December 11th, 2014
Bank competition, increased capital levels and poorly designed taxes, such as capital gains tax and negative gearing, have been singled out for reform in the final report of the Financial System Inquiry.
The 320 page report argues Australian banks need to hold more capital to survive future financial crises.
The inquiry, which was led by former Commonwealth Bank chief executive David Murray, also proposes significant changes to financial system aimed at encouraging competition and stability.
It targets failings in the superannuation industry and proposes self-managed super funds be prevented from borrowing to buy assets such as property and shares.
Taxes that distort the system also come under fire in the report, including capital gains tax and negative gearing.
Other proposed changes include competition among super funds for the right to manage default savings. The report also backs a new regulator, the “Financial Regulator Assessment Board”, as well as a regular review of competition in the sector.
It recommends imposing minimum education standards for financial advisers and the introduction of an “innovation collaboration committee” to ensure policy and regulation keeps pace with technological change.
We asked our experts for comment.
Stephen King, Professor at the Department of Economics, Monash University
The Report of the Financial Systems Inquiry is solid and predictable. But that does not mean it is not important. It sets a clear path forward for the federal government to improve the Australian financial system. Its main recommendations deserve bilateral support in parliament.
The two big areas for the inquiry are the resilience of the Australian banking system and superannuation. We know what to do here and the report in many ways restates the obvious. The big banks currently have an “implicit government guarantee”. The reliance on this guarantee needs to be reduced by requiring banks to hold more capital or more equity and to use financial instruments, such as “bail in bonds”, that minimise the potential need for a taxpayer bailout.
The report recognises that increased capital requirements are not costless. There will be a cost passed through to bank shareholders and to bank depositors and borrowers. But this cost really reflects the political reality that a large bank cannot be allowed to fail. It simply has Australia following the rest of the world.
A minor quibble is the standard used by the report. It wants Australia’s major banks to be in the top quartile of internationally active banks in terms of capital levels. While this is a useful short-term goal, it is better to think of absolute capital requirements and fundamental risk in the longer term. Relative levels do not really reflect bank resilience. For example, suppose that international banks let their standards slip so that their capital holdings fell. Would the government be happy to have Australian banks holding lower capital as well? Presumably not. Australia needs to think of absolute, not relative, capital standards going forward.
The report also considers superannuation. The problems here are fairly well understood – high fees, ineffectiveness of competition and the management of funds in retirement. The report supports a range of other government and non-government reports, for example by the Grattan Institute, calling for action in this area.
Where the report is less successful is in relation to regulatory structure and accountability. The report does not want a major change in the regulatory structure for the financial sector but would like to establish a new Financial Regulator Assessment Board to assess the performance of the regulators. The financial regulators would be accountable to this board and the board would report to parliament. At the same time the report recommends the Australian Prudential Regulation Authority and Australian Securities and Investments Commission receive funding for three years so they have more autonomy. In other words, the financial regulators have less direct accountability to the parliament.
This is poor regulatory design. ASIC and APRA need to be directly accountable to parliament. The main parliamentary lever on independent regulators is through the budget process. An unelected Assessment Board simply creates another level of bureaucracy and further separates regulators from accountability to the Australian public.
The report also recommends that ASIC has an explicit competition mandate. However, Australia already has a competition regulator. An inevitable result of the report’s recommendations will be that the financial system has overlapping competition regulators. At a minimum, this will increase costs. At worst, it can lead to regulatory confusion and contradictory decisions. For example, if the Australian Competition and Consumer Commission clears a merger between two financial institutions but ASIC, in its recommended three year competition review, finds the merger was anti-competitive, will ASIC or the ACCC be required to seek divestiture under section 50 of the competition laws? If so, will financial institutions need to get approval from both regulators if they wish to merge?
Deborah Ralston, Executive Director at the Australian Centre for Financial Studies and Professor of Finance at Monash University
Technology has emerged as the inquiry’s handmaiden.
In addressing the on-going dilemma of finding an appropriate balance between stability and efficiency across the financial sector, the inquiry has turned to the use of technology.
As the inquiry stated from the outset, price signals should be encouraged rather than impeded. For the most part, the report’s recommendations are based around the use of technology to promote competition, encourage transparency and innovation, to ensure a better outcome for consumers and business.
As the Final Report states, “technology driven regulation is transforming the financial sector”.
The recommendations from this inquiry will drive further growth in this area.
Increased information flows to consumers on retirement projects, a register of financial advisers, greater information on small and medium-sized enterprises for alternative credit providers, and improving guidance and disclosure in general insurance will all contribute to a more efficient and competitive financial sector.
Mark Brimble, Discipline Head of Finance and Financial Planning, Griffith Business School
The report advocates education standards for financial planners should increase. Some parts of the industry are already focusing on this area. However, there is still a lack of clarity in the report around how to put these higher standards in place. What is missing is also who should be responsible for regulating these standards and the time frame in which they should be implemented. There is also a lack of detail in relation to the education requirements. For example, the report refers to a “relevant degree” but goes no further to explain what this means.
The report also opted to advocate for increased financial product disclosure rather than directly addressing the conflicts of interest within the advice industry. Whether increased disclosure requirements will achieve much is doubtful. Clients are already bombarded with information, however if rules are introduced to clearly disclose conflicts and the risks of products, it may be useful. Yet disclosure rules are not a panacea for quality financial advice.
The report also focuses on superannuation with the premise that it is a savings, rather than a wealth accumulation, vehicle. The recommendations around banning borrowing in self-managed funds are positive and surprising. The last thing that retirees need is to leverage up their superannuation and allow significant levels of debt to be accumulated.
In these areas the report is not terribly controversial and simply reinforces current public discussion. However, it remains to be seen how quickly these recommendations are actually implemented by government.
Michael Peters, Lecturer at the University of NSW Business School
From the outset the inquiry had its sceptics. Absent from the panel was any representation from the mutual banks, credit unions, co-operatives, customers, employees, unions, small business or ordinary Australians who rely on an accessible and affordable financial system.
The question was justly asked “what is the purpose of the inquiry?”
The report has five specific themes that focus on a more transparent and innovative financial sector with a flexible superannuation regulatory regime.
There is some recognition in the report that the extraordinary size of Australian banks' mortgage books may be unrealistic. Today, many homes in suburbs within a 10 kilometre radius from a major city are simply out of the reach of most Australians. However, people are still borrowing to buy and the banks are simply selling an income stream for loans that will never be repaid.
It is always good to read that taxpayers should stop funding privately owned businesses, and the report makes one such recommendation. A better capitalised banking sector means there will be less need to make that phone call to the Treasurer. The banks may not be happy with putting aside capital, or what they may see as dead money for that very rainy day, but it is a small price. The alternative is a very expensive insurance policy to cover the loss of deposit holders' funds.
The report also recognises the need for more transparency and competition within the sector.
For the credit card users, the report’s cryptic message is there should be improved fee regulation. An emerging threat to the sector is crowd funding. Combined with the rise of mobile phone and search engine owned payment systems, this is a game changer. Surprisingly, the report focuses little on this possible challenge, nor does it look at the future or even the current role of the not-for-profit mutual sector. The report also lacks detail around providing competition in a market dominated by the Big Four banks.
The report has very few surprises in the recommendations it does make, the surprises are in relation to what it omits to say or recommend.