Deposit guarantees are vital for banking durability.

SINCE the advent of the credit crisis, our understanding of the unique role played by banks has once again evolved (older heads would say it has been "refreshed"). Numerous institutions around the world have been wholly or partially nationalised in recognition that the banking system is the critical infrastructure through which liquidity is collected (via savings) and distributed (through loans) to all parts of the economy.

Australia's highly profitable major banks rank among only 22 AA-rated banks in the world, and have generally thrived throughout this calamity. The biggest bank, Commonwealth, is to be commended on its commitment to aggressively maintaining liquidity in the face of these challenges.

Rather than rationing credit to the $250 billion a year housing finance market, CBA has backed the sector's integrity by buying BankWest outright and acquiring direct and indirect stakes in Aussie and Wizard. Last year, it recorded 12 per cent growth in its home loan book, yet managed to keep its 90-day default rate down to just 0.38 per cent through conservative lending (that's less than a sixth of the default rate on prime US home loans).

CBA recently reported the loan-to-value ratio on its $275billion mortgage portfolio was a remarkably low 37 per cent.

We have come to appreciate that banks are not private entities in the conventional sense. Given their role as the economy's principal conduit for the aggregation of savings and the distribution of credit, banks, by definition, require various forms of implicit and explicit government help to negotiate shocks such as those we've witnessed lately.

The taxpayer-funded Reserve Bank, founded in 1959, in part to prevent banking crises, lends to these institutions daily to support their liquidity. At certain points in the crisis, the Reserve has injected billions of dollars into the banks' short-term funding markets to minimise their cost of finance as concerns around counter-party risks led to spreads widening to previously unfathomable and non-economic levels.

More recently, taxpayers have provided deposit guarantees and offered to lend the banks the Government's rock-solid AAA credit rating, which has allowed them to raise more than $60 billion of wholesale funds they would not have had access to. While banks have paid a risk premium for these guarantees, it is an open question whether this fee reflects the value of the service they've received.

And though some of the majors might argue they don't want deposit guarantees, it is sobering to consider how they'd react if the Government formally legislated that there would be no implicit guarantees either. The truth is that deposits are the shortest term of all available funding sources and can waltz out the door any day. History has repeatedly demonstrated that deposit guarantees of one form or another are essential for banking durability.

The most recent call for help has been the $2 billion in taxpayer cash and the $26 billion in guarantees that the banks requested to prop up commercial property lending in the event that there was an exodus of foreign capital.

While one can argue about what all this is worth, such interventions have stimulated calls for greater reciprocation from these "utilities". CBA has started doing its bit, with the announcement of repayment holidays for distressed borrowers. But repayment holidays just allow the unpaid debt to accrue interest and compound for 12 months, whereupon the borrowers face an even larger liability.

A more substantive policy opportunity for the banks to work with the community is through debt-for-equity swaps for families facing unemployment and the risk of being forced out of their homes. There is a growing coalition of support for this initiative among socially oriented institutions such as the Bendigo and Adelaide Bank and the ACTU, respected academic economists in Australia and overseas, and even the Opposition.

The elegance of this idea is that it should not result in any new taxpayer spending (read no impact on the May budget) and should not require the banks to make any capital commitments. But it has the potential to save many thousands of families from the poisonous social consequences of losing their home.

The smartest strategy would be for the Government to set aside a small portion, say $500 million, of its existing $8 billion commitment to the mortgage securitisation market, to help with the funding of debt-for-equity swaps for households that have had a key breadwinner lose their job.

Such a family could convert an existing, say 70 per cent, home loan with CBA into a new package where they would have a much smaller 50 per cent normal mortgage combined with an interest-free "shared equity" loan (like those provided by Bendigo and Adelaide Bank). By doing so, the family could cut their monthly mortgage repayments by up to 30 per cent or more for the next 25 years. And the shared equity loan only incurs a cost if the borrower does well and the value of their home increases — if it does not, they just repay the principal amount with no interest.

The family wins, and taxpayers win because they are just reallocating a small amount of an existing $8billion commitment to support liquidity in housing finance (that is, there is no budgetary impact). But rather than just funding bog-standard home loans for any old borrower, this money would be saving families from foreclosure. In fact, every $100 million that was reallocated would save about 1250 families. Taxpayers could expect to get their original investment back plus a return. The Government wins because it gets to unveil an innovative policy to help mitigate rising unemployment.

Banks benefit because they do not have to wear financial losses or reputational risks from repossessing homes, while also contributing back to their communities.

Christopher Joye led the 2003 prime minister's home ownership taskforce and has presented to the Obama Administration on debt-for-equity swaps. He is chief executive of Rismark International.