PART III
Further consideration of the banking and financial sector
Chapter 10
Need for a root and branch inquiry
10.1
In May 2011, after concluding a comprehensive inquiry into competition
in the Australian banking sector, this committee recommended that an
independent inquiry into Australia's banking and broader financial system be
established.[1]
Since this recommendation was made, there does not appear to have been any
developments in the sector that would refute the need for a broad ranging
independent inquiry. On the contrary, since this committee completed the
Competition Inquiry, other sector‑wide risks and long-term funding issues
have been further highlighted.
10.2
This chapter briefly outlines some of the reasons as to why an inquiry
into the financial system is warranted. It also identifies key issues that
would be particularly worthy of examination.
A banking sector in transition
10.3
The responses to the global financial crisis will fundamentally change
the global banking system. Internationally-agreed regulatory changes intended
to address key vulnerabilities exposed by the crisis have been finalised and
work to implement them is now underway. At the same time, the Australian
banking sector has been dealing with a number of other changes, including
foreign legislation with extraterritorial effects as well as various domestic
reforms. Professor Kevin Davis from the Australian Centre for Financial Studies
described the cumulative effect as a 'virtual tsunami of regulatory change',
much of which 'is a piecemeal response to problems identified in the GFC'. The
professor indicated that this result strengthens the case for an independent
inquiry:
... a critical question is whether those changes are just
papering over the cracks in a structure that is ultimately unstable.[2]
10.4
The head of Treasury's Markets Group considers that the Australian
banking system is in a period of transition and will not return to how it
functioned pre-crisis:
I think that sometimes a lot of people seem to ignore the
fact that we are in this transitional period and they are looking back pre GFC.
In my view, we are not going to return to a pre GFC model for a financial
system—primarily in other countries. When I say that, I do not mean our
regulatory structure, which has proved quite resilient but I mean in terms of
potential risks that banks may take in terms of their lending practices, the
seeking of credit by consumers. I think we are seeing that in the number of
consumers who are much more reluctant to leverage off their own credit.[3]
10.5
Although they recognised that the banking sector is in a period of
transition, some witnesses questioned where the sector will end up:
I would like to know where we are going. If I am going to go
somewhere I would like to have an idea of what that destination might be.
I would not want to leave it to whatever gods of the banking sector there might
be to see where we end up before we decide what to do about it ... I
think there is a real opportunity for us. Because we are not in crisis, because
we are in a good place, because the banking sector across all institutions is
really sound, that is in fact a really good reason for us to hold an inquiry
and to make some determinations about where that destination is. I certainly
would reject one of those arguments and say that we have got a great
opportunity to influence the course of where our banking sector goes and
influence the outcomes for consumers in this.[4]
10.6
An ING Direct executive remarked 'transition is never going to
stop ... [w]hether it is
regulatory or simply the dynamics of the global landscape or whether it is the
domestic and the consumer landscape':
There is a time at some point to determine that there is a
need to review the landscape and see in general how the Australian public is
being treated and whether they are getting a fair go or not.[5]
10.7
Other witnesses added that the government should consider its role in shaping
the result of the transition, noting that it has performed this role in the
past:
The extent to which we should simply let evolutionary forces
take their sway is that you cannot stop evolution, but governments certainly
can influence it. One only has to look at the Australian financial sector to
say that governments have influenced the development of the Australian
financial sector over the course of the last 20 or 30 years, partly through tax
changes, through superannuation, partly through other regulations. I think we
need to be aware that financial institutions operate under a range of special
privileges which governments concede to them or provide them. It is appropriate
for governments to ask the question: are those privileges, those rights and
those constraints they operate under the right ones in terms of the way in
which the system is going to evolve?[6]
Over fifteen years since the previous inquiry
10.8
The last major comprehensive inquiry into the Australian financial
system was the Financial System Inquiry chaired by Mr Stan Wallis (the Wallis
Inquiry) which reported in 1997. The inquiry was asked to provide:
... a stocktake of the results arising from the financial
deregulation of the Australian financial system since the early 1980s. The
forces driving further change will be analysed, in particular, technological
development. Recommendations will be made on the nature of the regulatory
arrangements that will best ensure an efficient, responsive, competitive and
flexible financial system to underpin stronger economic performance, consistent
with financial stability, prudence, integrity and fairness.[7]
10.9
The inquiry fundamentally changed the regulation of the financial system
in a number of important ways, particularly as it led to the creation of APRA. However,
the nature of the banking system has changed significantly since the Wallis Inquiry.
Obviously an important development was the global financial crisis and its flow‑on
effects, such as its impact on debt markets, funding costs and competition.
Substantial internationally-driven and domestic regulatory changes have also
taken place since the Wallis Inquiry, as well as other developments that are
easier to overlook such as changes to technology and consumer behaviour. ING
Direct observed:
The challenge also is that, in addition to the regulation
changing, not only has the world changed but also the way that consumers
operate and think has changed. Consumers have more access to information. The
challenge is that finance for most people is very important, but often it is a
low-interest category, so financial education also becomes very important, and
I think we need to invest more in making sure that people are financially
literate. The challenge on our side is that, in many cases, our products
sometimes become complex. One response to that is to say, 'Okay, you've got to
give customers more documentation.' So you end up with a very big document
that, frankly, most customers do not read. So the challenge for us is to make
simpler products that the customers can understand.[8]
10.10
Following the global financial crisis, there have been a number of
parliamentary inquiries into banking issues and a number of policy
announcements and proposals by the government. The most recent is the
consultation initiated by Treasury in September 2012 regarding APRA's crisis
management powers. While these inquiries and policies may result in important
improvements to the sector, they necessarily focus on specific groups of issues
rather than the financial system as a whole. In other countries, debates have
taken place regarding the desired structure and regulation of their banking
systems in response to the global financial crisis. In the US, debate about its
financial sector was widespread; an example of the formal consideration being
the Dodd‑Frank Wall Street Reform and Consumer Protection Act. In
the UK, the Independent Commission on Banking was established in 2010 and
reported in 2011. The Commission, chaired by Sir John Vickers, was asked to
consider structural and related non-structural reforms to the UK banking sector
to promote financial stability and competition. It made a number of
recommendations that led to the release of a white paper in June 2012. A key
recommendation from the Vickers Report being pursued by the UK government is
the ring-fencing of banks so that retail activities such as deposit-taking are
separate from international wholesale and investment banking operations.
10.11
While the effects of the global financial crisis were clearly more acute
in the US and the UK, complacency in Australia would be unwise. Professor Davis
argued that 'we should be thinking about designing the desirable financial
sector of the future':
In my view, 'if it ain't broke don't fix it' mentality needs
to be replaced by asking the questions of while it may not be broke, could it
be better and how do we ensure that it will not break in the future.[9]
Competition
10.12
Given the focus of this committee's previous inquiry into banking
issues, it should not be surprising that one of the key issues identified by
the committee for consideration by an independent inquiry is the state of
competition. Competition in the banking sector is a means to encourage increased
efficiency, support the performance of the broader economy and enhance the
welfare of Australians. Consumers benefit from greater choice in products, more
innovation and lower prices. Increased competition in the sector has previously
benefited consumers—the growth of non-ADI lenders in the 1990s and early 2000s
challenged the major banks' lending rates and the expansion of foreign banks
introduced new products such as online savings accounts with higher interest
rates.
10.13
As discussed in chapter 2, market concentration in the financial sector
has increased in a number of product markets. The major banks have increased
their share of many banking activities due to the diminished role of foreign
banks and the funding challenges facing non-ADI lenders due to the state of the
securitisation market. The smaller banks also do not appear able to gain market
share in the post-crisis sector:
One would have thought that if competition was working, and
working better than it was a few years ago, then the smaller banks, the
nonbanks, the credit unions and the building societies would have started to
take market share from those major four. It is clear from our submission, which
has been based on research, that the interest rates that are being offered by
the smaller lenders, the credit unions and the non-bank lenders are noticeably
lower than those of the major four, but they just do not have access to
sufficient funding to be able to have a critical mass in the market—as they
did, certainly in the non-bank sector, pre-GFC. They needed to have only about
a 13 to 15 per cent share of the market to have the big four looking over their
shoulders to see what they were doing. Now the big four do not need to worry
about what the smaller lenders are doing, because they have 80 per cent of the
market.[10]
10.14
Some witnesses questioned perceptions of competition in the sector.
A representative of Abacus stated:
We think there are real questions around competition and
whether there is enough effective competition in a market. It strikes me as odd
that the Bank of Melbourne would put out a press release saying how it is going
to be taking it up to the big four. That seems kind of ironic to me. There are
questions about whether consumers are well enough informed and what the
industry, our regulators and the government can do to ensure that we get better
informed consumers so that they can make a choice. But we also have to provide
them with that choice in banking as well.[11]
10.15
More intense competition is presently observable in some markets, such as
for retail deposits. However, this may have a long-term impact on smaller banks
that have traditionally been more reliant on deposits.
Regulatory structures and distortions currently in place
10.16
Related to competition are questions about the major banks being too big
to fail and the benefits that they gain from this (the possible benefits for
their funding costs were noted in chapter 4). As also identified earlier in
this report, certain tax distortions impact foreign banks and may affect their
ability to compete with the major established Australian banks.
10.17
Some witnesses questioned the desired role, size and operation of the
financial sector, and whether the current regulation of the sector is meeting
its desired objectives. Professor Davis argued:
There are two important considerations here. First, what is
the underlying vision of how financial markets operate and the appropriate form
for regulation? Second, can we design the structure of the financial sector to
operate more efficiently and robustly or do we simply take as given the
existing structure which historical evolution reflecting the interplay of
market and regulatory forces has endowed us with? ... My view is that
there is an inherent dynamic within the financial sector towards increasing
complexity, which, if accepted as a natural state of affairs, leads to
increasingly complex, costly and intrusive regulations and which prompt
innovative responses by financial institutions aimed at escaping the regulatory
straightjacket. But I think there is a possible alternative. Legislation could
design a simpler structure where some financial institutions face well-defined
limitations on their allowable activities and consequently require simpler
regulation. In such an alternative scenario, the other financial institutions
could be less fettered provided that if or when they fail their exit is
graceful with minimal disruption to the financial sector and at no cost to
taxpayers.[12]
10.18
Another issue is the special privileges granted to the sector by the
government and whether they strike the appropriate balance. Professor Davis
argued:
Any inquiry would have to look at the balance of the benefits
of having a licence to operate in particular parts of the financial sector
against the constraints that are imposed, and what is the appropriate balance
of those. It would also have to look at what that balance of privileges and
constraints does to the overall efficiency of the financial sector.[13]
Funding mix and stability
10.19
The funding mix utilised and the cost of funds banks face has changed
significantly following the global financial crisis. As a number of sections of
this report have discussed, the sector is facing greater challenges in securing
sufficient amounts of reasonably priced funds, either because of market developments
or regulatory changes. Given that funding issues are interrelated with both competition
and financial stability, the implications of these changes for the sector and
the consideration of any risks associated with these funding models is clearly
important.
10.20
As part of this, the interaction of the superannuation system with the
banking sector could warrant examination. A large portion of Australia's
savings are in superannuation where they are largely invested in equities. This
pool of savings will grow further as the superannuation guarantee is gradually
lifted to 12 per cent. However, Australia's banks are unable to secure
sufficient funds domestically to support their lending activities, and need to
turn to volatile international wholesale debt markets. An independent inquiry
could examine this disconnect as well as proposals that could address this
outcome in a way that is mutually beneficial for both the superannuation and
banking sectors.
Broad support
10.21
The establishment of a root and branch inquiry into the financial system
has broad support. One of the major banks, NAB, indicated its support at a
public hearing:
... we would be
conceptually supportive of a full inquiry. We would like to see the terms of
reference being quite broad and covering all the issues that we think need to
be covered.[14]
10.22
Abacus, the industry body for credit unions, building societies and mutual
ADIs had the creation of a well-resourced independent inquiry as its main
recommendation to the committee:
It has been 15 years, as you know, since the last one
and the world is a pretty different place to 1997, particularly in the banking
sector. We have had 15 years of tumultuous change that includes the global
financial crisis, the subject of this inquiry, and the subsequent massive
economic and regulatory fallout.[15]
10.23
The MFAA was also supportive, although it emphasised the need to act
quickly.[16]
Professor Ian Harper, a member of the Wallis Inquiry panel has also recently
publicly called for a new inquiry.[17]
It would also appear that Treasury is supportive (or at least has been
recently). In its incoming government brief following the 2010 election, it
advised the government that:
While there is considerable work being done in a number of
areas, both domestically and internationally, to improve existing arrangements,
there is a clear need for a comprehensive review of the financial sector
regulatory framework ... Such a review could draw together outcomes of the
work currently being undertaken both here and internationally, and consider broader,
more systemic issues, including the lessons from the financial crisis and the
balance between the dual objectives of stability and safety, on the one hand,
and competition and efficiency on the other.[18]
Committee view
10.24
The committee considers that an independent root and branch inquiry into
the financial system is required. While the onset and ramifications of the
global financial crisis provided an argument for such an inquiry to be delayed,
this argument is now less compelling. The nature of the future regulatory
environment is becoming clearer. International regulatory changes have been
agreed to and steps to implement them domestically have commenced. It is
recognised that Australia's financial system is in transition, but to some
extent it will always be in transition. There is now an opportunity to examine
the state of the banking sector following the global financial crisis and to
consider whether it is delivering what Australians want from it. Similar
questions have been asked in other countries and have led to significant policy
changes. While Australia avoided the worst of the crisis, this should not be
allowed to result in complacency about the structure and performance of our
financial system.
10.25
There are many issues that a comprehensive inquiry could review. The
emphasis on financial sector stability has served Australia well, but has the
crisis stifled competition and innovation? A highly competitive but unstable
banking system is obviously undesirable—the benefits of competition would quickly
vanish if the system could not withstand a crisis. A system that is only
concerned with stability and does not adequately facilitate competition,
however, would ultimately be detrimental to consumers in the long-term, as they
may have to tolerate fewer choices of products, a lack of innovation and higher
prices. While Australia's post-global financial crisis banking system scores
well for stability, and there are competitive forces within the sector, there
remains concern about the overall state of competition. Whether these concerns
are being adequately considered—and what can be done to improve
competition—remain important questions despite recent parliamentary inquiries
and government policies regarding banking competition. A comprehensive inquiry
could examine whether there are means to encourage greater competition without
affecting stability.
10.26
Further, such an inquiry could also examine the regulatory arrangements
imposed on the sector and consider whether the current system is appropriate.
The global financial crisis has demonstrated that the major banks have a
special role in the economy as they are not only too important to fail, but are
also too important to stop or contract their lending activities. Whether the
current regulatory structure acknowledges this appropriately should be debated.
Additionally, a stocktake of the current collection of regulations could be
undertaken to review whether they are achieving their objectives, and to assess
their overall costs and benefits for the sector and for taxpayers.
10.27
Related to both stability and competition there are legitimate questions
about the funding models being used by banks. Australian banks are
significantly exposed to volatile offshore funding markets. While steps were
taken by the government during the crisis to allow them to access funds, and
changes to funding mixes have been made since the crisis, the ability of banks
to secure sufficient quantities of stable funds in the future is an important
issue. At present, demand for credit is subdued and households are saving more.
The increased competition among banks for stable funds, such as deposits, is
currently manageable for market participants and affected borrowers, but this
may not be true in the future. It is not clear whether sufficient consideration
of this new funding model has been undertaken. The role that Australia's
growing superannuation savings could play in the financial system should also
be considered.
10.28
Finally, the committee believes that the transition to the next stage in
the development of the Australian financial sector needs to be guided by a
clearly articulated vision of what the sector should look like and how it
should function rather than being the accidental product of piecemeal
regulatory responses. A full inquiry into the future shape of the financial
sector will help articulate that vision. This future inquiry should give due
regard and scrutiny to the evidence received by this Senate inquiry.
Recommendation 10.1
10.29
That an independent and well-resourced root and branch inquiry into the
Australian financial system be established.
Senator David
Bushby
Chair
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