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Cap on bank guarantee to stop investment exodus

Phillip Coorey and Jacob Saulwick
October 25, 2008

THE Federal Government will limit its free guarantee of bank deposits to amounts of $1 million and examine ways to help unguaranteed institutions that have had to freeze billions of dollars in funds to stop a stampede of withdrawals.

The Treasurer, Wayne Swan, announced the changes late yesterday as experts estimated about $21 billion in mortgage and other funds had now been frozen by unguaranteed institutions.

The move came as markets slid against growing fears of a global recession. South Korea's Kopsi index fell 10.6 percentage points yesterday to end the week more than 20 points down, a bigger weekly fall than any during the 1997-98 Asian financial crisis. In Japan the Nikkei plunged 9.6 points to hit a five-year low. In response, Australia's ASX 200 lost 2.6 points to close at 3869. The dollar fell to US65 cents. London's FTSE was down eight points in early trade last night, Sydney time.

Mr Swan said the new measures would "make our financial system even more secure in the face of the worst global financial crisis since the Great Depression".

Branches of foreign banks, originally omitted from the guarantee scheme, have had a limited form of the guarantee extended to them but with conditions attached to prevent Australian taxpayers underwriting their overseas operations.

The Government will make the prospect of shifting large sums from non-guaranteed institutions into guaranteed banks, credit unions or building societies less attractive by charging a fee.

In return for the guarantee, a fee of between 0.70 percentage points and 1.5 percentage points will apply to every dollar over $1 million. The fees will apply from November 28, and the amount charged will depend on the credit rating of the institution.

The guarantee will be free for deposits up to $1 million, covering 99.5 per cent of all deposits.

While the threshold and fee are expected to stop large withdrawals from non-deposit investment banks, the mortgage funds remained worried that retirees and others would continue to want to shift their nest eggs to the guaranteed banks.

The Reserve Bank reportedly wanted a threshold of $500,000. And some industry insiders thought the fee was too low to act as a disincentive to move funds, and they wanted it set at 2 per cent.

Seniors Australia counselled its members with frozen investments to stay calm because most would still receive their regular income, despite being unable to access their deposits.

Mr Swan indicated the Government could not extend the guarantee to the mortgage funds but said Treasury and theAustralian Securities and Investments Commission would examine urgent measures "in relation to retail investor hardship" caused by the freezing of funds. The solution could involve use of ASIC¡¯s modification powers under the Corporations Act, Mr Swan said. Centrelink would also help those who might need short-term help. Some self-funded retirees are now expected to qualify for a part pension.

Richard Gilbert, chief executive of the Investment and Financial Services Association, said 13 of the nation¡¯s top 20 fund managers had frozen about $12 billion to stop the stampede in withdrawals. He welcomed the Government¡¯s offer.

The chief executive of Seniors Australia, Michael O¡¯Neill, said: "What we¡¯re seeing is sentiment-driven alarm ¡­ It¡¯s vital to hold steady and have faith that the national government will soon provide an effective policy response."

About $21 billion is now frozen in mortgage and other investment funds, said Anthony Serhan, the head of research at Morningstar Australia.

The Government could not provide guarantees for the mortgage funds, he said. While some funds have robust business models, the industry was littered with failures.

He said a number of smaller funds - which use money raised from investors to lend to developers - had dropped into receivership or administration, cruelled by falling property prices.

After being criticised for not consulting the Reserve Bank directly over the initial unlimited guarantee, Mr Swan said yesterday that the changes were approved by all the regulators, including the central bank.

He castigated the Opposition Leader, Malcolm Turnbull, who has been a frequent critic of the guarantee and has accused the Government of ineptitude for failing to foresee the problem.

"It's time for the Opposition to stop playing with fire for cheap political purposes," he said.

One senior banker told the Herald that politics had exacerbated the panic.

By heading off a rush of funds from foreign bank branches, the Government is trying to prevent an acceleration of the credit crunch. Bankers have been concerned that if institutions not covered by the guarantee lose deposits, they will be forced to call in loans made to businesses.

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