Thursday, 23 October 2008

Why Raising the Guarantee on Bank Deposits in Canada Is NOT a Good Idea Right Now

The CBC report Flaherty Expected to Announce More Help for Banks says he will raise the $100,000 guarantee on bank deposits, an action "aimed at helping Canadian banks weather the storm during the global financial crisis...". It turns out he announced that the federal government will guarantee inter-bank loans not increase deposits according to a more up to date report on CTV called Ottawa Takes Action to Boost Inter-bank Borrowing.

Whew! Thank goodness he did not raise the deposit guarantee. Imagine the consequences if he had.

People would ask themselves, "What exactly is going on that banks or depositors now need such protection? Are the previous assurances that Canadian banks are just fine not true anymore?"

Here's what further effect I think such an announcement would have:
  • people conclude that there must be a need for such protection, i.e. that banks are actually much weaker than they had been told, thus creating or exacerbating the very condition that the new guarantee seeks to placate; bank stocks would get hit, weakening the banks in reality
  • to the extent that people actually trust the guarantee, they have a greater incentive to see cash as the safe haven; they can now safely take more money out of the stock market and put it in a bank! After all, how many Canadians have more than $100,000 in cash that needs protecting? Certainly not ordinary working Canadians, it's people with substantial investment portfolios who are now in a state of severe stress as they watch the markets melting down day by day. The urge to sell out of the market and put it in cash in a bank increases, thus further weakening the market.
The time to up the guarantee is when something actually happens. Otherwise it risks becoming a self-fulfilling prophecy. Sometimes doing nothing is better than action.

1 comment: said...

I think the small business owners might feel better as they can routinely have six figures in cash on deposit. But your point is well taken in that based on the information available, Canadian banks are well capitalized and putting a guarantee that isn't needed might help proliferate the fear.

An interesting note: I've been chatting with other advisors and the consensus is that the investors are not panicking as much as during the tech bubble, and that they are on average sticking to their plans more than one would expect given what's seen and heard in the media.

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