Five-and-a-half years ago, amid the financial strife unleashed by the collapse of Lehman Brothers, the US government stepped in to bail out financial institutions across the US – deciding the risk of moral hazard was preferable to an even greater financial calamity.
The outrage flowed from large sections of the US public – why should the apparent architects of the crisis be saved from their own mistakes?
In Australia, amid mounting rumours of a run on a second-tier bank, the Rudd government moved quickly to guarantee all bank deposits up to $1 million. It was enough to stem any panic – and cost taxpayers nothing.
The guarantee still stands for deposits up to $250,000. But it is not clear how it would be funded should it be needed.
And now, as submissions roll in for the Abbott government's financial system inquiry, debate is centring not only around this explicit guarantee enjoyed by all Australian banks – but also the implicit, unspoken understanding that a government would be all but forced to bail out any one of Australia's big four banks, each of which is considered far too big to fail.
Sitting in the big four banks is $522 billion worth of Australian household deposits. This is equivalent to one-third of Australia's gross domestic product; the loss of just a fraction of these funds would represent a major burden for taxpayers.
Treasurer Joe Hockey has tasked the financial system inquiry to examine the issue. In a speech in November last year he highlighted how the big four banks had grown larger since the GFC by acquiring smaller lenders such as St George and Bankwest.
"In short, the four major banks have largely become the Australian financial system," he said.
Hockey is facing the strongest calls yet to impose a tax on the big four banks, to force them to pay for the protection this unofficial guarantee provides.
Submissions from the big four's smaller competitors – regional banks, customer-owned banks and credit unions – have argued that a tax on the big banks would address the funding advantage those institutions receive from being perceived as invincible.
And the Reserve Bank is warning that the inherent risks posed by Australia's too-big-to-fail banks can encourage moral hazard – the state in which a person or institution acts less prudently if they know they will be protected from the consequences of their actions.
It has supported the idea of a tax on the biggest banks and credit unions to help fund the government guarantee on deposits up to $250,000 – known as the Financial Claims Scheme.
Bank regulator, the Australian Prudential Regulation Authority, has also advocated the nation's biggest banks should be forced to set aside more capital to act as an additional buffer in the face of economic shocks. This is something the major banks have resisted.
This month, a report from the International Monetary Fund, which highlighted potential risks to global financial stability, warned that implicit government guarantees were creating free taxpayer subsidies for big banks around the world.
It said too-big-to-fail lenders were able to borrow at much lower rates and take bigger risks because of their government guarantee – and urged policymakers to remove this advantage.
That followed a study by New York Federal Reserve economists that concluded the largest US banks had a significant funding advantage over smaller lenders due to their too-big-to-fail status.
But the big four banks in Australia have dug in against any further policy change. Their submissions to the inquiry push back against calls for a too-big-to-fail tax, warning that such a levy could in fact increase moral hazard by reinforcing the idea that they are too big to fail. This is despite some banks acknowledging the public statements from credit rating agencies that say they receive an additional uplift – two "notches" – in their rating because of the assumption that they would receive government support in a crisis.
The debate has put the big Australian banks in the awkward position of assuring shareholders and deposit holders of their invulnerability while also – essentially – arguing that they would not seek or expect to receive government assistance in the face of potential collapse.
Speaking in Melbourne last week, ANZ's Australia chief executive Phil Chronican played down the idea that his bank was invulnerable in the eyes of homeowners and shareholders.
"I don't think anyone has agreed that we're too big to fail," he said.
Commonwealth Bank, in its submission to the inquiry, labelled the credit rating agencies' "two notch" call as "subjective", saying it only further fuelled the perception that the banks were invulnerable.
"[CBA] believes that there is a difference between implicit guarantees for particular institutions and general government support," it said.
"[It] does not believe that there is an implicit guarantee for the major banks but that there is general government support for the whole banking system."
The big four banks are being forced to boost the amount of capital they hold in reserve as insurance against losses, as part of a global push to shore up stability of "systemically important" banks.
The new rules, known broadly as Basel III, have divided the banking industry, with financial system inquiry head David Murray suggesting last month that they could be hurting economic growth in Australia and Asia.
But the Customer Owned Banking Association, which represents mutual banks and credit unions, says they do not go far enough to address the fact that the big four receive "billions of dollars of funding advantages for free" because of their size.
"Given the systemic risk that sits around these too-big-to-fail banks, is [this] an adequate response?" chief executive Louise Petschler says.
COBA is one of the groups now calling for a too-big-to-fail levy on the major banks.
"This is not an unfair tax on our largest banking institutions – it is a simple mechanism to restore a competitive imbalance created by too big to fail," its submission to the inquiry argues.
"It reflects the fundamental principle that major banks should be required to make a contribution to government which recognises the financial benefit they derive from a taxpayer-funded subsidy."
Calls for such a tax on the big four banks have been building since the global financial crisis. Last year, the previous Labor government put forward the idea of a super profits tax on the major banks, while the Greens have been pushing the idea since 2011.
"The experience of the global financial crisis in Australia was that the big four banks came out of it in rude financial health and with greater market share," says deputy Greens leader Adam Bandt.
"They were able to do that because the Australian public and the Australian government stood behind them. Policymakers and other players in the market are realising that, and seeing that there's a solution."
Treasury has raised the prospect of a tax on the big banks, saying it would be one way of addressing the too-big-to-fail issue and reducing their funding advantage over other lenders.
But it has warned that any tax would need to be priced carefully to avoid creating new distortions, and that it would mean choosing a different path to other countries at a time when G20 members were trying to "harmonise" regulation.
Before the inquiry can seriously think about the issue, it must first consider just how vulnerable Australia is to a major bank failure. Analysts say a full-blown collapse of one of Australia's big banks would be highly unlikely but catastrophic.
They say the only reason why such an implausible outcome is being seriously considered is because Australia's economy is so heavily weighted towards housing.
"All our eggs are in one basket here," Credit Suisse strategist Damian Boey says. "Most of the loan book is wrapped up in housing collateral. In a really bad situation, what you would find is that house prices would go down because people would lose their jobs.
"This would lead to a crash in the market, with demand unable to keep up with supply."
The chances of this playing out are unlikely, because policymakers stand ready to support the banks. While the big banks may deny this, it is this understanding that makes them too big to fail, meaning any collapse would ultimately be shouldered by taxpayers.
"The problem here is that a lot of people know this. This is the reason why people have been buying banking shares, because they are too big to fail, and you can take them as risk free, pretty much. That's how the thinking goes," Boey says.
This "positive feedback loop" is central to the dilemma policymakers now face. This is clearly of concern to the Reserve Bank, which oversees Australia's financial stability.
The huge GFC-era bank bailouts are fresh in regulators' memories, and the aftershocks will linger for years more.
The British economy is still recovering from the bailout of banks RBS and Lloyds which together cost UK taxpayers £65 billion ($117 billion). It will take Ireland decades to pay back its debt from bailing out the Anglo Irish Bank.
While the Reserve Bank says Australia's major banks are better able to withstand a crisis because they have had little exposure to the complex credit products that were the catalyst for the GFC, it says systemic risk can be heightened by perceptions that the majors are too big to fail.
"This can result in competitive distortions, allowing these entities to grow larger and become even more systemically important," its submission to the inquiry warns.
"It may also encourage moral hazard as banks that are perceived to be too big to fail may take on excessive risk with the assumption that the public sector will step in to cover the costs."
Regional banks have called for the government to not only examine a levy, but to also consider other policy options to tackle the too-big-to-fail issue.
These include higher capital charges on the big four, a fee for their deposit insurance and even breaking up the majors though a divestiture program.
In a joint submission to the inquiry, Bank of Queensland, Bendigo and Adelaide Bank, Suncorp and ME Bank say the best way to address the issue would ultimately be for the government to commit to letting them fail.
But it says even this is fraught with problems, as it would be unlikely to change public perceptions.
"It is inconceivable that a government would arrange to constitutionally bind itself against the option of protecting the national interest from a large bank failure," it says.
"This essentially means the problem cannot be solved directly."
It raises the broader dilemma of too big to fail, which is that no matter what governments do, the deposit holders and shareholders will tend to believe that they will receive a helping hand in a crash, effectively deepening the moral hazard risk by making shareholders and deposit holders less likely to apply scrutiny to the bank themselves, or to pressure it to scale back any excessive risk-taking.
The likelihood of a bank failing in Australia is hard to determine, which makes it difficult for any government to calculate its potential cost to the economy – and therefore, how much to stow away in case of such an emergency.
Rodney Maddock, an economics professor at Monash University and former CBA executive, says based on the current size of the big four banks, it would be impossible for any tax to cover a bailout.
"The banks have about $500 billion each in liabilities. If one of them collapsed and was worth nothing, it would have to find $500 billion or about 20 per cent to 25 per cent of GDP," he says.
Mortgage finance group Morgij Analytics has calculated that the implicit government guarantee on the big banks is worth $2.5 billion.
While support for a too-big-to-fail tax is divided, there is growing consensus that the current Financial Claims Scheme should be prefunded.
There is no money set aside to pay the guarantee; in the event of a collapse, it is understood the government would fund it with a levy on the remaining financial institutions.
Treasury says the scheme is flawed because those who receive funding – depositors and therefore the banks – "do not pay for the benefit they enjoy".
Credit Suisse's Boey says a bigger tax targeting the profits of the big four banks – while not ideal, as it would flow on to depositors – was still the most sure-fire way of bringing in much-needed funding to guard against any future collapse. "Australia has not been building up a buffer for a very long time, and now we're trying to catch up," he says.
