As part of its review of failure and crisis management arrangements in the Australian financial system the Council of Financial Regulators has recommended that the Government consider introducing a financial claims compensation scheme to enhance current
arrangements. The scheme would provide retail depositors in a failed authorised deposit-taking institution immediate access to at least some of their funds and would provide some protection to retail
policyholders in insurance companies.

This was the first such review since APRA was established and follows the publication of the “Study of Financial Guarantees” undertaken by Professor Kevin Davis following the failure of the HIH Group of
Companies.

Whilst the review endorsed many of the arrangements currently in place for dealing with distressed financial institutions, the Council observed that on closure of a distressed financial institution there is
currently no mechanism for providing depositors/policy holders with access to their funds on a timely basis.

While the relevant legislation give depositors/policyholders first claim on the assets of a failed
institution, it makes no provision for timely payments. Given the lengthy nature of the wind-up process, it could take many months, or even years, before funds are available for distribution. As demonstrated by the case of HIH, this can create financial hardship for many households and businesses, which can generate pressure on Government to ‘do something’. At the same time, while wishing to remedy this
shortfall in Australia’s failure management arrangements, the Council is not attracted to the cumbersome pre-funded deposit insurance and financial system guarantee schemes found in many other countries.

Against this background, the Council has recommended to the Government that it consider a ‘minimalist’ Financial Claims Compensation Scheme with the following characteristics:

• The scheme would be administered by APRA. No new agency would be necessary.
• The scheme would apply to retail deposits in authorised deposit-taking institutions (ADIs) and the policyholder claims of life insurers and general insurers.
• The scheme would provide depositors with access to 90 per cent of their funds in a closed institution up to a maximum limit (for example, $50,000).
• Depositors would also be able to lodge a claim for further monies, up to a predetermined amount, against the scheme in limited and specified circumstances (for example, up to $1 million where an ADI had failed just after the proceeds of a house sale were deposited).
• The arrangements for compensation would only apply to the financial institution’s liabilities in Australia. The scheme would not apply to financial products offered by Australian authorised financial institutions in other countries.

Monies provided to the scheme to assist depositors/policyholders would be repaid from the sale of assets of the failed institution; and only if there proved to be a shortfall would the scheme need to levy
other financial intermediaries. There would be no cross-industry subsidisation within the scheme so that there would be no recourse to authorised deposit takers to compensate for any losses incurred by the
failure of an insurer and vice versa.

The Governor of the Reserve Bank of Australia, Mr Ian Macfarlane AC, as Chair of the Council, has been asked by the Treasurer to undertake a programme of consultation with the industry to discuss and explain the proposal as outlined in the report and to report back to the Treasurer.