Wednesday, November 17, 2010

The Federal Bond Insurance Corporation (FBIC)

Whilst just about every man and his dog in the bank debate remains focussed on the irrelevance of interest rate margins, this blog has been thinking about how to address the underlying cause, the banks' dependence on foreign funds and how to manage it.

It's come up with the following: The Federal Bond Insurance Corporation (FBIC).

The FBIC is a government corporation, much like Australia Post or Export Finance & Investment Corporation. It's role is to monitor and manage offshore bank borrowing.

It does this through charging the banks fees for wrapping their foreign bond issues in a AAA rating.

The fees are pooled in the corporation and act as the collateral that supports the bonds. The corporation can issue its own debt to leverage this capability but should be kept to very conservative gearing ratios.

This has the following benefits:

- it shifts the current implied Budget guarantee for the banks' wholesale debt into an open an transparent relationship with a separate entity which is funded by the banks
- over time, the pool also grows through its own investments and profitability
- thus, it removes the burden of guarantee from the Budget, as well as mitigating much of the moral hazard currently at work for the major banks
- because of the AAA rating, the additional cost of the insurance is offset by the reduced cost of funds for the big banks in foreign markets, the banks therefore have no excuse to make unilateral interest rate rises at home
- the transparency bought to wholesale funding also helps in this regard. But more importantly, it frees our regulators from the current shadow game of hiding the problem, what this blogger calls Invisopower!
- the corporation could be situated somewhere between APRA and the RBA and also be given some kind of macro-prudential charter governed through a board that includes representatives from both. This should include containment of offshore bank borrowing within certain pre-ordained constraints that ensure the country does not over-leverage itself
- it might also be guided by a pro-competition agenda in which big bank fees are used to actively subsidise the fees charged to smaller banks. This will build competition for the big four in a new generation of medium-sized banks, instead of the current ludicrous suggestions of returning to the failed experiment of non-bank lenders
- obviously, and most importantly, the FBIC frees the nation from the risk of a major run by foreign creditors and the calamitous fallout if the Budget guarantee is not as effective as everyone currently thinks (for instance, in the event of a Budget crushing event in China)

In short, an FBIC would enable a transition to a lower risk, higher competition financial system without bringing current players to their knees.

This blogger is quite certain it's missing all sorts of downsides and unintended consequences with this suggestion. It invites you to improve it in comments and to pass on the post.


Anonymous said...

Would it also cover the gearing and foreign borrowing of the big four's overseas investments? ie New Zealand, UK, etc, or only the borrowing used to fund Australian investments? How would that work?

Anonymous said...

And who insures the FBIC?

The previous comment about ensuring that the Aussie govt isn't responsible for insuring non-Australian investments is also spot-on.

But I applaud you for thinking about alternatives such as this.

Anonymous said...

Just thinking through the "unintended consequences" part.

To work, it would have to be introduced in New Zealand at the same time, so New Zealand didn't turn into some kind of Hong Kong/Cayman Islands/Swiss/whatever clearing house for the Big Four (through their NZ subsidiaries)...

And it would have to apply to foreign borrowing used to invest in overseas investments - otherwise they could just set up (or shack up with) overseas-based investment groups to do the dirty work in Australia while keeping the bank at arms length from the FBIC....

And of course protect Australia from banks' overseas indiscretions.

Would the FBIC only oversee Australian banks, or all banks that operate in Australia, including wholly foreign owned ones?

I should say, I think it's the kernel of a great idea and much better than anything else put forward so far. Mostly because it takes the emotion out of the argument - banks can't pretend that relying on borrowing from foreign sources isn't a risk and the government can't pretend (forever) that guaranteeing the banks isn't a risk. At least this approach brings everything out in the open - but like any proposal, it has a tendency to act like bubbles in wallpaper - fix one bit and it bubbles up somewhere else. And there's been a lot of wallpapering going on.....

Anonymous said...


Whilst just about every man and his dog in the bank debate remains focussed on the irrelevance of interest rate margins, this blog has been thinking about how to address the underlying cause, the banks' dependence on foreign funds and how to manage it.

Perhaps we could try something totally different that apparently nobody even consider these days: do nothing.

Yes - let's do nothing and instead of trying to "fix" the system introducing new pieces, let's remove the problematic pieces.

Stop the government guarantee to bank debit, remove tax benefits for property investment (any tax decrease would be good actually), remove councils red-tape on construction, restrictions on land suply, etc. The less interference the better. We wouldn't be in this mess in the first place if we didn't have all these distortions in the system - especially in the interest rates.

What's lost in the economical debate currently, in my opinion, is the notion that the state is not omniscient, therefore it can't anticipate the effect that any interference will cause in the economy. Even if it wanted to (people think that individuals in the state are "purer" than in other sectors of society).

I enjoy reading this blog and other good Australian blogs (delusionaleconomics, unconventionaleconomist), especially posts on the real estate bubble.

But when it comes to solutions I still think the Austrian school of economics has the right answers.

BTW, tasmanianrealestatetrouble is on my favourites list as well.

Finally, thanks for allowing anonymous posts! :-)