Option 2 - Extend the DGS

46. Table 1 assesses the high-level terms upon which the scheme could be extended (on looser, existing, tighter, or fully commercial terms) and summarises the economic, stability and fiscal effects against the status quo. The key design features involved are: price, cap, coverage, whether the scheme is voluntary or not, and the length of extension.

47. The terms and how they combine is important. As it is neither feasible nor sensible to go through each combination of features possible for the four broad variations of the extend option, the following assumptions have been made:

• Length of extended term to 31 December 2011 and the end date is fixed. This date has been chosen as end of the fiscal quarter which includes October 2011, when the Australian scheme expires. Any extension shorter than one year be less desirable as it does not provide time for the sector to adjust, and is less likely to be at a point where asset recovery rates are more likely to be seen as rising. An extension for significantly more than a year would be getting to be more permanent in nature and further removed from the crisis response roots of the initial intervention. The scheme would risk becoming “business as usual”.

• The scheme is voluntary for eligible institutions to join. Membership of the WFGF is also not dependent on being a member of the retail scheme. The economic and stability pros and cons of delinking the retail and wholesale scheme are finely balanced, including a possible variant of making it compulsory for some groups only (e.g. banks). The main reason for making the current scheme voluntary and to remove the linkage to the WFGF is to reduce the fiscal exposure and to encourage firms to move into a non-guaranteed environment as early as possible. The current scheme is voluntary with few potentially eligible firms deciding not to join, while some join in order to access the WFGF. If the scheme was to be compulsory for all eligible institutions (while continuing to exclude those firms that are currently ineligible - i.e. those in moratorium or default), then it would mean all risk profiles (aside from those already in some form of default) are covered, it would potentially be more difficult for non-eligible institutions to compete for investor funds with a wider population of guaranteed firms, and it may signal that there are prevailing conditions that require it (when they do not). On the other hand, it would mean that the scheme would include all risk profiles across eligible institutions, which is closer to a compulsory insurance arrangement.

• If terms are “loose” (or more generous), then caps would be high with, crudely, low risk sharing and greater economic and fiscal costs. If terms are “tight” (less generous), then caps would be low with high risk sharing and lower economic and fiscal costs. The cap for the status quo was set in line with other crisis level caps at the time reflecting the concerns about depositor confidence and depositor flight to guaranteed institutions in Australia. [Withheld - under active consideration ].

• Based on similar arguments used for caps, if terms are loose, then coverage is open to all eligible institutions irrespective of their ratings. If terms are tight, the coverage is limited to more highly rated institutions.

• Price is one of the most influential features in a voluntary scheme as this affects incentives to join. The extent to which fees are subsidised affects the extent to which risk is underpriced (distorting decisions by firms and investors, and increases moral hazard), makes it more difficult for non-guaranteed institutions to compete and for covered institutions to adjust to a non-guaranteed environment.