David Murray’s Financial System Inquiry has identified five key challenges and “nine priority issues facing the system” broken up into 25 “observations”.
Each “observation” is essentially a challenge, or a summary of an issue that’s confronting the nation’s financial structures.
The inquiry is now seeking “additional evidence from interested stakeholders to support, or contest, these observations.”
We’ve gone through the observations and had a look at the implications of each in the current Australian financial system. Remember, these topics are likely to be the target of major reform proposals in the inquiry’s final report.
Each is just a summary of the observation. The full report is here.
Observation 1 – Changes to special treatment of the major banks and Macquarie’s measurement of capital:
The inquiry says that even though the banking sector is competitive “the application of capital requirements is not competitively neutral.”
That is a huge call – explosive stuff for the first observation, and Australia’s Mutual sector (one member of which – Police Bank – I’m a Director) and the regional banks will be cheering.
The inquiry highlights that “Banks that use internal ratings-based (IRB) risk weights have lower risk weights for mortgage lending than smaller authorised deposit-taking institutions (ADIs) that use standardised risk weights, giving the IRB banks a cost advantage.”
This means it’s cheaper for a Major Bank or Macquarie to write a mortgage and lend to home owners because they have to hold less capital.
Importantly for smaller ADI’s the inquiry asks if it should not see “direct government support to the RMBS market” as was advocated by Morgij Analytics CEO Graham Andersen in his submission to the inquiry.
Observation 2 – A standardisation of payment platforms to allow better competition :
The inquiry notes that regulation is needed on payment platforms but that “differences in the structure of payment systems have resulted in systems that perform similar functions being regulated differently, which may not be competitively neutral.”
There is that term again – the one we’ve heard so often from Finance Minister Mathias Cormann in discussing his FOFA changes – “competitive neutrality”.
Clearly the inquiry is noting that Australia needs an even-handed approach to all players within the financial system if it is to work best in Australia’s economic interests.
This might include, according to the inquiry, capped fees for merchant services, open up access to different platforms or allow no surcharges.
Observation 3 – Foreign capital is funding Australia:
This is the most vanilla of the observations and simply states that, “Ongoing access to foreign funding has enabled Australia to sustain higher growth than otherwise would have been the case. The risks associated with Australia’s use of foreign funding can be mitigated by having a prudent supervisory and regulatory regime and sound public sector finances.”
Sounds like prudential limits for offshore borrowings as a percentage of balance sheet funding are in play.
Observation 4 – democratising access to capital across all Australian businesses:
It is often tough for small business in Australia to access funds. At least if you don’t want to factor – sell – your accounts receivable or offer the lender the mortgage on your house, office or factory.
This makes it difficult to grow and the inquiry says “there are structural impediments for small- and medium-sized enterprises to access finance. These impediments include information asymmetries, regulation and taxation.”
This is an interesting observation and the inquiry says this might be dealt with by the facilitation of a “small- and medium-sized enterprise finance database to reduce information asymmetries between lenders and borrowers.”
Peer-to-peer lending anyone? Crowd financing perhaps? Regulations would need to be looked at but this is a solid idea.
Observation 5 – grow the domestic bond market:
As small businesses become large they would often like to access capital markets for funding and local bond issuance is a natural progression.
But the inquiry highlights that “Australia has an established domestic bond market, although a range of regulatory and tax factors have limited its development.”
The inquiry is suggesting issuance without prospectus and the rules around such issuance.
Once again as with the above the inquiry seems to be suggesting that regulators could make it easier for borrowers to bypass established capital markets and access the vast pool of private money and wealth in the economy and looking for a return above term deposit rates.
Observation 6 – Superannuation is too expensive:
The inquiry does not muck around here, stating: “There is little evidence of strong fee-based competition in the superannuation sector, and operating costs and fees appear high by international standards. This indicates there is scope for greater efficiencies in the superannuation system.” (Emphasis added.)
This is a big story in light of the overall financial planning and FOFA debates and moves the issue up the production chain – it’s not just an issue for advisers and planners, but for the funds themselves.
The inquiry suggests an investigation of broadening the governments “MySuper” options and looks at overall superannuation portability.
Observation 7 – stop the growth in superannuation leverage:
Leverage is what kills speculative investments when prices move against the investor faster than anything else.
The inquiry observes that leverage is growing the Australian super sector and that “If allowed to continue, growth in direct leverage by superannuation funds, although embryonic, may create vulnerabilities for the superannuation and financial systems.”
This is an ominous and important warning.
Borrowing to purchase housing in your self managed super funds is clearly in the inquiry’s sights. It specifically says it is interested in feedback on the restoration of the “general prohibition on direct leverage in superannuation on a prospective basis.”
Certainly it would have large knock-on effects for housing affordability, given the increasing investment share of total lending since leverage was allowed in self managed funds.
It would also, as the report notes, be good for systemic stability.
Observation 8 – Stop mucking around with rules around super:
Uncertainty is poison and while many Australian are happy with their 9.25% going into super each year the level of confidence in the rules that govern its investment, drawdown and tax arrangements are clearly in the inquiry’s sights too.
The inquiry notes that “Superannuation policy settings lack stability, which adds to costs and reduces long-term confidence and trust in the system.”
Observation 9 – Too-big-too-fail needs addressing:
This one is dynamite as the inquiry notes that the notion that some banks will be saved with government help while others will not needs to be addressed.
Specifically the inquiry observes that “these perceptions can be reduced in Australia by making it more credible to resolve these institutions without Government support.”
The inquiry is interested in looking into a bail in regime where there is an “ability to impose losses on creditors of a financial institution in the event of its failure’ together with tougher regulations and regulatory powers.
Observation 10 – Not a fan of macro-prudential tools:
RBA Governor Glenn Stevens said over the weekend he favours macro-prudential tools which limit the type of lending banks can do around certain constraints.
But the inquiry noted “The effectiveness of these for a country like Australia is not yet well established, and there are significant practical difficulties in using such tools.”
It is still willing to investigate however.
Observation 11 – Time to standardise Australian capital rules with global benchmarks:
APRA take note.
In reality if the inquiry is saying that the banks shouldn’t get a free ride on housing asset risk weight calculation, then a look at the overall capital calculation seems prudent.
The inquiry notes that Australia has gone early and harder than other jurisdictions which means that “differences such as those in definitions of capital do limit international comparability.”
Why, or if, that is relevant is an open question but the inquiry wants this investigated.
The majors, who with each results presentation have taken to giving both a local capital number and their own calibration of an international comparison, will be pleased.
Observation 11 – The documents produced in the financial system are too complex to understand:
The inquiry wants documents to be easier to read and when related to consumers because it does not “enhance consumer understanding of financial products and services, and impose significant costs on industry participants.”
The inquiry wants to encourage debate including a consideration of “a move towards more default products with simple features and fee structures.”
Observation 12 – we need to lift the standards of financial advisers:
In the current climate this is a big one. The report says:
“Affordable, quality financial advice can bring significant benefits for consumers. Improving standards of adviser competence and removing the impact of conflicted remuneration can improve the quality of advice. Comprehensive financial advice can be costly, and there is consumer demand for lower-cost scaled advice.”
The inquiry wants educational standards of advisers raised with a “national exam” and a national register including credentials.
It’s hard to argue that Australia’s vast investment pool and superannuation savings shouldn’t attract the best and the brightest, but this observation will be extremely contentious in some quarters.
Observation 13 – Technology is going to change insurance and that’s not necessarily a good thing:
The inquiry observes that because of the specificity now available using technology, the long-held practice of insurance pooling may be reduced.
Of course that will lower some costs but increase others. More worryingly however some Australians may not be able to get insurance.
Observation 14 – Regulation may not be working well enough:
This one is short and sweet:
“The regulatory perimeters could be re-examined in a number of areas to ensure each is targeted appropriately and can capture emerging risks.”
More – and tougher – regulation seems on the table for the financial system particularly around retail payments and conduct.
Observation 15 – Maybe the existing regulators need an overhaul:
APRA, ASIC you have been warned.
The inquiry says “Australia generally has strong, well-regarded regulators, but some areas of possible
improvement have been identified to increase independence and accountability.”
While it wants to give them more independent funding it also wants to increase reviews of performance and clarify the “metrics” of assessing this performance.
Think a regulators’ regulator.
Observation 16 – Tighten up regulator cooperation:
The Council of Financial Regulators (CFR) is the top tier of Australian regulator co-ordination and cooperation and the inquiry notes that “during the GFC and beyond, Australia’s regulatory coordination mechanisms have been strong, although there may be room to enhance transparency.”
But it wants to have a closer look. Could the RBA get prudential regulation back?
Observation 17 – Make ASIC stronger:
We don’t need to add anything here:
“Regulators’ mandates and powers are generally well defined and clear; however, more could be done to emphasise competition matters. In addition, ASIC has a broad mandate, and the civil and administrative penalties available to it are comparatively low in relation to comparable peers internationally.”
Observation 18 – Regulators have difficulty getting the best staff:
It’s not just about cash or conditions but the inquiry wants to enhance regulators ability to perform their roles effectively by attracting and retaining suitably skilled and experienced staff.
It’s easier said than done, and a real issue for financial regulation, stability and competition.
Observations 18 and 19 – The accumulation phase of superannuation is heavily regulated but retirement is a free-for-all:
The inquiry wants more Australian to buy annuities so as to ensure that income is still there for the life of the retiree.
To this end the inquiry notes that “the retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees.”
In order to address this it wants to see if Australia should “provide policy incentives” – read taxation – and at the same time reduce the “regulatory and other policy impediments to developing income products with risk management features that could benefit retirees.”
Observation 20 – Technology is changing the landscape:
The inquiry says that technology drives innovation and efficiencies which benefit consumers but that “Government and regulators need to balance these benefits against the risks, as they seek to manage the flexibility of regulatory frameworks and the regulatory perimeter.”
The inquiry wants to become technologically neutral in order to foster innovation and floats the idea of an innovation body to advise government on technology developments.
Observation 21- technology is generating a heap of customer information but there are privacy concerns:
This is a concern for consumers and the sharing and or storage of data needs to be reviewed according to the inquiry.
Observation 22 – Cyber security risks have been heightened:
The inquiry wants the government to co-ordinate the industry response to increased cyber-security risks from the “The financial system’s shift to an increasingly online environment.”
Observation 23 – Australia needs to ensure integration with Asia’s growing financial system:
This one goes without saying although the inquiry’s suggestion that “financial system developments in the region will require continuing Government engagement to facilitate integration with Asia” is a bit surprising given the private sector nature of the system and earlier observations that the government needs to step back from support of the system.
Observation 24 – APRA, we aren’t happy with your go it alone attitude:
You be the judge, but this observation looks like a pop at APRA.
The inquiry “observes” that, “Government efforts to promote Australia’s policy interests on international standard setting bodies have been successful. Domestic regulatory processes could be improved to better consider international standards and foreign regulation, including processes for collaboration and consultation about international standard implementation, and mutual recognition and equivalence assessment processes.”
Yup – that one didn’t miss.
Observation 25 – Australia should better cointergrate internally :
The inquiry is simply looking for a body to better “promote accountability and provide economy-wide advice to Government about Australia’s international financial integration”. Nobody’s taking charge.
As you can see this inquiry has covered a huge amount of territory and each of its observations is designed to spark deep conversations about the future of the financial system in the country.
You can access the full interim report here.