News story 10th Dec 2014

Financial System Inquiry: expert reaction

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.

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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.

Professor Stephen King, 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.

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.

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.

Professor Stephen King

Professor of Economics Monash Business School

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?

Professor Deborah Ralston, Monash Business School and Executive Director at the Australian Centre for Financial Studies

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.

This article has appeared in The Conversation.

  • deborah-ralston-pr

    Professor Deborah Ralston

    CSIRO-Monash Cluster Leader Professor, Department of Banking and Finance, Monash Business School

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    Professor Stephen King

    Professor of Economics Monash Business School

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