Money & Capital Markets - Deposit and Wholesale Funding - Dissertation Example

Money & Capital Markets - deposit and wholesale funding guarantee schemes Executive Summary The present work is an attempt to capture the features and the purpose of incorporating wholesale funding and deposit guarantee schemes in the economies of Australia and New Zealand. The backdrop of implementing such schemes is the global financial meltdown which resulted to a worldwide crash of the financial community. The basis of the crisis was the loss of faith which people initially had on the mechanism of the financial sector. There were massive withdrawals and large scale capital flight from the financial centres of the world. Australia and New Zealand consider wholesale funding and demand deposits as the primary source of financing various national projects. The two economies, to avoid such mass pessimism, decided to implement guarantee schemes which would make the respective governments the guarantors of people’s money deposited in the above two forms. The scheme that the nations had replicated from many European nations, apparently gained a wide popularity. Though critics point out to the scheme’s probable failure in the longer run, it hasn’t shown any such adverse effects hitherto and is expected to bestow a positive impact. Table of Contents Table of Contents 3 Introduction 4 The Liabilities Guarantee Schemes 5 Purpose of the deposit and wholesale funding guarantee schemes 5 Features of the deposit and wholesale funding guarantee schemes 7 Conclusion 10 Appendix 12 Trends in the Economic Growth Rates of Australia and New Zealand, prior and post implementation of the Guarantee Schemes 12 12 Trends in the Change in Liquidity positions of Australia and New Zealand 12 12 References 13 International Monetary Fund (2009) Australia: 2009 Article IV Consultation - Staff Report; and Public Information Notice on the Executive Board Discussion. Washington, D.C., USA: IMF Publications. 13 Swan, W. (November 25, 2008) “Guarantee Scheme for Large Deposits and Wholesale Funding Appropriation Bill 2008: Second Reading Speech”, Canberra [Online]. Available at (Accessed: April 28, 2010). 13 The Treasury of Australian Government (2008) “Australian Government’s 2008 Deposit and Wholesale Funding Guarantees: Design and Operational Parameters” [Online]. Available at < http://www.treasury.gov.au/documents/1431/PDF/Design_and_operational_parameters_281008.pdf> (Accessed: April 28, 2010). 13 Bibliography 14 International Monetary Fund (November, 2008) Regional Economic Outlook: Asia and Pacific. IMF Publications. 14 OECD (2008) OECD Economic Outlook, Volume 2008, Issue 2. OECD Publishing. 14 OECD (2009) OECD Economic Surveys: New Zealand 2009, Vol. 4. OECD Publishing. 14 United Nations (2009) Economic and social survey of Asia and the Pacific; 2009: addressing triple threats to development. United Nations Publications. 14 Introduction Soon after the worldwide panic, financial turmoil struck the globe. Various economies flurried around to guard and hedge themselves against any potential impact of the same. Two such instances could be found in the economies of Australia and New Zealand, who have been acquiring liabilities in the form of demand deposits and wholesale funding since a long time. Accepting such deposits happened to be one of the prime sources of financing national interests and hence, the basis of investment. With the global financial system under pressure, there were little chances of attracting a continual flow of such resources and furthermore, the domestic financial systems were at the verge of facing a massive withdrawal move. News about the collapse of Lehman Brothers a few days back, added to the already burgeoning threat of an upcoming financial crash. Amidst such chaotic scenario, the Australian and the New Zealand governments thought it would be best to implement measures which could at least assure the people about economic stability in the respective nations. Hence, the domestic administrative bodies of the two countries followed the examples set by some of their European counterparts, in introducing guarantee schemes to monetary deposits. These schemes held the national governments as the guarantors of the liabilities held in the form of deposits in authorised deposit-taking institutions (ADI’s) incorporated in each of the two individual nations, irrespective of their origins (The Australian Government, 2008). The present paper is an attempt to summarise the ultimate objectives of the decision-makers while setting the liabilities guarantee schemes and the innate features of the same. The latter portion will figure out the actual targets of the proposal, as well as adjudge whether the schemes had really been beneficial to the economy or not. The Liabilities Guarantee Schemes The schemes, announced by the end of 2008, were meant for the protection of national interests in the two nations and thus, were imposed on every authorised deposit-taking institution (ADI) regardless of their country of origin. In fact, these modifications were also enforced in foreign subsidiaries of domestic financial institutions, to make people believe in the steady situation at home. To be exact, the rules though meant to ensure the smooth functioning of the ADI’s, were obligated upon all other sectors affiliated under the national prudential rules of the two nations. According to the rules, while the deposits and debt instruments worth AUD 1 million and less came free of cost, those valued above it were charged a nominal amount for the service. The nature of protection were, nonetheless, more complicated than what is presented in the present work and depended upon the amount of money involved. Since the scheme was meant to restore normality in the mode of financing, the activities of all institutions requiring hefty initial capital funding had also been attempted to be shielded. Examples of such institutions are domestically owned banks, foreign subsidiaries incorporated to the domestic nation, building societies, credit unions, etc (Australian Government, 2008). Purpose of the deposit and wholesale funding guarantee schemes As it emerged, the deposit and wholesale funding guarantee schemes were broadly introduced to help mitigate the economy-wide misgivings about an inevitable financial crash. They were aimed at maintaining stability in economic operations and assuring the bank customers about the security of their hard-earned money. Hence, the key objectives which operated underneath such schemes could be underlined as follows. 1. Triggering faith in economic activities among the people The primary purpose had been to instil or rather replenish the lost faith in the minds of the people about the financial stability of the concerned nations. The panic following the financial crash, suffered by the US monetary system, had mushroomed throughout world and instigated many to act emotionally. With many big names succumbing to the economic catastrophe, people grew dubious about their financial security. The middle-class populace throughout the world had voraciously started to withdraw their hard-earned money before they received bankruptcy notice from their respective banks, which they believed would reach their doors sooner or later. On the other hand, the financial institutions which had managed to stay afloat during the situation declined to sanction loans fearing a similar fate. Thus, economies were entangled in nothing less than a dilemma with a dwindling domestic reserve and inaccessible foreign reserves; literally, there were no way-out visible to start off with new ventures and support the piteous economic state. It was then that the national governments of some of the European nations came up with the idea of guaranteeing the money saved in demand deposits and of the wholesale debts being appealed for. With the administrative bodies acting as guarantors, there was little suspicion left in the minds of the people about the safety of their money. Australia and New Zealand, after witnessing the success of the scheme in the West, undertook such measures expecting optimistic changes in the national economic outlook in their respective economies too. The national governments of the two nations hoped that such moves would signal a robust economy to the nationals as well as outsiders. 2. Restoring liquidity and economic stability With people widely disapproving of the global economic situation and backing off from making new investments, the impact of the crisis seemed to be never-ending. There was an urgent need to restore liquidity in the nations to avoid an upcoming recession. Having proposed guarantee schemes, the governments tried to coax the nationals to carry on with their regular financial activities, namely, savings and borrowings with the ADI’s. A widespread concern was raised among people on the probable consequences of acting on sentiments. It was meant to relatively escalate the national situations in Australia and New Zealand above all others (Swan, 2008). 3. Attracting greater amounts of funds The global economic situation was in the middle of a crisis with massive capital flights from every corner of the world. The investors, having withdrawn their resources from dubious projects, were seeking proper grounds for investment and hence restore their lost opportunities. The time seemed ripe enough to attract prospective investors, but it was necessary to assure them of the safety of their money first. Moreover, it was also necessary to implement these schemes as soon as possible, i.e., prior to such measures being taken by other nations. That is why the Australian and New Zealand governments came up with the idea of acting as guarantors for the depositors and creditors and decided to enforce them as early as October 2008 (Goodman, 2009). The purpose of these schemes was to shove the economies towards the paths of economic growth and development once more. In fact, the objectives of the national governing bodies were served as well given that there was a sudden rise in the amounts of wholesale funding and demand deposits being received by the authorised demand-taking institutions, following the implementation of the proposals. Australia alone raised AUD 140 billion in the form of long-term wholesale funding and AUD 400 billion in short-term funding, within seven months of the policy declarations (International Monetary Fund, 2009). Features of the deposit and wholesale funding guarantee schemes Having illustrated the purposes of the guarantee schemes, it is now important to brief about the contents or rather the features of the same. These schemes were aimed at providing protection to the funds at disposal of the ADI’s. But, there existed variations in the extent as well as in the nature of these protections, which have been discussed in the following paragraphs. 1. The deposits and wholesale funding guarantee schemes in Australia and New Zealand were implemented in the month of October of 2008 just after the explosion of the US house bubble shook the roots of the global financial system. 2. These schemes were aimed at restoring the credit crunch situation being faced by the concerned nations following the crisis. The prime target was to revive the lost faith of the mass and instigate them to carry on with their normal financial operations. 3. Demand deposits and wholesale funding apparently seemed to be two of the structural modes of financing investment ventures in Australia and New Zealand and hence, the respective governments figured it as their utmost priority to protect the channels of the same. With a tumultuous financial situation as a backdrop, there were no other feasible way-out left for the governing bodies other than to hold themselves as guarantors to people’s money. This could at least restore confidence in the minds of people and dissuade them from withdrawing. 4. The scheme meant for the protection of the wholesale funding was slightly different from the one focusing on protection of the demand deposits. However, they were targeted towards the authorised deposit-taking institutions only. These institutions included domestic banks, foreign banks with domestic branches, credit unions, building societies, etc. In short, the list identified by the governments, included all such bodies which needed a continued flow of money into their businesses. 5. The wholesale funding guarantee scheme was featured by the following characteristics These schemes were restricted upon the securities being issued by the authorised deposit-taking institutions only. The securities with a term of 60 months and less were considered as eligible for the guarantee. Nature of the guarantee was to protect the interests of the creditors throughout the entire term of the security and furthermore, till the closure of the securities or until the issuance of new ones. The guarantee was meant to hedge the unstructured debt instruments rather than the structured ones. The guarantee could be enacted for securities issued in any one of the following currencies, namely, Australian Dollar (AUD), New Zealand Dollar (NZD), Euro, United States Dollar (USD), Yen and Hong Kong Dollar (HKD). The guarantee applied for all securities subjected to Australia and New Zealand, irrespective of their place of issuance, i.e., internally or externally. 6. On the other hand, the nature of the scheme meant for the protection of the demand deposits varied slightly from those targeted towards the protection of the wholesale funds. Demand deposits happened to be another one of the primary sources of financial domestic investments. They came as liabilities to the banks which the latter forwarded to the potential investors in lieu of interests. Such a mechanism served a two-fold purpose – raising profits to the banks and capital creation in the economy. Some features that the domestic governments specified in their proposals for protection have been discussed underneath. The government had pledged to the protection of the demand deposits termed for three years, with the authorised deposit-taking institutions. The guarantee did not cover other money-making instruments like those linked with market investments. The market portfolios were featured with an innate risk and a guarantee often instigated the owners into getting indulged in highly risky projects thus exposing the government to risks of market fluctuations as well. The guarantee came free with the deposits worth AUD 1 million per person per institution. However, the depositors were charged a nominal fee for deposits in excess of AUD 1 million. Every entity legitimated by the national legislative body was liable for protection or rather guaranteeing their reserves. Such entities included individuals, businesses and even government entities. The guarantee could be claimed by any entity regardless of the residence of the depositor. The only requirement to draw benefits from the scheme was that the deposits must be made with the ADI’s covered by the prudential regulations of the concerned nations. The governments of the two nations did not plan to carry on with the guarantee schemes for long and rather agreed to be the guarantors for as long as the mayhem lasted in the market (The Treasury of Australian Government, 2008). However, their sensitive move was enough to assure the creditors and the depositors about the security of their money. The fact that the move was adopted in as early as 2008 catalysed the growth or rather the recuperative process of Oceania. The region was soon found to have spared itself from the intensity of the brunt unlike many others in the West. But, despite the prevalent success of the schemes, critics pointed out a few loopholes which raised concerns about the continuation of the system. Conclusion Wholesale funding and deposit guarantee scheme are two of the primary channels of financing investment projects in Australia and New Zealand. However, the global financial crash of 2007 had shrunk back the availability of investible resources, thus endangering the continued flow of funds into these nations. To avoid a recessionary situation, the national government decided to guarantee against these securities and deposits. Such a move apparently won back the confidence of the customers and helped to revive the normal mode of economic activities. But, a few points were raised by opponents of the plan in both the countries. One of the major critics of the scheme emerged to be the Australia-New Zealand Shadow Financial Regulatory Committee, rose a few points in this regard – The government should charge appropriate prices for assuring guarantees. This is because in most of the cases, private sector investments are associated with heavy risks and thus, charging a similar commission from equi-valued deposits was synonymous to undervaluing the services of the government itself. Moreover, the banks and financial institutions should be made more equipped to fight back the vices of a roaring external competition. The committee argued upon the need to expose the domestic financial bodies to some amount of risk to help them take their own care rather than being patronised by the administration at equally tumultuous times. Instead of promising a protection till normality is restored, the government could focus more on implementing measures to bring back normality. The schemes were implemented far before any financial disruptions were reported in either of the two nations. This is to say that implications of enforcing a guarantee scheme prior to any reports of bank failure failed to create an impression in the minds of the people about the credibility of government moves (Australia-New Zealand Shadow Financial Regulatory Committee, 2009). However, despite the highly debatable points being raised by the committee, the success of the guarantee scheme could not be slighted. In fact, it could be said as a counter argument that gad it not been for the guarantee schemes of the national governments, the concerned nations would have faced a similar crisis like their peers in the West. Hence, the schemes indeed came at the right moment and acted as nothing less than an economic saviour. Appendix Trends in the Economic Growth Rates of Australia and New Zealand, prior and post implementation of the Guarantee Schemes Trends in the Change in Liquidity positions of Australia and New Zealand References Australian Government (2008) “Schedule 1: Eligible Institutions”, Guarantee Scheme for Large Deposits and Wholesale Funding [Online]. Available at (Accessed: April 27, 2010). Australia-New Zealand Shadow Financial Regulatory Committees (Septmber 22, 2009) “Is a credible exit from Government debt and Deposit Guarantee Programmes Possible?”, Statement Number 6. [PDF]. Available at (Accessed: April 28, 2010). Goodman, S. (2009). “Australian Government Guarantee Scheme for Deposits and Wholesale Funding” [PDF]. Available at (Accessed: April 28, 2010). International Monetary Fund (2009) Australia: 2009 Article IV Consultation - Staff Report; and Public Information Notice on the Executive Board Discussion. Washington, D.C., USA: IMF Publications. Swan, W. (November 25, 2008) “Guarantee Scheme for Large Deposits and Wholesale Funding Appropriation Bill 2008: Second Reading Speech”, Canberra [Online]. Available at (Accessed: April 28, 2010). The Treasury of Australian Government (2008) “Australian Government’s 2008 Deposit and Wholesale Funding Guarantees: Design and Operational Parameters” [Online]. Available at < http://www.treasury.gov.au/documents/1431/PDF/Design_and_operational_parameters_281008.pdf> (Accessed: April 28, 2010). Bibliography International Monetary Fund (November, 2008) Regional Economic Outlook: Asia and Pacific. IMF Publications. OECD (2008) OECD Economic Outlook, Volume 2008, Issue 2. OECD Publishing. OECD (2009) OECD Economic Surveys: New Zealand 2009, Vol. 4. OECD Publishing. United Nations (2009) Economic and social survey of Asia and the Pacific; 2009: addressing triple threats to development. United Nations Publications. Read More