Government Guarantees and the Reasonableness Test
Updated: Jan 21, 2022
Government Guarantees and your Strata Funds
Government guarantees (more formally known as the Financial Claims Scheme (FCS) in Australia) are an interesting and globally, a quite common component of well governed financial systems.
Predominately borne out of the chaos and uncertainty of the 2008 Global Financial Crisis, the aim was to sure up confidence in the nations banking system and prevent large scale drawdowns (called ‘runs on the bank’) that remove the capital held by the bank and eventually will seize up its ability to function.
In response to the investor confidence panic in the wake of the GFC, on 12 October 2008, the Government announced temporary arrangements to enable the provision of a guarantee for the deposits and wholesale funding of Australian ADIs.
Up until 1 February 2012, deposits up to and including $1 million in eligible ADIs — including banks, buildings societies and credit unions — were guaranteed by the Government without charge under its Financial Claims Scheme (FCS). Since then, a new permanent cap of $250,000 per person per institution on deposits guaranteed under the FCS took effect from 1 February 2012.
So, what does this mean to the average Australian? The answer lies upon several considerations and its true value is based on probabilities.
It is very reassuring to know that, in the event of a bank collapse, a fixed amount of your savings (which hasn’t changed since 2012) will be swiftly printed at the Reserve Bank of Australia and handed back to you.
However, as (recent) history has shown, the propensity and desire at both a fiscal (Federal Govt) and monetary (Reserve Bank) level to protect the economy through stimulus almost make the FCS irrelevant. If a bank was going to collapse, COVID should have done it, and yet here we are with most major banks posting record profits! The major Australian banks are some of the best run in the world, and periods like 2020/21 are proof of their good governance.
The rub is that the deposit holders, the very people that the FCS is designed to protect, wear the impacts of huge stimulus through higher inflation and minimal rates of return on their savings. On top of that, it does not come for free, with the industry liable for any shortfall paid by the Government after liquidating a bank, by way of a special levy in the event of the scheme being triggered. Not many guesses are required to work out who ultimately will be wearing those costs.
The FCS is an important component in ensuring continued confidence in our banks, no question. As a long-term saver however, you have to ask yourself whether the opportunity cost of absolute protection (up to $250,000 per account) from bank failure is worth the additional contributions needed to make up the difference between low interest and high inflation rates. This is especially the case over extended periods when the differential compounds the problem. See our article on compounding for more information.
So when considering shorter term savings, usually in alignment with your 10 year maintenance plan, term deposits offer good security and capital protection. Looking longer term, in which you often find higher cost items more subject to inflation, and so decisions must be made as whether there is scope for seeking better long term potential returns, or the stomach for higher strata levies to make up the difference.
Prudence and Reasonableness when investing Strata Funds
The relevant acts (which vary from state to state, see our articles on relevant states for more detail) often speak of the importance of ‘the person investing the funds must exercise the care, diligence and skill a prudent person of business would exercise in managing the affairs of another person.’
To put it another way, the decisions made at a committee level (which applies to many of their responsibilities) need to made on the basis of a reasonable decision when investing their maintenance, capital works and sinking funds. This can include choosing term deposits of course.
The 'reasonableness' test was a real focus in putting together Strata Guardian. There are plenty of investment managers out there, many of who do a great job in their selected area of the investment world.
The difficult job from a committee point of view is ascertaining the appropriateness of the manager's investment style against the needs and requirements of their beneficiaries and lot owners. Committee Treasurers are often not experienced in investment advisory!
Our view is that in building an investment solution that only caters to the Australian Strata Community, it will help in confirming to the key decision-makers that the solution chosen is 'fit for purpose' in this way.
When constructing our portfolio's, we are able to dissect the requirements of an Australian Strata building's needs and build the resultant portfolio's accordingly. The liquidity (ability to sell quickly), diversification and volatility requirements, along with the benchmarks (inflation +%) are carefully considered to ensure that our typical client's investment needs are met.
We do this by managing a portfolio of high-quality, reputable exchange-traded funds that are always on market and accessible by our investors with the express purpose of achieving higher than term deposit returns whilst taking an appropriate level of risk for their investment timeframe.
It is this focus that brings confidence in the fact that by selecting Strata Guardian, our priorities are in alignment with your priorities.
We welcome you to check out what a portfolio could look like for your building today through our no-obligation onboarding portal which will provide a full breakdown of the portfolio and annual fee estimates before you make a decision.