Should Malaysia guarantee bank deposits?

Source TheStar

AS governments around the world are rushing to guarantee deposits with their financial institutions in the wake of a spreading financial crisis, the question is if Malaysia should follow suit — and when.

If Malaysia decides to do so, it won’t be the first time. During the Asian financial crisis of 1997/98, there was a significant shift of money from local to foreign banks, which were perceived to be safer than the local banks.

To stop the situation from worsening and to ensure that local banks had sufficient deposits to provide enough liquidity for their banking activities, the Government gave an assurance that deposits with local banks were safe. Savers were assuaged and the shift dwindled.

Now we are in an ironically happy situation — relatively speaking that is — where many people perceive local banks, because of their lack of exposure to the US subprime mortgage crisis, to be stronger than some of the foreign ones.

It may be just too early for the Government to think of giving another such assurance to depositors right now since the banks here are little exposed to the credit and lending crisis overseas and their critical ratios all still look good.

But there is no harm in giving some deep thought to the issue, especially since it is central to the health of a financial system. If depositors lose confidence in the financial institutions and withdraw their money, liquidity will simply dry up and lead to a total collapse of the system.

Right now, there is a deposit insurance scheme in operation. This is sponsored and supported by the Government under Perbadanan Insurans Deposit Malaysia or PDIM, the deposits insurance body. Under the scheme, each account holder per bank is insured up to RM60,000 in the event of bank failure. This covers the over 90% of depositors who have RM60,000 or less in deposits per bank.

But the amount of deposits covered is a whole lot less than that because the large depositors in the system are government bodies, corporations, partnerships and businesses, each of whose accounts can run into the millions.

Many of them will maintain just a couple of accounts and it would be too much trouble and too little benefit to spread it over 36 banks and gain an insurance coverage of just RM2.16mil (36 times 60,000) under the current deposit insurance scheme.

Under the PDIM scheme, RM191.5bil of deposits were insured as at Dec 31, 2007. But the total deposits as at the same date with commercial banks in Malaysia amounted to RM821bil. That means less than a quarter of total deposits are insured.

While the scheme is good for ensuring that the bulk of depositors is protected in the event of bank failure, it does not insure the bulk of deposits in the system. Thus, the deposit insurance scheme that Malaysia has is one that protects small savers but is of little help when it comes to problems that can affect the entire financial system — more than that is required to stop a systemic failure.

So far, contagion has not resulted in severe disease yet. The financial system is sound. But if the economy slips into recession, and output of goods and services contracts as worldwide demand falls, things can get sour here. And if there is a severe fall in property prices, it will worsen things.

And then there are peculiar problems in guaranteeing bank deposits — there could be a surfeit of deposits from overseas coming in here to take advantage of a government guarantee.

Conversely, if neighbouring Singapore decides to guarantee deposits, there could be an outflow of funds from here to there if we do not follow suit.

Yes, it may still be a bit premature to talk about guaranteeing all deposits in the banking system. But it is clear we must continue to watch the situation very closely and, if it is time to give that assurance, we simply must.