctuates. Depositors can then vote with their feet, and bring down the cost to themselves of the levy, while at the same time alternatively rewarding and punishing well and badly behaved banks.

Well behaved banks would benefit from an influx of depositors, which would drive down the cost of their finance. Possibly the surest fire way of driving home to banks, and to their customers, that higher risk involves a discernible, immediate cost.

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