By Eric Johnston
HIS bank was nearing collapse - at least that's what the reports were saying - and his car was packed with bags bulging with cash.
Two decades after Australia's last big banking crisis, one of the then senior managers of a state bank that faced a run on its deposits remembers the moment when customers lost confidence and he and his colleagues had to hit the streets.
As reports spread that the bank was struggling under the weight of losses from commercial property loans, there was a smattering of unusually large withdrawals. This accelerated in a matter of days until millions of dollars were flying out the bank's doors. This forced senior managers to take extraordinary measures to win back trust - and deposits - before the cash ran out.
A bank run is a death spiral that even the world's biggest struggle to snap out of before regulators step in. In most countries, few banks suffering a run will survive more than five days. At the state bank's head office, four senior staffers drove up to the loading dock and their cars were filled with bags of money.
They were sent out to the suburbs with instructions to top up the funds of the branches suffering the heaviest withdrawals.
It was a war of financial attrition, with the hope that customers would again believe there was more than enough money to go around.
"You would just drive around until you got the message with the name of the branch where to go," one of those involved said.
All this was done under strict secrecy. Just a handful of the bank's managers knew of the rescue operation.
If word got out, it threatened to shatter the very confidence it was trying to restore. Even regulators were not told about the cash dumps.
"We drove back into head office several times a day and we'd just load up the boot with hundreds of thousands of dollars," said the person, who is now a senior executive at a big four bank. "It was real - we were right in the middle of it."
The scars of this early 1990s banking crisis have been critical in shaping a deeply conservative culture among regulators and some senior bankers over the past two decades.
Today, that culture is regarded as one of the main reasons Australia has so far escaped the worst of the crisis that continues to hobble most of the world's developed economies.
This week - two years after the global financial crisis hit its apex with the spectacular collapse of Wall Street investment bank Lehman Brothers - the world's top banking regulators, including regulators from Australia, finally agreed on rules intended to shield the global banking industry from financial disasters. Bearing the name of the Swiss border town where the rules were thrashed out, the Basel Committee of Banking Supervision signed off on a package of changes that places banks around the world on a more conservative setting and forces them to hold a larger cushion of funds to protect against losses.
The accepted wisdom from the banking community is that Australia's banks are already well prepared to comply with the new standards, but that assertion is only part of the story. Australian banks are deeply tied to the global
banking system, so changes that affect the ability of overseas banks to lend will inevitably influence the ability of Australian banks to provide credit - whether for a business loan, a credit card or a home mortgage.
The measures, to be introduced gradually over the next few years, are aimed at rebuilding global confidence in the banking system.
"What the reforms will do is overall make the world's banking and related sectors more liquid and better capitalised," says Charles Littrell, a general manager with the Australian Prudential Regulation Authority.
But in the global push to make banks safe, do they threaten to curb the very activity that banks are in the business of doing: lending money?
Banks are not like normal businesses. Even the way they report their balance sheet is all upside down. Most people think of their cash in hand as an asset, while their debts (usually to a bank) are liabilities.
In a banker's view of the world, deposits are called liabilities, while mortgages or business loans are assets.
Banks are ultra-highly geared businesses that rely on funding well in excess of what shareholders have put in to the business for the bulk of their financing requirements. This additional funding, needed to provide loans, is made up of deposits and wholesale borrowings.
Some liken banks to inverted pyramids - giant stores of borrowed funds supported by just a slither of real money.
Shareholder equity or retained profits - the safest form of cash - rarely account for more than 5 to 10 per cent of total liabilities.
Any ordinary business, such as a miner or manufacturer, with leverage to the equivalent of 90 per cent of their balance sheet would pretty much be out of business.
This leaves banks with little margin for error.
As one banker puts it: "We're that leveraged, we wouldn't want to be in the business of lending money to a bank."
And as Lehman Brothers showed, when things do go wrong in a bank that has borrowed money from many other banks, the consequences can be spectacular.
A big lesson of the financial crisis is that any bank that tries to support a massive lending book with a just a drop of shareholder capital has a bleak future.
Lehman, which was not even the most highly geared of the global bad banks, had just $1 of equity for every $30 it lent out.
Northern Rock - a small British mortgage bank that was the first to be rescued by the British government - had a stated aim of growing its mortgage book faster than profits.
At its peak, Northern Rock was lending out the equivalent of $50 to just $1 of equity. At these ratios it only requires a small number of loans to turn bad before shareholder equity is wiped out.
In Australia, under the gaze of APRA, the ratio is closer to $1 of equity for every $10 in lending.
Reserve Bank figures released this week show the nation's banks are holding $131 billion of tier 1 capital against $1.39 trillion of loans (measured by their relative risk).
But do the new global rules go to far for Australian banks?
Australia's big banks campaigned hard against being subject to the new rules or at the very least called for some watering down of the proposals to recognise they did not take excessive risks.
The big four Australian banks are among the few around the globe to carry a credit rating of "AA", ranking them among the world's safest.
Yesterday, new Commonwealth Bank chairman David Turner again argued Australia should be cautious about signing up to a ''global solution'' on regulation, warning high capital and liquidity levels would reduce the availability of credit.
''While regulators in some jurisdictions clearly need to address the adequacy of their regulatory regime post the global financial crisis, it is important that we, in Australia, think carefully before adopting a 'one size fits all' approach,'' Turner said at the release of the bank's annual report.
The new Basel rules require banks to boost the level of safe capital.
For Australian banks their tier 1 ratio will rise from a minimum of 4 per cent to 6 per cent. In addition, they must also include a 2.5 per cent "buffer" that banks can draw down in times of strain, taking the tier 1 to 8.5 per cent. Australian banks have already been sitting at or above these levels for the past year.
But the biggest worry for local banks is a requirement they must have enough government bonds on hand to make sure they can support 30 business days of lending without any new funds coming in the door.
Here the assumption is that banks should be self-funding for a month in the event of another freeze on global markets.
Known as the liquidity coverage ratio, this represents a fourfold increase over the current five-day funding rule and is what has many in the finance industry in a sweat.
National Australia Bank chief economist Alan Oster said many underestimate what the rules mean for Australia.
"What worries me is the financial crisis was a really good stress test and Australian banks were fine.
''Now they might implement rules that are going to cause problems for Australia," says Oster.
At the same time, Australia's relative tiny level of government debt means banks will simply not be able to get their hands on enough government bonds to fulfil the requirements.
Banks now have enough cash to support their lending. But some this is going to be put into government bonds. If banks intend to continue lending at the same rate, they will need to borrow more funds from wholesale markets.
Ratings agencies have little tolerance for Australian banks to substantially increase borrowings and would be expected to react with a ratings downgrade.
None of the big banks would be prepared to give up their highly prized AA ratings, meaning the only option is to curb lending.
"If you stop lending, this has a real impact on the economy," Oster says.
Australian banks, through the Australian Bankers Association, continue to argue for leeway on further requirements that banks increase their holdings of top-rated government bonds.
"Australia faces a problem given the lack of government debt and we still have a task ahead of us to demonstrate how we're going to meet the liquidity coverage ratio
in a way that others are meeting it overseas," said ABA chief executive Steven Munchenberg.
For all their strengths, Australia's major banks also have a glaring structural weakness. They don't have enough deposits, so they rely on wholesale borrowings, much of it from overseas, to fund about half their lending.
This is fine in normal times, but as the financial crisis accelerated through September 2008, it soon became apparent that wholesale borrowing markets were shutting down. Australian banks faced the threat of not being able to fund their day-to-day activities.
APRA says it is "pointless and unhelpful" to stand against the tide of international reform but also points out there is still some way to go before we know the shape of the final rules.
Not only do the measures need to be signed off at a meeting of G20 leaders in November, there's a further two years consultation with industry to follow, the bank regulator argues.