Extending the Australian government’s Financial Claims Scheme protection to the deposits of superannuation fund members would effectively relieve regulation which unintentionally limits yield opportunities and increases the risk they will lose their retirement savings in a critical bank failure.
Administrated by the Australian Prudential Regulation Authority, the government-backed FCS ensures depositors at ‘authorised’ financial institutions (primarily banks, insurers and other institutions like credit unions) are shielded form losses due to the collapse of the deposit takers.
As it is now, the interest rate banks pay short-term deposits of institutional super funds (held on behalf of their members) is up to 80 basis points lower than what they pay for the same types of deposits made by individuals or self-managed super funds.
The difference is the unintended consequence of several features of bank regulation. As such, the effect makes little sense and the problem could be rectified with the stroke of a pen.
The simple regulatory step of applying FCS coverage to institutional super funds would calm trustees in the event of a crisis and reduce the chance of a ‘run’ on super, providing protection which would enable APRA to treat them as stable deposits.
As stable deposits, banks would be free to invest them in higher-yielding assets, adding about 80 basis points to investor returns on their deposits within super.
There are three good reasons to make this change:
- it increases the retirement income of all people with superannuation investments some of which sits in deposits;
- it removes the risk a future treasurer will declare superannuants will lose their money in a bank failure while all other ordinary depositors (and SMSFs) in the failed bank are protected and
- the cost of making the change is minimal.
The consequences are substantial. With around $A100 billion in such deposits it amounts to around $A500 million to $A1 billion per year of reduced income for members of institutional super funds (more-precise data is not available).
The lifetime effect of the reduced income on super savings could reduce income of those affected by around $A12,000 over the course of their retirement.
Two particular features of bank regulation combine to create this significant and inequitable distortion.
One is the Liquidity Coverage Ratio (LCR) regulation, which requires banks accepting ‘non-stable deposits to invest in low-yielding liquid assets. The problem is short- term deposits of institutional super funds – held on behalf of members – are treated by APRA as ‘non-stable’.
There is no attempt to ‘look through’ the super fund and regard the multimillion deposit as being a collection of many much smaller amounts on behalf of fund members.
Arguably that approach makes some sense. A super fund makes its investment decisions on behalf of all its members and could be expected to pull the entirety of its bank deposit if it thought the bank was in difficulty and the deposits not covered by the Financial Claims Scheme (FCS).
The regulation has merit in the sense of reducing the risk of a liquidity crisis if non-stable deposits run from the bank when adverse shocks hit the banking system.
There are potential workarounds for this but they are complicated and expensive.
The second level of complexity arises from the operation of the FCS. This protects individual depositors in a failed bank up to a maximum of $A250,000 per head.
Institutional super fund deposits of many millions are on behalf of many members, mostly for amounts well below $A250,000. Other than the first $A250,000 of the multimillion institutional deposit the FCS does not apply. There is no ‘look through’ to who are the ultimate owners of the deposited funds.
Under the current system should a bank fail, members of institutional super funds with deposits in it would lose virtually all of their funds held in deposits at the bank. Not only is this inequitable it is not credible politically.
Imagine a federal treasurer arguing individuals should wear the loss of compulsory super savings, managed by an institutional super fund, arising from a bank failure. A government would no doubt bow to the inevitable electoral backlash and provide compensation – to a level of certainty a case could be made de facto coverage already exists.
The cost is actually very small. Increasing FCS coverage would increase the reported amount of government ‘contingent liabilities’ but this is a completely fictitious number.
Given APRA’s priority position as a claimant on bank assets in a liquidation, the likelihood of it suffering any shortfall which would impose any significant cost to the government budget is infinitesimally small (indeed, another case could be made that government accounts should actually be amended to reflect this reality).
Such a change would also reduce revenue from the major bank levy (MBL), since deposits covered by the FCS are excluded from the MBL base. The government has already said it has a revenue target for the levy and could simply make the necessary adjustment to the levy rate.
There appears to be no logical reason why institutional super fund members should be penalised as they are by the way bank regulation operates. A simple, warranted, change to the FCS coverage and consequential, warranted, adjustment of LCR regulation by APRA would remove this distortion.