The significant number of submissions to the inquiry supported the bill and repeat a limited number of points to argue there is a need for the bill, rather than addressing the provisions of the bill itself. The majority of concerns raised in submissions are identical to those raised during the inquiry into the Crisis Resolution bill (see chapter 1).
Submitters who argue the bill is required to prevent the bail-in of bank deposits argue the following points:
uncertainty as to whether bail-ins could happen in Australia was created by the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Act 2018 (the Crisis Resolution Act), specifically the insertion into the Banking Act of section 11CAA containing the ‘any other instrument’ paragraph;
the terms and conditions of deposit accounts can be changed to include bail-in provisions;
the government may not choose to activate the Financial Claims Scheme (FCS), and in any case it would be insufficient to cover all deposits;
deposit bail-ins have already occurred in Australia in the late 1800s and more recently in Cyprus; and
the government supports the work of the G20-established Financial Stability Board which argues for bail-in provisions, and other countries have already introduced such legislation;
there is no harm caused by the bill and if the government has no intention of allowing bail-in, it should pass the bill.
In response, the Australian Prudential Regulation Authority (APRA) and the Treasury state it is not possible under current legislation for banks to bail-in deposit accounts—legislative certainty already exists and the bill is unnecessary.
One submission argues that bank deposits should be capable of bail-in so as to impose better market discipline on the banks.
'Any other instrument'
Box 2.1: Banking Act Division 1A of Part II, Subdivision B—Conversion and write-off provisions
The Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Act 2018 inserted a new subdivision into the Banking Act.
This subdivision, Subdivision B—Conversion and write-off provisions, adds a new section to the Banking Act, section 11CAA Definitions.
Among the new definitions added in this section is one defining conversion and write-off provisions.
conversion and write-off provisions means the provision of the prudential standards that relate to the conversion or writing off of:
Additional Tier 1 and Tier 2 capital; or
any other instrument.
A key concern for submitters is deposit accounts are capable of being captured under the 'any other instrument' paragraph in section 11CAA of the Banking Act and thus of having conversion or write-off provisions written into the terms and conditions. Some submitters suggest that unless there was an intention to include deposit accounts there would be no need for the paragraph.
It is suggested by submitters that ‘any other instrument’ is 'open to subjective interpretation'. It could include customer deposits because International Accounting Standard 21 (IAS 32) defines a financial instrument as including deposits: ‘a financial instrument is any contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity’. Another submission cites legal advice that the Australian Accounting Standard AASB 132 defines a financial instrument in a similar way.
Interpretation of 'any other instrument'
However, policy and regulatory agencies advise the definition of 'any other instrument' is not open to interpretation but rather constrained by the Banking Act 1959 (Banking Act), the content of prudential standards, principles of statutory interpretation, and the extrinsic material to the Act which would be used by a court to interpret the paragraph.
Regardless of whether a deposit account is a ‘financial instrument’, as a matter of law, APRA advises ‘any other instrument’ could not be interpreted to include bank deposits because the definition in the Banking Act refers to the provisions of prudential standards relating to conversion or writing-off. The definition is contained with Division 1A, Subdivision B—Conversion and write-off provisions. This does not cover bank deposits because APRA prudential standards do not require these provisions to be included in bank deposits.
Further, the prudential framework cannot be altered to include deposits. This is because APRA is constrained by the Banking Act which requires APRA to use its directions powers consistent with the objects of the Banking Act. Section 2A of the Banking Act states:
2A Main Objects of this Act
(1)The main objects of this Act are:
(a) to protect the interests of depositors in ADIs in ways that are consistent with the continued development of a viable, competitive and innovative banking industry; and
(b) to promote financial system stability in Australia.
With regard to any court interpretation of the paragraph, APRA advises the term ‘any other instrument’ would not be interpreted by a court as extending to deposits. This is because principles of statutory interpretation would require a court to view the general words to be limited by the specific reference to ‘additional Tier 1 and Tier 2 capital’. As such, only instruments of a similar nature would fall within the general definition. Deposits are fundamentally different to additional Tier 1 and Tier 2 capital instruments.
The Treasury supports this point—the extrinsic material that clarifies the meaning intended by the Parliament, specifically the Explanatory Memorandum for the Crisis Resolution bill that introduced the amendment, states the purpose of Part II, Division 1A, Subdivision B is: ‘to provide certainty that capital instruments can be converted or written off as provided for in APRA’s prudential standards’.
And further, the EM states:
…the amendments are applied to capital instruments other than those issued as AT1 or T2 capital to provide flexibility in the event of future changes to the regulatory capital framework. In order for the amendments to apply, any such instrument will need to be issued with terms included for the purposes of conversion and write-off provisions in APRA’s prudential standards at the time.
The specific paragraph, ‘any other instrument’ was included so any future classes of capital that may be added with regards to an ADI's loss absorbing capacity could be done so without requiring legislative change.
Further, the Division confers no powers on APRA, it only ensures the efficacy of contractual provisions in existing contracts.
Terms of customer deposit accounts
Drawing upon a definition of ‘financial instrument’ provided by the International Accounting Standard, some submissions claim deposit accounts, as financial instruments, are therefore captured under ‘any other instrument’ and potentially capable of having conversion or write-off provisions added.
It is suggested financial institutions could insert into the terms and conditions of banking accounts, conversion or write-off provisions at any point in time, particularly as such terms and conditions provide institutions with flexibility to include ‘unfavourable amendments without any sufficient forewarning to retail depositors’.
Following from this, it is suggested that during a severe financial crisis an ADI could, either at the direction of APRA or unilaterally, amend its deposit account terms and conditions to include write-off and conversion provisions that would allow for a bail-in.
APRA’s power to make such a direction is said to come from section 11CA(2)(p) of the Banking Act, which allows APRA to direct an institution, through prudential standards, to make changes to its systems, business practices or operations.
Some submissions also claim subsection 11CAB(1) of the Banking Act requires deposit account terms and conditions to contain terms that stipulate the bank account can be either converted or written off, even if there are at present no conversion or write-off clauses currently in the terms and conditions of retail bank account products of major authorised deposit-taking institutions.
Another submission suggests legal immunities could protect institutions that do insert bail-in provisions contrary to the law if this is done at the direction of APRA.
It is the case that ADIs can unilaterally change the terms and conditions for customer deposits. However, APRA advises ADIs cannot do so if the change is to facilitate a conversion or write-off of customer deposits. This is because it would be inconsistent with the unfair contract terms legislation under the Australian Securities and Investments Commission Act 2001 (ASIC Act)—a term allowing an ADI to write off or convert a retail deposit would amount to an unfair contract term.
Some submissions acknowledge section 761A of the ASIC Act defines a ‘basic deposit product’ and permits ADIs to include certain clauses within the basic deposit product terms and conditions that might result in the reduction of the account balance. These submissions acknowledge such an action is only permitted in a limited number of circumstances, and conversion and write-off are not permitted under the definition. However, the same submitters argue this does not sufficiently limit the ability of ADIs to insert bail-in provisions. In particular, it might not prevent the Treasurer from issuing a legislative instrument to allow ADIs to insert conversion and write-off provisions into the terms and conditions of basic accounts and such an instrument might not be disallowable by the Parliament.
It is useful at this point to refer to the objects of the Banking Act, specifically to protect customer deposits. It is not clear how such an action by the Treasurer under the Banking Act would be consistent with the Banking Act. Neither is this explained by submitters who suggest it could be a possibility.
APRA states furthermore, even if an ADI was not prohibited by unfair contract terms legislation from changing the terms in this way, APRA would be required to use its powers under the Banking Act to protect depositors and prohibit an ADI from changing these terms to insert write-off provisions. While APRA has broad directions powers, these must be used consistent with the objects of the Banking Act.
Whilst there are two key objects to the Banking Act—to protect the interests of depositors in ADIs and promote financial stability—these are complementary, one does not take precedence over the other. This is explained by APRA:
A ‘bail-in of deposits’ would offend both APRA’s depositor protection objective and its financial stability objective. A bail-in of deposits would not only cause depositors at the ‘bailed-in’ institution to lose a portion of their deposit funds, it would reduce the confidence of depositors across the banking system thereby reducing financial system stability. It would also starve authorised deposit-taking institutions of the stable deposit funding on which they rely to provide credit to the economy. This is why APRA has described depositor protection as a paramount objective—it lies at the heart of both of our statutory objectives under the Banking Act. As such, APRA has never sought, nor supports, a ‘bail-in of deposits’ power.
The Treasury concurs: the objects of the Banking Act, which direct APRA, ‘are wholly incompatible with conversion, write-off or bail-in of deposits’.
There is also a further explicit legislative provision in the Banking Act directed to protecting deposits. Section 13A(3) provides for priority repayment of ‘protected accounts’ (including deposit accounts) in the unlikely event an ADI is unable to meet its obligations.
The Banking Act, according to the Treasury, ‘explicitly provides for priority repayment of deposits in the unlikely event that an authorised deposit-taking institution were unable to meet its obligations’.
This is another ground, APRA advises, that would prohibit it from directing ADIs to insert conversion or write-off provisions into customer deposit accounts. Such a direction would be inconsistent with the objective of depositor protection. According to APRA, ‘such a direction would be found to be invalid’. Thus, it is not possible for APRA to require banks to bail-in deposit accounts.
The Treasury also stated:
Nothing in the Banking Act or any other Commonwealth legislation extends power to the Australian Prudential Regulation Authority to implement or authorise or direct the implementation of bail-in, in respect of deposit accounts as defined in the bill.
Financial claims scheme
Many submissions also raise concerns about the FCS. These concerns include:
the FCS does not protect against bail-in because it can only be activated after a financial institution has failed;
a failure to appoint a statutory manager could affect the activation of the FCS;
it is the decision of the Treasurer as to whether the scheme would be activated, and the Treasurer may choose not to activate the scheme; and
the scheme is capped at $20 billion per institution and this may not be sufficient to cover all protected deposits.
However, it is not the case that a statutory manager has to be appointed prior to the activation of the FCS. Section 16AD of the Banking Act, which provides for a declaration to be made to activate the payment of account-holders under the FCS, specifies the minister can make a declaration if any of the following requirements are satisfied: APRA applies for an ADI to be wound up; a statutory manager is in control of the ADI's business.
The provision to allow the Treasurer to make a declaration to activate the FCS upon the appointment of a statutory manager means the Treasurer can activate the FCS at an earlier time. Prior to the amendment contained in the Crisis Resolution Act, the Treasurer could not declare the FCS until such time as APRA had applied to the Federal Court for an ADI to be wound up.
While it is a decision of the Treasurer to activate the scheme, it is not clear why the Treasurer would choose not to activate the scheme. Failure to activate the scheme would run entirely counter to protecting the stability of financial system.
Treasury estimates indicate the $250,000 cap would cover 99.2 per cent of household deposit accounts by number and 81.7 per cent of household deposits by value. There is not an absolute $20 billion cap per institution under the FCS. While sub-section 16AD(2) of the Banking Act provides for an amount of not more than $20 billion to be credited to the Financial Claims Scheme Special Account, the Reserve Bank of Australia advises additional funds could be made available by the Parliament, if needed.
History of bail-ins
Some submissions cited previous bail-ins in Australia, in 1892 and 1893 during an economic depression resulting from a collapse in land prices.
However no explanation is provided as to how the legislative and regulatory regime in the late 1800s relates to that in place today.
Financial Stability Board
Some submissions argue the Australian government is committed to a global bail-in framework through its involvement with the Financial Stability Board.
The Financial Stability Board, at the Bank for International Settlements, comprises senior representatives from ministries of finance, central banks, and supervisory and regulatory authorities of the G20 countries, plus Hong Kong, Singapore, Spain, and Switzerland, and international bodies including the European Central Bank and the European Commission. It acts as a coordinating body to set policies and minimum standards for financial sector stability.
Submitters note a publication from this organisation, Key attributes of effective resolution regimes for financial institutions, suggests that any financial institution that could be systemically significant be subject to a resolution regime that has the attributes established in the document.
The intent of the framework is that financial institutions in distress are able to resolve their problems without exposing taxpayers to loss (that is, by taxpayers having to bail-out troubled institutions as occurred during the global financial crisis). Under such a framework, shareholders and unsecured and uninsured creditors would absorb losses in a manner that respects the hierarchy of claims in liquidation. One attribute of the framework is a bail-in resolution. This resolution provides for the write down or conversion into equity or other instruments of ownership of the firm, a number of items, including unsecured and uninsured creditor claims.
Submissions state Australia agreed to the 2014 G20 Leaders Communique which welcomed the FSB framework. It then implemented the framework through the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Act 2018, in particular through the amendment to the Banking Act to insert section 11CAA.
Measures to address risk in the financial system
As discussed above, no Australian law, including section 11CAA of the Banking Act, permits deposit accounts to be bailed-in.
APRA cautions against confusing the broad concept of 'bail-in' (the conversion of certain prescribed liabilities such as capital instruments) with the narrower 'bail-in of deposits', and explains the rationale for a 'bail-in' of prescribed liabilities is to protect taxpayers:
The purpose of bail-in is to avoid a ‘bail-out’, where taxpayers’ funds are used to rescue banks. A key problem with ‘bail-out’ is that those who receive a benefit (a risk premium) in good times (such as shareholders and subordinated debtholders) are protected from bearing the usual burden of restoring the institution to health in bad times (as would happen with any other company). Instead this burden is transferred to taxpayers in a bail-out. Shareholders and subordinated debtholders that are protected from the risk of failure in bad times may incentivise banks to engage in riskier behaviour—this is commonly known as moral hazard.
APRA addresses risks posed by too-big-to-fail institutions in two ways. It requires Australian ADIs to hold higher levels of equity (capital) than most peer jurisdictions. Further, it requires ADIs to have additional 'loss absorbing capacity' (LAC), under which certain capital instruments must be converted to equity when an institution faces financial difficulty. These capital instruments are known as additional Tier 1 and Tier 2 capital.
APRA is of the view its approach to LAC, through the use of regulatory capital instruments, achieves the objectives of the FSB's bail-in reforms without the need to implement a statutory bail-in power that could be applied to a wider range of liabilities, as is the case in some other jurisdictions:
The Australian regime did not implement a power to ‘bail-in’ deposits, precisely because this would have been contrary to APRA’s purpose and objectives.
In summary, as expressed by the Treasury, there is already legislative certainty that deposits cannot be subject to any form of conversion, write-off or bail-in. This is because the Banking Act contains several explicit provisions that expressly rule out the possibility of any form of conversion, write-off or bail-in of deposit accounts, and this is reinforced by consideration of relevant extrinsic materials and the history of the Crisis Resolution Act.
Hypothetical 'hidden intention' to allow bail-in
Regardless of whether there is ambiguity under current legislation, some submissions have stated there will be no detrimental consequences to passing the legislation.
If the parliament does not pass the legislation, this argument proceeds, it could signal an intent to permit bail-in so the government does not have to bail-out any financial institution should there be a future crisis. Because of this, if the bill is not passed, submitters claim it may undermine the confidence of Australians in ADIs and result in a withdrawal of cash from banks.
Key concerns with the bill
Treasury, other than arguing the bill is unnecessary because there is already certainty that bank deposits cannot be bailed in, expresses concern that the bill introduces a definition of 'deposit account' which is not then used consistently in potentially relevant places throughout the Banking Act, for instance in the depositor priority provisions in section 13A.
This would introduce multiple definitions to capture a single concept in the Banking Act, which would risk introducing uncertainty regarding the interpretation of the Banking Act.
Support for bail-in
In contrast to the majority of submissions, one submission argued against the bill, proposing the opposite, that the Banking Act should make it explicit that bank deposits are at some risk of write-off or conversion to shares. It is suggested such a measure would strengthen market discipline on bank lending.
Nick Hossack argues:
The owners of banks (shareholders) and bank executives have financial incentives to take levels of lending risk that exceed the socially optimal level of risk. This arises in part because of the limited liability structure of incorporated banks, where owners [shareholders] and executives can capture the profits derived from excessive risk, while the downside is limited to zero and/or subsidized by taxpayers.
In addition to removing the discipline of a potential run on bank withdrawals, the bill would not eliminate or solve the problem of large lending losses leading to bank failure because the failing bank would still need to be managed. Prohibiting depositor liability shifts bank lending risk back to taxpayers. By eliminating the option of using deposits, the bill would increase the risk taxpayer money would be needed to keep the bank operational—a further taxpayer subsidy for too-big-to-fail banks.
Better education for consumers
Although opposing bail-in provisions, Digital Finance Analytics supported measures to provide clearer information to depositors to alert them to potential risks to their deposits. It cited the Reserve Bank of New Zealand dashboard of data for financial institutions that allows depositors to assess the relative risks across institutions.
The committee notes the concerns expressed by submitters that their bank deposits might become subject to bail-in should a financial institution become unstable.
However, the committee is of the view the Crisis Resolution Act and its amendment of the Banking Act are not well understood, neither are APRA's priorities and powers with regard to ADIs, or that in the unlikely event of financial crisis, the government's overwhelming efforts would be directed towards stabilising the financial system.
The committee is of this opinion for several reasons:
'any other instrument' cannot be interpreted to include bank deposits;
the prudential framework cannot be altered to require bank deposit account terms and conditions to include conversion and write-off principles; and
the Australian Prudential Regulation Authority is directed, by the Banking Act, to protect the interests of depositors in ADIs.
Further, while depositors may be unsecured creditors, they are not the same as all unsecured creditors because of the ‘depositor preference’.
The committee concurs with the advice of the Treasury and APRA that the explicit protection of deposits in the Banking Act—the objects clause, priority repayment, and the Financial Claims Scheme—is inconsistent with a concern deposit accounts could be subject to any kind of conversion, write-off or bail-in.
The committee further notes any piece of legislation can be amended or repealed with the authority of the Parliament.
The committee recommends the bill not be passed.