As we revealed yesterday the Reserve Bank has sent a proposal for a modest deposit insurance scheme to the Federal Government.

But we don’t need a deposit insurance system for bank deposits, we need to sort out the regulation of banks and other financial groups to make sure there’s not a repeat of the Northern Rock or Bear Stearns debacles in Australia.

It’s an idea that has been around for a decade, but the current justification for the scheme is the ham-fisted way the Bank of England and the UK’s Financial Services Authority handled the bailout of Northern Rock.

In yesterday’s Financial Stability Review, the RBA argued:

This experience (Northern Rock) is consistent with the Council’s previous analysis that arrangements in Australia would be enhanced by the establishment of a scheme to repay depositors in a failed authorised deposit-taking institution (ADI) in a timely fashion.

Under the existing legislation, depositors rank ahead of other creditors in a failed ADI, although they are likely to have to wait some time before they could be repaid.

Given this, the Council is working on an Early Access Facility, which would provide early repayment of up to $20 000 per depositor in a failed institution; it is estimated that this cap is sufficient to cover the entire deposits of around 80 per cent of depositors.

Such a facility was recommended to the previous Government, and is before the current Government, while Council members have continued to investigate a number of technical issues relating to making early repayments to depositors in a closed institution.

But if you read the review you will find it is full of comments about how well our banks are doing, how well capitalized they are, how profitable and how they are regaining market clout in business and home mortgage lending. And the best insurance is well regulated, strongly profitable and prudently run banks.

The real lesson from the failure of Northern Rock is that there was no lead regulator to take the running and force the management of the bank out and have it taken over with a minimum of fuss — the Bank of England, the FSA and the British Treasury all had to get involved.

No one can say who would be responsible if one of Australia’s big banks ran into problems. Would it be APRA, the regulator of financial prudence, solvency and liquidity; ASIC which has oversight of corporate behaviour; or the RBA which is responsible for maintaining a stable financial system? If the situation involved one of the big banks taking over a competitor, the ACCC would also get involved.

And while that bureaucratic bunfight was being sorted out, the bank could wither away very quickly.