The governments in the western world are intervening in a free market environment in a way that is unprecedented. President Bush has discussed changing accounting standards to allow a softer version of the current crisis and in Australia Kevin Rudd has declared that the Australia government will guarantee deposits of Australian banks. Issues arise in this scenario. Take for instance a bank with an AAA rating prior to this announcement. They have made decisions based on security and compliance measures to minimise their risk realising that there is a cost in implementing these measures but that the market will value the reduced risk as evidenced by their AAA rating. Conversely smaller non bank financial institutions may not have the financial strength to fulfil the requirements of an AAA rating or conversely they may decide that their strategy is to pay a higher interest rate to attract depositors who would be aware of the higher risk. Now with the government guaranteeing deposits there is no reason to get paid lower rates so we should expect to see a movement towards riskier financial institutions which were the very institution that instigated the collapse in the first place. It is not as simple as AAA banks increasing their interest rates because they have incurred costs and implemented policies to gain their rating. Certainly there is the temptation to loosen the controls to allow greater risk to stay competitive.
Continue reading ‘Movement Towards Deposits in Riskier Financial Institutions’ »