It looks like this bad idea (as discussed here and here) will not lay down. Today’s Australian Financial Review (sorry, not on line) reports that the system the government is looking at implementing is firming up. In this one, the government would effectively pay out the first $20,000 of any loss up front and then step in to get its money back first.

As systems go, this is probably closer to the least atrocious - but the moral hazard problem remains.

Essentially, depositors will still know that the first $20,000 of their deposits are completely safe. The incentive, then, with the first $20,000 is simply to go for high return, regardless of the risk of the institution. Provided you keep the amount below the magic threshold, it is safe. You get the return of the riskier investment with the safety of a government guarantee.

If the government has to implement this sort of thing, then at least there should be some risk remaining with the depositor over every dollar deposited. A better system would be to guarantee only (say) 50% of the deposit, up to the threshold - and no interest due. This would then allow for people to get some cash out of the insurance - to help run their lives - without doing much more than that and, importantly, leaving most of the risk with them.

Even this would increase moral hazard from where it is now. The government just seems to be in a space where there is no industry interference it does not like.