RESERVE Bank governor Glenn Stevens has drawn a line under his independence, declaring that any decision to bail out a failing bank or other financial institution would rest with the Government.
Shareholders and top executives of any failing financial institution should be made to pay dearly for any public support, Mr Stevens said yesterday.
In a speech at the Australian National University, he flagged that the Reserve Bank would be much more conservative than the US Federal Reserve in managing a financial crisis.
However, he expressed confidence in the strength of Australia's banks, which he said had managed the housing boom without the excesses of the US.
The Reserve Bank's board minutes, released yesterday, praised banks for insulating the Australian business sector from the global financial crisis.
When companies lost their access to world bond markets last August, banks had stepped into the breach, increasing the amount of money they raised offshore and keeping funds flowing to business.
The minutes show the Reserve Bank believes that the combination of its own rate rises and the additional increases from private banks will be enough to bring inflation under control.
Mr Stevens said that after the public bail-outs of the Northern Rock building society in Britain and the Bear Stearns investment bank in the US, it was time to draw some lessons.
He said the only circumstances in which a bank should be bailed out were when it was solvent (with more assets than liabilities) and holding good collateral but was facing a run from depositors.
Some observers have suggested the US Federal Reserve organised the bail-out of Bear Stearns without satisfying itself of the quality of its assets because it feared a domino collapse among other financial institutions.
Mr Stevens said it was vital for the central bank to obtain a clear idea of the solvency and collateral of a bank quickly, and that co-operation with the Australian Prudential Regulatory Authority was essential. He said the Government needed to be involved early.
"Any decision to extend support to an insolvent institution on systemic or national interest grounds would be one properly taken by a government under advice, not a central bank itself," he said. "If support for an institution in difficulty were to turn out to be more than just temporary, the public sector would face difficult issues of how to structure that support.
"Any such support should, however, come at considerable cost to the private owners and managers of the troubled entity. Public sector support should not be used to 'bail out' private shareholders or those who were responsible for running the troubled institution."
The US Federal Reserve agreed to accept asset-backed securities, including sophisticated instruments known as collateralised loan obligations, as security for emergency funds to banks.
Mr Stevens said the Reserve Bank would reject security that could not be easily valued and lacked enough excess collateral. "This probably rules out exotic instruments except under the most dire of circumstances."