Today’s Australian Financial Review has an interesting piece (sorry, not online and the ABC article is sketchy) that has Peter Costello, Australia’s Treasurer – read finance minister for non-Australians reading this- endorsing the principle of introducing deposit insurance in Australia. The ABC article says John Howard, our Prime Minister, also endorses the idea.

Peter Costello seems to expect that this will not raise costs for depositors nor introduce moral hazard into the system. Perhaps a rejoinder on porcine aviation might be appropriate. Deposit insurance is a great idea – in the same way that world peace, socialism and universal love are great ideas.

If it does not cost, it provides no benefits. If it does not introduce moral hazard, it has no effect. Customers have to be aware that, if they go for a higher interest rate, the risks are higher. The whole S&L mess inthe US was caused by deposit insurance – customers only had price differentials in mind and did not have to worry that they were depositing their cash in a dodgy institution.

Additionally, if anyone can tell me how you can have deposit insurance without having to pay for it I would be fascinated to hear about it.

Yes, there have been some losses in collapsed insurance companies and, in the late 80s, a couple of ADIs and other deposit taking institutions collapsed, with some losses. Creating a whole deposit insurance scheme with all of the added costs and moral hazard is not an appropriate response.

[UPDATE]Updated pieces on this here and here<

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