Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding

One of the international effects of the global financial crisis was a dearth of liquidity at the end of 2008 and an enormous perceived risk for large banks. As a result, “international long-term wholesale funding markets essentially closed to non-sovereign borrowers,” according to Australian authorities (Schwartz 2010). Australia’s banking system was robust at the time of the global financial crisis; however, as institutions experienced restricted access to funding, especially in international long-term wholesale funding markets, investors became reluctant to buy long-term bank debt, and the lack of access had “potentially serious implications for liquidity and lending activity” (Reserve Bank of Australia 2012; Schwartz 2010).

It was against this backdrop and coupled with similar announcements in a number of other countries that the Australian government created the Government Guarantee Scheme for Large Deposits and Wholesale Funding as part of its other measures created in response to the global financial crisis (Reserve Bank of Australia 2013).

The Australian Government Guarantee Scheme for Large Deposits and Wholesale Funding, also known as the Guarantee Scheme, was announced by the government on October 12, 2008, and began on November 28, 2008 (Reserve Bank of Australia 2012). It was administered by the Reserve Bank of Australia on behalf of the Australian government (Reserve Bank of Australia 2013). The government announced that the Guarantee Scheme would remain open until markets normalized, rather than establishing a set expiration date (Schwartz 2010). This case will deal only with the wholesale funding component of the scheme.^FNThe Guarantee Scheme had two components: a wholesale funding guarantee and a deposit guarantee. The deposit guarantee covered deposits up to A$1 million at no cost and amounts above that for a fee. It was replaced in 2012 with a cap of A$250,000 (Reserve Bank of Australia 2012).

The wholesale funding component of the Guarantee Scheme allowed Australian depository institutions (known in Australia as authorized deposit-taking institutions, or ADIs) to issue securities with maturities of up to five years (less in the case of foreign bank branches)^FNForeign branches had restricted access to the Guarantee Scheme (Schwartz 2010). that were fully guaranteed by the Australian government (Reserve Bank of Australia 2013; Schwartz 2010). The government did not establish minimum maturity requirements for eligible debt or place a limit on the total value of liabilities it would cover (Schwartz and Tan 2016).

There were two processes for institutions issuing securities based on maturity: one for short-term liabilities (with maturities of less than 15 months)^FNFor specific information on this process, refer to the Guarantee Scheme Rules (Australian Government 2012). and the second for long-term liabilities (with maturities of 15 to 60 months)^FNAustralian Government 2012. (Australian Government 2012). Institutions eligible for the scheme included banks, building societies, and credit unions. To apply for the scheme, an institution had to complete an eligibility certificate provided by the Reserve Bank of Australia (acting as the program’s “scheme administrator”). Further, after an institution had been approved for a guarantee, it had to provide a separate certificate for each type of liability (Schwartz 2010).

Eligible short-term liabilities took the form of senior unsecured debt instruments in any currency with maturities of less than 15 months. The instruments could be issued in bearer, registered, or dematerialized form. They could not be complex and had to fall in the categories of bank bills, certificates of deposit/transferable deposits, debentures, or commercial paper, and applications could be made for issuance programs (Australian Government 2012).

Eligible long-term liabilities took the form of senior unsecured debt instruments in any currency with maturities of 15 to 60 months. The instruments could be issued in bearer, registered or dematerialized form. They could not be complex and had to fall in the categories of bonds, notes, or debentures, and applications could be made for issuance programs (Australian Government 2012).

All guaranteed liabilities were subject to a monthly fee for eligible debt issued on or after November 28, 2008. The issuing institution was required to pay this fee within seven business days of the last calendar day of each month in arrears (Australian Government 2012; Reserve Bank of Australia 2012). The amount of the fee depended on both the credit rating of the institution (lower-rated institutions had to pay a higher fee to access the guarantee) and the value of the guaranteed liabilities. The same fee applied regardless of the term of the debt (Reserve Bank of Australia 2012). The fee ranged from 70 to 150 basis points (bps) per annum depending on the credit rating of the institution.^FNFor short-term liabilities only, the following applied: in calculating the value of these liabilities, the gross proceeds of the fund raising were to be used (Australian Government 2012).

Last, “all Australian institutions were required to have systems in place to identify separately guaranteed liabilities and other liabilities. For wholesale liabilities, systems had to be in place before the guaranteed liabilities were issued” (Australian Government 2012).

There were several safeguards built into the Guarantee Scheme. Any institution seeking involvement had to have approval from the Australian Prudential Regulation Authority (APRA), Australia’s bank regulator. Foreign bank branches, which were subject to less Australian supervisory oversight, had multiple additional restrictions for participation, including shorter maturity limits and caps on the amount that could be issued. Last, the Council of Financial Regulators, an agency that served in an advisory capacity during the Guarantee Scheme’s creation and operation, required monitoring of exposures and regular reports on both individual bank exposures and foreign branch activities (Schwartz and Tan 2016).

The Guarantee Scheme’s wholesale funding component had an immediate effect on Australian institutions. They had only issued bonds worth A$2 billion ($1.31 billion)^FNThe monthly average spot rate in November 2008 was $1 = A$1.5266. in the three months before the Guarantee Scheme’s introduction, but in the program’s first three months, they issued A$73 billion of bonds, of which A$70 billion was guaranteed through the program (Schwartz and Tan 2016).

The Guarantee Scheme’s peak use came during its initial period of operation, “when risk aversion among investors was highest” (Schwartz and Tan 2016, Schwartz 2010).

As markets began to reopen, use of the Guarantee Scheme eased (see Figure 1). In late 2008, guaranteed bonds represented 100 percent of total bond issuance; by late 2009, they only represented about 30 percent. Guaranteed short-term wholesale funding peaked in February 2009 at A$22.4 billion, but quickly fell to around A$17.1 billion by January of the next year (Schwartz 2010; Schwartz and Tan 2016).

Australia’s four main banks—Commonwealth Bank, Westpac Banking Corporation, National Australia Bank, and Australia and New Zealand Banking Group—represented the Guarantee Scheme’s largest users, accounting for about two-thirds of total guaranteed issuance. However, issuance as a share of liabilities was higher among non-major Australian banks. Before the crisis, these non-major banks chose not to issue many bonds and instead operated in residential mortgage-backed securities markets. When the crisis made these markets unpalatable, the non-major banks responded by making significant use of the Guarantee Scheme and issuing large amounts of guaranteed bonds (Schwartz and Tan 2016). This pattern can be seen in Figure 2.

Source: Schwartz and Tan 2016.

Source: Schwartz and Tan 2016.

Institutions predominantly used the Guarantee Scheme’s wholesale funding component for long-term liabilities. The majority of short-term debt issuance came from non-major institutions, which is partly explained by the fact that, as part of the Guarantee Scheme’s slew of safeguards, foreign-owned branches were not allowed to issue guaranteed debt with maturities of greater than 15 months (Schwartz and Tan 2016).

By June 2009, as global markets became healthier, banks began issuing unguaranteed bonds. Issuance of guaranteed bonds, which had accounted for almost all bond issuance following the Guarantee Scheme’s implementation, fell to close to zero in early 2010. “This reflected that the sharp compression in bank bond spreads over 2009 was more pronounced for unguaranteed bonds than for guaranteed bonds, particularly for higher-rated issuers. As a result, it was generally advantageous for the double-A-rated banks to issue unguaranteed rather than issuing guaranteed and incurring the associated fee” (Schwartz 2010).

On February 7, 2010, the government announced that the Guarantee Scheme’s wholesale funding component would close to new issuance on March 31, 2010. Any institution that wished to apply for the program had until March 24, 2010, to do so, and institutions could issue guaranteed liabilities up to and including March 31, 2010. After March 31, any liabilities already covered under the Guarantee Scheme “would remain guaranteed until either they matured or were bought back and extinguished by the issuer,” and institutions were required to keep paying monthly fees on these guaranteed liabilities (Schwartz 2010, Schwartz and Tan 2016).

By the time the Guarantee Scheme’s wholesale funding component closed to new issuance on March 31, the beneficiaries had issued about A$166 billion of guaranteed liabilities. At that time, the amount of guaranteed wholesale funding represented about 15 percent of all wholesale liabilities. Ultimately, the monthly fees generated by the Guarantee Scheme totaled A$4.5 billion in government revenue (Reserve Bank of Australia 2013, Schwartz 2010, Schwartz and Tan 2016).

After the closure of the Guarantee Scheme, previously issued guaranteed bonds matured and the amount of guaranteed bonds began to fall. This fall in supply was compounded by buybacks: as the markets improved, and the maturity profiles of the remaining guaranteed debt shortened (approximately 12 and 18 months remaining to maturity), the cost of maintaining government-guaranteed debt became more expensive than issuing unguaranteed debt. Thus, institutions began repurchasing their debt, at first in small amounts, but increasing as conditions improved^FNThe first buyback of guaranteed debt occurred early in mid-2009, but buyback activity was not prominent until 2011 (Schwartz and Tan 2016). (Schwartz 2010, Schwartz and Tan 2016).

Institutions repurchased about A$16 billion of guaranteed bonds by mid-2012. Some of the biggest issuers of guaranteed bonds began large-scale repurchases in late 2012 and early 2013, during which time they bought back about A$15 billion of guaranteed bonds. These buybacks contributed to a decline in the supply of guaranteed bonds to about A$57 billion, as seen in Figure 3 (Reserve Bank of Australia 2013).

Source: Reserve Bank of Australia 2013.

Non-major institutions bought back a larger share of their guaranteed debt than did major institutions, even though major institutions accounted for more than half of total buybacks in absolute terms. While major institutions bought back A$33 billion (about 33 percent of their issuance under the Guarantee Scheme), non-major institutions bought back about A$25 billion of guaranteed debt, which represented slightly more than 50 percent of their issuance (Schwartz 2010, Schwartz and Tan 2016).

The scheme’s final bond matured in early 2015, and the scheme formally ended in October 2015 (Reserve Bank of Australia 2012).