Can You Bank On Banks?

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News of banks failing makes us question how safe is our money.

Of course, when you make a deposit into your bank account, you usually assume that your money will be secure, and that it will be available when you need it. But how safe are these assumptions?

Deposit protection

In Australia, deposits made in approved deposit-taking institutions (“ADI”) (generally banks, credit unions and building societies) are covered by the Financial Claims Scheme (“FCS”) – a government guaranteed scheme covering:

  • up to $250,000
  • per account holder
  • per ADI.

Importantly, if an account holder has multiple bank accounts with the same ADI then they will only be covered up to a total of $250,000. For example, if Sam has three accounts with the XYZ bank – a savings account, and two term deposits, and they total $300,000, then she will only be covered for a total of $250,000, meaning $50,000 of her deposits will not be covered by the FCS.

To ensure your money is ‘protected’ by the FCS you need to apply these two simple rules:

  1. Only deposit with ADIs; and
  2. Keep your deposits to $250,000 or less with any one particular ADI

To be clear, the FCS guarantee is not per account, it is per ADI.

Practically, this can be a nuisance to manage if you have a large amount of cash, but then again, if you want protection over convenience, you have to go to some extra effort. Let’s look at an example.

Fred has just sold his investment property and has realised a large gain of $500,000. He usually banks with the XYZ Bank, and as he has no immediate plans for the money, is considering taking out a 30 day term deposit to get some interest on his money while he decides what to do next.

In this example, if Fred placed all his money with the XYZ Bank only half of it would be protected. To have all of it protected he would need to take out two term deposits: $250,000 with the XYZ Bank, and $250,000 with the ABC Bank (assuming he had no other deposits with either institution).

Why do banks go broke?

As a rule, banks have historically gone broke because their liabilities are predominantly liquid, whereas their assets are invariably illiquid. That is, for banks to be profitable, they lend the money people put on deposit with them to others at a margin (i.e. lend at an interest rate greater than the interest rate they pay depositors).

Some deposits can be ‘locked away’, for instance, term deposits of a year or longer, but some loan products, like home loans, are lent for decades.

ADIs have to manage this liquidity mismatch via prudential safeguards – like keeping a minimum amount of their assets liquid (i.e. cash or easily convertible to cash). That said, every ADI works on the basis that only a small fraction of depositors will ever ask for their money back on the same day. If too many turn up, they won’t have the cash available to pay out all accounts.

For instance. a fun fact you may like to know is that many banks limit how much cash you can withdraw at a branch without prior notice. Why? Because they don’t have millions and millions of dollars sitting in the vault just in case it might be needed. Rather they only have enough money for a little more than they think they’ll need in the ordinary course of business.

Like any business, banks have to be profitable to survive. If they make large losses, they go broke. So, how might a bank make losses?

The first and most obvious way is that their borrowers stop making repayments, and the lender’s loan book goes bad. They will typically try to call in the security and sell it, but that will take time, and if they can’t recover what’s owed, they make a loss. This is what happened in the US during the GFC.

Another way banks can go bust is if they are caught in a liquidity trap. That is, they need money in a hurry to pay out depositors, but their assets are tied up in illiquid assets (like long-term loans), and to exit those illiquid assets they have to realise huge losses. This is what has happened with the Silicon Valley Bank (SVB). They had assets well in excess of their liabilities, but when depositors wanted their money back en masse, SVB had to start selling the bonds (i.e. assets) they held, which triggered massive losses because the market value of those bonds had fallen as a result of rapidly increasing interest rates.

For instance, if SVB held a 10-year bond issued at annual interest of 2%, and the latest 10-year bonds attracted annual interest at 4%, then the only way for SVB to ‘sell’ or ‘liquidate’ their 10-year bond at 2% annual interest is to sell it for less than the amount they paid for it (because the only way a person would be interested in a lower yielding asset is if it was sold at a discount). The losses made selling an asset for less than its carrying value will flow through the business’s profit and loss, and if people think those losses may cause the bank to fold, they rush to get their money out, which only exacerbates the problem.

With all this in mind, we conclude that your money is generally ‘safe’ so long as:

  1. People continue to have confidence in the banking system; and
  2. People don’t panic; and
  3. The business holding your deposit remains solvent.

That said, if you want to be extra cautious, you can take advantage of the government’s ‘free to consumers’ money-back guarantee (i.e. FCS), provided your deposit:

  1. Is held with an ADI covered by the FCS; and
  2. You keep your total deposit balance with any ADI to less than $250,000.

The takeaways from this article are:

  • Check whether the business holding your deposit(s) is covered by the FCS (i.e. ask them or check online). If not, consider whether you are happy with that risk; and
  • Check your total deposit balance and, if you have more than $250,000 in total with any single FCS backed ADI, then take action as needed to spread your money around different FCS backed deposit-taking institutions to manage your risk.

Update 24/04/2023

Link to grouped ADIs

You can see which ADIs are linked under the one licence here

$20b limit per ADI licence

Following on from a podcast listener’s question, I followed up with APRA about a further possible limitation to the FCS – a cap of $20b per ADI. It turns out this is true and is ‘legislated’ and not indexed. The is problematic, because the CBA has $80b in deposits, so would would happen if any pay out was capped to a quarter (i.e. $20b/$80b)? Does that mean that only a quarter of the $250k could be claimed per account?

I decided to ask APRA, and their answer (see below) is concerning.  Paraphrasing, they said ‘we don’t know’. 

“The FCS is initially funded by the Australian Government through a standing appropriation of $20 billion per failed authorised deposit-taking institution (ADI) or general insurer (GI). It is possible that additional funds in excess of the $20 billion per institution 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 against the institution’s assets in the liquidation process. If the amount realised is insufficient to cover FCS payments and costs, the Government can recover the shortfall through a levy on the respective industry. How the standing appropriation is financed is a matter for Government and may depend on the circumstances at the time of an event.” 

All the best,

– Steve McKnight