Australians who have a bank deposit in an Australian Authorised Deposit-taking Institution (ADI) need to guard against the risk of confiscation through a bank bail‑in.





2018 Crisis Resolution Powers Legislation

Last year in 2018, a significant amount of attention was given in Australia to the issue of bank bail‑ins given that:





bank bail-ins were recently implemented in 2012 via the Bank of Cyprus (in Cyprus) where 47.5 per cent of deposits above 100,000 euros were forcibly converted into bank equity (or shares);

member countries of the G20 (including Australia) signed multiple communiques in 2010 and 2014 that were drafted by the Financial Stability Board which agreed to designing and implementing an international bail-in regime that would address the risks posed by Global Systemically Important Banks; and

Australia’s Federal Parliament enacted, in February 2018, the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Act 2018 (Crisis Resolution Act) which provided the Australian Prudential Regulatory Authority (APRA) with powers to order the conversion or writing-off of (capital or financial) ‘instruments’ during a financial crisis.





Despite repeated denials from the Morrison Government, Commonwealth public servants and Federal Parliamentarians that a bail-in of bank deposits could occur in Australia, concerns about the bail-in of bank deposits continue to mount in some quarters given the vagueness of how the Crisis Resolution Act (under Section 31 – Subsection 11CAA (Definitions)) defines the word ‘instruments’ in the context of conversion and write-off.[1]





Moreover, analysis by Martin North and John Adams through a series of YouTube videos[2] in 2018 expose a legal loop-hole that would provide a pathway for APRA to initiate a bank bail-in if required. In our series of videos, our analysis showed that:





for a bail-in to occur under the Crisis Resolution Act, subsection 11CAB(1) requires that the ‘instrument’ must have terms and conditions which expressly states up-front that the instrument is able to be bailed-in;

the terms and conditions (T&Cs) that currently underpin the deposit accounts of Australia’s major ADIs do not include clauses which state that deposit accounts could be converted or written-off (i.e. bailed-in) as required by subsection 11CAB(1); however

the T&Cs of Australia’s Big 4 banks do include clauses that would allow the banks to alter their standard T&Cs instantaneously if ordered by the Federal Government without any adequate forewarning or notice to their customers;

given the above points, APRA could possibly initiate a bail-in of retail bank deposits during a financial crisis by requiring the banks to change their T&Cs and then subsequently issue a recapitalisation directive which would order banks to convert retail or institutional bank deposits into share equity that would be compliant with Australian federal law.

Despite these points and the ongoing concerns regarding the state of the law, both the Morrison Government and the Federal Parliament have not sought to clarify or enhance the Crisis Resolution Act that would boost confidence by eliminating the legal risk of a bank bail-in of deposits, hence the uncertainty surrounding bank deposits continues.





2019 International Monetary Fund Report - Australia

To compound this uncertainty is the recently released 2018 International Monetary Fund (IMF) Financial System Stability Assessment[3] (released in February 2019) which was conducted on Australia.

In this report, the IMF stated in paragraph 54 (on page 33) that Australia should implement a statutory bail-in regime based on ‘best international practice’, given the exposure and leverage of Australia’s ADIs to the property sector and the domestic and international systemic risks that this poses.





While the IMF does not explicitly define what ‘best international practice’ looks like, international examples of ‘statutory bail-in’ do exist including in New Zealand, the European Union, the United States and Canada.





For example, New Zealand’s regime, which is called Open Bank Resolution (OBR), is worthy of note in particular as it is perhaps the most fully transparent statutory bail-in regime in the world and is advertised openly on the New Zealand Central Bank website[4]. OBR states that the cost of a bank failure is primarily placed upon on the bank’s shareholders and creditors (i.e. depositors), rather than New Zealand taxpayers.





Nevertheless, despite this call from the IMF for a statutory bail-in regime (to which the Australian Government did not formally respond to), the 2018 analysis conducted by Adams and North demonstrates that such calls are not necessarily required, but perhaps beneficial if greater transparency and clarity of the law can be achieved.





Bank Bail-ins have already occurred in Australia

Claims that bank bail-ins similar to what occurred in Cyprus in 2012 cannot happen in Australia ignores what has occurred previously in Australian history.





Indeed, the historical evidence (as documented by several authors) suggests that bank bail-ins (i.e. depositor money being use to recapitalise banks), occurred during the 1892 depression in Melbourne.

For example, according to the PHD thesis of Dr Chris Berg[5]:

“Almost every bank that had suspended in the first half of 1893 had reconstructed and reopened by mid-August that year. However, the consequences of reconstruction were severe. Of the £65 million of deposits held in banks which ultimately reopened, £9 million was converted into preference shares or interminable deposits. £42 million had been repaid by 1901, but the last repayment to depositors was made as late as 1918 (Royal Commission into Monetary and Banking Systems 1937).”





Bank bail-ins during this period occurred through the various ‘reconstruction’ schemes which were introduced in 1892 and 1893 when many Melbourne-based banks and building societies faced significant financial stress. As noted by the Reserve Bank of Australia[6]:





“The details of reconstruction schemes varied across banks, but all followed the same broad pattern. Shareholders were called on to invest fresh capital in the reconstructed bank and were released from liability for calls on unpaid capital from the old bank. The major part of depositors' claims were extended for long periods, generally for a minimum of four years, before any withdrawals could be made, and in some cases these claims were converted into preference shares.”





As noted by journalist and historian Michael Cannon[7], one of the first Melbourne based banks involved in the bail-in of depositor funds was the Australian Deposit and Mortgage Bank which was headed by well-known leading figure (and member of the Victorian Parliament) James Balfour MLC.





In March 1892, the Australian Deposit and Mortgage Bank experienced such significant financial difficulty as the economic depression widened that:

it suspended payments to depositors (i.e. they imposed capital controls); and

a bank reconstruction was proposed whereby depositors would receive 5 per cent preference shares (i.e. shareholders would be first in line to receive a 5 per cent dividend) in a reconstructed company called the Australian Mortgage and Deposit Bank.





This episode of bank bail-in was reported on in glowing terms in the Melbourne publication, Tabletalk, which reported on 25 March 1892[8]:





“The advantage of the scheme to shareholders was manifest, for it prevents the necessity of sharp and heavy calls. Depositors will get interest which they will not if they elect to be dealt with by the liquidator, and they are not likely to get back their principal any more quickly than by taking fully paid up shares, negotiable soon in the open market. The scheme is certainly the most equitable for depositors of any company recently suspending payment.”





By June 1892, a Victorian court ordered that the reconstruction occur, although the proposed 5 per cent preference shares were reduced to only 2 per cent.





Australian Mortgage and Deposit Bank ultimately failed as a commercially viable bank and was forced into liquidation.





Conclusion

In the next economic crisis, the ongoing solvency of several Australian ADIs is likely to be brought into question given their significant leverage and exposure into the Australian real estate sector which currently represents the biggest financial bubble in Australian history.





For policy makers who seek to maintain financial stability across Australia, the need to maintain sufficient liquidity among Australian ADIs is paramount.





Australian ADIs have approximately $AUD 650 billion of potential capital (across three tiers including bank reserves, the hybrid securities and the Reserve Bank of Australia’s Committed Liquidity Facility) that can be used to ensure the ongoing viability of the Australian banking system.





In an extreme debt deflationary scenario, this level of capital may be insufficient to maintain the financial solvency of particular individual banks and of the Australian financial system as a whole[9].





In such a scenario, the bail-in of retail and institutional bank deposits may be required to avoid Australia entering into an economic depression or to stop the potential contagion of Australia destabilising global financial markets.





The possibility that retail or institutional banks deposits in Australia may be subject to a bank bail-in during the coming economic crisis remains a real risk that all Australian depositors must ultimately seek to manage.





John Adams is the Chief Economist for As Good As Gold Australia

[1] To review my previous analysis of the bank bail-in issue, please see my article, Will the Prime Minister order a ‘Smash and Grab’ of bank deposits, https://www.adamseconomics.com/articles/will-the-prime-minister-order-a-smash-and-grab-of-bank-deposits





[2] The Adams/North five-part YouTube video series about bank bail-in can be found at www.adamseconomics.com under Videos – Economics Sub Tab.





[3] https://www.imf.org/en/Publications/CR/Issues/2019/02/13/Australia-Financial-System-Stability-Assessment-46611





[4] See the following link: https://www.rbnz.govt.nz/regulation-and-supervision/banks/open-bank-resolution





[5] Dr Chris Berg is a Senior Research Fellow for the School of Economics, Finance and Marketing at RMIT University.





[6] Also see the Reserve Bank of Australia 2001 publication, ‘the 1890s Depression’, https://www.rba.gov.au/publications/rdp/2001/2001-07/1890s-depression.html





[7] A detailed account of the Australian Deposit and Mortgage Bank can be found in Cannon, M., (1972), “Land Boom and Bust”, Heritage Publications, Melbourne, Australia





[8] https://trove.nla.gov.au/newspaper/article/13846519





[9] See John Adams’ analysis regarding the inadequacy of the 2017 Bank stress test conducted by APRA at the following link: https://www.adamseconomics.com/articles/apra-airbrushes-australian-history-to-avoid-economic-armageddon