tag:theconversation.com,2011:/au/topics/financial-system-inquiry-8317/articlesfinancial system inquiry – The Conversation2023-12-20T19:05:20Ztag:theconversation.com,2011:article/2192172023-12-20T19:05:20Z2023-12-20T19:05:20ZIt’s not just about accumulating super. Australians need to learn how to spend their retirement savings<figure><img src="https://images.theconversation.com/files/566181/original/file-20231218-25-wecasm.jpg?ixlib=rb-1.1.0&rect=310%2C129%2C5440%2C3699&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/senior-woman-smartphone-makes-selfie-her-1422403571">Robert Kneschke/Shutterstock</a></span></figcaption></figure><p>Australia’s superannuation and retirement income system is complex and difficult to navigate.</p>
<p>Retirees need to make decisions on numerous issues where they have less than full information and understanding, both financial and non-financial. They also require access to retirement products to help them manage and balance income needs against longevity risk.</p>
<p>Recognising these issues, the government released a <a href="https://treasury.gov.au/consultation/c2023-441613">discussion paper</a> this month seeking views on three key issues: </p>
<ol>
<li><p>helping super fund members navigate the retirement income system</p></li>
<li><p>supporting superannuation funds to deliver better services</p></li>
<li><p>making retirement income products more accessible.</p></li>
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<p>Australia has one of the largest and most sophisticated pension systems in the world. Valued at more than <a href="https://www.apra.gov.au/quarterly-superannuation-statistics">A$3.5 trillion</a> as at September 2023, and is the <a href="https://www.thinkingaheadinstitute.org/research-papers/global-pension-assets-study-2023/">5th largest pension scheme</a> in terms of asset size.</p>
<p>It is also the <a href="https://www.mercer.com/insights/investments/market-outlook-and-trends/mercer-cfa-global-pension-index/">5th most highly rated retirement income system</a> internationally behind the Netherlands, Iceland, Denmark and Israel.</p>
<h2>What is wrong with the super system?</h2>
<p>But while the super system ranks highly in terms of integrity and sustainability, the numbers are not as flattering when it comes to “adequacy”.</p>
<p>Adequacy is the level of income available to retirees depending on their different circumstances. According to a recent <a href="https://www.mercer.com/insights/investments/market-outlook-and-trends/mercer-cfa-global-pension-index/">study</a>, Australia is ranked 20th out of 47 worldwide on the adequacy index.</p>
<p><a href="https://www.investmentmagazine.com.au/2023/02/purpose-of-super-law-to-herald-tax-reform/">Reform</a> in the <em>pre-retirement</em> phase of Australia’s retirement income scheme is ongoing and designed to support accumulating wealth for retirement.</p>
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<a href="https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="Unidentified man taking notes as he puts money into a jar" src="https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=450&fit=crop&dpr=1 600w, https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=450&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=450&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=566&fit=crop&dpr=1 754w, https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=566&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/566184/original/file-20231218-21-vshzy.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=566&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Much emphasis has been placed on accumulating super with less attention being given to actually using it.</span>
<span class="attribution"><a class="source" href="https://www.shutterstock.com/image-photo/saving-money-man-hand-putting-coins-1933937894">iHumnoi/Shutterstock</a></span>
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<p>These ongoing reforms have been designed to make superannuation easier to understand and to reduce much of the decision making required. They’ve been needed because of an apparent lack of skills, interest and financial literacy among Australians.</p>
<p>While the message that we need to save to be comfortable in retirement is getting through, the lack of information about how to manage these savings once we retire means many retirees are left to navigate the complex system as best they can.</p>
<p>Given the complexity and volatility of Australia’s financial system, it’s hardly surprising many of the decisions made by retirees don’t produce the best financial results. For example, more than <a href="https://treasury.gov.au/consultation/c2023-441613">84%</a> of retirement savings are held in account-based pensions which, if not properly managed, can run out. This is despite government and community awareness that outliving your savings is a real possibility.</p>
<p>About 50% of retirees currently withdraw at the minimum pension rate, which means many people experience a lower standard of living than what would normally be expected with the super they have accumulated. This can result in wealth not being used and instead being passed on to the next generation.</p>
<h2>Help is needed now because the retiree sector is booming</h2>
<p>Over the next decade there is going to be a big increase in the number of people retiring and transitioning from the accumulation phase of their super to the pension phase. It’s estimated <a href="https://treasury.gov.au/consultation/c2023-441613">2.5 million</a> Australians will move to the retirement phase in this period.</p>
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Read more:
<a href="https://theconversation.com/super-has-become-a-taxpayer-funded-inheritance-scheme-for-the-rich-heres-how-to-fix-it-and-save-billions-202948">Super has become a taxpayer-funded inheritance scheme for the rich. Here's how to fix it – and save billions</a>
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<p>Following the 2014 <a href="https://treasury.gov.au/publication/c2014-fsi-final-report">Financial System Inquiry</a>, the government introduced the <a href="http://www5.austlii.edu.au/au/legis/cth/consol_act/sia1993473/s52.html">Retirement Income Covenant</a> in 2022 to force super fund trustees to develop a strategy that would provide better retirement outcomes for their members.</p>
<p>The strategy is based on retirees maximising their expected retirement income, managing expected risks to their retirement income and having flexible access to super funds during their retirement.</p>
<p>A 2022-23 review conducted by <a href="https://asic.gov.au/regulatory-resources/find-a-document/reports/rep-766-implementation-of-the-retirement-income-covenant-findings-from-the-apra-and-asic-thematic-review/">Australian Prudential Regulation Authority and the Australian Securities and Investments Commission</a> found while trustees were providing more help to retirees, overall there was a lack of progress and urgency among trustees to improve retirement outcomes.</p>
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Read more:
<a href="https://theconversation.com/should-i-put-more-money-into-my-super-what-are-the-benefits-and-can-i-take-it-out-before-retirement-if-i-need-it-201950">Should I put more money into my super? What are the benefits and can I take it out before retirement if I need it?</a>
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<h2>How the system could be improved</h2>
<p>Several proposals have been put forward to improve the experiences and decision-making of retirees. These have included:</p>
<ul>
<li><p>improved support from and education by superannuation fund trustees </p></li>
<li><p>changing how people view their super savings from an accumulation of wealth to a system that enables drawdown of retirement savings over time to fund expenses.</p></li>
<li><p>providing an automatic rollover of retirement savings into an income-stream instead of allowing a lump sum withdrawal on retirement</p></li>
<li><p>expanding existing income products (that are starting to be offered by several financial institutions) which combine providing investment choice with a pension for life</p></li>
<li><p>setting up a MyRetire product that would run parallel to <a href="https://treasury.gov.au/programs-and-initiatives-superannuation/mysuper">MySuper</a> and provide a simple and cost-effective retirement income system for less engaged members. MySuper only applies to the accumulation phase. Once a member starts an income stream in retirement, their MySuper account ceases</p></li>
<li><p>improving access to financial planning advice which is shown to play a significant role in preparing Australians for retirement.</p></li>
</ul>
<p>The government, superannuation industry and the community all have a greater role to play in improving the financial outcomes and experiences of retirees.</p>
<p>With Australia’s ageing population, the need to better support retirees to achieve a dignified retirement is becoming more urgent.</p>
<p>All Australians expect and deserve a financially secure retirement.</p>
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Read more:
<a href="https://theconversation.com/politics-with-michelle-grattan-jim-chalmers-says-australians-will-be-better-off-next-year-219905">Politics with Michelle Grattan: Jim Chalmers says Australians will be better off next year</a>
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<img src="https://counter.theconversation.com/content/219217/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Marc Olynyk is Chair of the Financial Planning Education Council (FPEC). FPEC has been accrediting higher education courses and supporting research in financial planning for more than 20 years. FPEC seeks to raise the standard of financial planning education, and promote financial planning as a distinct learning area, as a profession, and as a career of choice for new students and career changers. FPEC is comprised of representatives from the higher education sector, financial planning practice, and professional associations. Fpec receives administrative support from the Financial Advice Association Australia.</span></em></p>Australians are good at accumulating savings for retirement but they are not so good at mapping out the best way to spend their savings once they retire.Marc Olynyk, Director of Financial Planning, Deakin Business School, Deakin UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1490022020-10-29T05:13:27Z2020-10-29T05:13:27ZWe put forward a way to govern ASIC better. The government said no<p>The current governance/management crisis at the Australian Securities and Investments Commission (ASIC) has seen a deputy chairman <a href="https://www.theguardian.com/australia-news/2020/oct/26/asic-deputy-chairman-resigns-after-70000-rental-payment-revealed">resign</a> and the chairman <a href="https://theconversation.com/asic-chair-james-shipton-steps-aside-after-adverse-finding-by-auditor-general-148728">step aside under a cloud</a>.</p>
<p>It might have arisen simply because of lax internal accounting, compliance, and reporting procedures regarding payments (larger than those approved) benefiting the chairman and deputy chairman (a bad look for a regulator). </p>
<p>Or it might reflect something more substantive about whether the way ASIC is set up is consistent with good governance.</p>
<p>The <a href="https://treasury.gov.au/publication/c2014-fsi-final-report">financial system inquiry</a> set up by the Coalition after taking office examined the governance structure of ASIC in 2014. I was one of members of the inquiry.</p>
<p>ASIC’s governance (and also that of Australian Prudential Regulation Authority, the Australian Competition and Consumer Commission and other statutory authorities) is built around a “commission” structure. </p>
<p>A small group of full-time executives (appointed by the government as “commissioners” and one designated as the “chairman” or chief executive) are responsible for both the governance and management of the organisation.</p>
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Read more:
<a href="https://theconversation.com/asic-chair-james-shipton-steps-aside-after-adverse-finding-by-auditor-general-148728">ASIC chair James Shipton steps aside after adverse finding by Auditor-General</a>
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<p>This contrasts with the conventional corporate structure found in the private sector where a board (in theory appointed by the shareholder owners, but often a self-perpetuating “<a href="https://www.ownershipmatters.com.au/research-news/2020/10/25/many-are-called-few-are-chosen/">mates club</a>”) is separate from the day-to-day management of the business which is undertaken by the chief executive and other full-time employees. </p>
<p>The board is responsible for monitoring company performance, determining strategy (including approving funding plans), and hiring and firing the chief executive.</p>
<h2>We considered carefully the best way to run ASIC</h2>
<p>In considering the governance structure we noted that a board structure involving part-time external directors was put in place when the Australian Prudential Regulation Authority was established in 1998 but discarded after a few years. </p>
<p>This reflected the recommendation of the <a href="https://parlinfo.aph.gov.au/parlInfo/download/library/prspub/XZ896/upload_binary/xz8964.pdf;fileType=application%2Fpdf#search=%22library/prspub/XZ896%22">royal commission into the collapse of HIH insurance</a>, which concluded that the board structure had blurred accountability between management and the board.</p>
<p>Our inquiry (<a href="https://treasury.gov.au/publication/c2014-fsi-final-report">the Murray financial system inquiry</a>) also decided that a board structure was not appropriate.</p>
<h2>What was needed was oversight</h2>
<p>Why not? Well, it is very hard to imagine the federal treasurer giving up the powers to appoint (and sack) the chief executive, determine the funding level, and set mandates and performance objectives. In practice the board would have little to do.</p>
<p>In fact all that would really be left would be monitoring the performance of the regulator. </p>
<p>While the regulators are required to report to the minister and are monitored in other ways (including by the audit office) we came to the view that a separate overarching Financial Regulator Assessment Board (FRAB) would be the best way to oversee the performance of all of the regulators.</p>
<p>Although the treasurer could do this, we came to the view that in practice things would slip under that treasurer’s radar. </p>
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<a href="https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=288&fit=crop&dpr=1 600w, https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=288&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=288&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=362&fit=crop&dpr=1 754w, https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=362&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/366334/original/file-20201029-19-1kfqc4o.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=362&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://treasury.gov.au/publication/c2014-fsi-final-report">Financial System Inquiry final report, November 2014</a></span>
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<p>It was one of the only two (out of 44!) recommendations rejected by the government. </p>
<p>But it has resurfaced as a recommendation of the <a href="https://financialservices.royalcommission.gov.au/Pages/default.html">Hayne royal commission</a> into misconduct in the banking, superannuation and financial services industries.</p>
<p>Recommendation 6-14 is for the establishment of a new oversight authority, differing in some details from our recommendation, but otherwise similar.</p>
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<a href="https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=276&fit=crop&dpr=1 600w, https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=276&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=276&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=347&fit=crop&dpr=1 754w, https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=347&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/366336/original/file-20201029-15-1a1jkfq.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=347&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="attribution"><a class="source" href="https://financialservices.royalcommission.gov.au/Pages/reports.html#final">Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry final report , February 2019</a></span>
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<p>In its response to the Hayne report the government <a href="https://treasury.gov.au/publication/p2019-fsrc-response">accepted</a> this recommendation, despite having earlier rejected ours. </p>
<p>Consultation on draft legislation to set up such a body took place in early 2020, but the bill has not yet been brought to parliament.</p>
<p>Whether having such an oversight authority will help resolve ASIC’s internal management and governance failings is an open question.</p>
<h2>The current structure isn’t helping</h2>
<p>In the <a href="https://treasury.gov.au/publication/fit-for-the-future-a-capability-review-of-the-australian-securities-and-investments-commission">2015 ASIC Capability Review</a> (led by Karen Chester – subsequently appointed as an ASIC Commissioner), a significant recommendation was to “realign its internal governance structure to achieve a clear separation of the non-executive (governance) and executive line management roles”.</p>
<p>The primary focus of the commissioners would become “setting the strategy of the organisation and supervising overall delivery and performance against the strategy, along with making, and taking ultimate responsibility, for key regulatory decisions”.</p>
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Read more:
<a href="https://theconversation.com/its-about-to-become-easier-to-lend-irresponsibly-to-help-the-recovery-146916">It's about to become easier to lend irresponsibly, to help the recovery</a>
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<p>Commissioners would no longer be in charge of individual divisions, a change ASIC later adopted in 2018.</p>
<p>Has it worked? If <a href="https://www.afr.com/companies/financial-services/why-frydenberg-needs-to-take-the-axe-to-asic-20201025-p568af">reports on internal ASIC conflicts</a> in the media are to be believed, not really.</p>
<p>The proposed assessment authority wouldn’t help with uncovering compliance failings such as those prompting the current crisis – they remain the responsibility of the auditor. </p>
<h2>Our idea could help put it right</h2>
<p>But it would help with the broader goal of ensuring ASIC is working well. </p>
<p>Its remit would include how ASIC’s governance and management arrangements enable it to achieve the mandate and performance expectations set for it by the government.</p>
<p>Whether the government will go beyond a knee-jerk reaction to the current scandal and actually adopt such a more considered approach is anyone’s guess!</p><img src="https://counter.theconversation.com/content/149002/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>It was one of only two recommendations the government rejected.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1478432020-10-12T18:45:27Z2020-10-12T18:45:27ZNone of the justifications for weakening bank lending standards quite makes sense<p>The budget plan to scrap Australia’s decade-old responsible lending obligations warrants detailed examination. </p>
<p>It is hard to see how the stated reasons for easing what’s asked of banks and other lenders make much sense, and the timing is strange.</p>
<p>Introduced in 2009, the <a href="https://ministers.treasury.gov.au/ministers/nick-sherry-2007/media-releases/new-national-responsible-lending-laws">responsible lending obligations</a> made it illegal to offer credit that was unsuitable for a consumer based on their needs and capacity to make payments.</p>
<p>In the leadup to last week’s budget Treasurer Josh Frydenberg announced plans to <a href="https://ministers.treasury.gov.au/sites/ministers.treasury.gov.au/files/2020-09/Consumer-credit-reforms-fact-sheet.pdf">dismantle</a> a regime he said had become “<a href="https://ministers.treasury.gov.au/ministers/michael-sukkar-2019/media-releases/simplifying-access-credit-consumers-and-small-business">overly prescriptive, complex and unnecessarily onerous on consumers</a>”.</p>
<p>“Now more than ever,” he said, it had become important there were “no unnecessary barriers” to the flow of credit to households and business.</p>
<p>But, if well designed, responsible lending obligations ought to be largely irrelevant to responsible lenders. They take account of needs and capacity to repay anyway.</p>
<h2>The standards don’t hurt responsible lending</h2>
<p>Their merit lies in restraining “bad apples” and preventing the good ones from letting loan standards slip and permitting lax management to allow bad practices.</p>
<p>The <a href="https://financialservices.royalcommission.gov.au/Pages/reports.html#final">Hayne Royal Commission</a> into the financial services industry chastised banks and others for misconduct when it came to lending. The banks say they have listened and implemented better practices. </p>
<p>They probably have, which should mean the minimum standards embodied in responsible lending obligations make little difference to them.</p>
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Read more:
<a href="https://theconversation.com/its-about-to-become-easier-to-lend-irresponsibly-to-help-the-recovery-146916">It's about to become easier to lend irresponsibly, to help the recovery</a>
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<p>Another of Hayne’s recommendations, that would have outlawed conflicted remuneration for mortgage brokers, was <a href="https://www.afr.com/politics/coalition-backs-down-on-ending-trail-commissions-for-mortgage-brokers-20190312-h1caoj">rejected</a> by the government in favour of a <a href="https://www.afr.com/politics/federal/frydenberg-moves-on-royal-commission-mortgage-broker-recommendations-20190825-p52kke">best interests</a> obligation along the lines of the responsible lending obligations for lenders that it wants to remove.</p>
<h2>The timing is odd</h2>
<p>The timing of the responsible lending obligations decision is hard to justify. </p>
<p>The Australian Securities and Investments Commission spent much of 2019 consulting on a review of its responsible lending guidelines and released a new version <a href="https://download.asic.gov.au/media/5403117/rg209-published-9-december-2019.pdf">in December</a>.</p>
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<a href="https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=1000&fit=clip"><img alt="" src="https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=971&fit=crop&dpr=1 600w, https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=971&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=971&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=1220&fit=crop&dpr=1 754w, https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=1220&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/362869/original/file-20201012-18-ttt2h2.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=1220&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px"></a>
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<span class="caption">Wagyu and Shiraz needn’t rule out a loan.</span>
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<p>Then in June it lost an appeal in the long-running “<a href="https://www.abc.net.au/news/2020-06-26/asic-appeal-on-westpac-wagyu-shiraz-home-lending-dismissed/12396646">Wagyu and Shiraz</a>” case in which it attempted to prosecute Westpac for relying on general borrower expense benchmarks.</p>
<p>If anything, that should have somewhat settled bank concerns that the responsible lending obligations required too much of them. </p>
<p>Banks such as Westpac are no longer required to rely on detailed examination of an applicant’s past expenditure levels when assessing whether payments can be met.</p>
<p>In the words of Justice Perram of the Federal Court, “I may eat Wagyu beef everyday washed down with the finest shiraz but, if I really want my new home, I can make do on much more modest fare”.</p>
<p>Instead banks will be able to focus on whether applicants are willing to forgo discretionary spending (on things such as school fees) in order to obtain the loan size required for buying an otherwise unaffordable house. </p>
<p>The change will put some of the onus of assessing loan suitability back on the borrower, which is what the Treasurer <a href="https://ministers.treasury.gov.au/sites/ministers.treasury.gov.au/files/2020-09/Consumer-credit-reforms-fact-sheet.pdf">says he wants</a>.</p>
<h2>They ought to be becoming less burdensome</h2>
<p>It might be that the responsible lending obligations impose excessive assessment costs on the banks. And the extra work for applicants to provide the required information might dissuade them from applying.</p>
<p>But with the recent introduction of <a href="https://www.commbank.com.au/banking/open-banking.html">open banking</a> allowing banks to access applicants’ data with their permission, and “fintechs” developing products to cost-effectively mine that data, it seems likely that loan assessment costs (including meeting responsible lending obligations) are likely to decline.</p>
<p>If costs are the issue, why change the rules in the midst of a cost-reducing revolution?</p>
<h2>And they ought to have stopped bad loans</h2>
<p>Another argument has been that abolishing responsible lending obligations will facilitate growth in lending. </p>
<p>Maybe – but not permanently without increasing unsuitable lending. Responsible lending obligations may slow the approval process but could only have reduced the level of loans on issue if one or both of two conditions apply:</p>
<ul>
<li><p>the information-supply requirements (gathering of which should help applicants understand their borrowing capacity) have dissuaded potential applicants, meaning removing them would allow more poorly-informed borrowers to take out loans</p></li>
<li><p>the obligations have led to banks lending less to unsuitable borrowers, meaning removing them will encourage more lending to unsuitable borrowers</p></li>
</ul>
<p>Another argument, that the Australian Prudential Regulation Authority can police and enforce good lending behaviour ignores the fact that APRA’s remit relates to credit risk and safety of the banks. </p>
<p>It has no mandate for (nor expertise in) considering whether borrowers will be put into financial hardship by loan obligations.</p><img src="https://counter.theconversation.com/content/147843/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis was a member of the government's 2014 financial system inquiry.</span></em></p>If anything, the standards are becoming easier, rather than harder, to apply.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1372402020-05-01T02:56:40Z2020-05-01T02:56:40ZWhy the Reserve Bank should fund super funds during the COVID-19 crisis<figure><img src="https://images.theconversation.com/files/331641/original/file-20200430-42946-d81vsu.jpg?ixlib=rb-1.1.0&rect=479%2C443%2C3041%2C1562&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>A significant number of wealthy individuals have used the ability of self managed super funds (SMSFs) to borrow for property and other investments to supercharge their funds. </p>
<p>It is not something done by retail and industry funds. </p>
<p>According to freedom of information documents obtained by the <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">Australian Financial Review</a>, in 2018 the largest 100 self-managed super funds had borrowings averaging around A$10 million each. </p>
<p>Given the tax benefits granted to superannuation, this exploitation of the system by Australia’s super-wealthy is scandalous, albeit legal. In 2018 more than 200 members of those biggest 100 self-managed super funds were members of the <a href="https://en.wikipedia.org/wiki/Financial_Review_Rich_List_2018">Financial Review Rich List</a>.</p>
<p>Along with other members of the 2014 <a href="https://treasury.gov.au/review/financial-system-inquiry-murray/the-panel">Australian Financial System Inquiry</a> chaired by David Murray, I voted enthusiastically for a recommendation to ban borrowing by funds.</p>
<h2>Normally, borrowing creates risk</h2>
<p>Unfortunately, after intense lobbying from the self-managed super fund sector, the Coalition government <a href="https://www.afr.com/companies/financial-services/richest-smsfs-are-leveraged-to-the-gills-20200421-p54lrg">rejected that recommendation</a>.</p>
<p>I am sure that each of the panel members put different weights on the arguments as to why “no leverage in super” would be good policy. </p>
<p>I focused on two. </p>
<p>First, leverage can lead to funds taking excessive risk, and it also enables some to “rort” the system by getting more assets into the tax-preferred status of super at the expense of the taxpayer</p>
<p>The second argument is about financial sector stability. Leveraged (indebted) financial institutions can be at risk of insolvency and exposed to runs by creditors. A highly levered financial system with lots of interconnectedness can face problems of fragility. Keeping super “un-levered”, as is generally the case for institutional super funds, would be good for stability.</p>
<h2>These are not normal times</h2>
<p>But even funds that can’t borrow, such as retail and industry funds, face problems if there is a “run” of members wishing to withdraw money.</p>
<p>That could arise because, believing that there are legislated limits on when members can access funds, they have invested significant amounts in longer term, illiquid assets such as toll roads, airports and office buildings in order to produce superior long term returns.</p>
<p>Changing the rules on when members can withdraw funds, such as with the current change to allow <a href="https://treasury.gov.au/sites/default/files/2020-04/Fact_sheet-Early_Access_to_Super.pdf">withdrawals of up to $20,000</a>, pressures funds to sell off assets they had planned on holding to generate enough cash to meet withdrawals. </p>
<p>Between $30 billion and $50 billion may have been <a href="https://www.abc.net.au/news/2020-04-28/superannuation-early-withdrawal-risks-retirement-system-collapse/12192580">pulled out already</a>. </p>
<p>It isn’t a good time to be selling assets. Depressed sale prices mean the value of all members’ accounts will be further depressed.</p>
<p>Super funds could borrow to obtain the cash needed to meet withdrawals. But that would expose their members to considerable risk if asset prices fell further. They would have to have to pay back the loan from assets that were worth less.</p>
<h2>For now, I’ve changed my mind</h2>
<p>But if the liquidity problem is purely temporary, brought on by a temporary change in legislation, borrowing might not be such a bad option compared to a forced sale of assets.</p>
<p>While I have not changed my view on prohibiting borrowing in general, I think current circumstances warrant a limited exception. </p>
<p>That exception is that where there is a temporary liquidity problem, brought on by a government change in rules, the institutional super funds should be able to borrow from the Reserve Bank. </p>
<p>Banks can borrow from the Reserve Bank in emergencies. Why not super funds?</p>
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<em>
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Read more:
<a href="https://theconversation.com/the-australian-government-opens-a-coronavirus-super-loophole-its-legal-to-put-your-money-in-take-it-out-and-save-on-tax-135306">The Australian government opens a coronavirus super loophole: it's legal to put your money in, take it out, and save on tax</a>
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<p>In this regard, I am at variance with commentators like David Murray and indeed the Reserve Bank itself. Moreover, I think there are reasonable arguments for making access to the Reserve Bank ongoing.</p>
<p>Bank access to the Reserve Bank, often referred to as the Reserve Bank being a “lender of last resort” is not about bailing out insolvent institutions. It is about providing temporary liquidity, at a price, to solvent, but illiquid institutions.</p>
<p>And the current issue is one of illiquidity, not insolvency. In principle at least, unlevered accumulation funds can’t go insolvent. If the value of assets falls, liabilities (amounts due to members) fall correspondingly.</p>
<h2>The government should fix a problem it created</h2>
<p>When an unexpected policy change creates a liquidity problem for super funds, it behoves policy makers to find a solution that avoids the need for funds to generate cash by selling assets at depressed prices. </p>
<p>Allowing super funds to borrow from the Reserve Bank using <a href="https://www.investopedia.com/terms/r/repurchaseagreement.asp">repurchase agreements</a> would be such a solution. And since the need for liquidity is a consequence of the policy change, those borrowings should not attract a penalty interest rate.</p>
<p>It is important to note that these borrowings are different to the type we argued against in the financial system inquiry. </p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/heres-a-radical-reform-that-could-pay-every-retiree-the-full-pension-131289">Here's a radical reform that could pay every retiree the full pension</a>
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<p>There, we were concerned about funds increasing the size of their portfolios by borrowing and taking on additional risks. </p>
<p>Here, the borrowings would enable funds to avoid shrinking their portfolios and enable them to reduce the risks and costs they (more precisely their members) face.</p>
<h2>And consider making the fix permanent</h2>
<p>My suggestion is that while borrowings by super funds should generally be prohibited, accessing temporary liquidity support from the Reserve Bank should not be part of that prohibition.</p>
<p>If access to such a facility is made ongoing, there would be a case for offering it at penalty interest rates and subjecting funds to liquidity regulation. But those are questions best left for reasoned discussion in more settled times.</p>
<p>Oh, and there has to be a severe crackdown on the ability of wealthy individuals to rort the tax benefits of super by borrowing through their self-managed super funds. </p>
<p>For the government to allow such borrowings but not support institutional funds by allowing borrowing from the Reserve Bank in times of crisis seems, at best, anomalous.</p><img src="https://counter.theconversation.com/content/137240/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis was a member of the 2014 Financial System Inquiry (the Murray Review).</span></em></p>It is normally a bad idea to let super funds borrow, but these aren’t normal times. There’s a (limited) case for allowing them to borrow from the Reserve Bank.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/1318872020-02-27T18:55:52Z2020-02-27T18:55:52ZRequiring firms to only sell financial products we can use is good, but not enough<figure><img src="https://images.theconversation.com/files/317513/original/file-20200227-24690-1cqd2uy.jpg?ixlib=rb-1.1.0&rect=379%2C27%2C3151%2C1595&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">
</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>The government’s <a href="https://treasury.gov.au/publication/c2014-fsi-final-report">financial system inquiry</a>, on which I sat, reported five years ago.</p>
<p>It recommended that the creators of financial products be subject to a design and distribution obligation (DDO), which would mean the products they sold had to not only make money for them, but also meet the needs of the people buying them. </p>
<p>An insurance policy that couldn’t be claimed on would fail the test, as would a product that charged fees for advice that wasn’t given, as would any number of products later detailed in the 2018 report of the <a href="https://financialservices.royalcommission.gov.au/Pages/default.aspx">financial services royal commission</a>.</p>
<p>It’s the first half of 2020, and the Australian Securities and Investments Commission is seeking input into how the obligation will work. It has asked for comments by <a href="https://asic.gov.au/about-asic/news-centre/find-a-media-release/2019-releases/19-369mr-asic-consults-on-guidance-for-the-new-product-design-and-distribution-obligations/">March 11</a>.</p>
<h2>Requiring products to be useful is good…</h2>
<p>There ought to be nothing controversial about the idea. It reflects the fundamental premise upon which the free market economy is founded – that transactions should provide gains to both the seller and buyer.</p>
<p>Reputable financial institutions, seeking to meet community expectations, ought to already meet such obligations, although they are likely to incur some (hopefully minor) administrative costs.</p>
<p>However, as history and the royal commission have reminded us, even reputable institutions’ procedures can go awry and lead to badly designed products that exploit consumers. </p>
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<em>
<strong>
Read more:
<a href="https://theconversation.com/comminsure-proves-the-need-for-a-banking-royal-commission-57954">CommInsure proves the need for a banking royal commission</a>
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<p>Less reputable firms exploit consumers anyway, leading to a race to the bottom in terms of product quality.</p>
<h2>…but not enough</h2>
<p>Unfortunately, even if a financial product meets the DDO requirements, which means it is suitable for its intended consumers, it can be a bad purchase for consumers who aren’t aware of its true worth. Retail customers who overpay for a “suitable” product can lose just as much (if not more) as those being sold one that’s unsuitable.</p>
<p>Many financial products (actually, most financial products) have characteristics that make them hard to value accurately. When product outcomes depend on future events – as do insurance products – accurate valuations can be almost impossible even for customers who are financially literate.</p>
<p>For example a consumer might assume that there is a 10% chance of an event happening, when the true probability is less than 1%. Not only would they overpay on insurance (perhaps repeatedly), they would be unlikely to ever know about it.</p>
<h2>It’s hard to tell when prices are bad</h2>
<p>Suppose a producer can supply a financial product profitably for any price over $6. Suppose that buying it for any price under $8 would would benefit the consumer, but that the consumer is unable to tell what it is really worth. </p>
<p>Since the supplier’s profits increase as the selling price increases, what is there to stop the supplier increasing the price to more than $8 and harming consumers, in part because some would never get the product? </p>
<p>Standard answers talk about competition, disclosure, financial advice and financial education. </p>
<p>But if consumers don’t have the information they need (or the time they need) to do the calculations, what’s likely to happen instead is that competition will cut the worth of the products in ways that are not obvious to consumers.</p>
<p>As important as disclosure, advice and education are, they haven’t been able to stop this happening in the past.</p>
<h2>What we are seeing are first steps</h2>
<p>Plans by the Australian Prudential Regulation Authority to make banks and other deposit-taking institutions designate an accountable executive as responsible for the “end-to-end” creation and delivery of each product under a Bank Executive Accountability Regime (<a href="https://www.apra.gov.au/banking-executive-accountability-regime">BEAR</a>) would be an important step. </p>
<p>The government has announced plans to extend it to all financial institutions, making it a <a href="https://treasury.gov.au/consultation/c2020-24974">FAR</a> (Financial Accountability Regime).</p>
<p>But there is nothing in either the BEAR or FAR rules that that would require the executives to price their products fairly.</p>
<hr>
<p>
<em>
<strong>
Read more:
<a href="https://theconversation.com/hilda-survey-reveals-striking-gender-and-age-divide-in-financial-literacy-test-yourself-with-this-quiz-100451">HILDA Survey reveals striking gender and age divide in financial literacy. Test yourself with this quiz</a>
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<p>DDO’s, together with the Securities and Investments Commission’s new temporary banning powers, should help to rid the financial sector of the most egregious types of consumer abuse. But will they do nothing to prevent profit seeking institutions setting prices for “suitable” products that cause poorly informed consumers harm.</p>
<p>It is not clear what could, short of instilling a sense of “fairness” into corporate cultures. While welcome, DDO’s are only the start.</p><img src="https://counter.theconversation.com/content/131887/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Banks and other financial institutions will be left with plenty of ways to treat customers badly under new, overdue, rules.Kevin Davis, Professor of Finance, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/600402016-05-31T02:16:49Z2016-05-31T02:16:49ZMortgage brokers: ASIC goes fishing<p>The Australian Securities and Investments Commission (ASIC) inquiry into the way mortgage brokers are paid may uncover some isolated shady dealings but the system of remuneration for brokers is already regulated well enough by intense competition. </p>
<p>Assistant Treasurer Kelly O’Dwyer announced the inquiry last year in line with <a href="http://fsi.gov.au/publications/final-report/executive-summary/#recommendations">recommendations from the Financial System Inquiry</a> and ASIC recently commenced the inquiry with a scoping paper. The focus is likely to be on whether the advice of brokers is in the best interests of the customers.</p>
<p>As always, there are questions about whether the remuneration incentives for brokers distort their advice. And, again as always, there are questions about whether the fact that big banks own some brokers leads these brokers to favour the products of their owners, and not necessarily to offer the products most appropriate to the customer. </p>
<p>In many ways, the inquiry is just part of the ongoing reviews of different parts of the finance sector. The same arguments are likely to be rehashed.</p>
<p>In <a href="http://download.asic.gov.au/media/3537759/peter-kell-speech-to-australian-mortgage-innovation-summit-published-18-february-2016.pdf">announcing the review</a>, ASIC Commissioner Peter Kell was clear that:</p>
<blockquote>
<p>“We are focused on consumer protection issues in the context of personal credit products, ranging from small amount credit contracts through to home loans.”</p>
</blockquote>
<p>There has been some discussion in the press that loans organised by brokers <a href="http://www.afr.com/brand/chanticleer/mortgage-broker-salad-days-are-numbered-20160525-gp3se5">default at a higher rate than loans written by banks</a>. The Australian Prudential Regulation Authority (APRA) might regard this as a concern for financial stability, but ASIC will be concerned with whether people are getting loans they really should not be. The focus will clearly be on consumer outcomes.</p>
<p>It’s worth looking at the mortgage broking sector mainly because it has been growing rapidly and is now quite big. About half of all mortgages are provided through brokers, <a href="https://www.mfaa.com.au/IndustryInformation/Documents/1527742_MFAA_Broker%2020Study_final_email.pdf">up from 40% a decade ago</a>. The upfront commissions for brokers are about 0.5%, which yields annual revenue of close to A$2 billion.</p>
<p>So it is a big and rapidly growing financial sector and ASIC has duly been charged to have a look around for problems. Australia already has laws addressing any concerns. The <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/nccpa2009377/">National Consumer Protection Act</a> has, since 2011, put the onus on providers to act in the best interests of customers. ASIC is really just checking up that the law is being complied with.</p>
<p>While there may be some bad behaviour, it is hard to see what the concern is. People have a choice. </p>
<p>They can go to their own financial institution and buy a mortgage direct from the manufacturer. Alternatively, they can look around among financial institutions to find the mortgage that works for them. </p>
<p>Now they can also go to one of the dozens of mortgage brokers to see if one of them can find a better deal. From the customers’ point of view, there are hundreds of retail outlets (banks and mortgage brokers) offering mortgages.</p>
<p>The fact that mortgage brokers are taking market share away from the banks suggests that customers really appreciate the mortgage broker effectively cutting the buyer’s cost of searching.</p>
<p>There shouldn’t be a problem with the banks paying the broker for delivering the customer, as there is a clear cost saving to the bank. It does not need to have as many branches or as many staff. </p>
<p>Seen from the bank’s point of view, it can originate the mortgage through its own branch and incur some overhead and running costs, or initiate the loan through the broker channel and pay the broker for its overhead and running costs.</p>
<p>Ultimately, the client is buying a product, in this case a mortgage. The price the customer pays is transparent, as are the terms and conditions. </p>
<p>If brokers were not providing a good service, customers could easily swing back to searching for their own mortgage among the banks, or simply walk down the street to another broker. Smart customers will thus keep the providers honest and make sure competition works as it should.</p>
<p>There is a not a lot of academic research into the issues associated with remunerating mortgage brokers. What there is tends to be from the US, which has not had a good record in managing mortgages over recent years. The <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2220013">most relevant paper</a> suggests that loan quality can be improved though requiring registration, higher education standards and continuing education and/or by requiring brokers to post bonds.</p>
<p>The ASIC inquiry will uncover more information about the sector. It may also find some people have behaved badly (as in any area of human endeavour), but it’s hard to see a significant structural problem in a very competitive market.</p><img src="https://counter.theconversation.com/content/60040/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>The ASIC inquiry into how mortgage brokers are paid won’t do much to change an already competitive system.Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/569822016-04-06T23:49:52Z2016-04-06T23:49:52ZSuperannuation ‘objective’ likely to be captured by industry<p>As the government <a href="http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2016/Objective-of-superannuation">moves closer</a> to enshrining the objective of superannuation in legislation, it’s worth considering the unintended consequences that could come from such a move. </p>
<p>Based on <a href="http://fsi.gov.au/publications/final-report/chapter-2/super-system-objectives/">recommendations</a> of the Financial Systems Inquiry (FSI), chaired by former Commonwealth Bank chief David Murray, the change to legislation is open to “intellectual capture” by industry participants. The background of most of the people involved means, as <a href="http://www.johnkay.com/2012/07/22/finance-needs-stewards-not-toll-collectors">John Kay says</a>, that they may see things “through the eyes of market participants rather than the end users they exist to serve”. <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2720157">My research with Sue Taylor</a> suggests that such capture is visible in the Australian superannuation system more widely.</p>
<p>The idea that there should be a fundamental purpose of super is not obvious. The Treasury paper says “a legislated objective will provide a way in which competing superannuation proposals can be measured”. But how many Trojan horses will be released to subvert the regulatory review process and provide arguments against proposals that otherwise have merit? We do not have objectives for the education and health systems, for instance.</p>
<p>The <a href="http://www.austlii.edu.au/au/legis/cth/consol_act/sia1993473/">SIS Act</a> already has “a sole purpose test” in section 62. Like much of the Act, the section is complex, clumsy and lacks clarity. Its purpose appears to be to prevent SMSFs from investing in the family home. However, it takes over 900 words to say that a superannuation fund must be set up to provide benefits on the death, disability or retirement of a member.</p>
<p>The absence of reference to insurance benefits in the Treasury paper is possibly an oversight. It is unfortunate however, because life and disability insurance are intimately connected with retirement planning and should not be lost to superannuation.</p>
<p>A significant number of people are forced to retire for health reasons, and the integration of retirement and disability benefits allows for seamless and higher benefits.</p>
<p>Death benefits should decline as superannuation balances increase, and spouses should make provision for each other if one has lower superannuation benefits as a consequence of time out of the workforce (particularly if it was to care for the children of both).</p>
<p>While the case is not made vociferously, the industry would seem to resent insurance premiums inside superannuation as it reduces the market for more profitable individual policies at thrice the price.</p>
<p>The failure of most superannuation funds to provide lifelong annuity benefits received <a href="http://fsi.gov.au/publications/final-report/chapter-2/retirement-phase/">prominence in the FSI report</a>, is the ostensible driver of the discussion on objectives. The FSI recommendation in the Treasury paper, is:</p>
<blockquote>
<p>“to provide income in retirement to substitute or supplement the Age Pension.” </p>
</blockquote>
<p>Set as a subsidiary objective, is to:</p>
<blockquote>
<p>“facilitate consumption smoothing over the course of an individual’s life”. </p>
</blockquote>
<p>Three elements of the wording may be critical for future debates: </p>
<p><strong>“Facilitate”</strong> implies no compulsion; <strong>“to provide”</strong> suggests compulsion perhaps after as well as before retirement. </p>
<p>Superannuation funds, of course, love compulsion in any form as it increases their funds under management. The majority of the public seem to agree, but majority approval does not justify interference in people’s lives without good reasons. It <a href="http://www.brookings.edu/%7E/media/Projects/BPEA/1986-1/1986a_bpea_hubbard_judd_hall_summers.PDF">has long been known</a>that young families are liquidity constrained and this is aggravated by mandatory superannuation contributions. If we must have a legislated purpose, it should avoid any suggestion that compulsion should be part of it. </p>
<p><strong>“Substitute or supplement the Age Pension”</strong> seems an acceptable objective for the individual, but the question is broader and deeper. I would be concerned that “substituting the Age Pension” could be used to justify reduction in the Age Pension as <a href="http://www.solepurposetest.com/news/change-super-reduce-cost-age-pension/">some</a> might have it, or more inappropriate means tests. </p>
<p>The <a href="http://www.tai.org.au/system/files_force/PB%2060%20Sustaining%20us%20all%20in%20retirement.pdf?download=1.">Australia Institute</a> makes the point that a higher universal pension with no tax concessions for superannuation would be cheaper, easier and fairer. <a href="http://actuaries.asn.au/Library/fsf06_paper_asher_means%20tests.pdf">I agree that</a> the means tests in their current form are unfair and represent an unwarranted interference in the lives of pensioners – and do need reform.</p>
<p><strong>“Consumption smoothing over the life time”</strong> and “an acceptable standard of living in retirement” are not the same. </p>
<p><a href="http://www.actuaries.org/oslo2015/papers/PBSS-Asher.pdf">My research with Adam Butt, Gaurav Khemka and Ujwal Kayande</a> on retirement planning assumes as self-evident that the aim of planning is for relatively level consumption over the lifetime – after adjusting for the costs of children and for mortgage repayments. Most calculators, however, can suggest that users reduce themselves to penury in order to meet unrealistic retirement objectives. </p>
<p>Objectives such as 65% of pre-retirement income or the <a href="http://www.superannuation.asn.au/resources/retirement-standard">ASFA comfortable standard</a> are seldom right. The first is almost always too high – the latter appropriate for someone slightly above middle income, but too high for some and low for others.</p>
<p>If we must have a fundamental objective, I suggest: </p>
<blockquote>
<p>“To facilitate consumption smoothing for families/households over the course of life.”</p>
</blockquote>
<p>If we must also refer to fiscal pressures: </p>
<blockquote>
<p>“Integrate with other government programs to address special needs, and to achieve intergenerational equity.”</p>
</blockquote><img src="https://counter.theconversation.com/content/56982/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Anthony Asher receives funding from the Centre for International Finance and Regulation. He is convenor of the Actuaries Institute's Retirement Incomes Working Group. The opinions in this article do not reflect the views of either of these organizations, or his employer.</span></em></p>Legislating an ‘objective’ for super could have many unintended consequences.Anthony Asher, Associate Professor, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/514902015-12-01T19:12:31Z2015-12-01T19:12:31ZWhy levying GST on banking has been in the ‘too hard’ basket<p>South Australian Premier Jay Weatherill has <a href="http://www.premier.sa.gov.au/images/speeches/20150923australianfinancialreviewtaxreformsummit.pdf">argued</a> for broadening the GST base to include all financial services, something also floated by the Financial System Inquiry. The idea has merit, although the complexity of the issue makes assessing the consequences and merits difficult.</p>
<p>Currently, some financial services (such as insurance) for which explicit fees are levied are subject to GST. But a major part of banking - taking deposits and making loans - is not. Historically it was seen as too difficult because of the nature of financial intermediation, but modern technology should make it feasible – albeit still difficult.</p>
<p>To understand the issues involved, a short primer on GST is required. GST, or Value Added Tax (VAT), applies a rate of tax (eg 10%) at each stage of the production process, based on the value added by the business (essentially equal to wages and profits). It achieves this by levying the tax on the value of the goods sold by the business but allowing tax credits for the GST included in the price paid by the business for purchases of goods and services as inputs (referred to as input tax credits).</p>
<p>Each business in the production process supply chain pays a net tax amount equal to the GST tax rate applied to its value added. When the completed good or service is sold to a consumer, the price incorporates all the net GST amounts paid in the production process, such that total GST revenue is essentially the 10% tax rate applied to the pre-GST sale price of goods and services sold to consumers.</p>
<h2>The challenge</h2>
<p>How would this apply to taking deposits (on which interest is paid) and making loans (on which interest is charged)? The value added in this process is relatively easy to identify. The difference between those interest rates (the net interest margin), if we ignore explicit fees charged for services provided, must cover costs of purchased inputs of goods and services by the bank (such as paper, pens, ink, or nowadays computer services) plus wages and profits.</p>
<p>So total value added by a bank can be readily calculated as the sum of its wage bill and its profits. The problem lies in splitting the value between business and retail customers and providers of deposits and loans.</p>
<p>As a very simplistic example, suppose the bank has $90 of deposits and $100 of loans (and $10 of equity capital) and a total value added (net interest margin minus purchased input costs) of $5. What method can be used to divide that $5 between depositors and borrowers as the value of services provided to each? And if there are numerous depositors and borrowers (and some of them business and some retail customers), possibly receiving or paying different interest rates, how much of the value added represents the cost of services provided to each?</p>
<h2>Why it makes sense</h2>
<p>Putting this process into the “too hard” basket, however, creates distortions to production and consumption. First, banks pay substantial amounts of GST on purchased inputs, and receive input tax credits which they are largely unable to use. Of course, banks can be expected to pass on the taxes paid to customers in the form of lower deposit rates or higher loan rates.</p>
<p>This creates a distortion of costs for business customers of the bank. For example, the loan interest they pay indirectly includes an implicit GST cost, but they do not receive any input tax credits to offset the GST amount they add to their product price.</p>
<p>As a very simplistic example, consider an individual who provides personal services using no purchased inputs for deferred payment and has a bank loan to meet living expenses until the payment is received. The loan interest is $10 and the individual needs a net $1,000 for those services and is subject to GST as a business. If there is no input tax credit on the loan interest the individual will need to charge GST on $1010, or GST of $101 such that the gross price charged to the purchaser of these services would need to be $1,111. If the loan included (for example) an input tax credit of $1 because intermediation services were “GST-able”, the gross price would only need to be $1,110 (because the net GST bill paid by the individual would only be $100).</p>
<p>Because of the current GST exemption, businesses do not get the benefit of all the GST paid in the “upstream” parts of the production process and therefore need to charge higher prices. </p>
<p>A second type of distortion arises from consumer demand for financial services. While the GST paid by banks is reflected in interest rates paid and charged, the absence of GST on the value added by bank intermediation reduces the relative price of financial services. Arguably, this contributes to higher demand for financial services relative to other goods and services, perhaps contributing marginally to the growth in size of the finance sector over recent decades.</p>
<p>A third type of distortion arises from decision making by banks regarding supply and pricing of different types of financial services. For example, costs of intermediation can be recouped by the net interest margin or by explicit fees for services associated with intermediation – some of which may be “GST-able”.</p>
<h2>Difficult to measure</h2>
<p>Is it possible to overcome these difficulties? One would hope so. Banks have very sophisticated activity based costing systems and funds transfer pricing systems which are designed to identify the cost and value created by each transaction. Using these to identify value added for each type of transaction, and thus the base for applying GST, may be complicated but not infeasible.</p>
<p>Is it worth doing? Certainly the sum of profit and wages paid (ie value added) of banks, is a very large sum, much of which is not subject to GST. While the banks will claim they pay large amounts of GST (on their purchased inputs) which they can not claim as input tax credits, it is ultimately the users of bank financial services who pay those amounts.</p>
<p>Broadening the GST base to fully include financial intermediation would increase GST revenue (estimated at around A$3.5 billion from households) and would remove a number of distortions from the current system (including almost A$1 billion from over-GST taxation of business. But identifying precisely the overall effects, the benefits, and the cost of change is a fairly Herculean effort.</p><img src="https://counter.theconversation.com/content/51490/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Calls for GST on banking make sense, but working out the ultimate benefit is no easy task.Kevin Davis, Research Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/494302015-10-20T03:04:11Z2015-10-20T03:04:11ZSuper members the winner in sensible financial inquiry response<p>The government has today accepted virtually all of the recommendations of the expert panel behind last year’s <a href="http://fsi.gov.au">Financial System Inquiry</a>. Clearly we can argue about some, and people would prefer to pick and choose depending on their predilections, but rather than allow the reform process to be unpicked by stealth, the government has opted to support its experts. That is a welcome change.</p>
<p>The inquiry had three main issues to deal with: the safety of our banking system in the light of the global financial crisis, the increasing importance of the superannuation industry to our financial system as a whole, and how new technologies and related innovations might impact the system. While the banking issues are well understood the other two pose new challenges for Australia.</p>
<p>Inquiry chair David Murray and his colleagues focused heavily on superannuation. This is appropriate since the superannuation sector is now a major part of the financial system. By the time of the next inquiry it may even manage more assets than the banks.</p>
<p>The one recommendation which was rejected by the government in <a href="http://www.treasury.gov.au/%7E/media/Treasury/Publications%20and%20Media/Publications/2015/Government%20response%20to%20the%20Financial%20System%20Inquiry/Downloads/PDF/Government_response_to_FSI_2015.ashx">its response to the inquiry</a>, Recommendation 8, was intended to limit the ability of superannuation funds to borrow. The FSI approached this as a prudential issue, worrying about potential risks from leverage within the superannuation sector. The government has rejected the argument saying it may be an important issue in the future but is not now, preferring to monitor what is happening rather than prohibiting it. </p>
<p>The choice not to reject any other recommendations on superannuation is far more important.</p>
<p>The government supports the FSI’s concerns about the efficiency and competitiveness of the superannuation system. It has charged the Productivity Commission with reviewing the current system and suggesting ways in which the system might be made more competitive. This will be a major challenge of the superannuation sector and involve them in a lot more policy analysis over the next couple of years.</p>
<p>On the management of retirement income streams, the approach is more nuanced. It will require funds to develop products and then leave members with the right to choose between these new products and their current choices. The approach will be fleshed out as part of the two ongoing reviews in the area.</p>
<p>Industry funds will struggle with the next two recommendations: on choice of fund and on governance.</p>
<p>The government has committed to extend choice of fund by removing the deemed choice provisions of some industrial agreements. This does seem sensible policy although it will be criticised. Since most people have choice of which funds their savings will go into, it seems inappropriate to lock other people into a restricted set. It is hard to argue that having more choice will hurt anyone and it could lead to greater competition between funds.</p>
<p>The issue of strengthening governance is also going to be disputed but should be inoffensive. Rotating directors and having independent directors are normal requirements in the corporate world and, with many funds managing tens of billions of dollars in savings, it seems sensible to allow funds to find the best directors possible. It may also be easier for independent directors to recommend the amalgamation of funds which is badly needed and should produce significant benefits for savers.</p>
<p>Can the government make the superannuation more competitive in the expectation that it will produce better outcomes for savers? Clearly the answer is yes. The superannuation system has evolved over time, driven by rules and by changes in rules. Its size is a product of rules and regulations. Steps to make the system more transparent, to allow greater choice, and to enhance the professionalism of management can all be expected to produce better outcomes for savers.</p>
<p>The politics of the government’s response is sensible. The Productivity Commission will be cheering. It will have a whole new stream of work and be brought back into the centre of government policy analysis. This is a very healthy development.</p><img src="https://counter.theconversation.com/content/49430/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock has consulted for the superannuation and banking industries in the past.</span></em></p>It’s a good thing that Australia’s large and growing super sector will attract greater policy focus in coming years.Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/476342015-09-18T00:39:50Z2015-09-18T00:39:50ZThe unfinished business facing Australia’s new treasurer<p>When Australia’s new treasurer walks into the office on Monday morning, a stack of unfinished business awaits. A quick scan of the Treasury website reveals four major inquiries begun in the past 18 months that are still in progress – the <a href="http://fsi.gov.au/">Financial System Inquiry</a>, the <a href="http://competitionpolicyreview.gov.au/">Competition Policy Review</a>, the <a href="http://www.treasury.gov.au/ConsultationsandReviews/Reviews/2015/Tax-White-Paper">Tax White Paper</a> and the <a href="http://www.treasury.gov.au/ConsultationsandReviews/Reviews/2015/NAIP-Taskforce/Interim-Report">Northern Australia Insurance Premiums Taskforce</a>.</p>
<p>The outcomes of these processes open up the possibility of bold decisions that would uplift the outlook for the nation’s economic growth and longer-term prosperity. It is worthwhile to delay a rush to judgement, and consider a framework and narrative that incorporates and informs all of these areas of inquiry.</p>
<p>The most obvious piece of pending business is the government response to the Financial System Inquiry led by David Murray over the course of 2014. The government response, which had been promised for a few months now, appeared ready to be issued this week. </p>
<p>Indeed, close observers have been left wondering whether there would be much “response” in the response, in light of pronouncements that have already been made. Banking regulator APRA has issued guidance on bank capital (with significant market impacts this year); the government has drafted new legislation on superannuation governance that has been released for public consultation; the decision has been made to not impose a deposit insurance scheme; ASIC’s capability and funding model are currently under review; and the RBA has conducted a payments review including interchange fees.</p>
<p>Off the back of these reviews, other mini-inquiries and consultations have emerged. The Assistant Treasurer Josh Frydenberg in August announced a regulatory review of the payday lending industry. The review of retirement income stream regulation that took place last year is still pending outcomes, and perhaps partly rolled into the Tax White Paper process. </p>
<p>The Northern Australia Insurance Taskforce is examining ways in which the government’s balance sheet can be used to reduce insurance premiums in specific regions of Australia – perhaps without the rest of the Australian community fully appreciating the knock-on impacts this could have for other policyholders. Also under-appreciated are other changes in the insurance industry, such as how the Medibank privatisation is redrawing the regulatory landscape on health insurance.</p>
<p>Yet, one wonders whether the two core positions in the FSI report have been lost in all of the noise: the need to enable efficient funding of the economy by removing distortions, and the ability to promote competition and innovation through appropriate policy settings. </p>
<p>Removing distortions and enabling competition including through innovation in the financial system are both absolutely critical; they are the engine of sustainable financial sector growth. And there is a lot of work to be done.</p>
<p>What does sustainable financial sector growth look like, and why is it important? What is the policy framework that surrounds it? The narrative that will explain this to the Australian community needs to be developed and communicated. Without it, the bold policy choices that are yet to be made are likely to come across as tedious, intangible and maybe just too hard.</p>
<p>The story is straightforward, but is not told often, or well. When we hear from politicians about our economic future, the focus is usually on the goods-producing sectors – mining, agriculture, food, specialised manufacturing. In services we focus on easily-understandable cross-border movement in people – tourism and higher education. We rarely hear boosterism applied to financial services.</p>
<p>Yet, financial services is the largest single industrial segment in the Australian economy by gross value added. It is the largest contributor of corporate tax to the Australian government. It is a major employer in most states, and dominant in NSW and Victoria. It is also probably the largest single services export from Australia to the rest of the world, as ACFS detailed in a recent report. Its above-average rate of productivity growth over the past decade suggests that Australia’s financial sector is innovative.</p>
<p>Of course, the financial services sector also plays an important role in intermediating funds that support growth and innovation through the rest of the economy. The financial services sector runs the payments system, the credit system and the capital markets system that both funds business activity and provides wealth management products for households. Financial services also manage risk through insurance.</p>
<p>What the government has done thus far with the FSI report is fine, but there is potential to go a lot further. The need for this can be seen in the gaps where the financial system has been found wanting: credit to small business, generation of venture capital, creation of a broader suite of retirement income products, the high cost of insurance in some sectors. </p>
<p>Creating supports for clusters for innovation in finance, writing legislation that would enable digital identities while protecting personal financial data, forcing greater access to and use of data so as to level the playing field for competition – these are proactive and forward looking recommendations that may not be easy but must be done. Push the financial sector into the digital age, and the rest of the economy will follow.</p>
<p>And then there is the infrastructure. The NBN may be on its way, but what about data storage in the cloud? This has become essential infrastructure that allows financial firms to store their data at lower cost. Enabling this functionality while protecting firms from cyber crime would be a whole-of-economy advance in Australia’s global competitive position.</p>
<p>A framework that removes distortions and enables competition and innovation – this speaks to the agile, innovative, creative future that Prime Minister Malcolm Turnbull articulated in his victory speech on Monday night. Build the narrative around the inquiries, and good outcomes are sure to follow.</p><img src="https://counter.theconversation.com/content/47634/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Amy Auster does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A bulging in-tray of reviews awaiting response awaits Malcolm Turnbull’s choice of treasurer in his new cabinet.Amy Auster, Deputy Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/468852015-09-01T01:10:00Z2015-09-01T01:10:00ZTapping super not the answer to home ownership decline<figure><img src="https://images.theconversation.com/files/93464/original/image-20150831-25742-6z1r7x.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Chipping away at your super account can have compounding results.</span> <span class="attribution"><span class="source">Image sourced from shutterstock.com</span></span></figcaption></figure><blockquote>
<p>“All Australians should be able to retire with dignity and decent living standards.”</p>
</blockquote>
<p>So states the recently released superannuation <a href="http://www.ceda.com.au/2015/09/01/media-release-ceda-retirement-report">report</a> of the Committee for Economic Development of Australia (CEDA). </p>
<p>CEDA’s report is commendable. And although I agree with most of its recommendations, including what the purpose of super should be, how retirement income products dealing with longevity risk should be developed and how super tax laws should be made more equitable, I have one serious misgiving: I do not believe active employees should be able to use their super funds to invest in owner-occupied housing. </p>
<p>The American 401(k) system (also a defined contribution model like Australian super) provides a cautionary tale on the damage caused by what’s known as pre-retirement leakage. Unlike Australia, it is fairly easy for US workers to access their 401(k) retirement accounts during active employment. Even prior to preservation age, which is 59<a href=""></a>½ in the US, individuals are able to use their workplace retirement accounts for a number of purposes, both with and without tax consequences.</p>
<p>For instance, the US tax code allows individuals under specified circumstances to take loans against the value of their retirement funds without tax penalty. Although such funds are required to be secured and paid back like any other commercial loan, studies show many employees are never able to restore the money to their 401(k) accounts. Not only does this lead to diminished pension pots, it also means there will be less money upon which interest or investment returns can build on in the long-term.</p>
<p>The US 401(k) system also permits employees to take hardship distributions for a number of reasons, including purchasing of a first home, university education and medical expenses. In these circumstances, not only does the individual not face any tax penalties for the withdrawal (except for having to pay ordinary income tax), they are also not required to pay back the money to their account.</p>
<p>Finally, employees can take money out of their 401(k) accounts if they “really” want. What I mean is, absent even an authorised loan or hardship distribution, employees before preservation age can withdraw funds from their retirement accounts. We call this “expensive money” because both a 10% excise tax and 20% employer withholding of funds apply. In the end, these employees receive 70 cents in the dollar for withdrawing money prematurely from their retirement account.</p>
<p>Such leakage in the US causes a significant erosion of assets in retirement - approximately 1.5% of retirement plan assets “leak” out every year. This can potentially lead to a reduction in total retirement assets of 20% to 25% over an employee’s working years, according to experts.</p>
<h2>Remember the role of super</h2>
<p>I do not disagree with the CEDA report that housing makes a critical contribution to sustaining living standards and helping to address elderly poverty. Needless to say, there should be a multipronged federal government response to the spectre of increasing poverty in old age because of the lack of home ownership. Many useful suggestions are made in the CEDA report in this regard.</p>
<p>But using super, even if only for first-time home buyers, should not be the answer. Indeed, CEDA agrees with much of the recent <a href="http://fsi.gov.au">Financial System Inquiry</a> report (the Murray report), which concludes that super legislation should state explicitly and clearly that its purpose is to provide retirement income. </p>
<p>While increasing home ownership for younger workers is an admirable policy prescription, it is not consistent with the retirement income focus of super. Allowing workers to use their super funds to buy homes means there will be much less money in the pension pot to grow over time to provide the necessary retirement income.</p>
<p>And the harm is ongoing. Making such a change would lead to a further constrained supply of housing, meaning more money chasing the increasingly limited stock of property, tending to drive home prices up even further. </p>
<p>Of course, when, not if, the housing market crashes, much of the super savings tied into such property will also be lost. This problem stems from a lack of diversification in one’s retirement portfolio through an over-investment in the family home. The consequent lack of investment diversification among asset classes means super is less likely to be able to survive future shocks to the Australian economic system. </p>
<p>The lesson from the United States is clear: pre-retirement leakage from super should be permitted only under the most exceptional of circumstances. Even for the very best of reasons, like first-time home ownership, Canberra should prevent super fund leakage during active employment to ensure the primary objective of super: retirement income adequacy.</p><img src="https://counter.theconversation.com/content/46885/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Paul M. Secunda is a law professor at Marquette University Law School in Milwaukee, Wisconsin. This year, he serves as the Chairman of the ERISA Advisory Council of the US Department of Labor, which advises the U.S. federal government on retirement plan pension policy. He is spending six months this year studying the Australian Super Guarantee as a senior Fulbright Scholar and Senior Fellow at Melbourne Law School. All opinions presented here are done so in his individual capacity, and do not represent the views of any of the organisations with which he is affiliated.</span></em></p>First home buyers may be doing it tough, but lessons from the US tell us raiding super is not the solution.Paul Secunda, Senior Fulbright Scholar in Law (Labour and Super), The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/468522015-08-30T20:07:43Z2015-08-30T20:07:43ZUser-pays ASIC model shift costs, but is bad for the public interest<p>The <a href="http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2015/Proposed-industry-funding-model-for-ASIC">discussion paper</a> released by Assistant Treasurer Josh Frydenberg suggests that businesses be “levied” to pay for a large part of the costs incurred by the Australian Securities and Investment Commission. </p>
<p>At present ASIC is largely funded from consolidated revenue. The new proposal is that industry should pay a much larger share. In essence costs would be shifted from government onto business.</p>
<p>The arguments made in the discussion paper in support of this increase in business taxes are:</p>
<ul>
<li><p>the Financial System Inquiry suggested it;</p></li>
<li><p>the change would ensure that the costs of the regulatory activities undertaken by ASIC are borne by those creating the need for regulation (rather than all taxpayers);</p></li>
<li><p>it would establish price signals to drive economic efficiencies in the way resources are allocated in ASIC;</p></li>
<li><p>it would improve ASIC’s transparency and accountability.</p></li>
</ul>
<p>There are a number of problems with the proposal.</p>
<p>The fact that it was suggested by the Financial System Inquiry is important but not decisive. It seems likely that the Government will pick and choose amongst the recommendations of the Inquiry, supporting some and not others. The recommendation is thus a factor but not a deciding one.</p>
<p>The second argument is far more interesting. The discussion paper pitches the proposal as an example of user pays. The logic is that consumers of financial products need to be protected and that the costs of ASIC providing that protection should be paid by the firms operating in that industry. </p>
<p>By similar logic all consumer product protection undertaken by the ACCC should also be costed out to the industries involved. All food safety protection might be dealt with the same way and all border protection might be farmed out to all international travellers. We would not even need public schools, because students could be charged for the educational services they receive.</p>
<p>Clearly we could operate that way. In effect, our taxation system would not be necessary and it would be replaced by a complex system of user charges. Unfortunately the Minister is not proposing to reduce general taxes, just to raise some specific ones.</p>
<p>The suggestion that the system of levies paid by industry would improve ASIC’s transparency and accountability appears naïve. Under the current arrangements ASIC has to fight for its funding in the budget round with a Finance Department determined to restrain the growth of public spending. </p>
<p>The new proposal shifts ASIC towards a cost-plus framework, overseen by an array of committees to entities it regulates. Thee would still be some budgetary oversight but inevitably the disciplines would be weaker.</p>
<p>The proposal is rather like asking the players before a match to announce publicly how much they were going to pay the referee. It will be difficult for the groups being regulated by ASIC to complain about its spending for fear of potential retribution. Costs are likely to rise as a result.</p>
<p>The way in which the system will be managed creates further problems. Frydenberg proposes setting panels of industry representatives to oversee the ASIC budget proposals. For a minister responsible for reducing red-tape, it is a very unusual proposal. It is complex, it shifts even more costs onto industry, and is likely to be completely ineffective. </p>
<p>Inevitably it will result in groups fighting with each other to shift ASIC’s costs from between categories and ASIC has the potential to set them off against each other. And there will still be some budgetary oversight so there are no savings just costs.</p>
<p>The proposal will have strong support from ASIC and Finance, and will probably succeed. ASIC has lobbied hard to have accepted its cost-plus model of funding raised from the parties it regulates. The Finance Department too will appreciate having more of ASIC’s costs shifted off budget.</p>
<p>However it is not clear that the proposal is in the public interest. It does not reduce costs. It is an increase in business taxes. The budgetary pressure on ASIC will be reduced and ASIC is likely to grow a lot bigger. The mechanisms proposed to raise the funds are also complex and shift further costs onto the industry.</p>
<p>Looking further ahead, if ASIC succeeds in shifting costs onto industry, other regulators will surely follow. The consumer protection functions of the ACCC are almost the same as those of ASIC so it will certainly follow the new funding model. </p>
<p>Separating the regulators from most of the normal disciplines in the budget round could make them lazier, cost-plus operations, but there are also examples in the international experience where by encouraging the regulator and the regulated closer together creates increased potential for regulatory capture.</p><img src="https://counter.theconversation.com/content/46852/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Both ASIC and the finance department want a user-pays model, but costs - borne by business - will rise.Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/461872015-08-17T04:54:42Z2015-08-17T04:54:42ZThe obvious and not-so-obvious problems with Hockey’s bank deposit tax<p>The federal government has given itself until the end of the year to respond to the many recommendations contained within last year’s <a href="http://fsi.gov.au/publications/final-report/">Financial System Inquiry report</a>, but in one area it has already decided to act against the Chair David Murray’s advice.</p>
<p>From January 1, 2016 the government will levy a bank deposit tax. In <a href="http://www.afr.com/news/politics/hockey-wants-to-exempt-small-banks-building-societies-from-deposit-tax-20150809-givb6u">all likelihood</a> this will be 0.05% of deposits up to $250,000. The scheme would be limited to the big four (ANZ, NAB, CBA and Westpac). The thinking is that the big four are big enough to absorb the tax, without passing it onto depositors. The small banks, credit unions and friendly societies would be exempt.</p>
<p>Under the proposal, if a bank fails and needs a bail-out, the money generated by the tax (one estimate puts it at A$500 million annually) would foot the bill. Whether that’s correct is debatable. A modest A$10 billion bailout would require the scheme to run for twenty years.</p>
<p>Murray says this “ex ante”, or upfront arrangement, is the incorrect approach. He argues the levy should be “ex post” - in other words, the scheme should seek to collect the funds <em>after</em> a bank becomes insolvent, from all of the banks that remain. This, he argues, would only be necessary in the event that the government was not able to recoup its costs through the liquidation of the failed bank’s assets. Pretty unfair to those banks that were well run, and, in effect, a free pass to the ones that fail.</p>
<p>Murray is very wrong indeed. The government will struggle to recoup its costs from an insolvent bank, because…it’s insolvent. In addition, bank rescue is usually aimed at re-capitalising the bank, which precludes liquidating its assets. But more important even than that, is that the conventional wisdom has come down firmly on the side of the “ex ante” argument, and Murray <a href="http://kevindavis.com.au/secondpages/workinprogress/2015-04-30-Depositor%20Preference%20and%20Deposit%20Insurance.pdf">should have been aware of that.</a> </p>
<h2>A flight to smaller banks?</h2>
<p>There are a raft of other issues this proposal throws up. First, it should be the big four plus one: Macquarie should not be exempt. Secondly, what happens to deposits in excess of $250,000? Will they attract a higher tax? In which case most depositors will simply split their deposits. Or will they attract a lower tax? In which case we will, in effect, be levying a poverty tax - that is to say, poorer, smaller depositors will be taxed more. Hardly fair.</p>
<p>Then there are the arguments put forward by the Australian Bankers’ Association (ABA) which highlight the disadvantage this scheme will have on larger banks: the scheme will encourage a flight of depositors to smaller banks.</p>
<p>There are two sides to this argument however. The first is it will level the playing field between the big and small banks. Small banks currently have to pay more for deposit funding because they are perceived as presenting a higher risk. The other side of the coin is that small banks currently have to pay more for deposit funding because they are - well - higher risk, and so should pay more.</p>
<p>In our rush to punish the big four we should be circumspect about distorting the market by distorting the cost of deposit funding. ABA Chairman Steve Munchenberg’s assertion that taxing the big four is unfair, because it is only the small banks that would need rescuing, is arguably nonsense. Where else would we get the concept “too big to fail”? Not from the dangers posed by the collapse of small banks. Furthermore, the <a href="http://www.theguardian.com/business/2008/dec/28/markets-credit-crunch-banking-2008">empirical evidence that emerged from the GFC</a> was that it was big banks that toppled more than small ones.</p>
<h2>The real problem with the tax</h2>
<p>There is a fundamental shortcoming with this proposal for a flat rate tax, and one which has not been discussed: protection of depositor’s funds is akin to an insurance contract. The insurance is against the risk of the bank collapsing. In return for which an insurance premium is charged. But the premium does not fluctuate. It is a flat rate (0.05%). A flat rate premium for a variable risk distorts the price of risk. The risk in question is a crucial one: insolvency. This represents a distortion of the risk which is the raison d'être for having the safeguard of depositor protection in the first place. Hardly optimal to have said raison d'être muddy the waters and encourage a critical point of failure.</p>
<p>In all probability, a risk-sensitive premium, able to fluctuate up and down as the risk of the bank not remaining solvent rises and falls, would be preferable. The <a href="http://www.imf.org/external/pubs/ft/scr/2013/cr1366.pdf">IMF has recommended this</a> for Europe, and there are several European countries where <a href="https://www.imf.org/external/pubs/ft/wp/2014/wp14118.pdf">such schemes</a> have been operating for some time.</p>
<p>There are differences in the risk-sensitive premium arrangements employed across those countries, and some have been more successful than others. One of them was Greece. So these types of arrangements need further study. But if operating optimally, a risk-sensitive deposit tax would almost certainly create a more effective deterrence against excessive risk taking by banks, than would the current proposal for a flat rate fee of 0.05%. For a government that is avowedly free-market, this should not be a tough sell.</p><img src="https://counter.theconversation.com/content/46187/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andrew Schmulow does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A flat rate bank deposit tax could be distorting, and not for the reasons the banks suggest.Andrew Schmulow, Principal, Clarity Prudential Regulatory Consulting Pty Ltd. Visiting Researcher, Oliver Schreiner School of Law, University of the Witwatersrand, Johannesburg., The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/441842015-07-08T20:05:35Z2015-07-08T20:05:35ZLiving longer means it’s time Australians embraced annuities<figure><img src="https://images.theconversation.com/files/87265/original/image-20150703-30213-mbv9rw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Retirees don't always succeed in ensuring their retirement income lasts the distance.</span> <span class="attribution"><span class="source">Image sourced from Shutterstock.com</span></span></figcaption></figure><p>Few people are likely to be interested in buying an expensive financial product which offers little return, particularly when that return is based on their life expectancy. But annuities, which provide a series of regular payments until the death of the annuitant in return for a lump sum investment, deserve closer attention. </p>
<p>Despite the benefits of annuitisation, there is considerable evidence of <a href="http://www.limra.com/Secure_Retirement_Institute/News_Center/Retirement_Industry_Report/Annuities_-_Solving_the_Annuity_Aversion_Puzzle.aspx">annuity aversion</a> among individuals. This has led to what economists call the “annuity puzzle”. It’s like this: let’s agree there are some benefits, we won’t buy it anyway.</p>
<h2>The good…</h2>
<p>Life annuities provide longevity insurance, which is another way of saying they guarantee the annuitant an income until death. Managing longevity risk is an integral part of any retirement system. The recent <a href="http://fsi.gov.au">Financial System Inquiry</a> (FSI) regards longevity protection as a “major weakness” of Australia’s retirement income system. </p>
<p>The most popular retirement product, Account-Based Pensions (ABPs), provides flexibility and liquidity but leaves individuals with longevity, inflation and investment risks. The FSI recommends that superannuation trustees pre-select a comprehensive income product for retirement (CIPR) that has minimum features determined by the government. This product will help members receive a regular income and manage longevity risk. This is the main job of annuities.</p>
<p>One important feature of annuities is the return of capital (ROC). Investors are guaranteed up to 100% return of capital in the first 15 years of annuity purchase. If the investor dies in this period and does not have a joint owner or nominated person to receive payments when they die, a lump sum payment is made to her estate.</p>
<h2>The Bad…</h2>
<p>The idea of losing liquidity by locking up capital in annuities does not make the product very appealing. Also, the lower rate of return compared to investing directly in financial markets or alternative financial products is a reason why Australians shun annuities.</p>
<p>Annuitising is also seen as an irreversible choice in most cases and therefore investors are careful when to commit to it. This decision is delayed further when individuals have bequest or capital preservation needs, making full annuitisation an unlikely choice for most retirees. Today’s annuity with ROC to some extent caters for some of these concerns, but some of these drawbacks continue to loom large in the minds of investors.</p>
<h2>An alternative</h2>
<p>Let’s consider deferred annuities instead. A deferred annuity is a financial security for which the annuitant makes a premium payment to the insurer. In return, the insurer agrees to make regular income payments to the insured for a period of time. However, unlike regular annuities, the first payment is deferred until an agreed future date, i.e. the deferred annuity does not make any payments until after the deferred period is passed. </p>
<p>They are cheaper compared to regular annuities, yet provide the necessary longevity insurance. Deferred Life Annuities (DLAs) continue payments until the death of the annuitant. DLAs have been acknowledged in <a href="http://www.asx.com.au/asxpdf/20141028/pdf/42t7k89h51ntbj.pdf">14 submissions to the Financial System Inquiry</a> and received widespread support from industry bodies and associations encouraging its uptake. Legislative barriers, however, prevent the development of such a product in Australia. </p>
<p>The major risk to the annuitant purchasing deferred annuities is that she may not survive the deferred period, forfeiting her annuity premium. The Return on Capital concept could be employed to help overcome this. There is also a degree of counter-party risk involved since the life company might become insolvent before retirees’ income payouts begin.</p>
<p>What if we didn’t need life insurance companies to provide this longevity insurance? Could the big superannuation funds provide the income retirees need? They certainly could, by taking some lessons from the deferred annuities concept to build a Group Self-Deferred Annuity (GSDA). A certain percentage or amount of retiree’s wealth (depending on size of balance at retirement) goes to the superannuation fund’s “deferred investment pool” at retirement. This serves as premium for the deferred annuity. The retiree still holds liquidity and controls remaining wealth and has opportunity for higher consumption even before the annuity payments begin. Remaining wealth may be subject to account based pension regulations ensuring minimum drawdowns.</p>
<p>According to such a structure, the annuity begins to pay out at age 80 or 85 years and the retiree’s income level will be a function of the premium invested, investment performance and mortality assumptions. With this approach, superannuation funds would be able to provide the much needed longevity insurance without resorting to complex products outside of superannuation. The “deferred investment pool” would undoubtedly require meticulous management as it would serve retirees beyond the deferred age. </p>
<p>If the retiree died before reaching the income payment stage, a discounted amount of her premium may be returned to her estate. The upside to surviving the deferral period is that the retiree may receive high mortality credits; additional return above the risk-free rate of return on the annuity income. Mortality credits stem from the redistribution of pooled wealth among surviving participants from retirees who die in the payment period. </p>
<p>While we seek to have a comprehensive income product in retirement, there are several starting points. A Group Self-Deferred Annuity is one option.</p><img src="https://counter.theconversation.com/content/44184/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Osei K. Wiafe does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Annuities in their current form are largely unpopular, but with a bit of tweaking they could provide the retirement income fix Australia needs.Osei K. Wiafe, Research Fellow, Griffith Centre for Personal Finance and Superannuation (GCPFS), Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/424742015-07-01T20:12:21Z2015-07-01T20:12:21ZIs it time to reform the cornerstone of Australia’s insolvency regime?<figure><img src="https://images.theconversation.com/files/86954/original/image-20150701-25059-bv7nfa.jpg?ixlib=rb-1.1.0&rect=1227%2C933%2C6397%2C4444&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Voluntary administration has been the widely-used step in efforts to prevent a company being dissolved.</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>The last time Australia had a comprehensive evidence-based review into our corporate insolvency laws was in 1993, chaired by the late Ron Harmer. Among the most notable reforms of that landmark review was the ground-breaking creation of voluntary administration, which allowed companies at risk of insolvency to continue trading in the hands of appointed overseers. </p>
<p>Since then, there have been other reports covering various aspects of insolvency law, including a <a href="http://www.aph.gov.au/binaries/senate/committee/corporations_ctte/completed_inquiries/2002-04/ail/report/ail.pdf">Parliamentary Joint Committee in 2004</a>; the <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/Completed_inquiries/2008-10/liquidators_09/index">Senate Inquiry into Administrators and Liquidators</a> in 2010, and David Murray’s 2014 Financial System Inquiry.</p>
<p>Public submissions have just closed on the latest draft report by the Productivity Commission, which floats a number of suggestions that have gained currency in insolvency circles, particularly drawing on <a href="http://www.arita.com.au/in-practice/arita-submissions">submissions</a> of the Australian Restructuring Insolvency and Turnaround Association (ARITA). The theme is that the current law needs to do more to facilitate restructuring.</p>
<p>The report contains much useful data and confirms that the bulk of Australian businesses are small. Notwithstanding this, the report doesn’t examine the debate about whether one size fits all and its suggestions regarding restructuring largely focus on the “big end of town”. </p>
<h2>Reforming voluntary administration</h2>
<p>While Harmer gave us a “state of the art” rescue procedure in voluntary administration, (which was later adapted by the British) it can be argued it is too expensive and is a sledgehammer for most small companies, so a simpler breathing-space for them might be a useful addition to the menu of procedures. </p>
<p>The Report rightly rejects the need, raised by the Murray Inquiry, for importation of the expensive <a href="http://www.investopedia.com/terms/c/chapter11.asp">US Chapter 11</a> bankruptcy provisions. But it does recommend one welcome adoption from the US, the outlawing of “ipso facto” clauses, where contracts provide for automatic termination on insolvency. </p>
<p>This prevents companies from trading during insolvency, as it can affect leased goods, premises and key supplies. This impediment to rescue could easily be removed. We have long had the prohibition in our Bankruptcy Act, so why not in the Corporations Act too?</p>
<p>In the 1993 reforms, directors’ liability for insolvent trading was deliberately linked to voluntary administration, the latter designed to maximise chances of the company surviving, or if not, a better outcome than on liquidation. If directors allow the company to incur debts once they knew or should have known it was insolvent, they will be personally liable; but if they appoint an administrator, they have a partial defence. But it is said fear of liability means directors are triggering voluntary administration too early, and since it is an insolvency procedure, the attendant stigma leads to value destruction. </p>
<h2>Safe harbour for directors</h2>
<p>There has been a call for a “business judgment” defence; a “safe harbour” if directors act in good faith and call in an independent restructuring expert. The Federal government took this up following the 2008 financial crisis, but an then-incoming Minister David Bradbury dropped it on 2011, citing lack of evidence of any problem.</p>
<p>The PC has picked up the ball once again, and adds ARITA’s suggestion of “pre-positioned” sales, with safeguards if related parties are involved. However, the PC envisages the “safe harbour” as a positive duty, not a defence. </p>
<p>It does not discuss how this would interact with the other duties in the Corporations Act. Also, it is not a “business judgment”, since the directors would be relying on the adviser. Will the “independent restructuring advisers” be regulated, and need qualifications? And how would small companies afford them? </p>
<h2>Too early - or too late</h2>
<p>Lastly, the report fails to mention the more likely driver for triggering voluntary administration too early - namely the Australian Taxation Office’s Director Penalty Notice regime, which also links director liability to voluntary administration or liquidation. </p>
<p>Paradoxically, it is also said that voluntary administration is often used too late. Thus, the report recommends it should be available if the company may become insolvent in future; that may be beneficial, but then it says voluntary administration should not be available if the company is insolvent. </p>
<p>This would be a backward step, and overlooks the difficulty of deciding whether a company is technically insolvent. Further, it removes the flexibility of voluntary administration. Granted, the report cites evidence that very few voluntary administrations lead to survival - but it does not follow that we should prevent it being used to try a rescue. </p>
<h2>Bankruptcy discharges</h2>
<p>The report also touches upon schemes of arrangement, a costly court-driven rescue procedure. It proposes a “panel” could replace the court for some aspects, but generally fails to consider how schemes relate to voluntary administration and informal rescue.</p>
<p>On receivership, it recommends extending the duty of care of receivers when disposing of assets. It then makes an “information request” asking whether there is evidence of any problem! As for exit, the report takes up ARITA’s suggestion of a streamlined procedure for small liquidations. This is laudable, though the main issue will be funding it. Another welcome suggestion is that directors should all have an identification number, aimed at reducing “phoenix” activity, but with wider monitoring advantages.</p>
<p>Lastly, to encourage enterprise through “fresh start”, it suggests Australia should follow the UK and reduce the automatic bankruptcy discharge period from three years to one. This has merit, but since most bankruptcy (78%) is consumer related, it needs more thought about the impact on all stakeholders.</p>
<p>Keeping the public discussion going on these reform ideas is welcome. But the draft report lacks holistic analysis and there is a danger that piecemeal changes could have unintended consequences. It seems time we had another “Harmer”.</p><img src="https://counter.theconversation.com/content/42474/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>David Brown does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Voluntary administration was considered a state-of-the-art rescue procedure for struggling companies in 1993. But is is time for another wide-ranging review of our insolvency laws?David Brown, Co-Director, Bankruptcy and Insolvency Scholarship Unit, University of AdelaideLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/402362015-04-30T04:30:13Z2015-04-30T04:30:13ZHow changing our bank account numbering system will be a win for customers<figure><img src="https://images.theconversation.com/files/79225/original/image-20150424-14571-pigpgw.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Enabling consumers to keep their bank account numbers when switching institutions will encourage greater competition</span> <span class="attribution"><span class="source">AAP Image/Dan Peled</span></span></figcaption></figure><p>It’s a pain to change mobile providers, but at least keeping your number is easy. It’s much more of a pain to change banks and much of that pain is because we have to change bank account numbers. Why don’t we have bank account number portability in the same way that we have mobile number portability?</p>
<p>The answer is the big four banks would prefer to keep switching accounts difficult. This contrasts with the approach in the United Kingdom. </p>
<p>In March 2015, the UK <a href="http://www.fca.org.uk/">Financial Conduct Authority</a> (FCA) released <a href="https://www.fca.org.uk/static/documents/research/making-current-account-switching-easier.pdf">a report</a> highlighting the benefits of bank account number portability in encouraging consumers to switch banks. The result is increased competition in the financial system.</p>
<p>The FCA report revealed that 35% of consumers and 40% of businesses “would be much more likely or more likely to switch if they had portable account details”. The research signalled that customers view account number portability as reducing the risk of changing banks. This is because it makes the process quicker and smoother. The reasons are:</p>
<blockquote>
<ul>
<li><p>customers do not need to change details;</p></li>
<li><p>the risk of incoming and outgoing payments going astray diminishes; and</p></li>
<li><p>businesses do not need to inform customers of changes.</p></li>
</ul>
</blockquote>
<h2>How could portability be implemented?</h2>
<p>For bank account number portability to be effective, the customer’s details and payments need to be accessible by both the old and new bank. The FCA report states that one option is a “central utility model”. </p>
<p>This model could include features such as a “Know Your Customer” database to store customer details for identification and a “payment mandates database”. The idea is for providers to continue offering competing products and services to customers, whilst using a “shared banking platform”. The FCA does not provide specifics of how bank account number portability would be implemented. However, it provides a framework to be further examined.</p>
<p>A report by <a href="http://www.infosys.com/finacle/solutions/thought-papers/Documents/bank-account-number-portability.pdf">Jain and Kudidhi</a> provides a more detailed approach of how bank account number portability using a central database could be implemented. </p>
<p>It involves a local database for each institution to initiate switching requests working alongside a central database, accessible by all banks, with all customer account numbers. This approach is similar to that used for mobile number portability which has been working in Australia since September 2001.</p>
<h2>Additional factors for bank account number portability to properly function</h2>
<p>The Australian payment system is currently based on a series of bilateral networks between financial institutions. These networks facilitate the transactions of direct credits and direct debits. </p>
<p>For this to occur, each customer has an account number to identify the specific account, and a bank, state, branch (BSB) number. To switch banks, customers are required to change their BSB and customer account numbers and redirect incoming or outgoing transactions to the new account details. </p>
<p>The <a href="http://banking.treasury.gov.au/content/reports/switching/downloads/switchingarrangements_aug2011.pdf">Fraser Report</a> commissioned by the Australian government suggests an alternative numbering system to the existing BSB and account number system to allow account number portability. </p>
<p>A simpler alternative however, could be to merge the current BSB and account number to form a unique customer account number rather than having to develop a completely new one. This parallels the mobile numbering approach where the two digits after “04” previously indicated the network operator and now only do for non-ported numbers.</p>
<p>The FCA report also noted some payment details would have to be separately incorporated into the bank account number portability model such as the International Bank Account Number (IBAN) and continuous payment authorities. However, Australia does not use IBANs and changing banks will not create issues with continuous payment authorities as it also means changing credit card providers.</p>
<p>A centralised database system is also important and is sometimes regarded as a high cost item. However, a process may be established where one of the four big banks will manage the database, which is then checked by the remaining big banking institutions. This would avoid the costs of establishing a new institution. In the telecommunications sector, Telstra runs the equivalent data repository known as the <a href="http://www.telstra.com.au/consumer-advice/ipnd/">Integrated Public Number Database</a>.</p>
<h2>Encouraging greater competition</h2>
<p>If, as is the expectation of the <a href="http://fsi.gov.au/">Financial System Inquiry</a>, the <a href="http://theconversation.com/four-pillars-or-four-pillows-bankings-comfy-collective-23297">four pillars policy</a> is to remain then we need mechanisms to improve the vibrancy of competition in the retail banking sector. Account number portability will make switching quicker, easier and more likely. If mobile phone operators can put their competitive offerings on the line, why can’t the banks?</p><img src="https://counter.theconversation.com/content/40236/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rob Nicholls receives funding from the Australian Research Council and the Centre for International Finance and Regulation. He is a member of the Australian Labor Party.</span></em></p><p class="fine-print"><em><span>Charlotte Ann Penel receives funding from the Australian Research Council and the Centre for International Finance and Regulation. </span></em></p>It’s a pain to change mobile providers, but at least keeping your number is easy. It’s much more of a pain to change banks and much of that pain is because we have to change bank account numbers. Why don’t…Rob Nicholls, Postdoctoral research fellow, Swinburne University of TechnologyCharlotte Penel, Researcher on competition in the financial sector at the Centre for International Finance and Regulation and UNSW, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/383612015-03-09T23:21:52Z2015-03-09T23:21:52ZNaming and shaming helps keep banks honest<p>The <a href="http://www.smh.com.au/business/nab-takes-years-to-pay-compensation-after-investment-nightmare-20150220-13kb34.html">NAB investment advice scandal</a> is just the latest to hit the press in Australia, after <a href="http://storm.asic.gov.au/">Storm</a> and <a href="https://theconversation.com/years-on-asic-still-grappling-with-swap-rate-fixing-scandal-35851">LIBOR</a>.</p>
<p>This particular scandal will probably follow the others in that there will be: a fuss in a Senate Committee, embarrassing details emerging in the press, copious mea culpas from management, assignment of blame (typically on a former CEO) and then back to business as usual – until the next one. [Which will probably be the <a href="http://www.ird.govt.nz/aboutir/media-centre/media-releases/2009/media-release-2009-12-23.html">foreign exchange</a> benchmark manipulation scandal].</p>
<p>But why does this keep happening? Surely bankers do not, even though the bonuses keep rolling in, relish another round of bank bashing.</p>
<p>Innovation and technology in banking has given individual investors access to products previously only available to superannuation funds and hedge funds. </p>
<p>Asking the industry to stop coming up with new ideas is not going to work, given they need constant growth in income. Nor is asking bankers to behave nicely - it has failed so far. And wholesale education of punters has had a patchy history - greed often overcomes common sense.</p>
<p>One option is to look at what other jurisdictions are doing. A novel suggestion given Australia survived the global financial crisis (GFC) by good regulation, sound finances, good government, cautious lending etc. But Australia is not unique in facing such financial sector scandals.</p>
<p>In the USA after the GFC, a new regulatory body was formed called the Consumer Financial Protection Bureau (CFPB) with a goal pretty much spelt out in its name. The CFPB has started to flex its muscles, recently hitting <a href="http://www.acainternational.org/cfpbarticle-cfpb-fines-ge-capital-225-million-for-deceptive-credit-card-practices-32311.aspx">GE Capital</a> with fines and restitution costs of some US$225 million for “deceptive credit card practices”. It also issued penalties of some US$35 million to Wells Fargo and JPMorgan Chase for “<a href="http://www.reuters.com/article/2015/01/22/us-usa-banks-fines-idUSKBN0KV2C020150122">illegal mortgage kickbacks</a>”.</p>
<p>One of the most innovative actions taken by the CFPB is the creation of a “complaints database” available to everyone with an internet connection. Similar complaints/disputes procedures are available from ASIC and the Financial Ombudsman Service (FOS) in Australia, but data entry is cumbersome and only general summary statistics are provided. The CFPB lets anyone <a href="https://data.consumerfinance.gov/dataset/Consumer-Complaints/x94z-ydhh?">see and analyse</a> the entire database.</p>
<p>This type of action makes everyone sit up and take notice before a problem occurs rather than after.</p>
<p>Not convinced? The Australian Telecommunications Industry Ombudsman (TIO) has had an easy to use complaints procedure for some time. And it works, <a href="http://www.tio.com.au/publications/blog/consumer-complaints-at-a-six-year-low">complaints are falling</a>.</p>
<p>Nor is the CFPB alone. The UK Financial Conduct Authority (FCA) has not (yet) created a central complaints database accessible to the public, but has demanded all banks it supervises significantly upgrade their complaints processes. The FCA also requires <a href="http://www.fca.org.uk/firms/systems-reporting/complaints-data">complaints statistics</a> to be reported on a regular basis. The FCA then <a href="http://www.fca.org.uk/firms/systems-reporting/complaints-data/firm-level">names and shames</a> banks in a semi-annual report. Large institutions such as Lloyds Banking Group are already using improvement in these statistics as inputs to management remuneration. Name and shame works.</p>
<p>The Financial Ombudsman Service in the UK, which has roughly the same mission as the Australian FOS (which coincidentally has done some <a href="http://www.fos.org.au/news/media/cba-and-macquarie-financial-planning-remediation-plans-designated-as-significant-events/">excellent work</a> in the CBA and Macquarie planning scandals) operates yet another complaints service, which handled a half million complaints in 2014. </p>
<p>The UK FOS produces <a href="http://www.financial-ombudsman.org.uk/publications/annual-reviews.htm">copious statistics</a> on complaints to banks and insurers including interestingly the “socio-economic background of consumers who complained to the ombudsman”. This last insight is important as it shows, like similar figures from the CFPB, that complaining is most often done by the well-off, and not those who are less financially literate - a clear gap, since misconduct is no respecter of wealth.</p>
<p>The point is not that someone, somewhere has come up with a good idea, but that overseas governments have restructured their regulatory systems and appear to be making headway on some difficult consumer-related issues. </p>
<p>If that takes a Royal Commission in Australia, the banks and their regulators have only themselves to blame for putting their collective heads in the sand for so long.</p><img src="https://counter.theconversation.com/content/38361/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>There are simple solutions to prevent more financial scandals in Australia - the question is, will the government take them up?Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/383592015-03-04T03:11:49Z2015-03-04T03:11:49ZTo clean up the financial system we need to watch the watchers<figure><img src="https://images.theconversation.com/files/73719/original/image-20150304-31825-itfaoj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Who's watching Australia's financial regulators?</span> <span class="attribution"><span class="source">Cobalt123/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc-sa/4.0/">CC BY-NC-SA</a></span></figcaption></figure><p>Scandals involving Australia’s financial advice sector and the regulation of it have continued into another month, the latest chapter of which has involved <a href="http://www.brisbanetimes.com.au/business/banking-and-finance/forgery-sackings-and-millions-in-compensation-nab-under-fire-over-financial-planners-20150220-13kdjk.html">NAB’s financial advice</a> division.</p>
<p>But this is not the first time NAB has attracted attention for its behaviour and the oversight of it.</p>
<p>There was the time when the Australian Investments and Securities Commission (ASIC) allowed NAB to review and <a href="http://www.canberratimes.com.au/business/banking-and-finance/asic-allowed-nab-to-check-and-alter-media-release-into-banks-wealths-navigator-errors-20150220-13kfnn.html">massage ASIC’s own media statement</a> about NAB <a href="http://media.canberratimes.com.au/business/businessday/secret-files-expose-nab-6281323.html">malfeasance</a>. </p>
<p>And the controversy when it was discovered senior lawyers from NAB had been allowed into ASIC, to work, observe, and no doubt given the chance, to advise, caution and warn. Followed by ASIC stating, on the record, that no NAB lawyers were allowed to infiltrate and contaminate its policy development branch. Only to be made fools of by their own evidence, that in fact <a href="http://www.smh.com.au/business/banking-and-finance/watching-the-watchdog-secondments-spell-trouble-at-asic-20150224-13n6xb.html">NAB lawyers were present and working in the policy formulation space at ASIC</a>.</p>
<p>Only when the problems at NAB were revealed was the public informed NAB had sacked 37 senior advisers for <a href="http://riskinfo.com.au/news/2015/02/24/37-nab-advisers-shown-the-door/">“failing to meet standards”</a>.</p>
<h2>ASIC captured?</h2>
<p>ASIC’s remit is to enforce proper market conduct and ensure consumer protection. ASIC has failed to do this, seemingly working to accommodate the perpetrators of consumer abuse – banks - at the expense of their victims – bank customers. ASIC’s documented failings are now so numerous that it can be argued, I think compellingly, that this is part of a pattern of “<a href="http://www.wsj.com/articles/regulatory-capture-101-1412544509">regulatory capture</a>”.</p>
<p>Regulatory capture gave rise to the <a href="http://www.hsgac.senate.gov/subcommittees/investigations/media/senate-investigations-subcommittee-releases-levin-coburn-report-on-the-financial-crisis">market misconduct and consumer abuse</a> that was rampant in the United States, in the lead-up to the sub-prime disaster. The sub-prime industry was the one that gave us those market misconduct gems: “low-doc”, “no-doc”, “LIAR” and “NINJA” loans. The sub-prime disaster then metastasised into the global financial crisis, the repercussions of which are still being felt.</p>
<p>We have our own troubled crop here in Australia, sowed by bad seeds, that have left the financial advice industry bereft of credibility, and in crisis. When failed ethics were not profitable enough, financial advisers <a href="http://www.theage.com.au/business/banking-and-finance/nab-scandal-rogue-financial-planners-given-latitude-by-lack-of-regulation-20150227-13qd3n.html?">committed outright forgery</a>. And when whistleblowers told ASIC, it did nothing. In fact, only when these scandals were reported on by Fairfax journalist Adele Ferguson, did ASIC start to take serious steps. This is regulatory capture preceding regulatory forbearance.</p>
<p>Why does all of this matter? Because good financial advice is vital for the efficient allocation of savings into the most deserving investments, which in turn is the best way to ensure economic growth and the prosperity of Australia and its people. This industry is too much in the national interest not to function properly. And if need be it must be protected from itself.</p>
<p>Actions stemming from parliamentary oversight – calls for a Royal Commission - have been neutered, and fallen prey to party politics. The Senate’s <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Senate/Economics/ASIC">report into ASIC</a> and Commonwealth and Macquarie ran to over 600 pages. It came down strongly in favour of a Royal Commission. The dissenting opinion ran to six pages – 1% of the report. It was the dissenting view that the Abbott government adopted, when it <a href="http://www.canberratimes.com.au/business/banking-and-finance/forgery-sackings-and-millions-in-compensation-nab-under-fire-over-financial-planners-20150220-13kdjk.html?skin=text-only">declined</a> to appoint a Royal Commission.</p>
<h2>Fixing the problem</h2>
<p>One potential solution to this Gordian Knot – an enfeebled, suborned and possibly collusory regulator, answerable to a legislature crippled in its responses by party politics – is the proposal by the <a href="http://fsi.gov.au">Financial System Inquiry</a> for the establishment of a Financial Regulator Assessment Board (FRAB). </p>
<p>A similar body - the <a href="http://www.bankofengland.co.uk/financialstability/Pages/fpc/default.aspx">Financial Policy Committee</a> - was established in the UK, in response to the disastrous failings of the UK’s financial regulators. Is it a success? It’s too early to tell.</p>
<p>The FRAB would be a council of the wise, not connected to ASIC (or APRA – the FRAB would cover both), and whose job it would be to evaluate ASIC’s and APRA’s performance, and make recommendations for improvements. The beauty of the proposal is that the board, not beholden to government, would evaluate the performance of the two regulators, and offer ongoing guidance as to where they fall short. </p>
<p>The FSI report states:</p>
<blockquote>
<p>“The Assessment Board should have a diverse membership to avoid being unduly influenced by a particular group; … and suggesting that the Board be supported by a separate secretariat within Treasury. A diverse membership would also help ensure a balance of views and deal with potential conflicts involving individual members.”</p>
</blockquote>
<p>Such a board, operating at arms length from the major protagonists, wouldn’t fall within their zone of influence or intimidation. It would be capable of steering, in this case ASIC, into confrontation with the industries it regulates, if confrontation is needed – as surely with hindsight, it was.</p>
<p>Most of the details in the proposal are sketchy. There will be pushback from the industry and, as suggestions have it, there already is from both regulators. But if that pressure can be resisted, then the government could clean up the cleaners, and in the process remove responsibility to an independent board of oversight. And if that is achieved, there is a better chance of ensuring the efficient functioning of this vital part of the economy.</p>
<p>What is pretty much assured is that an ongoing system of “watching the watchers” has a strong potential to improve what we have now. The Brits recognise this, we should too. Certainly, it couldn’t make things any worse.</p><img src="https://counter.theconversation.com/content/38359/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Andy Schmulow is affiliated with: Legislative advisor to Fiona Patten, MLC, Victoria. Legislative advisor, Australian Secular Party.</span></em></p>The clear case of regulatory capture in Australia’s financial system is grounds for a new oversight body.Andrew Schmulow, Senior Research Associate, Melbourne Law School, The University of MelbourneLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/362082015-01-15T00:12:55Z2015-01-15T00:12:55ZWhy we still don’t expect financial planners to sit an exam<figure><img src="https://images.theconversation.com/files/68986/original/image-20150114-3859-1ys0q2m.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Financial planners may be considered professionals, but there's no national exam to put them through their paces.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>While financial planning is on the pathway to <a href="http://www.gowerpublishing.com/pdf/SamplePages/Conceptions-of-Professionalism-CH1.pdf">professionalism</a>, its education standards continue to be the subject of much discussion – and for good reason. </p>
<p>The current standards set by ASIC mandate a comparatively low level certification program that can be completed in just days. This is clearly inconsistent with the notion of a profession and is certainly not congruent with the complex financial market, product, legal, business and behavioural knowledge and skills a modern planner requires.</p>
<p>Recent key national reviews acknowledge this and have all recommended increasing education standards to bachelor degree level. These include the <a href="http://fsi.gov.au">Financial System Inquiry</a>, The <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/Joint/Corporations_and_Financial_Services/Financial_Adviser_Qualifications/Report">Parliamentary Joint Committee on Corporations and Financial Services Inquiry</a> and the Australian Financial Services Licence Industry Working Group. </p>
<p>It is also worth noting that some segments of the industry and some professional associations already have degree level education requirements for membership/employment and ongoing continuing professional development. </p>
<p>So where is ASIC on this and why have the current low standards persisted? </p>
<p>Well, they have tried to raise them. In June 2013 ASIC <a href="http://asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-212-licensing-training-of-financial-product-advisers-updates-to-rg-146/">proposed</a> to enhance its guidelines for training of financial advisers in various ways, but this did not progress. </p>
<p>ASIC’s preference is for the introduction of a national exam which it first <a href="http://asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-153-licensing-assessment-and-professional-development-framework-for-financial-advisers/">raised</a> in April 2011. The issue was <a href="http://asic.gov.au/regulatory-resources/find-a-document/consultation-papers/cp-212-licensing-training-of-financial-product-advisers-updates-to-rg-146/">raised again</a> last year when ASIC suggested that a national exam “may replace any obligation to do a training course”. </p>
<p>The original model was for the test to take the form of an online three-hour exam both for new advisers and for existing advisers (to be repeated every three years). </p>
<p>More recently, ASIC Chairman Greg Medcraft restated this preference as a fundamental component of <a href="http://www.afr.com/p/opinion/asic_chair_says_set_exams_for_planners_KsJkyswSVengfHmYAmzY6K">his vision</a> for financial advisers where the industry sets the competence levels. This is a departure from ASIC’s earlier proposals, and would see ASIC test competencies by overseeing the exam. </p>
<p>As a result, ASIC is positioning itself to move away from the education/training side of the current regulatory regime, where it has largely failed to deliver an appropriate framework. </p>
<p>This leads to the question of whether requiring advisers to undertake an exam every three years would improve adviser competence and lead to better quality advice.</p>
<h2>Simple in theory…</h2>
<p>The advantages of a single national exam are drawn from the potential efficiency of it – one instrument that can be completed online, give some indication of adviser competence, and provide a clear pass/fail measure that could be easily benchmarked. It is also a simple measure for consumers to utilise. </p>
<p>But the proposal does also raise a number of concerns.</p>
<p>Financial planning contains a diverse array of knowledge and skill areas (eg economics, investment, tax, legal, retirement, estate, insurance, risk, business, behavioural and client engagement ). It is hard to imagine how any reasonable measure of competence could be drawn from one online exam covering all of these. </p>
<p>At the same time, it is difficult to assess “soft” skills in a test or exam, yet they are a key part of effective financial advice.</p>
<p>The licensing regime currently requires planners to be RG146 accredited only in the areas which they provide advice. And exam would therefore need multiple modules or versions to allow for various permutations. </p>
<p>The logistics of implementing the exam for somewhere between 18,000 and 30,000 individuals would be complex and suggests a sophisticated examination regime and significant effort in educational design to ensure the integrity of the instrument and its outcomes.</p>
<p>There are few examples of doing this in related professions (law, accounting, nursing, teaching, medicine) with most professions opting for a continuing professional development model.</p>
<p>The problem with the national exam is therefore simple – who pays?</p>
<h2>…Difficult to deliver</h2>
<p>To do it well, given the scale and complexity of advice, would come at significant cost. With ASIC’s budget being cut and industry suggesting it is not willing to fund it, it’s unclear how it would be achieved, particularly given concerns about the educational efficacy of it as proposed. So it appears it is unlikely to be implemented as ASIC has suggested. </p>
<p>Rather, the proposal should be seen as part of a broader framework that builds on existing elements such as higher education degrees in financial planning, professional associations and the Professional Standards Councils framework. </p>
<p>Proposals to restrict who can call themselves a financial planner/adviser (including draft legislation) and a compensation scheme add further to the options. </p>
<p>What might seem like an easy fix (just make them all do a test), is likely to be little more use in and of itself as RG146. However, as part of a broader professional framework a national exam may have a role to play. This could be for a more specialised purpose such as verifying currency of knowledge (given the continuous changes to taxation, superannuation and other relevant laws) than what ASIC envisages. </p>
<p>Other elements such as enforceable codes of conduct, complaints systems and compensations schemes would form the broader professional environment and assessment of competency. This would create a level and robust playing field for financial advice and should go some way to building consumer confidence in the sector.</p><img src="https://counter.theconversation.com/content/36208/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Mark Brimble receives funding from Commonwealth Office for Learning and Teaching - Fellowship Grant.
Mark Brimble is a member of the Financial Planning Association, a Fellow of Finsia, a CPA and Chair of the Financial Planning Education Council. Mark is also a member of the Australian Financial Services Licence Industry Working Group. </span></em></p>While financial planning is on the pathway to professionalism, its education standards continue to be the subject of much discussion – and for good reason. The current standards set by ASIC mandate a comparatively…Mark Brimble, Discipline Head of Finance and Financial Planning, Griffith UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/351582014-12-11T19:34:24Z2014-12-11T19:34:24ZMurray pushes for fewer super tax breaks but change is unlikely<figure><img src="https://images.theconversation.com/files/66922/original/image-20141211-6054-tegkbz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Financial System Inquiry says the purpose of superannuation is to provide a retirement income that can substitute or supplement the age pension</span> <span class="attribution"><span class="source">Lukas Coch/AAP</span></span></figcaption></figure><p>David Murray’s <a href="http://fsi.gov.au">Financial System Inquiry</a> may call for the removal of superannuation tax breaks but the government’s tax discussion paper, due to be released next week, is unlikely to advocate similar changes.</p>
<p>The FSI inquiry report recommends articulating the overarching purpose of the superannuation system so that future tax changes can be measured against the objective. </p>
<p>It says the purpose of superannuation is to “provide income in retirement to substitute or supplement the age pension”. This then prescribes, in theory at least, the tax breaks individuals can get from the system. </p>
<p>In this case, the maximum tax break an individual should get from superannuation would be roughly equal to the net present value of the age pension paid from age 65 to the median life expectancy.</p>
<p>The age pension is designed to keep people out of poverty after they leave the workforce. Yet how does the inquiry’s definition of superannuation fit with financial planning theory which says that people need to aim for <a href="http://www.oecd.org/daf/fin/44628862.pdf">70% of pre-retirement income</a> to maintain their lifestyle? </p>
<p>It makes redundant any discussion about whether the current compulsory contribution limit of 9.25% provides an adequate retirement income. It also implies that superannuation should attract few tax breaks.</p>
<p>However, this raises the question of whether the tax system should be used to encourage saving, either through superannuation or outside it. There are four reasons why the tax system should not be used for this purpose.</p>
<h2>The theory is don’t use taxes to incentivise saving</h2>
<p>First, the tax revenue forgone through the concession is borne by all taxpayers, while only those using the concession benefit from it. </p>
<p>Second and third, tax benefits only go to the wealthy who have disposable income to save and who have access to information to maximise the benefits of saving, such as accountants and lawyers. </p>
<p>Finally, tax concessions don’t increase savings, they just move preferences to where people save.But the reality is that they are used. </p>
<p>The report observes that superannuation tax breaks <a href="http://www.smh.com.au/business/tax-breaks-on-housing-shares-and-super-distort-behaviour-benefit-the-rich-murray-20141207-121x1c.html">distort behaviour and favour the wealthy</a>. However, a number of its observations will be difficult for the government to implement.</p>
<p>The inquiry report endorses <a href="http://taxreview.treasury.gov.au/content/Content.aspx?doc=html/home.htm">Ken Henry’s tax review</a> recommendation to reduce the tax benefits of popular negative gearing investing as well as the over-taxation of income from deposits. It also advocates that income from large superannuation balances should attract more tax, however this has a whiff of retrospective tax about it. </p>
<p>Another suggestion that post-tax contributions should be further limited is also unlikely to be adopted by the government. Few people use these concessions and they benefit empty nesters who are selling down to enjoy a hipster inner city lifestyle rather than those trying to minimize their tax obligations.</p>
<p>The report says the system that taxes super earnings at 15% in the accumulation phase but not in the retirement phase, leads to asset allocation distortions, tax arbitrage and prevents funds offering “whole-of-life” financial products. However, it is doubtful whether any of these problems are tangible and important enough to warrant changing the system. </p>
<p>Finally, the report suggested removing the company share dividend imputation system and reviewing the capital gains tax discount. Interestingly, the report argues these incentives distort asset allocation yet both these measures were introduced with the intention of removing tax distortions.</p>
<p>Imputation credits were introduced to lower the cost of capital towards equity rather than debt funding. The capital gains tax discount was introduced to prevent the over-taxation that potentially arises from capital gains all being taxed in one year leading to higher marginal tax rates. </p>
<p>However, the report’s focus on changing interest withholding tax on foreign lending institutions should be addressed. This tax distorts the funding decisions of financial institutions and places Australia at an international competitive disadvantage. If it has to be paid then almost invariably it will be paid by the Australian borrower, not the foreign lender, so it just raises the cost of capital with little revenue to be gained. </p>
<h2>Government unlikely to implement super tax changes</h2>
<p>Should these tax observations be included in the tax issues paper? They seem to warrant considered discussion but with two overarching caveats.</p>
<p>First, superannuation is a very long-term savings vehicle and changes reduces confidence in the system. </p>
<p>Second, savings in the system are there based on the good faith continuance of existing tax laws. In the past 35 years there has been only <a href="http://www.aph.gov.au/binaries/library/pubs/bn/eco/chron_superannuation.pdf">minor changes </a>that adversely affected existing superannuation account balances. </p>
<p>However, the chances of the government implementing these tax changes is slight.</p>
<p>Though <a href="http://www.smh.com.au/business/treasurer-joe-hockey-urges-banks-to-cooperate-with-regulators-20141207-121vxt.html">Treasurer Joe Hockey backed</a> the report’s recommendations to lower fees for super funds, it is unlikely that many of the report’s observations in terms of tax will go ahead.</p>
<p><a href="http://www.smh.com.au/business/the-economy/super-system-must-remain-strong-says-tony-abbott-20130926-2ufq0.html">Adverse changes to the superannuation system</a> are off the table for the first term of this government apparently. If superannuation tax breaks are measured against the age pension, a significant proportion of the population will be adversely affected. </p>
<p>Changes to capital gains tax is also unlikely to go ahead as most countries differentiate between regular income and capital gains. What remains is imputation credits for company dividends. Adverse changes here would be politically unwise as they are very popular among mum and dad investors and super funds.</p><img src="https://counter.theconversation.com/content/35158/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gordon Mackenzie receives funding from the Institute of Chartered Accountants for research into superannuation taxation.</span></em></p>David Murray’s Financial System Inquiry may call for the removal of superannuation tax breaks but the government’s tax discussion paper, due to be released next week, is unlikely to advocate similar changes…Gordon Mackenzie, Senior Lecturer, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/352512014-12-10T19:39:54Z2014-12-10T19:39:54ZMurray pinpoints inconsistency on financial advice and super trustees<figure><img src="https://images.theconversation.com/files/66800/original/image-20141210-13368-mme5tk.jpg?ixlib=rb-1.1.0&rect=54%2C182%2C4421%2C3053&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Big nest egg or small: shouldn't super fund trustees meet the same professional standards as individual financial planners?</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>Finally, <a href="http://fsi.gov.au/publications/final-report/executive-summary/">Financial System Inquiry</a> chairman, David Murray, has brought some consistency into two hot debates running in finance.</p>
<p>Parliament, financial media commentators and a whole range of vested interests have argued at length over the last year about who can give financial advice, how they should be remunerated, how they should be trained and what qualifications they should have. </p>
<p>At the same time there has been an <a href="http://www.mercer.com.au/newsroom/2014-superannuation-governance-survey.html">ongoing debate</a> in the media, through speeches and submissions, about who is appropriately qualified to be trustees of large superannuation funds.</p>
<p>The same groups have made the opposite arguments in the two cases. </p>
<p>One group of institutions, mainly the industry super funds, has been arguing that we need to have greater independence of financial planners and advisers. Another group of institutions, mainly the retail super funds, have been arguing that advisers can be aligned but should be more closely controlled. Most importantly, they argue that they should be more professional. The recent political fight around the roll back of Labor’s Future of Financial Advice (FOFA) reforms has essentially been focused on these issues of independence and professionalism. </p>
<p>At the same time the retail super funds have been pushing to ensure that a majority of the directors of superannuation funds should be independent. They are pushing the case for greater professionalism of superannuation trustees. By contrast the industry super funds have been arguing that this is not necessary, and that trustees do not need special knowledge. Most particularly they have argued that trustees coming from particular employers and particular employee groups, without any particular qualification, are appropriate.</p>
<p>Murray has pointed out the inconsistency. If the person advising me on my $200,000 superannuation fund must be professional, then the trustee for a fund managing $2 billion for its members surely deserves the same respect.</p>
<p>Clearly both are important. An adviser who gives me bad advice can ruin my retirement and my life. Notably however, a superannuation fund which makes mistakes can cost thousands of people security in their retirement. There are three reasons to think that the latter is more important.</p>
<p>The 2010 <a href="http://www.supersystemreview.gov.au/content/content.aspx?doc=html/final_report.htm">Cooper report</a> into the superannuation system pointed out that by 2035 the <em>average</em> superannuation fund supervised by the Australian Prudential Regulation Authority (APRA) (that is, excluding the self-managed sector) will be managing $53 billion on behalf of superannuants. This is a very large amount of money, the lifetime savings of thousands of members. Putting to one side the politics and the vested interests, clearly it is extremely important that the directors of superannuation funds be appropriately qualified and highly skilled. </p>
<p>The second reason is that superannuation sector is not simply important to individuals, but to Australia’s economic future. Murray makes clear that the superannuation sector is well on the way to being one of the largest components of the Australian financial system, not far from the size of the banks. Where and how it invests will shape much of Australia’s growth and development. This alone is a key reason to demand a high degree of professionalism in the management of the sector.</p>
<p>The third argument Murray makes for independence of directors, is that since people can choose which fund they join, the superannuation funds will be increasingly de-linked from particular industries. If anyone can join a fund, there is little reason for the trustees of the fund to belong to a particular sector of the workforce (employers or employees). </p>
<p>One would actually hope that APRA would have a say in approving who could be a trustee of a major superannuation fund, and would set very high standards of training and experience.</p>
<p>There are lots of vested interests involved in these debates. Murray has however given us reasons to sit back and ask, what is the best structure for the future? This is important to Australia’s future.</p>
<p>So let’s have some honesty and consistency in the public debate. If professionalism is important at the level of the individual then we should expect high standards of professionalism from the trustees of superannuation funds. Arguably, trustees of major funds should be held to a higher standard.</p><img src="https://counter.theconversation.com/content/35251/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock is affiliated with the Australian Centre for Financial Studies.</span></em></p>Finally, Financial System Inquiry chairman, David Murray, has brought some consistency into two hot debates running in finance. Parliament, financial media commentators and a whole range of vested interests…Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/352442014-12-09T19:38:00Z2014-12-09T19:38:00ZMurray inquiry not made for a future with fewer banks<figure><img src="https://images.theconversation.com/files/66701/original/image-20141209-6735-j5ted9.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Unlike America, Australia is overbanked.</span> <span class="attribution"><span class="source">Nicholas Eckhart/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>A key component of the <a href="http://fsi.gov.au/publications/final-report/">Financial System Inquiry</a> handed to Treasurer Joe Hockey this week was that “the financial system should be subject and responsive to market forces, including competition”. But on both market forces and competition, inquiry chair David Murray and his team squibbed it.</p>
<p>Much of the discussion of the Murray report in the financial press has been on the push back by the major banks against the inquiry’s insistence they hold more capital and properly account for the risks in mortgage lending. But the issue of the optimal structure of the Australian financial system, as opposed to its internal workings, was completely ignored.</p>
<p>Despite talk in Australia of coming “structural reforms”, Murray has set his face in stone against such reforms in the banking sector. And he’s not alone - the report points out that neither APRA nor the RBA nor the banking industry saw a strong case for such reforms.</p>
<blockquote>
<p>“The Inquiry does not recommend pursuing industry-wide structural reforms such as ring-fencing. These measures can have high costs, and require changes for all institutions regardless of the institution-specific risks.”</p>
</blockquote>
<p>The inquiry did not consider the considerable risk-reduction benefits of reforms such as ring fencing as against the putative costs. Murray points out that although Australia did dodge the global financial crisis, it is not immune to “financial shock” and as a result the banking system must be made more resilient, hence the call for more capital. These were precisely the same arguments made for major structural reforms, such as <a href="http://faculty.london.edu/fmalherbe/overview.pdf">ring fencing</a> in the UK, and the “Volker rule” in the USA, but such arguments were dismissed in the Australian context.</p>
<p>Ring fencing, <a href="https://hmt-sanctions.s3.amazonaws.com/ICB%20final%20report/ICB%2520Final%2520Report%5B1%5D.pdf">recommended</a> by the UK Independent Commission on Banking in 2011, is often portrayed as cutting loose the investment banking cowboys but, in fact, it is a very sensible crisis management tool for bankers and regulators. As outlined by the Commission, and in the process of being <a href="https://www.gov.uk/government/policies/creating-stronger-and-safer-banks">implemented</a> by the UK government, certain banking functions, such as payments and deposit taking, would be designated as being “permitted” inside the ring fence, and everything else would be outside. It is like having a “safe” bank within a bank.</p>
<h2>Four pillars distortions</h2>
<p>The elephant in the room in Australian banking is the “four pillars” policy, which is the unwritten rule that the pillars (originally six but now the four major banks) cannot acquire one another. The policy is not without its critics. In response to the Wallis Inquiry, which recommended scrapping the policy for competition reasons, Peter Costello maintained the prohibition on local takeovers, but left the door open (very slightly) to international acquisitions.</p>
<p>The four pillars responded to this near-death experience by increasing their importance and, in the almost 15 years since Wallis, have acquired smaller banks, such as Westpac’s take-over of St. George. They also branched out to acquire retail super funds. In 2013, the superannuation subsidiaries acquired by the four pillars, such as BT and First State, were 4 of the top 5 retail funds by assets (one of the original pillars, AMP was first). But getting bigger does not mean getting better, as evidenced by the financial planning scandals facing some of the major banks.</p>
<p>The Murray inquiry took a diametrically opposed position to Wallis on the four pillars, with a somewhat bizarre argument for a free-market advocate:</p>
<blockquote>
<p>“To prevent further concentration, the longstanding ‘Four Pillars’ policy, which precludes mergers between the four major banks, should be preserved as outlined in the Interim Report.”</p>
</blockquote>
<p>While the four pillars policy has been credited with helping Australia survive the global financial crisis, its impact is somewhat overrated as it relies on the argument that four CEOs cannot be as stupid as one or two - a fact that has been proven wrong elsewhere.</p>
<p>There are a number of questions that the FSI team failed to ask - “Why four pillars, why not two, three or six?” and “Why not international banks as part of the four/three or two?”</p>
<h2>Too many branches</h2>
<p>Australia is chronically over-banked. The latest <a href="http://www.apra.gov.au/adi/Publications/Documents/2014_PoP_PDF.pdf?WT.mc_id=1408POP-PDF">APRA statistics</a> show there are 69 firms with licenses as Authorised Deposit-taking Institutions (ADIs) with full service branches or other “face to face” customer contact operations. Between them, these ADIs operate 6,332 branches, which means there is a full service branch for every 3,650 people in Australia. It’s one service outlet for every 1,918 individuals if you count Australia Post (Bank@Post) stores. And there is one ATM for every 1,500 people, one Eftpos terminal for every 30 people.</p>
<p>With such overbanking and associated costs, how do Australian banks make such super profits? It can hardly be lack of competition as Murray believes, as there is competition a plenty. Fees of course are one answer, such as the <a href="http://www.abc.net.au/news/2014-03-18/credit-card-surcharges-top-800-million/5327092">credit card surcharges</a> that have recently come under scrutiny, not least by the Murray report which recommends banning unnecessary surcharges. </p>
<p>But bank bashing is national sport and it is much harder to answer the question: “What should a modern banking system look like in Australia?” First of all – it should be modern!</p>
<h2>What a modern banking system looks like</h2>
<p>The Murray inquiry makes great play of financial innovation, introducing concepts such as “crowdfunding” and “peer-to-peer lending”. These fashionable but largely irrelevant notions are little more than DIY advertising for someone to lend you money, a sort of banking dating site.</p>
<p>Surprisingly, the Murray report does not address one of the major disruptors in the Australian financial system – internet/mobile banking.</p>
<p>With 72% of online Australians and 35% of mobile phone customers using online/mobile banking, why are so many physical branches and banks needed - surely they will go the way of the corner shop? In future the competitors to the banks for payments, credit cards and insurance will not be other banks, but instead companies such as <a href="https://www.woolworthsmoney.com.au/wowm/wps/wcm/connect/WowMoney/WowMoney/Credit+Cards/">Woolworths</a> and <a href="http://www.abc.net.au/7.30/content/2014/s4062642.htm">Coles</a>. </p>
<p>In the US, JPMorgan Chase, one of the world’s largest banks, operates around 5,700 branches for some 70 million customer accounts. So technically, only one bank is needed to handle banking for Australia’s population of 23.1 million. Australian banks bring little innovation to banking, as they source the bulk of their technology from foreign suppliers and proven technology from one major bank could reduce costs considerably across the system.</p>
<p>The question of ownership and control is of course important. Having one bank, albeit as illustrious as JPMorgan, could be dangerous. But maybe two would be sufficient? One local to provide backup in the case that the other international bank failed?</p>
<p>What are the arguments for four pillars? None, other than status-quo.</p>
<p>The issue is not ownership nor the number of banks, it is regulation. If one of the banks was undoubtedly stronger than local banks could be, it would actually diversify the sector, which should reduce its riskiness overall.</p>
<p>But the Murray Inquiry did not consider how technology will radically change ordinary banking in the next decade, wasting the chance of making the structural reforms needed to adapt to such changes.</p><img src="https://counter.theconversation.com/content/35244/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Pat McConnell does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>A key component of the Financial System Inquiry handed to Treasurer Joe Hockey this week was that “the financial system should be subject and responsive to market forces, including competition”. But on…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/350152014-12-07T05:55:42Z2014-12-07T05:55:42ZA call for capital: Murray report pushes for higher banking standards<figure><img src="https://images.theconversation.com/files/66468/original/image-20141207-8664-ubbxdi.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">David Murray and Treasurer Joe Hockey have released the final report of the Financial System Inquiry.</span> <span class="attribution"><span class="source">AAP/Britta Campion</span></span></figcaption></figure><p>To increase the resilience of the Australian financial system the Big Four banks will be asked to carry larger capital buffers under recommendations made in the final report of the <a href="http://fsi.gov.au/">Financial System Inquiry</a>. The inquiry, led by former Commonwealth Bank chief executive David Murray, calls for change in Australia’s financial system to make it more resilient, efficient and equitable.</p>
<p>The report is a comprehensive and carefully written reflection of the large number of submissions the inquiry received over the past year. It also recognises Australia is not immune from future financial crises.</p>
<p>The report proposes major changes to the banking system likely to increase competition in the sector. These changes include narrowing the gap for mortgage lending requirements between institutions. The result will even the playing field between the Big Four banks and smaller financial institutions. </p>
<p>Borrowers in the small and medium business community, who have found it hard to secure finance, may also be pleased with the proposed revision of the relative treatment of home loans compared to corporate loans.</p>
<h2>A push to increase the capital buffers of banks</h2>
<p>The inquiry suggests increasing the level of capital all banks are required to hold to “unquestionably strong” levels. In particular, core Tier 1 capital should be increased. This may impact on profit margins and dividends for bank shareholders.</p>
<p>Most importantly, the inquiry distinguishes between buffers and hard minimums for capital. Capital buffers can be run down if needed and are important to ensure bank resilience during stress periods. Insufficient capital buffers trigger restrictions on dividends and bonus payments, whereas a breach of hard minimum capital levels triggers bank liquidation.</p>
<p>On the face of it, this is a proposal that would be hard to argue against. However, risks do exist. The implementation of such rules can be challenging and implementation will need to be handled carefully in Australia. That is because banks compete with non-bank financial institutions and with institutions outside Australia. </p>
<p>Capital increases for Australian banks may exceed the global Basel standards and trigger capital arbitrage, that is a “horse race” to transfer of risk to non-banks or overseas. However, the inquiry mitigates such concerns by emphasising that Australia should not deviate from these standards “unless there are specific domestic circumstances”.</p>
<p>To date, the costs and benefits of capital regulation have been unclear. Banks have many stakeholders, including financiers in the form of shareholders, bondholders and depositors. Through explicit and implicit governmental bank guarantees, Australian taxpayers are also stakeholders. </p>
<p>What needs to be understood is that financial resilience generally implies lower levels of risk, and lower risk generally means lower returns. The magnitude of this future risk return trade-off and impact on lending activity is unclear and further impact studies for Australia are needed. The inquiry recommends longer transition periods allowing such analysis.</p>
<h2>Measuring risk</h2>
<p>The inquiry notes the internal risk weighting models used by large banks often predict lower levels of risk – thus requiring lower capital levels – than the standardised approach used by small and medium banks. As a consequence, major financial institutions only have to <a href="http://www.abc.net.au/news/2014-12-07/financial-system-inquiry-murray-report-banks-hold-more-capital/5949404">set aside less than half the capital of regional banks, mutual banks and credit unions</a>.</p>
<p>Internal ratings-based models are calibrated to the low default experience in Australia. This is attributed to Australia’s extended period of economic growth since 1983, careful underwriting and regulation, as well as prudent monetary and fiscal policies. </p>
<p>In comparison, the standardised approach is based on average risk levels in a large number of leading economies. The approach reflects the economic downturns experienced globally in recent decades. </p>
<p>The inquiry suggests the gap between the risk weights for residential mortgages should be reduced. New Zealand has recently implemented such changes by increasing asset correlations, a measure for systematic risk, from 15% to 21% for high loan-to-value loans.</p>
<h2>Impact on bank concentration</h2>
<p>The implied increase in equity between small and large banks may increase long term competitiveness in the sector.</p>
<p>The following charts compare the market share of the Big Four, Medium Five (AMP, Bendigo & Adelaide Bank, Suncorp, Bank of Queensland and Macquarie Bank) and other banks.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=391&fit=crop&dpr=1 600w, https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=391&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=391&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=491&fit=crop&dpr=1 754w, https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=491&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/66274/original/image-20141204-3619-db25ko.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=491&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Total resident assets (absolute, in $ million), source: Australian Prudential Regulation Authority.</span>
</figcaption>
</figure>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=391&fit=crop&dpr=1 600w, https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=391&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=391&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=491&fit=crop&dpr=1 754w, https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=491&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/66275/original/image-20141204-3645-1rxiyjz.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=491&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Total resident assets (relative, in %), source: Australian Prudential Regulation Authority.</span>
</figcaption>
</figure>
<p>Basel II and the internal ratings-based approach were implemented in 2008, around the time of the global financial crisis. The charts show the Big Four have since increased their market share, while all other banks have lost market share. This may also be attributed to the ability of the Big Four to better access funding.</p>
<p><a href="http://www.afr.com/f/free/blogs/christopher_joye/why_banking_big_nine_would_be_win_dyeWmAUsMltyZYqnBhWBkN">The emergence of a “big nine” set of banks has been predicted</a> with these changes. A less concentrated banking system could decrease the systemic risk of individual banks and provide a more competitive banking system with lower fees for consumers. </p>
<h2>Mortgage concentration continues to be a concern</h2>
<p>Capital rules aim to protect banks from realised financial losses. It is also worth considering ways to avoid large bank losses in the first place. This may include prudent monetary policy to avoid asset bubbles and asset diversification.</p>
<p><a href="http://www.imf.org">According to the International Monetary Fund</a>, asset diversification is a major challenge for Australian banks where 62.7% of total loans relate to mortgages, 9.7% to commercial real estate loans and most of the remainder to small and medium sized company loans often secured by real estate. </p>
<p>Australian banks have a much higher exposure to mortgage loans to other developed economies. <a href="https://theconversation.com/australian-banks-are-too-exposed-to-mortgages-but-what-if-the-world-was-flat-31000">Hence, mortgage lending has been identified as systemic risk</a> to the industry and is addressed in detail in the report.</p>
<p>Much of the growth in total bank assets, shown above, has been in mortgage loans. Meanwhile small and medium-sized companies currently find it hard to secure finance. Increased internal ratings-based risk weights for residential mortgages may mean that more credit will be made available to businesses.</p>
<p>Beyond these proposals, <a href="https://theconversation.com/australian-banks-are-too-exposed-to-mortgages-but-what-if-the-world-was-flat-31000">other ways</a> to diversify asset portfolios exist. Securitised mortgages could be replaced with investments in other asset classes and geographies. For this to occur, transparency and global financial integration will be important.</p>
<h2>The legacy</h2>
<p>Previous inquiries, such as the Campbell Inquiry in 1981 and the Wallis Inquiry in 1997, laid the foundation for an internationally competitive financial industry. Those inquiries led to the deregulation of the industry and the creation of the Australian Prudential Regulation Authority.</p>
<p>It is early days yet, but this inquiry is also likely to have a major impact on the Australian financial system. The system is likely to become more efficient because of increased transparency and lower fees. It is likely to become more equitable from reduced discrimination among institutions and also more resilient.</p>
<p>However, Australia has not experienced real economic stress since 1983 and the current state of affairs is unlikely to persist. The resilience of the Australian financial system will need to be monitored, re-assessed and market parameters re-weighted as the economic environment changes over time.</p><img src="https://counter.theconversation.com/content/35015/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Harry Scheule does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>To increase the resilience of the Australian financial system the Big Four banks will be asked to carry larger capital buffers under recommendations made in the final report of the Financial System Inquiry…Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/334072014-11-06T19:25:34Z2014-11-06T19:25:34ZDon’t just target the big banks: why all banks need higher capital<figure><img src="https://images.theconversation.com/files/63711/original/kv69rfhc-1415164250.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Any banking system reforms must target all institutions</span> <span class="attribution"><span class="source">AAP</span></span></figcaption></figure><p>Banks borrow short and lend long. So if all of a bank’s depositors suddenly want their money, the bank would be unable to pay them. A bank may have made great loans but it can only unwind these loans slowly over time.</p>
<p>In most situations this doesn’t matter. Banks know their cash flows and play the probabilities, making sure they have a buffer of liquid assets to meet normal withdrawals.</p>
<p>However, a crisis can trigger a run on banks. Every depositor wants to get his or her money out of the bank before everyone else. The bank runs out of cash and closes its doors. It fails.</p>
<p>Bank regulation is at the heart of the current <a href="http://fsi.gov.au">Financial System Inquiry</a> chaired by David Murray. It will consider which regulations are important, which need to be strengthened and how <a href="http://www.bis.org/bcbs/index.htm">international banking rules</a> should apply in Australia.</p>
<p>Our recent <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2478496">research</a> compares some of the different rules that may be used to limit bank risk. We find that increased bank capital requirements are the most effective policy but must be applied across all institutions to stabilise the banking system.</p>
<h2>The global financial crisis</h2>
<p>The 2008 crisis resulted in plenty of traditional bank runs. In the United Kingdom, retail depositors lined the streets to take their money out of the failing Northern Rock.</p>
<p>We also saw a different type of bank run during this period. For example, a bank run led to the collapse of Lehman Brothers. Yet this didn’t involve retail depositors. It was institutions that stopped lending to Lehman Brothers on the wholesale market.</p>
<p>Australia’s banking system in 2008 was fundamentally sound. Our banks didn’t have abnormal levels of bad loans. Legal differences meant the default issues plaguing bank mortgages in California, Florida and elsewhere in the United States couldn’t occur in Australia. </p>
<p>Yet our banks were still exposed to the crisis through their reliance on imported wholesale funds. The Australian government responded to this risk of an “imported crisis”. In October 2008, it introduced explicit deposit insurance and guaranteed bank wholesale borrowing.</p>
<p>But why did Australia’s sound banking system come under pressure in 2008? Is there potential for Australia to import a banking crisis in the future? And what sort of banking regulations do we need to deal with this possibility?</p>
<h2>Importing a banking crisis</h2>
<p>Wholesale funds now provide a large part of the total funds available to banks in many countries. This has changed the nature of the risks they face.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=561&fit=crop&dpr=1 600w, https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=561&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=561&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=704&fit=crop&dpr=1 754w, https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=704&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/63663/original/sd32vc8q-1415143968.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=704&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
<span class="attribution"><a class="source" href="http://www.rba.gov.au/publications/rdp/2013/pdf/rdp2013-15.pdf">RBA Discussion Paper 2013-15 </a></span>
</figcaption>
</figure>
<p>Australian banks source much of their wholesale funding offshore. This inflow of capital allows Australia to undertake more investment, generating higher levels of growth and enhanced well-being.</p>
<p>Before the crisis, Australian banks were borrowing internationally an amount equal to 5% of our gross domestic product each year. In 2008, international funds flowing though the banks funded about one-fifth of Australia’s total investment.</p>
<p>The flow of international funds did not stop during the crisis. However, they became more expensive, transmitting the pain felt by European and US institutions to Australia.</p>
<p>Banks were not the only institutions affected by the sudden rise in the cost of foreign funds. Foreign direct investment, foreign portfolio investment, offshore capital raisings by Australian companies, and government borrowings were also impacted.</p>
<p>However, the impact on banks was more significant. Unlike other institutions, banks borrow money for relatively short periods but use the money to lend to companies and individuals for the long term. When they depend on short-term international funds, a sudden rise in the price of those funds exposes banks to higher costs and potential failure. Any failure can also have significant economic and political implications. The failure of one bank can lead to a run and the failure of other banks. </p>
<p>This means governments tend to intervene if bank failure is imminent. For example, Bankwest in 2008 was owned by flailing UK bank HBOS. It was facing failure and, following government intervention, was bought by the Commonwealth Bank.</p>
<p>The government’s move to insure bank deposits and wholesale funding stabilised the banking system during the crisis. Yet these were ad hoc policy responses. Australia still needs to develop long-term policies to deal with the next financial crisis.</p>
<h2>Developing the right regulation</h2>
<p>Our recent research compares some of the different rules that are used, or might be used, to try to limit bank risk from offshore funding. This research is unique as we consider the consequences of specific policies at times of crisis and also during usual operations. </p>
<p>A policy may be effective at preventing a crisis but if it means that borrowers pay more and depositors receive less most of the time, then the protection provided by the policy may be overwhelmed by the day-to-day cost to the Australian public.</p>
<p>We take it as given that ordinary retail depositors will have some form of implicit or explicit government protection, so our focus is on the risk of bank default on bondholders. A bank fails if an increase in the cost of wholesale funds cuts its cash flows so that it cannot meet its debt obligations.</p>
<p>Regulators can do many things to limit banks’ exposure to imported wholesale funds and maybe make them less exposed to importing a banking crisis.</p>
<p>Regulations may require that banks use limited or no imported wholesale funds at all. Banks would have to be fully funded by domestic savings. Some countries like China have policies like this. </p>
<p>This policy is unlikely to work in Australia because it would significantly limit investment during normal operations. There would be no risk of importing a crisis but there would also be less domestic investment as borrowers would face higher interest rates. India has adopted this type of policy for many years and it has adversely impacted growth.</p>
<p>Depositors may gain from being a source of scarce investment funds but there would also be other costs. The banking sector would contract due to the restriction on fund access resulting in less competition. </p>
<p>Another policy that would reduce the likelihood of importing a financial crisis is for the government to have an explicit or implicit policy of bailing out bondholders. This occurred in the UK and US during 2008.</p>
<p>This policy has undesirable implications. If banks know that taxpayers effectively insure their bondholders, they will reduce the amount of equity issued and increase their amount of bonds. This would result in an increase in new entrants to the market based on excessively risky funding models. </p>
<p>Having a larger number of banks adopting a fragile funding model increases the likelihood of bank failures. If banks know they will be bailed out if they fail, then banks are more likely to fail. A bail-out policy actually increases the likelihood of future crises.</p>
<p>The most effective policy for dealing with wholesale funding risk is to increase the amount of capital banks are required to hold. While regulators have asked banks to hold more equity capital as insurance against lending risks, this policy can also reduce funding risks.</p>
<p>If a wholesale funding squeeze means that a bank cannot pay its bondholders, then the bank fails. If the squeeze simply reduces the dividend to shareholders, then the bank continues to operate. So requiring banks to hold more capital and less debt directly reduces the risk of failure.</p>
<p>While our research suggests that uniform minimum capital requirements can stabilise our banking system, it has been suggested these requirements only apply to “big” banks. Such an asymmetric policy would be undesirable. If there are weak funding restrictions on small banks, this will encourage the entry of a greater number of smaller and potentially more fragile banks. The result is an increased risk of future crises.</p>
<p>An asymmetric policy of increasing the capital requirements on large banks but not on small banks could have a stabilising effect if the government resolved never to bail out the small banks. Small banks could enter and leave the industry as funding conditions allowed and act as a shock-absorber to the system. </p>
<p>Politically, however, this is unlikely to work. Bankwest was not allowed to fail but was folded into the Commonwealth Bank. Even a small credit union like the Fitzroy and Carlton Community Credit Co-operative was <a href="http://www.bankmecu.com.au/why-bank-with-us/news-media/media/bankmecu-and-fitzroy-carlton-community-credit-co-operative.html">folded into a larger bank</a> last year rather than being allowed to fail.</p>
<p>Any new regulations to deal with the possibility of a future crisis must also deal with political reality. Minimum capital requirements on all banks can stabilise the banking system. However, a policy that just targets the big banks is unlikely to succeed.</p><img src="https://counter.theconversation.com/content/33407/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Stephen King and Rodney Maddock received funding from CIFR for this project.</span></em></p><p class="fine-print"><em><span>Stephen King does not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Banks borrow short and lend long. So if all of a bank’s depositors suddenly want their money, the bank would be unable to pay them. A bank may have made great loans but it can only unwind these loans slowly…Rodney Maddock, Vice Chancellor's Fellow at Victoria University and Adjunct Professor of Economics, Monash UniversityStephen King, Professor, Department of Economics, Monash UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/317712014-09-21T20:32:03Z2014-09-21T20:32:03ZSmall business feeling the lending crunch – and three ways to help<figure><img src="https://images.theconversation.com/files/59481/original/p274hmzb-1411089659.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">With banks pulling back on lending to small business, the sector has had to look elsewhere for funding.</span> <span class="attribution"><span class="source">Shutterstock</span></span></figcaption></figure><p>Since the global financial crisis, credit growth in Australia has returned. But while growth in home lending between 2008 and 2014 was relatively strong (0.49% per month), it was actually negative for business lending (-0.04% per month).</p>
<p>This pattern of weaker business credit for corporates and small to medium enterprises is <a href="http://www.theguardian.com/business/2014/aug/28/business-lending-falls-for-second-quarter-smes">not unique to Australia</a> but has been reflected around the globe due to long-term factors, such as the consolidation of banks and the centralisation of credit assessment. The issue has been accelerated by shorter term cyclical factors, such as increased business risk since the GFC and reduced demand for business credit.</p>
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<p>Small and large business borrowers are relying more heavily on internal funding sources, such as retained earnings, and in the corporate sector there has been an evident diversification towards more market-based funding. But it is the “bank dependent” SME sector, with limited access to alternative markets that is feeling the pinch.</p>
<h2>Small business: the engine of the economy</h2>
<p>While it’s recognised businesses should not be funded unless they can generate an adequate return of capital, restricting the flow of funds to the SME sector can have a significant impact on the economy. </p>
<p>In Australia, for example around two million SMEs account for 68% of all industry employment and 56% of <a href="http://www.abs.gov.au/ausstats/abs@.nsf/mf/8155.0">industry gross value added</a>. Starving these businesses of funding will impact on employment growth and growth in GDP.</p>
<p>Negative credit growth for business has its roots in both demand and supply factors. In terms of the demand for credit there has been:</p>
<ul>
<li>reduced business leverage:</li>
<li>business diversifying funding sources post GFC</li>
<li>increased price of SME credit</li>
<li>stricter lending covenants and increased cost of eligible collateral.</li>
</ul>
<p>On the supply side, factors that have led Australian banks to have a preference for housing over business lending include:</p>
<ul>
<li>regulatory capital requirements</li>
<li>consolidation in the banking sector, and</li>
<li>costs of credit assessment for SMEs.</li>
</ul>
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<p>The ratio of business credit to total credit has been declining since the late 1980s. This longer-term trend is driven by concerns about increased credit risk arising from the business loan failures that occurred at that time, and the introduction of risk weighted capital ratios under the Basel I accord in 1988.</p>
<p>Under the Basel II Accord (2004) a new framework was introduced, leading to a greater differential in capital requirements for home and business lending.</p>
<p>This differential has had a major impact on bank balance sheets. Australian banks, with almost 63% of assets in residential property loans, have the largest proportion of residential real estate loans to total loans on bank balance sheets of all countries surveyed by the IMF. Although, the extent to which this focus on property “crowds out” business lending, and especially lending to higher risk SMEs, is difficult to determine.</p>
<p>The potential for capital requirements to adversely impact SME lenders was noted by the Financial Stability Board and Basel Committee’s Macroeconomic Assessment Group which <a href="http://www.financialstabilityboard.org/publications/r_100818b.htm">stated</a> in 2010 that as a result of tighter regulatory standards “bank-dependent small and medium-sized firms may find it disproportionately difficult to obtain financing.”</p>
<p>Regulations that provide disincentives for banks to engage in lending to SMEs have particularly grave implications for Australian business as approximately 90% of all intermediated credit in Australia is provided by banks.</p>
<h2>Assessing SME credit risk</h2>
<p>Increased consolidation in the banking sector has led to greater economies of scale in business lending. Where SMEs are concerned reliance on low cost credit scoring models, rather than traditional relationship banking can have adverse consequences. First, where young, high-growth SMEs are concerned, there is a high probability that such businesses will be denied credit, as their financial profile approximates that of a bankrupt firm with few assets, low liquidity and a low solvency ratio. </p>
<p>Second, given the importance of the capability of the business owner, credit assessment models that ignore this aspect are also more likely to make a Type 2 error, that is approve a loan which subsequently defaults. Third, individual banks may view SMEs as a segment rather than as heterogeneous businesses with varying risk profiles, leading to <a href="http://www.accaglobal.com/content/dam/acca/global/PDF-technical/small-business/pol-af-ftd.pdf">reduced business lending</a> to SMEs in the aggregate.</p>
<h2>Options for Australia</h2>
<p>*<em>A national SME database
*</em></p>
<p>Banks have special access to the financial information of small firms that are not subject to the disclosure requirements of equity markets, or have a publicly available risk rating. Therefore developing a national database on SME information, as is <a href="https://www.gov.uk/government/consultations/competition-in-banking-improving-access-to-sme-credit-data/competition-in-banking-improving-access-to-sme-credit-data">proposed in the UK</a>, could make significant inroads into the current level of information asymmetry that exists between the large Australian banks and other potential lenders, and would be well received by both financiers and borrowers.</p>
<p><strong>Lowering barriers to entry for non-bank lenders</strong></p>
<p>Two major categories of non-bank lenders have been targeted by international regulators – non-bank online lenders and securitisers. This segment is still embryonic in the Australian SME lending market.</p>
<p>The technology introduced by online lenders in terms of credit assessment and SME loan monitoring offers the potential for bank lenders to provide a more cost-effective technological solution to reduce the transaction costs of SME lending. Not only would online solutions reduce costs, but an effective regular monitoring process may overcome the need for non-monetary covenants being imposed on SME borrowers.</p>
<p><strong>Regulatory options</strong></p>
<p>The capital impost of SME lending may be slightly ameliorated by expanding the definition of “retail” SME loans to A$1.5 million in line with the Basel II framework. </p>
<p>Second, given the more homogeneous nature of housing lending, the concentration of such lending on bank balance sheets, and the potential for such lending to “crowd out” business loans, there is an argument to reduce the differential in capital requirements between home loans and SME loans by imposing the standardised Basel II risk weight on all home loans.</p><img src="https://counter.theconversation.com/content/31771/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>The authors do not work for, consult, own shares in or receive funding from any company or organisation that would benefit from this article, and have disclosed no relevant affiliations beyond their academic appointment.</span></em></p>Since the global financial crisis, credit growth in Australia has returned. But while growth in home lending between 2008 and 2014 was relatively strong (0.49% per month), it was actually negative for…Deborah Ralston, Professor of Finance and Director, Australian Centre for Financial Studies Martin Jenkinson, Research Officer, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.