The prudential supervision of financial intermediaries and their social
There seems to be a broad consensus that good supervision played an
important role in Australian financial intermediaries coming through the GFC
without the need for the government bailouts and takeovers seen in many other
countries. There are questions, however, about whether current or prospective
supervisory rules could inhibit competition.
The Australian Prudential Regulation Authority (APRA) described its role
in the financial system as follows:
Our mandate is to promote the sound and prudent management of
the institutions we supervise so that, in the case of deposit taking, the
institutions meet their promises to depositors under all reasonable
Institutions wishing to raise deposits from the public require
authorisation from APRA. They are hence known as 'authorised deposit-taking
institutions' (ADIs). They comprise banks (domestic banks and subsidiaries and
branches of foreign banks), building societies and credit unions.
In general, the prudential framework does not raise issues of competitive
neutrality between different types of ADIs:
...the prudential framework in Australia applies with few
exceptions to banks, building societies and credit unions equally. Where it
does not, there are prudential policy considerations—long-standing in one
case—that justify a degree of differentiation. Overall, APRA does not consider
that the prudential framework or its risk based approach to supervision acts as
an impediment to a competitive banking system in Australia.
In sum, APRA does not consider that its prudential framework
for ADIs or its supervisory approach is a material factor in the competitive
balance between different types of ADIs.
Competition and stability
A claim frequently made during the inquiry was that the goals of
stability and competition are conflicting. One stark example was the Westpac
There is a trade-off between competition and stability, and
getting that balance right is crucial.
Yet not a minute before, she had claimed:
...the Australian banking sector is highly competitive. It is
also strong and stable.
Asked to elaborate, she postulated:
There are examples one can look at where a heightened
competitive environment has led to some very poor practice and some very poor
underpricing of risk, which has led to instability.
A perhaps more nuanced version was offered by some prominent academic
...in the US...that intensity of competition, together with some
issues of regulation, could be argued as a major cause of the global financial
...the whole point of financial regulation is to achieve an
appropriate balance between competitive efficiency and system stability.
Increased competition can also increase moral hazard
incentives for banks to take on more risk. Declining profitability as a result
of increased competition could tip the incentives of bankers towards assuming
greater risk in an effort to maintain former profit levels.
At one extreme, there is a trade-off between competition and stability:
...a monopoly bank would be very profitable, and therefore
robust in a crisis, but would be unlikely to provide low-cost or innovative
products to its customers.
Treasury warned that competition concerns need to be balanced with
concerns about stability:
...there is going to be a trade-off there between ensuring a
safe, secure and stable financial system versus competition.
This seems somewhat at odds with their earlier view that:
Stability and confidence are important underpinnings for
efficient, competitive markets.
The competition authority's view is that:
It is the prudential requirements that bring about stability,
not the adjusting up or down of the competition level.
A British consultant not only claimed there was a trade-off between
competition and stability but purported to quantify it (Chart 11.1):
Bain & Company calculates that the cost borne by
taxpayers from an unstable banking industry is more than £1,000 per annum per
head—mainly as a result of reduced output and higher unemployment. By contrast,
regulators inclined to view the UK banking market as insufficiently competitive
would be hard pressed to identify the cost of this to customers as more than
£200 per annum per head. Those taxpayers and customers are, broadly speaking,
one and the same.
Chart 11.1: Costs
of instability versus suboptimal competition
Source: Bain & Co, 'Getting bank competition right
post-crisis', provided by Commonwealth Bank of Australia, Additional
information no. 7, 23 December 2010.
... financial stability does not have to be pursued at the expense
of competition or to the detriment of consumers.
A new market entrant suggested:
... stability is fundamental to a properly functioning banking
system, but that is not mutually exclusive with conditions which foster
APRA's perspective is that:
We are required under our legislation to balance this
objective of financial safety with efficiency, competition, contestability and
competitive neutrality. Beyond that, we do not have any specific responsibility
for competition in the deposit-taking sector. Of course, having prudently
managed and well capitalised deposit-taking institutions surely lays the
foundations for sustainable competition. Unless APRA are overzealous—and I do
not believe we have been—there need be no difficult trade-offs between
financial safety and competition over the longer term.
The reference APRA make to sustainable competition is important.
The type of competition, such as lending on very thin margins, that
occasionally arises and causes problems for stability is unsustainable
competition. It is this unsustainable competition which regulators such as APRA
seek to avoid occurring. As APRA remarked:
...in the period 2002-03 we did see quite strong competition in
housing lending which took the form of a dilution of credit standards, and that
was a form of competition which we were uncomfortable with... there was just a
competitive pressure to meet the customer by finessing, overriding or changing
strong credit standards in some cases and it was an issue that we were vocal
about at the time. That is competition which does raise prudential concerns.
And of course if you look at the subprime experience in United States, you will
see that whole problem writ very large.
Are the major banks 'too big to fail'?
There is a common view around the world that large banks are 'too big to
fail'. Usually regulators avoid explicit statements to this effect, but in the
US, following the insolvency of Continental Illinois in 1984, the Comptroller
of the Currency testified to Congress that the 11 largest banks were 'too large
to fail' and would be bailed out so that no depositor or creditor would face a
In Australia the major banks appear to be regarded as 'too big to fail',
or more accurately 'too big for the authorities to allow them to fail'.
I do believe that the four big banks are too big to fail.
There is no government that I could ever anticipate letting one of those big
major banks fail. The devastation to the economy would be so great that no
government could tolerate that. So that does give those four big banks an
implicit advantage—a considerable implicit advantage.
...no big bank will ever be allowed to fail to meet any
liability to its depositors or anyone else...
...whatever the government might say, financial markets
perceive each of the Big Four to be too big to fail and so protected by an
(implicit) government guarantee.
...they are systemically important and too big to fail.
The big four banks are able to raise funds much more cheaply
on international wholesale markets. This is, in large part, due to the
perception that the banks are ‘too big to fail’ and therefore ultimately
supported by the Commonwealth Government. This situation entrenches the market
power of the dominant oligopolistic firms, and they are able to extract significant
returns which are then largely distributed to shareholders and senior
The recent report by the UK's Independent Commission on Banking
highlighted the problems caused by banks too big to fail:
Banks ought to face market disciplines without any prospect
of taxpayer support, but systemically important banks have had and still enjoy
some degree of implicit government guarantee. This is the ‘too big to fail’
problem. Unless contained, it gives the banks concerned an unwarranted
competitive advantage over other institutions, and will encourage too much risk
taking once market conditions normalise. It also puts the UK’s public finances
at further risk, especially given the size of the banks in relation to the UK
economy. On top of the taxpayer risk from bank bail-outs, banking crises damage
the public finances because of their effects on output and employment. Indeed
the problem could arise in future that the banks are ‘too big to save’.
Similarly a UK parliamentary committee, inquiring concurrently into
banking competition there, warned:
We believe effective competition cannot take place in an
environment where firms which are perceived as ‘too important to fail’ are both
protected from the discipline of the market place and derive tangible benefits
from this status.
If banks are indeed too big to fail, this represents a, potentially very
large, contingent liability for the budget and hence the taxpayer:
The pre-GFC thinking was that banks should consolidate and
become big because there is an advantage in being big. But the GFC very well
demonstrated that a larger size is no longer a desirable thing. As a matter of
fact, larger sized banks can become a permanent headache for the taxpayer
because we do not know when these guys are going to stuff it up and come back
to the taxpayer. So I have some concerns about the size of Australian banks.
The Commonwealth Bank rejected this argument:
...we are a bank that does not take that view. We are a bank
that is run on the basis that we will not fail and the ‘too big to fail’ part
does not come into it.
Of course, the large banks overseas that failed would have also said
this could never happen.
There have also been references to banks being 'too interconnected to
...what led to the unravelling in the UK banking market was not
initially a large bank. It was Northern Rock, which was a relatively small bank
but had a significant systemic impact on the UK economy...The issue does not
really come down to the size of the bank. I think any banking situation where a
bank fails has the potential to have flow-on impacts.
These implicit guarantees may even be stronger now than before the GFC:
Lehman Brothers—a small bank in the US—was allowed to fail,
and I do not think there is any doubt that, with the benefit of hindsight, the
US regulators and US government would have bailed out Lehman Brothers had they
realised what a psychological impact it would have on the market for a
relatively small bank to collapse.
Asked whether the major banks had become 'too big to fail', APRA
We never ever confess that any institution is too large to
fail. There is a marketplace at work there and we have seen institutions around
the globe that were household names that have moved into government ownership
in other markets. What we seek to do is to minimise the risk that that will
happen with any institution of any size.
Capital requirements presently
APRA has broadly adopted the internationally agreed capital adequacy
rules, under which ADIs must hold capital equivalent to at least eight per cent
of risk‑weighted assets. The rules are developed by the Basel Committee
on Banking Supervision, at which APRA represents Australia. The current set of
rules, known as Basel II, provide for capital requirements to be calculated
using whichever is more appropriate of a default 'standardised' approach or a
more complex, 'advanced' approach.
It is sometimes claimed that the capital requirements discriminate
against smaller banks and mutual financial intermediaries because the large
banks are able to use the 'advanced' approach rather than the 'standardised'
approach to calculating required capital and so need to hold less capital
against home loans:
...we have to hold twice as much capital to support a mortgage
as what the major banks do because of the different approaches we have to
measuring our capital adequacy.
Under Basel II the risk weighting given to mortgages held by
small ADIs is around twice that of the big four banks...
To be able to use the advanced status you need to have very
sophisticated risk modelling, robust risk management and quite deep extensive
databases and then you can manage housing-lending portfolios using a much more
rigorous method. There is a complete overlay of governance and controls on top
of that. You need to do that not just for your lending to housing but for how
you manage operational risk and how you manage interest rate risk on the
banking books. So to be called an advanced bank requires a very comprehensive
set of requirements... when we look at how it all washes out, with all the
various changes, it is not clear from our evidence that there is a major
difference in the impact of Basel II between the advanced and standardised
banks when you put it all together.
...approval is based on the ADI's capabilities rather than its
There are additional imposts involved with the advanced approach too,
not just benefits:
...advanced ADIs are subject to other capital requirements that
are not applied to ADIs adopting the standardised approaches. For example, APRA
requires advanced ADIs to hold capital against interest rate risk in the
banking book. APRA also currently requires advanced ADIs to hold at least 90
per cent of the amount of regulatory capital that was required under the
original Basel regime; standardised ADIs are not subject to such a limitation.
In practice, the major banks as a group do not appear to have gained a
significant competitive advantage from being able to use the advanced approach:
Broadly speaking, the implementation of Basel II resulted in
reductions of capital for advanced ADIs of between zero and ten per cent, and
averaged around five per cent for standardised ADIs.
Notwithstanding such assurances, Heritage, Australia's largest building society,
would like the current arrangements changed:
Given that mutual building societies and credit unions
typically have significantly lower arrears rates for their mortgages than those
of the big banks, it is recommended that the risk weighting for mortgages held
by mutual building societies and credit unions be aligned with that of the big
four banks. This initiative levels the playing field for smaller ADIs. It also
frees capital to allow mutual building societies and credit unions to grow
their share of the retail mortgage market more aggressively in competition with
There were also claims that the capital rules are unduly harsh on small
...the Australian Prudential Regulation Authority (APRA) should
explore whether the risk-weightings on business loans secured by residential
properties are punitive. Currently, APRA requires the banks to apply a risk
weighting of 50-70 per cent for small business whereas regional banks have to
apply a risk weighting of 100 per cent for small business.
As was noted in Chapter 6 (see Chart 6.4), small business lending incurs
larger losses than do housing loans and so it is justified for there to be a
correspondingly higher amount of capital held against small business loans than
the concessional amount required for housing loans. The Reserve Bank provides
some quantitative estimates:
...small business borrowers are more than twice as likely as
standard mortgage customers to default...once a default has occurred, APRA
statistics suggest that a lender is likely to lose close to 30 per cent of the
small business loan’s value, compared with 20 per cent for housing loans.
Other current prudential requirements
APRA also require ADIs to have an adequate liquidity management
strategy. Some smaller ADIs are exempted from the more complex aspects of this.
The mutual ADIs benefit from this. If they regard the simpler rules are more
costly, they can just not apply for the exemption.
APRA also have prudential requirements covering governance, risk
management, fitness and propriety, large exposures, associations with related
entities, outsourcing and business continuity management; all of which apply
equally to banks and mutual ADIs.
The new Basel III capital and liquidity requirements
The international community has responded to the global financial crisis
by tightening the global prudential standards governing capital and liquidity.
The new measures are known as 'Basel III' and will be phased in from 2013.
APRA explained the benefits of these reforms:
Basel III is underpinning the capital of the banking system
globally and it is also strengthening capital and liquidity buffers in the
global system. We are participants in the global system.
APRA does not expect the rules to be unduly onerous for Australian
...APRA does not expect that the more stringent global capital
regime will have significant implications for ADIs in Australia, which remained
well‑capitalised throughout the global financial crisis...the main impact
of the Basel III capital reforms will fall on the larger ADIs due to (i) their
higher usage of structured capital instruments that will no longer be eligible
as regulatory capital, and (ii) a larger impact from the tighter definition of
capital deductions. Overall, APRA does not anticipate standardised ADIs being
materially affected by the capital reforms.
Westpac explain their concerns about the new Liquidity Coverage Rules (LCR)
Banks will also need to establish capacity to survive a “run”
on deposits for a month, rather than a week which applied under the old
standards. This will require them to hold more liquid assets, which may limit
funds available for lending to customers and add to overall costs.
APRA comment about these new requirements:
There is no doubt that there are challenges for our banks in
meeting that standard but also it is not as though our banks sailed through the
crisis without any liquidity issues. We know they needed the wholesale
guarantee for offshore funding and the deposit guarantee. There were various
sorts of assistance that were given to the banking system to help it through
the crisis and to help make sure that it was able to continue to operate in an
orderly fashion during the crisis. What the Basel III liquidity requirements
are about is trying to lessen the need for that public sector support next time
around. So it is not as though our banks were as robust on the liquidity front
as they might have been or could say, ‘We don’t need any reform whatsoever on
that side of things.’
The Basel III rules are designed to restore confidence in global banking
systems. In the longer term they should reduce the cost of funds for Australian
banks from those prevailing since the GFC:
Over time when these new capital reforms are bedded down
globally if that underpins more confidence in global banking systems you might
like to think that some of those more extreme risk premiums can come down.
The challenge posed by the shortage
of government bonds
There is a problem that as Australian governments have been running
surpluses and smaller deficits than most other economies represented on the Basel
Committee, banks will struggle to find enough bonds to meet the liquidity requirements.
One response would be to allow highly rated RMBS to be counted as liquid
assets. Unsurprisingly, this idea appealed to the Australian Securitisation
Forum and the banks:
...we would put that if residential mortgage backed securities
and certainly the higher rated tranches could be held as eligible assets under
the liquidity tests that Basel III will introduce for Australian banks.
...by accepting third party AAA RMBS paper (currently eligible
securities for repurchase transactions by the RBA) as an asset under the new
liquidity rules, this reform would not only assist in rebuilding the primary
and secondary securitisation markets in Australia, but would also assist banks
to meet their obligations under the pending Basel III regulations...
The problem with this idea is that in the GFC the RMBS proved not
to be liquid.
This was conceded by the Forum and a regional bank:
...there is good liquidity when market conditions are stable
and favourable, and when markets become stressed and disrupted that liquidity
Basel III has outlawed securitisation in terms of being
available for liquidity but you can understand why that would be the case,
because the performance of securitisation in offshore markets has been abysmal.
The best they could offer was the hope that by APRA:
...deeming them to be acceptable as eligible securities that
then can create the liquidity perception that aids the market.
Another approach would be for the Reserve Bank to issue its own paper to
create a riskless liquid security which banks could hold. Asked about this, the
Reserve Bank responded:
Any debt issued by the RBA would be very similar to that
issued by the Government. If the RBA were to issue its own paper to provide
banks with additional liquid assets, the RBA would need to consider which
assets to purchase with the proceeds of that debt issue. This would likely
involve purchasing private securities on an outright basis, thereby permanently
increasing the credit risk that the RBA it is facing. In contrast, accepting
private securities (including RMBS), on a repo basis provides an extra degree
of protection for the RBA. This is why counting RMBS as an eligible liquid
asset in the commercial banks’ portfolios is a less risky option than the RBA
holding the paper outright.
In the event, there has been an alternative arrangement put in place by
APRA and the Reserve Bank to deal with the problem:
The Reserve Bank of Australia (RBA) and the Australian
Prudential Regulation Authority (APRA) have agreed on an approach that will
meet the global liquidity standard. Under this approach, an authorised deposit‑taking
institution (ADI) will be able to establish a committed secured liquidity
facility with the RBA, sufficient in size to cover any shortfall between the
ADI's holdings of high-quality liquid assets and the LCR requirement.
Qualifying collateral for the facility will comprise all assets eligible for
repurchase transactions with the RBA under normal market operations. In return
for the committed facility, the RBA will charge a market-based commitment fee.
The size of the fee is yet to be determined, but the Reserve Bank have
described the principles underlying it:
The fee is intended to leave participating ADIs with broadly
the same set of incentives to prudently manage their liquidity as their
counterparts in jurisdictions where there is an ample supply of high-quality
liquid assets in their domestic currency. A single fee will apply to all
institutions accessing the facility.
Within ADIs only those with APRA's approval are allowed to have 'bank'
in their name. The main impediment to building societies and credit unions
being allowed to call themselves 'banks' is now the $50 million minimum capital
size that APRA requires before giving this approval. (Prior to 1998 they also
had to relinquish their mutual status).
There are currently 25 mutual ADIs—five building societies and twenty
credit unions—that have sufficient capital to meet this requirement but have
not applied to APRA for approval to style themselves as banks.
Abacus suggested there may be more applications:
I think now that some of our institutions will consider
asking APRA to consider their application for a bank licence.
APRA explained the policy rationale as:
...a test of substance, that the community has a view that
banks are intended to be strong, durable financial institutions...The term does
have a cachet of durability and strength.
The Government has asked APRA to review guidelines around use of the
term 'bank', and report to the Government in March 2011.
APRA's chairman explained:
...we have said to the government that we will review the
policy, and I will go into that review with an open mind and see what the
issues are. There are a number of complex issues involved here, including, most
importantly, financial stability impacts and customer understanding impacts. It
will need careful consideration, and we will do that...The Productivity
Commission also reviewed this issue this year when it was revisiting some of
the regulatory impacts and its report argued, in a sense, for maintaining the
status quo. It could not see a policy reason for changing that.
Asked about the value of their banking licence, the Commonwealth Bank initially
Our business would have very little value if we did not have
a licence. It is not valued in our books, though.
Perhaps sensing that the questioning was going towards a possible charge
for the licence, the Commonwealth Bank then sought to downplay its importance:
Senator CORMANN—So, essentially, in a comprehensive sense,
your Australian banking licence contributes to a lowering of, to a downward
pressure on, your cost of funds?
Mr Norris—No, it is that the business is assessed by the
rating agencies as to the strength of the business, and they have a number of
criteria that they will look at. The fact that we operate in Australia is one
part of that, from looking at the economic situation, but certainly the major
issues around rating are the resilience of the organisation, its sustainability
and its ability to continue to generate reasonable returns and profits; those
are the factors that are most relevant.
Credit Union Australia have enough capital that they could apply for a
banking licence, but have chosen not to do so. Asked why, they responded:
...we would no longer be a credit union, which is also a protected
term. We would then be a bank instead of being a credit union...we very much want
to position ourselves as an alternative, so calling ourselves a bank we believe
detracts from that as well as diminishes from our heritage as a credit union.
Our desire is nonetheless to be able to very clearly represent that we are in
the business of banking, and that is really what we are seeking.
A banking licence is related to having an exchange settlement account
(ESA) with the Reserve Bank. Abacus comment:
...smaller banking institutions, such as credit unions and
building societies, do not need to hold an ESA with the RBA because they can
access settlement services and the payments system through central ADIs owned
by the sector with specialist expertise such as Cuscal, Indue and ASL. However,
a number of Abacus member banking institutions have exercised their option to
become ESA holders.
Bank shareholding restrictions
One possible means of increasing the number of banks would be to ease
the requirements in the Bank Shareholders Act limiting the stake of any
single shareholder in a bank.
The Vic Martin report favoured retaining limits on bank shareholdings
but put the arguments on both sides:
A wide dispersion of shareholders is regarded as offering the
avoids dominance of control of a bank by one or few interests;
provides protection to depositors against a risk that a bank
might be operated to serve the needs of shareholders;
avoids the interdependence of a bank's viability with that of a
ensures reasonable independence and continuity of management; and
may enhance the bank's capacity to raise any additional capital
Against the above, the following points can be argued:
a requirement limiting shareholdings inhibits entry and hence
tends to increase concentration in the banking industry;
at least eleven unrelated shareholders (each of appropriate
standing) are required in order to form a bank. This can be very difficult and
a wasteful use of scarce, suitable domestic participants;
a body interested in sponsoring a new bank is not able, under
current administration of the Banks (Shareholdings) Act, to hold a
substantial shareholding (ie 10 per cent or above) in a bank and this is a
disincentive to sponsorship;
a requirement for a wide dispersion of ownership effectively
removes any likelihood of bank takeovers and may shift power too far in favour
of management. The security of tenure for management may inhibit efficiency and
a few large shareholders may more readily be able to reach
agreement on and to provide capital injections than a large number of
The Stephen Martin Committee cast the arguments as follows:
...a dominant shareholder poses the risk that a bank's deposits
might be used for the benefit of such a shareholder, or that public confidence
in the bank would be compromised by business problems experienced by the
dominant shareholder...The main argument against the ownership rules is that they
remove an important market discipline, by making it more difficult for an
inefficient bank to be taken over...[and] reduce the capacity of banks to benefit
from economies of scale. On the question of efficiency, it is important to note
that while the ownership rules limit the potential for banks to be subject to
takeover, they do not restrict more efficient banks from taking away an inefficient
bank's market share.
Mutual ADIs and banks
Notwithstanding that APRA supervises mutual ADIs to the same standard as
bank ADIs, this may not be the public perception. As one building society
Research conducted by Heritage indicates that, irrespective
of their dislike for the big banks, customers perceive them to be more secure
than the alternatives. This belief relates both to the size of the banks and to
a common belief that they have an explicit government guarantee that the
building societies and credit unions do not.
Some mutual ADIs would prefer the term 'authorised deposit-taking
institutions' be changed to 'authorised banking institutions':
...to reassure consumers that we are regulated in the same way
as banks and to reinforce our core function, which is banking.
Rather than being referred to as 'non-banks', with a possible
misinterpretation that they are not as secure or well-supervised as banks, some
mutual ADIs would prefer to be known as 'customer-owned financial
Their industry body argued:
APRA should allow all ADIs the non-compulsory option of
marketing themselves as “banks”. This would enable Abacus members to exercise
the option of marketing themselves as “mutual banks” to the market generally or
to market segments where the terms “credit union” or “building society” are
The Productivity Commission concluded:
It would seem, prima facie, that there is little beyond the
name ‘bank’ to distinguish some credit unions and building societies from
banks. It would be useful to remove any unnecessary restrictions which limit
the ability of building societies and credit unions to compete with banks on a
level playing field. The current restrictions on the use of terms such as
‘bank’ by other ADIs could be reconsidered.
Mutual ADIs are also disadvantaged relative to banks by institutional
investors being less familiar with them:
...the banking sector is a known quantity in the investment
community as opposed to credit unions. A fund manager cannot invest in a credit
union today, so they have not been examining them, whereas of course they have
a very strong view on the banking sector.
Credit Union Australia has consistently charged less for home loans than
the major banks. Asked how they can do this, they responded:
Firstly, we do not have to generate profit at the same
levels. We need to generate sufficient profits to maintain strong reserves and
to fund the growth and development of the organisation, but that is the limit
of our profit requirements. Anything in excess of that is returned through
better pricing. The fact that a shareholder based institution would be paying
out something like 60 per cent of its profits in dividends does give us a
significant pricing advantage—or, looked at another way, we return dividends to
our shareholders, who are our customers, through lower prices rather than in
the form of a separate dividend. It does support that model. We are aided by
the fact that we have a relatively simple business. It is a pure consumer
business. It does not have the volatility of business and corporate banking,
which obviously varies enormously with the economic cycle. Our intention is to
keep it a simple and low-cost business as well.
The Treasurer's December 2010 package foreshadows the introduction of a
'government protected' logo for ADIs which is intended to build confidence in
mutual ADIs and smaller banks.
Abacus, the peak body for building societies and credit unions, welcomed
the recent announcements, although they do not go as far as Abacus hoped:
[based on] ...18 months worth of market research on the
barriers that people have to switching to credit unions and building societies.
We constantly find the view that the big banks are covered by a separate and
better regulatory system, and that is a barrier to change. So we see the idea
of the protected deposits seal and that link back to government regulation as a
very pro-competitive reform.
...the government protected deposit seal, and that certainly
will go some way to improving the awareness of consumers around regulated
It also attracted praise in other circles:
So an education awareness program funded by government around
the safety of mutuals is very welcome.
It will encourage competition coming through there, so I
think that measure will be successful.
The Committee recommends that mutual financial intermediaries be allowed
to refer to themselves as a 'mutual bank' or 'approved banking institution' and
use terms such as 'credit union bank' in their name.
Other financial institutions
ASIC explained the difference between the prudential supervision by APRA
of authorised deposit-taking institutions (ADIs) and those financial
institutions which raise money in wholesale markets or by offering a stake more
like equity than a deposit:
The issue about which institutions are subject to prudential
regulation is a government decision, and the government has decided that the
deposit‑taking institutions should be prudentially regulated by APRA. All
institutions, both the ones that are regulated by APRA and the ones that are
not regulated by APRA, have to have a licence, and that is where we come in.
One of the conditions of having a licence is certain issues which go to the
financial management of the institution, so to that extent there is some form
of monitoring of the financial situation of these institutions. The government has
made a decision that there is greater prudential risk for institutions which
accept deposits and lend money than there is with institutions which just
borrow money on the wholesale market and lend the money.
Some non-ADIs felt they were subject to excessively harsh requirements. In
particular there was concern expressed over ASIC's RG156 rule related to the
issue of debentures:
This required that all the advertisements for debentures
should include a prominent statement to the effect that investors ‘risk losing
some or all of their principal and interest’.
Some non-ADIs also objected to how they are required to characterise the
bonds they issue:
The changing of the naming of the from 'debentures' to
'unsecured notes' will undoubtedly put further doubt in the investor's minds
with respect to the level of risk...
The regulators have a delicate balancing act between avoiding
terminology that may overstate the riskiness of investing with unsupervised
financial intermediaries (and so reduce the competitive pressure they can exert
on the ADIs) and ensuring that unsophisticated investors realise that the
unsupervised entities are riskier than ADIs. The Government's introduction of a
'government protected' logo may give an opportunity to allow the non-ADIs to
apply less critical language.
The Committee recommends that financial intermediaries not supervised by
the Australian Prudential Regulation Authority be required to state clearly
that funds placed with them are 'not guaranteed by government' but otherwise
should not be prohibited from applying familiar terms such as 'debenture' where
this would not be misleading.
Bank holding companies and the 'narrow banking' model
Professor Davis noted:
...there may be some scope in a proposal that I have seen from
the OECD that says you should get banks to change to a non-operating holding
company structure where one part of it is sort of the standard banking—taking
deposits; making simple loans—and the other subsidiary part of the nonoperating
holding company is the investment bank.
Professor Valentine observed:
...as a matter of history, at the Campbell committee we looked
closely at the holding company concept and, at that stage—and that was 30 years
ago—it seemed to us that there was a lot in it.
Suncorp Group has recently adopted a holding company structure to
separate its banking and insurance operations:
...it was about transparency and simplicity to be able to
explain the operations of each of our businesses more clearly.
The separation of banking and other operations was also suggested:
...one could start with the divestment of insurance / wealth
management from the Big 4, the fusion of which no defensible argument has ever
been mounted. Share-broking subsidiaries could readily be hived off. And so on.
It is noted that in April 2011, the Independent Commission on Banking in
the UK, in its interim report, recommended the ring fencing of banks' retail
activities to minimise the possibility of losses from the riskier investment
bank activities infecting a bank's retail business:
...a focus of the Commission’s work is the question of whether
there should be a form of separation between UK retail banking and wholesale
and investment banking. Ring-fencing a bank’s UK retail banking activities
could have several advantages. It would make it easier and less costly to sort
out banks if they got into trouble, by allowing different parts of the bank to
be treated in different ways. Vital retail operations could be kept running
while commercial solutions – reorganisation or wind-down – were found for other
operations...The Commission is therefore considering forms of retail ring-fencing
under which retail banking operations would be carried out by a separate
subsidiary within a wider group.
Some leading academic economists have become increasingly vocal
supporters of such an approach since the GFC:
...a specific, but serious, problem arises from the ability of
conglomerate financial institutions to use retail deposits which are implicitly
or explicitly guaranteed by government as collateral for their other activities
and particularly for proprietary trading. The use of the deposit base in this
way encourages irresponsible risk-taking, creates major distortions of
competition and imposes unacceptable burdens on taxpayers. Such activity can
only be blocked by establishing a firewall between retail deposits and other
liabilities of banks.
A harsher version of the approach of separating riskier activities into
a distinct part of a banking group is banning banks from any involvement in
riskier activities. Such an approach was considered (but not favoured) by the
Independent Commission on Banking in the United Kingdom in its recent report:
Banks must have greater loss-absorbing capacity and/or
simpler and safer structures. One policy approach would be structural
radicalism – for example to require retail banking and wholesale and investment
banking to be in wholly separate firms.
The ACTU supports 'narrow banking' as a response to the problem of banks
being 'too big to fail':
A regulatory regime should be considered in which Australian
banks are regulated as public utilities and forbidden from expanding into risky
asset classes and/or jurisdictions while they enjoy a Government guarantee
(explicit or implicit) of their liabilities...The Australian Government should
make it clear that it will not act to ensure the continued viability of non‑deposit
taking institutions that pursue excessively risky investments...
The Committee believes that APRA effectively ensures that Australian
banks do not pursue excessively risky investments. This is an area, however,
that could be usefully addressed by the broader inquiry into the financial
system for which the Committee has called.
Social obligations of banks
Banks have a special status. For businesses, 93 per cent of respondents
to a recent survey indicated their banking relationship is important or
They provide what could nowadays be regarded as an essential service:
...when I first started my working life I received my wages in
a little yellow envelope in cash and it was my choice if I placed some or all
of that money into a bank account. Today Australian people are forced to accept
their wages electronically into a bank account, we have no choice and are then
charged a fee by the banks to access our own money.
Australians do not have the day to day capacity to simply opt
out of the banking system. Banking is connected and integrated into our ability
as citizens to function and exist in modern society.
A bank account is a necessity for effective participation in
modern Australian economic life, and should therefore be regarded as an
Banks...do have a unique role in our community...Banks have a
special place in our society. They are the lifeblood of liquidity... Technology
and national security laws have ensured that participation in the banking
system has become a mandatory feature of modern life. The banking system’s
crucial role in supplying the economy’s financial arteries and transforming
savings into investment makes it different from most other industries.
Everyone knows the financial system—and that is why the
government is concerned—is such an important part of everyone’s life. Post GFC,
international debate has raged: are these just private sector profit-making
entities, as we view them in Australia, or are they a hybrid, providing an
essential service to the community?
Many would regard banks as having social obligations in exchange for the
privileges they enjoy:
Nevertheless banks protected by government insurance of small
deposits have some responsibility to return to the community a level of service
and a responsible level of profit-taking...Bank management, and most
particularly local bank managers, have responsibilities to the community.
Ultimately financial institutions must have a broader
responsibility for economic development in Australia.
The Brotherhood [of St Laurence] believes that all
Australians have a right to fair and affordable access to basic services,
including banking services. Fair and affordable access to essential services
helps disadvantaged and low-income people by enabling them to be part of
Australia's mainstream society, and by ensuring corporate, government and
community sectors all take responsibility for addressing social problems.
The government has recognised the special place of banks, and
it grants banks privileges and benefits that are not afforded to other sectors...The
banks may occasionally chafe under the restrictions, but they must concede the
system of prudential supervision imparts tremendous benefits to their
operations...I want a Social Compact between our Taxpayer guaranteed banks, their
shareholders and our Government and our Parliament. This must define the
relationship and must include direction on competition, expansion, expectations
of credit and savings, community service obligations, risks and rates.
The social contract should provide at a minimum, access to
“fee free” credit accounts for wage earners and for people on regular low
incomes, portability of credit accounts, exit fee free discharges from loans
and cost free access to ADR for individuals and small businesses and a
...our banking system has a social obligation to the Australian
community in addition to their economic and commercial role...we need them to
enter into a social and economic contract for the benefit of all
Australians...Australia's financial service should function in an accessible,
affordable and fair manner reflecting its status as an essential service.
Some suggested a competitive banking system may still not meet all
...competition alone is not enough to address the significant
problem of financial exclusion for low-income and vulnerable Australians.
Westpac considered banks were just like any other company, except for
the fact their deposit taking function required regulation:
...a bank is a company like any other company... we are a
regulated industry. We have depositors’ funds and that is why we have the level
of regulation that is required...
As noted in Chapter 14, concerns have been raised about changes to the
products the banks offer more vulnerable individuals, such as bank customers
being pushed into credit cards instead of being able to access small personal
Other countries monitor banks' performance on these matters:
...in the United Kingdom and the United States, performance
monitoring has become widespread in creating accountability among financial
institutions to develop affordable, appropriate products to address financial
exclusion. In the United Kingdom and elsewhere, competition regulators have
powers to conduct market studies to determine whether competition is benefiting
A desire to find innovative means of competing with the major banks has
led one smaller bank to offer a deposit account which pays only minimal
interest but instead offers a prize draw of $20,000 a month.
This has been criticised as encouraging savers to instead become gamblers.
The Brotherhood of St Laurence note:
On community service obligations: further regulation can be
used to ensure that financial institutions provide accessible basic services to
all customers. This can be necessary in markets where policymakers recognise
conflict between the profit motive of firms and the social policy goals of the
industry. For example, in privatised telecommunications, gas or electricity
markets, companies are not able to deny access to less profitable rural or low
The banks reject the idea that they should be obliged to provide basic
...the proposal to mandate that banks, as distinct from other
ADIs, offer a free transaction account to all account holders in Australia,
whatever their legal and financial status, is anti-competitive, and therefore
would distort the provision of retail banking services in Australia...no other
business in Australia is required to provide its services free of charge.
Even where banks provide a basic banking product, it may not be taken up
by those customers who could most benefit:
Especially with our clients, it takes some time to work with
them to ensure that they are thinking about their finances and their money
management issues and to build their financial literacy so that they are making
the decisions that are in their own best interests.
We think that the banks could do more in promoting those
products and identifying customers who would be eligible for such products—even
make it a default option that they get put on those sorts of
accounts...Generally, those accounts are available to those who have some form of
Centrelink income or have access to a healthcare card or a pensioner concession
card, for example. Banks generally know if that is the case with their clients,
particularly around Centrelink income because it is deposited into their accounts.
Bankers have played a trusted role as financial advisers in the
community, but are increasingly in a conflict of interest:
When people are asked to make financial decisions that they
do not fully understand, they often rely on other people for help, particularly
people that they regard as better qualified or informed. In the case of bank
products, people often rely on the advice they receive from bank workers. What
is not well understood is that bank workers in Australia are often paid
commissions to sell their bank’s products. The more products they sell—in other
words, the more debt they convince customers to take on—the more money they
make. In fact, encouraging bank tellers and call-centre workers to sell debt
products is an integral part of a bank’s marketing strategy. Consumers can no
longer be confident that the advice they receive from bank workers is objective
rather than conflicted.
The Committee recognises that banks are accorded a special status and
given special privileges. In exchange they have social obligations to provide
banking services to the broad community. These are obligations that the banks
should meet voluntarily rather than compulsorily. In areas where there are
unmet demands for basic banking services which the government believes on
social grounds should be provided to disadvantaged members of the community,
the government should invite banks to tender to provide the services and the
government pay to ensure they are provided.
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