The Financial Claims Scheme was a lifesaver.

WHEN the global financial crisis hit, the federal government took measures to reduce its impact on our economy. One of the more popular was the Financial Claims Scheme, which became known as the bank guarantee. Originally it covered deposits up to $1 million. From February 1, this fell to $250,000.

The introduction of the scheme created stability for the Australian banking industry but at a cost. The announcing of the guarantee actually increased panic levels among Australia's investors. This resulted in a mad rush to withdraw cash from other investments not covered by the guarantee, such as unlisted property trusts and mortgage trusts, which forced many of these to ban withdrawals.

In some cases the bans have only recently been relaxed, with partial withdrawals now allowed. The bans caused some problems for investors who could not access cash but, if the measure had not been taken, a fire sale of underlying financial assets would have wreaked more havoc.

It is generally agreed that the scheme needed to be introduced to reinforce the soundness of our banking industry. Although Australian banks had very sound asset positions the scheme was designed to ensure their liabilities, monies owed to depositors, did not create extra strain during the crisis.

It also helped Australian banks survive the tightening of credit by overseas banks and continue providing funding to our economy, although with much more stringent borrowing rules. The guarantee meant more cash was deposited with banks and led to a fall in the amount of funding required from overseas.

The scheme was always going to be temporary and, therefore, when it finished on January 31 this year, it should not have come as a surprise. Had the guarantee continued indefinitely our banking industry could have been tempted to embrace more risky business practices as were taken by their US cousins, the main cause of the crisis.

Instead of scrapping the scheme completely, it has been replaced with a permanent guarantee capped at $250,000. The cap applies to each account holder. This means where the account holder is a company, partnership, trust, or super fund the $250,000 guarantee applies to the entity. For accounts held by individuals jointly or separately, it applies to each individual.

This results in a couple that hold accounts as individuals effectively receiving a guarantee of $500,000. If a couple hold a bank account as trustees for a self-managed super fund the guarantee is only $250,000. Where accounts are held with a number of banks and financial institutions the $250,000 relates to each of those institutions. For multiple bank accounts held with a bank, the $250,000 applies to the total of all accounts. The maximum amount guaranteed with any bank or financial institution by an individual or entity, no matter how many accounts are held, is $250,000.

The guarantee is only payable after the Australian Prudential Regulation Authority has applied to have an insolvent bank or financial institution wound up and the relevant federal minister has agreed to apply the scheme. An investor must therefore wait until their bank is dead financially before they get the benefit of the guarantee.