How to Protect Your Cash Deposits in Case of a Bail-In

Rating agency Moody’s has voiced concerns about Australian banks lending money out faster than they take in deposits.

According to Moody’s, ‘The gap between loans issued and deposits across the banking sector grew by $34 billion between December and July to hit $497 billion.

The debt demand is largely being driven by our Aussie love affair with all things property — especially in Sydney and Melbourne.

If this trend continues (debt outstripping deposits), the banks have to rely more heavily on international wholesale funding markets to fund the shortfall.

The GFC showed us how flighty international funding markets could be when push comes to shove. Moody’s concern is that the more our banks become beholden to international markets, the greater the (nasty) repercussions could be if (or when) we experience another GFC type event.

With our banks increasing their exposure to international wholesale funding, will they be able to withstand a GFC MkII without relying on further government guarantees or worse still a ‘bail-in’?

A few weeks ago, I received this email in response to my Daily Reckoning articles on the possibility of a 90% fall in global share markets:

Hello Vern

You recent articles are very timely. Your estimate of a possible 90% fall in the markets does not surprise me.

Bob Prechter of the Elliott Wave Institute has recently given his preliminary estimate as 80%. It could well turn out to be worse.

In the Wednesday article where you showed how difficult it is to recover from a big loss you made the statement – Every 10% of losses requires an exponentially higher gain to recover.

The formula for your table is y = (100 x) / (100 – x) Where x is the percentage loss and y is the percentage gain required to recover.

This is not exponential. An exponential formula is of the type y = kx The compound interest formula is an example. Furthermore, an exponential increase need not necessarily be large. In everyday speech people use exponential in place of large but this usage is out of place in the context of mathematical calculations.

Enough of the fun stuff and back to serious business.

You are cashed up and feeling virtuous. Where do you keep your money?

In a bank? What if the housing bubble collapse causes the bank to fail?

Ah but you have a government guarantee up to $250,000.

What if the government finds the magnitude of bank failures becomes so great that it reduces the guarantee to say $50,000?

OK so the bank doesn’t fail and you are hanging on, waiting for the bottom of the depression and the money disappears?

The thieving government has declared the account to be inactive and confiscated the money.

(Warning to Kiwis. There is no government guarantee for bank deposits in NZ. If a bank gets into trouble the NZ Reserve Bank may authorise the failing bank to raid up to 100% of deposits to stay afloat.)

What if you take it out in cash. Where would you store it safe from loss by theft or fire?

In a safety deposit box? See above on government confiscation.

What if you put it in government bonds?

It is unlikely that the government would renege on its debts, but, it may declare that there is an emergency and that in the national interest bonds be not be paid out when they mature but rolled over. There you are at the bottom of the depression ready to make some killer deals and your money is locked up.

What if you put it into gold?

The price of gold falls when the stock market declines. Check what happened during the GFC. The coming depression will be deflationary which means that all asset values, including gold, will fall.

Vern, I need your advice. Where do I put my money?

Warren C

Thanks for the correction on ‘exponential’. Noted.

Warren’s concerns about how to secure your money during a once-in-a century market meltdown are well founded. When fear sets in, the tide goes out for all asset classes.

The theory is to be cashed up, ready to wade in and buy assets at never to be repeated discounted levels.

However, what happens if cash also gets swept out with the tide — like it did in Cyprus? Your brilliant strategy sinks like a stone.

For those who think the world has gone mad — negative interest rates, excessive money printing, record share markets, etc. — and there will be a day of reckoning, holding cash is the only option.

How do we protect our cash from bank confiscation (a bail-in)?

If you live in NZ (like Warren), you can’t. There’s no government safety net.

The Canadian government recently revealed plans to implement a bail-in regime.

The Murray Inquiry looked at protective measures for ‘too big to fail’ banks.

According to the Sydney Morning Herald:

The issue of bail-ins is already on the agenda for discussion at the G20 leaders’ summit in Brisbane in November when the Financial Stability Board, which co-ordinates global banking regulation, will put forward a regime for the world’s largest banks. Those rules won’t apply in Australia – instead it will be left to local regulators to work out how bail-in laws apply domestically.’

Why are governments talking about ‘bail-ins’ when supposedly the global economy is well on the road to full health? Do you think they might know just how fragile the financial foundations really are? You bet. Their actions speak much louder than their words.

Where does that leave investors with cash? Between a rock and a hard place.

The Australian government has given a guarantee for cash deposits up to $250,000.

The good news for our mates across the ditch is they can move their money into Aussie banks and be covered — with one proviso, they let us win the Bledisloe Cup.

All jokes aside, non-resident deposits (up to $250,000) are covered by the Australian Government Deposit Guarantee Scheme.

OK, so you’ve parked your money safely into an Aussie ADI (Approved Deposit Institution), but is your hard earned really safe if/when GFC MkII eventuates?

The answer is ‘nothing is 100% safe’.

All we can do as investors is make calculated decisions based on facts and then apply some common sense to those facts.

Here’re some facts on the Australian government’s deposit guarantee.

This is an extract from the Reserve Bank of Australia (RBA) website on how the government’s Financial Claims Scheme operates (emphasis mine):

Payouts of deposits covered under the FCS [Financial Claims Scheme] are initially financed by the Government through a standing appropriation of $20 billion per failed ADI (although it is possible that additional funds could be made available, if needed, subject to parliamentary approval). The amount paid out under the FCS, and expenses incurred by APRA in connection with the FCS, would then be recovered via a priority claim of the Government against the assets of the ADI in the liquidation process. If the amount realised is insufficient, the Government can recover the shortfall through a levy on the ADI industry.

Here is the link to the list of ADIs covered by the government guarantee:

Note, banks like St George (owned by Westpac) and Bank West (owned by CBA) are NOT on this list. Deposits in these banks are covered by the guarantee provided to their parent.

PLEASE NOTE: If you have $250,000 in Westpac and $250,000 in St George, ONLY ONE of those deposits is guaranteed. A little trick devil in the detail to be aware of.

Also, the guarantee is per taxable entity. Therefore, you could have $1 million with one institution split in four equal parts under the ownership of Smith Pty Ltd, Smith SMSF, and Mr Smith and Mrs Smith. Each of the owners is a taxpayer in their own right.

Back to the RBA statement. The initial (and possibly only) payout of deposits under the FCS is limited to $20 billion. The RBA statement does state that subject to parliamentary approval, additional funds could be made available. But this is not guaranteed.

Therefore, the major banks (CBA, NAB, Westpac, and ANZ) with deposit bases well in excess of $20 billion may or may not be fully guaranteed. It’s a risk. To minimise the risk, it’s suggested you spread your cash funds around the smaller ADIs that have deposit bases well below the $20 billion threshold.

The question is how safe are these smaller ADIs, credit unions, mutual building societies and mutual banks?

The following is an extract from the Customer Owned Banking Association website (emphasis mine):

Here’s the link:

All credit unions, mutual building societies and mutual banks are Authorised Deposit-taking Institutions (ADIs), and are regulated in the same way as all other Australian banks. They are regulated by the Australian Securities and Investment Commission (ASIC) under the Corporations Act 2001, and by the Australian Prudential Regulation Authority (APRA) under the Banking Act 1959.

All ADIs – that is, all Australian credit unions, mutual banks, mutual building societies and banks – meet the same strict, legally-enforceable standards, under the Banking Act and strict oversight by the Australian Prudential Regulation Authority (APRA). APRA’s strict rules on safety and capital continue to apply to all banks, building societies and credit unions to the same high standards.

Deposits in all ADIs of up to $250,000 were guaranteed by the Federal Government on a permanent basis from 1 February 2012.

There you have it. The small ADIs ‘meet the same strict, legally-enforceable standards, under the Banking Act and strict oversight by the Australian Prudential Regulation Authority (APRA).

Assuming APRA is on the ball (I admit this could be a big assumption), then the smaller institution’s books must be in reasonable order.

If they’re not, provided they have a deposit base less than $20 billion, the government has stated they will make your dollar (up to $250,000) whole.

If you are at the far end of the cynical scale, trusting the government is a leap of faith, but what else do you have?

The other risk for our Kiwi cousins is the currency risk: The Kiwi dollar could appreciate strongly against the Aussie dollar.

What am I doing? Spreading cash around a number of institutions (including small ones) to remain under the threshold and hoping the government will (if needed) make good on its word. This is a calculated risk, but after considering all other options, it’s the least of all evils (in my opinion).

Vern Gowdie+
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Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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