tag:theconversation.com,2011:/us/topics/murray-inquiry-9819/articlesMurray inquiry – The Conversation2017-05-11T02:42:47Ztag:theconversation.com,2011:article/773972017-05-11T02:42:47Z2017-05-11T02:42:47ZBudget 2017: lack of competition is why government is moving so hard against the banks<p>With it’s latest <a href="http://www.budget.gov.au/2017-18/content/bp2/download/bp2.pdf">budget</a> the government has made a number of moves to create a level playing field in the banking system. It’s taxing the five largest banks, announced a review of rules around data sharing, a new dispute resolution system for banks and other financial institutions, and new powers for the regulator to make bank executives accountable. </p>
<p>All of this is on top of <a href="http://sjm.ministers.treasury.gov.au/media-release/099-2016/">a Productivity Commission inquiry</a> into the competition within the Australian financial system, announced this week. </p>
<p>While some of these moves - such as <a href="https://theconversation.com/budget-bank-levy-too-big-to-fail-not-too-big-to-take-a-hit-77475">the bank levy -</a> will have a positive effect on making smaller banks more competitive, there are more policies that could be considered. These could include the separating out of the retail arms from the other areas of the large banks, increasing the capital requirements of larger banks to equal those of smaller banks, and developing new sources of funding for smaller banks. </p>
<h2>More for competition</h2>
<p><a href="http://www.budget.gov.au/2017-18/content/bp2/download/bp2.pdf">A new “one-stop shop”</a> for dispute resolution will replace the existing three schemes - Financial Ombudsman Service, the Credit and
Investments Ombudsman and the Superannuation Complaints Tribunal. Called the Australian Financial Complaints Authority (AFCA), it will give consumers, businesses and investors a binding resolution process when dealing with financial services companies. The scheme will provide for a basis for more competition as disputes on financial services are consistently resolved regardless of the provider. </p>
<p>And A$1.2 million has been given to fund a review of an open banking system in which customers can request banks to share their data, which could assist financial startups and other competitors enter the market and compete against the big four banks. Banks will likely be forced to provide standardised application programming interfaces (API) that enable financial technology companies to provide services for interested consumers.</p>
<p>The government has also provided A$13.2 million to the Australian Competition and Consumer Commission (ACCC) to further scrutinise bank competition and to run the AFCA. <a href="http://www.aph.gov.au/Parliamentary_Business/Committees/House/Economics/Four_Major_Banks_Review/Report">This follows a House of Representatives report</a> that called for an entity to make regular recommendations to improve competition and change the corporate culture of the financial industry.</p>
<p>The ACCC will provide Treasury with ongoing advise on how to boost competition in the sector. This may include a reduction of cost advantages of big banks, barriers to entry for new firms including change costs for consumers. </p>
<h2>A more concentrated and changing finance sector</h2>
<p>All of these changes come after a decade of consolidation and upheaval in the financial system, which has hurt competition and increased risk.</p>
<p>This chart shows the market shares of the big four Australian banks in terms of Australian loans and deposits:</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=392&fit=crop&dpr=1 600w, https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=392&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=392&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=492&fit=crop&dpr=1 754w, https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=492&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/168513/original/file-20170509-20740-1mq5rvj.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=492&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Market share Big 4 banks.</span>
<span class="attribution"><span class="source">Australian Prudential Regulation Authority</span></span>
</figcaption>
</figure>
<p>As you can see, since 2002 their market share has grown from 69.7% to 79.6% for loans and from 66.3% to 77.3% for deposits. Also, the gap between market dominance in loans versus deposits has closed since the global finance crisis. This means the big banks are attracting a greater share of bank deposits, which has an impact on the smaller banks. </p>
<p>With limited access to deposits, which is a relatively cheap way of raising capital, smaller banks have had to rely on the more expensive wholesale debt markets. Small banks also have difficulties to tap other funding sources such as covered bonds. This makes their products less competitive, and they have struggled as a result.</p>
<p>In part, that’s because a number of banks disappeared or merged with the big banks after the global financial crisis. This includes St George, Bankwest, Bendigo Bank, Aussie Home Loans, Adelaide Bank, RAMS and Wizard. </p>
<p>The <a href="http://fsi.gov.au/publications/final-report/">Murray Inquiry found</a> the big four banks have less than half the capital set aside for emergencies than some smaller financial institutions do. Again, this makes the smaller banks less competitive and needs to be addressed. The government should increase the capital requirements of larger banks to close the cost advantage for larger banks.</p>
<p>In addition, rising house prices have led to a further increase in the concentration of mortgage and other housing loans in the Australian banking system. Today Australian banks have about twice as many mortgages on their books <a href="https://theconversation.com/australian-banks-are-too-exposed-to-mortgages-but-what-if-the-world-was-flat-31000">as in the next highest developed economy</a>.</p>
<p>New financial startups, such as <a href="https://theconversation.com/what-you-need-to-know-about-peer-to-peer-lending-38836">peer-to-peer lenders</a>, have entered the banking system. In time they may rival the big banks in areas like personal lending, but they remain small in terms of market share. And the big banks’ unwillingness to share data may be a hindrance. </p>
<h2>Something needed to be done</h2>
<p>The concentration in the banking sector does not provide the best outcome to all Australians. It has led to a low range and low quality of financial services as well as high costs. This needed to be addressed. </p>
<p>The new banking levy will support competition, as it pushes up the cost for the big banks. The review into data sharing could also be a boon to financial startups and other competitors, although we don’t yet know what the outcome will be.</p>
<p>But even stronger government actions may needed to create a level playing field. The government should consider separating out of the retail arms, from the other areas, of the large banks. Failing that, the low capital buffers of the big banks need to be addressed.</p><img src="https://counter.theconversation.com/content/77397/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>The budget included a few measures to make the banking sector more competitive, but they don’t go far enough.Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/704082016-12-16T04:03:02Z2016-12-16T04:03:02ZThere are a few gaping holes in the proposals to beef up ASIC<p>Treasury has finally responded to the <a href="http://fsi.gov.au/publications/final-report/">Financial Services Inquiry</a> (also known as the Murray Inquiry), <a href="http://www.treasury.gov.au/ConsultationsandReviews/Consultations/2016/Design-and-distribution-obligations-and-product-intervention-power">releasing two proposals</a> to make the Australian Securities and Investments Commission (ASIC) “a more proactive regulator”. </p>
<p>But it is unclear that these proposals will lead to better outcomes for consumers. There a several holes in them, not least that they put the emphasis on the issuers of financial products to choose the “right” customers for their products. </p>
<p>It is questionable whether those who lost out from the sale of unsuitable products by the likes of <a href="http://www.skynews.com.au/business/business/company/2016/12/01/storm-financial-loses--17m-damages-claim.html">Storm Financial</a> and <a href="http://www.smh.com.au/interactive/2016/comminsure-exposed/heart-attack/">Comminsure</a> would be any better off had these proposals been in place.</p>
<p>Further, these proposals fail to adopt successful consumer protections used in similar product categories, and there are lots of questions about how the “right” consumer is determined.</p>
<h2>The proposals</h2>
<p>The first proposal is to require the issuer of a financial product to ensure those products are targeted only at the “right” people. For example, the right person for a high growth investment product might have a high tolerance for risk and be many years from retirement.</p>
<p>The second proposal would give ASIC the power to temporarily intervene when a product is launched that has a risk of causing significant financial or emotional cost. </p>
<p>The idea is that a product issuer should state who the product is suitable for. An issuer should state who is the ‘target market.’ They would have to consider the needs of their consumers - their ability to understand the product, and whether and how they might benefit. The issuer might be an insurance company who is liable to pay out a claim, while the distributor or seller is the person who sells insurance. </p>
<p>Meanwhile the seller should have controls to ensure the product is sold only to the right consumers, and the issuer should select sales channels and marketing strategies suitable only for that market.</p>
<p>If the product is not suitable for certain consumers then the product must be designated inappropriate for that “non-target” market. Unemployment insurance, for example, often excludes the self employed. The self-employed, then, would be a “non-target” market for this kind of financial product. </p>
<p>None of this would apply to ordinary shares or consumer credit products but would apply to margin loans, managed investments, insurance and others. It would also not apply if the product were sold by someone giving personal financial advice, as that person is already subject to a “best interests” duty towards the client.</p>
<h2>There is a lot missing</h2>
<p>The main issue with the proposals is that it is unclear how to differentiate between consumers in a way that is meaningful for both those selling the products and those buying them.</p>
<p>How is the individual consumer to know who the target market for a particular product is and whether he or she as an individual falls within that target market?</p>
<p>There are differences between an obligation to assess whether a product is suitable for a particular individual such as consumer credit, and indicating whether a product is generally suitable for a class of persons who may have some similar characteristics. </p>
<p>Issuers are tasked with assessing the risk that their product will not reach the wrong target market, and whether consumers will be able to understand complex products sold via that channel.</p>
<p>Issuers have to consider the needs of the class of consumers in the target market, their ability to understand the product, the nature of the product, and benefits to a consumer. All of this would take into account the characteristics of the target class of consumers – proximity to retirement, income, wealth, financial literacy and access to financial information. </p>
<p>But in what way do the issuers make these judgements, and are they the appropriate parties to do it? Further, there are several suitability tests used in similar products that are not included.</p>
<p>The key thing tested when it comes to applying for consumer credit is the capacity to pay, or, more accurately, the capacity to repay. On the other side is the capacity to bear a loss. It may not matter to some classes of consumers if their investments result in losses, but it will be critical to others.</p>
<p>If a person cannot pay for a type of insurance without, say, dipping into superannuation funds, should it be sold to him? If a person stands to lose the (modest) family house or retirement funds if she invests in a high risk product, should it be sold to her or to those, who with her, form the target market?</p>
<p>Marketing by class or category has been with us for a long time. We now have big data and individual access to data about ourselves. So it must be possible to fashion a better way to ensure individuals receive the product must suitable for their individual circumstances.</p><img src="https://counter.theconversation.com/content/70408/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Gail Pearson is on the Executive Committee of the Consumers' Federation of Australia. She is the President of the International Association of Consumer Law.</span></em></p>Treasury has put forward proposals with huge gaps and that put the onus on the issuers of financial products.Gail Pearson, Professor, Business School, University of SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/581622016-04-21T03:27:28Z2016-04-21T03:27:28ZStronger role for ombudsman is the key to protecting bank customers<p>The federal government responded to calls for a banking royal commission <a href="https://theconversation.com/morrison-warns-banks-not-to-pass-on-new-user-pays-impost-to-finance-asic-reform-58136">with a raft of changes</a> to the Australian Securities and Investment Commission (ASIC) but for consumers, <a href="https://theconversation.com/comminsure-case-shows-its-time-to-target-reckless-misconduct-in-banking-55748">who bore the brunt</a> of the recent financial scandals, it is further potential changes to the Financial Ombudsman Service (FOS) that may matter the most.</p>
<p>The media has focused on recommendation for change at ASIC, where the majority of recommendations announced yesterday were outcomes of the <a href="http://www.asic.gov.au/capability-review">ASIC Capability Review</a>. The review was itself was recommended by the <a href="http://fsi.gov.au/">2015 Financial System Inquiry</a>, which commenced began back in 2014. </p>
<p>It is good to see movement on these recommendations, though some of the fine points such as the user-pays funding model and ASIC’s new recommended internal governance structure may remain subject to debate.</p>
<p>Equally if not more important for consumers is the government’s new review - also announced yesterday - of the Financial Ombudsman Service (FOS) and other external dispute resolution schemes. This is where average Australians takes up cases of carelessness, wrongdoing, negligence and fraud every day. According to reports, the FOS alone received 30,000 complaints last year. It is the coal face. </p>
<p>The FOS, itself operating under ASIC’s regulatory guidance, is the natural place for consumers to find their voice. It is an independent body for dispute resolution, keeping cases away from the courts with the aim of enabling consumers to win remedial action at lower cost and in less time. There are reported issues around about the response time of staff at the FOS, and the overall resources available to support work volumes and complexity, but the need for a strong FOS appears to be undisputed.</p>
<p><a href="http://fsi.gov.au/consultation/submissions20140520/">Submissions to the original Financial System Inquiry</a> in early 2014 attest to the role of the FOS, and hint at its potential effectiveness. In one submission, the <a href="http://fsi.gov.au/files/2014/04/Consumer_Credit_Legal_Centre_NSW.pdf">Consumer Credit Legal Centre in NSW</a> provides case study after case study of consumers who went to the FOS seeking help for unpaid insurance claims, fraudulent mortgages and irresponsible lending practices. </p>
<p>In an ideal world, these circumstances would not arise – but no system is perfect, or immune from abuses. The submission of <a href="http://fsi.gov.au/files/2014/04/CHOICE.pdf">consumer group Choice</a> to the inquiry also recognised the role of external dispute resolution schemes for both consumers and the benefit of the overall system. </p>
<p>In light of ongoing issues and scandals in the financial sector, it might be reasonable to consider further beefing up the resources and powers of the FOS. Policing a system through high level surveillance is one way to detect problems; gathering intelligence from the grassroots is another. </p>
<p>But the system is messy. In addition to the FOS, the external dispute resolution landscape includes the Credit and Investment Ombudsman and the Superannuation Complaints Tribunal, each with their own guidelines of where and how they can get involved in a case. This is a confusing menu of options for the consumer, even after the 2008 consolidation that brought the number of schemes down from eight to three. </p>
<p>The role, powers and governance of these bodies will now be the subject of another independent review, with an expert panel to be convened and asked to report back by the end of this year. Among other items, this review might consider removing these bodies from ASIC. </p>
<p>Such a separation would leave ASIC free to concentrate on its core role: ensuring market integrity through surveillance and enforcement. It would relieve ASIC of the responsibility for consumer protection in financial services – the only industry where ASIC instead of the ACCC has a mandated role in relation to consumer protection. </p>
<p>A suggestion to relocate responsibility for consumer protection in financial services from ASIC to ACCC was <a href="http://fsi.gov.au/files/2014/08/Erskine_Alex.pdf">one of the suggestions made by Alex Erskine</a>, in a paper submitted to the Financial Services Inquiry and published by the Australian Centre for Financial Studies in 2014. In the paper, Erskine argues that ASIC suffers from being charged with six policy objectives and insufficient tools – thus failing the Tinbergen Principle that holds that every single policy objective needs to have at least one policy tool if it is to be realised. </p>
<p>This analysis merits careful consideration. In every other industrial sector in Australia, the ACCC is charged not only with consumer protection, but also competition. </p>
<p>The importance of competition in promoting efficiency and encouraging satisfactory consumer outcomes was a theme that carried through the findings and recommendations of the Financial Services Inquiry, and remains a subject of great public debate in relation to the financial services sector. </p>
<p>ACCC holds sufficient power to investigate any matter of unconscionable conduct, whether within a single firm or on an industry-wide level. It is also the competition regulator. These activities sit within its core mandate and institutional expertise. What is the role of this regulator in Australia’s financial system?</p>
<p>The opus magnum of the Financial System Inquiry continues to be written, as the industry now awaits the outcome of another highly significant review.</p><img src="https://counter.theconversation.com/content/58162/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>Out of the many changes the federal government has made to ASIC, the review of the Financial Ombudsman will have the biggest impact on customers.Amy Auster, Executive 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/458842015-08-11T02:32:59Z2015-08-11T02:32:59ZExplainer: banks are raising capital, but should we be worried?<figure><img src="https://images.theconversation.com/files/91367/original/image-20150811-11088-13mrxs5.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Large Australian banks are being required to significantly increase their levels of equity capital.</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>Last week’s A$3 billion capital raising by ANZ Bank <a href="http://www.smh.com.au/business/markets/asx-dragged-down-by-banks-as-anz-starts-3b-capital-raise-20150806-git3nq.html">was seen as bad news</a> by equity investors, even though there has been no significant information released which might suggest poorer future performance of Australian banks. Any such concerns would also be somewhat offset by <a href="http://www.asx.com.au/asxpdf/20150810/pdf/430d81r228vdpk.pdf">robust quarterly figures</a> from NAB. <a href="http://www.theaustralian.com.au/business/financial-services/investors-brace-for-5bn-cba-equity-raising/story-fn91wd6x-1227476548037">Media reports</a> have suggested the Commonwealth Bank will follow with a capital raising of its own when it presents its annual results this week. </p>
<p>The straightforward answer to why ANZ (and other banks) would undertake such a large capital raising, and risk adverse market reaction, is that regulatory developments mean they have little choice.</p>
<p>The prudential regulator, APRA, has stated a need for large Australian banks to have significantly higher levels of equity capital, and has indicated an increase in capital ratios of 200 basis points as an indicative amount. </p>
<p>The regulatory timetable involved rules out the possibility of generating all those funds internally by retention of earnings (although banks are likely to try to lure more investors into dividend reinvestment schemes rather than taking cash, by increasing the share discounts offered to them under such schemes. (Dividend reinvestment schemes are a popular way for some companies to retain capital, but have a relative low take up rate (20%) among investors.)</p>
<p>The regulator is seeking higher capital as part of its objective of ensuring Australian banks are seen to be well capitalised and thus not at risk of failure. This was recommended by the <a href="http://fsi.gov.au">Murray Inquiry</a>, and higher capital requirements is a common theme globally – with even some bankers acknowledging capital levels had got too low for comfort prior to the financial crisis.</p>
<p>Minimum capital required is linked to a concept known as risk weighted assets (RWA) – more capital is required for higher risk assets and weights are applied to various asset categories to reflect risk in the calculation of RWA. For the ANZ, RWA are around A$400 billion compared to total assets of around A$900 billion.</p>
<p>For the Australian banks there are two forces prompting higher capital amounts. One is increases in the minimum expected capital/RWA ratio. APRA has signalled it agrees with the Murray Inquiry recommendation that Australian banks should be, but are not currently, <a href="https://theconversation.com/australian-banks-are-strong-should-we-pay-for-them-to-be-stronger-44712">in the top quartile internationally.</a> The second is the increase in risk weights to be applied to mortgage loans of the major banks, which will increase measured RWA.</p>
<p>Why should the market react so negatively? Higher capital will, after all, make banks safer. The answer lies in the potential effect of a higher capital ratio on bank return on equity. If there is no change in return on assets and bank total profit, earnings will be spread over a larger number of shares, implying a reduced return on equity. A reduction in bank share prices can be seen as reflecting a downgrading of market expectations of the future yield on bank shares. </p>
<p>But here there can be much debate about the eventual outcome. With lower leverage, bank shares have less risk. The required rate of return of investors could thus be expected to decline – although whether sufficient to offset the projected decline in the actual return on equity, is contentious. </p>
<p>There is also another offsetting factor. With reduced leverage, bank issued debt and deposits have less default risk, and (together with less such funding needed to support their balance sheet) this should reduce interest funding costs and improve bank profits. </p>
<p>But given perceptions of “too big to fail” and explicit and implicit government guarantees, the magnitude of this effect can be questioned. So, some negative share price effect is to be expected, but whether investors over-reacted remains to be seen.</p>
<p>Why $3 billion? Some back-of-the-envelope calculations provide insight. An increase of 200 basis points (2 percentage points) in the capital ratio as suggested by APRA would mean an extra amount of capital required of around $8 billion (given by 2% of $400 billion RWA). Over the course of a year, ANZ could expect to retain (or obtain via reinvested dividends) around half of annual profits of around $7-8 billion, giving another, say, $4 billion capital. </p>
<p>So, together, these give around $7 billion of the required $8 billion within a one year horizon, with the possibility of raising further regulatory capital via issue of hybrid preference shares (and earnings retention) over a longer time frame.
Of course, these informal calculations do not take into account the effect of the increase in mortgage risk weights, or general growth in business, which will increase RWA and thus create a need for yet further capital. </p>
<p>In this environment, it is not surprising to see banks like ANZ and NAB looking to sell off non-core businesses to reduce RWA and achieving increased regulatory capital from the proceeds.</p><img src="https://counter.theconversation.com/content/45884/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Kevin Davis was a member of the Australian Financial System (Murray) Inquiry whose recommendations on bank capital are reflected in the APRA decisions referred to in this article</span></em></p>Investors may not like it but Australian banks have been given little choice by the prudential regulator other than to undertake capital raisings.Kevin Davis, Research Director, Australian Centre for Financial Studies Licensed 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/405612015-04-22T02:55:20Z2015-04-22T02:55:20ZBanks chastened by Senate, but UK experience serves real lesson<p>The full extent of the arrogance of the Four (and a half) Pillars was on full display at the Senate Hearing into the financial product misselling scandal this week in <a href="http://www.canberratimes.com.au/business/banking-and-finance/banks-senate-hearing-we-need-to-lift-our-game-on-financial-advice-20150421-1mpzxm.html">Canberra</a>. </p>
<p>The only long-standing CEO who was in the position at the time of these scandals was Macquarie Bank’s Nicholas Moore (ANZ did send the deputy CEO Graeme Hodges, Westpac had better things to do). Moore admitted that, after being belatedly prompted by the Securities and Investment Commission (ASIC), 195 cases of possible misselling had been reviewed, of which 108 had been found eligible for compensation totalling A$9.5 million. Moore noted that some 189,000 letters had been sent out but give no idea of how many cases remain to be reviewed.</p>
<p>Relative newcomers, the National Australia Bank’s Andrew Thorburn and the Commonwealth Bank of Australia’s Ian Narev were thrown into the fray, fresh-faced and suitably contrite. “At the outset, I apologise once again unreservedly to the customers who received poor advice from us,” Narev told senators. But Narev has only been CEO for three years; where were the directors who were at CBA throughout the scandal? </p>
<p>Thorburn, (appointed as CEO in August 2014) admitted that NAB had also “let some clients down” but promised that “trust and transparency” would be the watchword for its customers over the next decade.</p>
<p>But a look at how such scandals are handled overseas might give a different perspective. Each quarter, the Financial Conduct Authority (the UK equivalent of ASIC) publishes a <a href="https://www.fca.org.uk/consumers/financial-services-products/insurance/payment-protection-insurance/ppi-compensation-refunds">report</a> on how customers are being compensated for Payment Protection Insurance (PPI) products that were mis-sold to them. </p>
<p>In January 2015, a total of £424.5 million was paid out to customers whose complaints were upheld by the UK’s major banks, bringing the total paid out on the PPI redress scheme since January 2011 to £18.5 billion (around A$35 billion).</p>
<p>And in another <a href="http://www.fca.org.uk/consumers/financial-services-products/banking/interest-rate-hedging-products">scandal</a> involving the misselling of complex Interest Rate Hedging Products (IRHP) to small businesses, current compensation paid by the major banks is running at some £1.8 billion but could grow <a href="http://www.euromoney.com/Article/3445742/Mis-selling-The-importance-of-Crestsign-v-RBS.html">much bigger soon</a>. </p>
<p>A <a href="http://www.researchonline.mq.edu.au/vital/access/manager/Repository/mq:20489?f0=sm_creator%3A%22McConnell%2C+Patrick%22">reading</a> of the PPI scandal might cause the boards of Australian banks to have a rethink as they chat convivially after their next board meeting. The PPI scandal emerged over a decade with customers’ complaints being arrogantly ignored by banks, until competition inquiries pointed out case after case of mis-sold PPI products. At this point it should be noted that the PPI cases involved quite small sums of money, often less than £100, not the hundreds of thousands of dollars lost by customers in the Opes Prime or Storm Financial scandals.</p>
<p>The UK banks stonewalled until a court case was decided against them and they were forced by the regulator to set up a comprehensive redress and compensation program. Note Andrew Thorburn of NAB is already well aware of the angst of PPI as the FCA recently <a href="http://www.theage.com.au/breaking-news-business/nab-staff-sacked-over-uk-scandal-20150415-3u34w.html?skin=text-only">fined</a> the troubled Clydesdale Bank (which NAB has owned since 1987) more than $40 million for continuing “serious failings” in handling customers’ complaints.</p>
<p>Now one could argue that UK banks are bad and that Australian banks are boy scouts. But is the alternative perspective that UK regulators are better than Australian ones? </p>
<p>As information trickles out about back-door payments and strong arm gagging of customers, the probability of the latter being accurate increases. </p>
<p>It is little wonder that the major banks back an industry compensation scheme for cases of misselling, not least because it will be the customer who ultimately pays for it. After all, an industry scheme was <em>sort of</em> endorsed by the Murray <a href="http://fsi.gov.au/">Financial System Inquiry</a>. But David Murray (CBA chief executive from 1992 to 2005) also pointed out that “government provision can avoid conflicted incentives, but it can come at a cost to taxpayers and involve moral hazard”. In the end, the taxpayer rather than the banks’ shareholders will pay up under such a scheme.</p>
<p>As the Australian financial products scandal drags on over years, the call for a Royal Commission will grow; after all the government has set up a Royal Commission to address issues raised by the <a href="http://www.tradeunionroyalcommission.gov.au/Pages/default.aspx">big end of town</a> into trade unions. If such a Commission is forced on this government - or the next - the banks will only have themselves to blame. They should get on the front foot now.</p><img src="https://counter.theconversation.com/content/40561/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>Major banks including the ANZ, NAB, the CBA and Macquarie have faced a public humbling, but professed contrition must become real action.Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/358512015-01-05T23:16:11Z2015-01-05T23:16:11ZYears on, ASIC still grappling with swap rate fixing scandal<p>The wheels of justice grind exceedingly slow and nowhere slower than in the Sydney headquarters of the Australian Securities and Investments Commission (ASIC). A recent <a href="http://www.smh.com.au/business/anz-traders-sidelined-during-asic-inves">report</a> appears to show that ASIC is still, just under two years after the events, following leads on possible manipulation of the Australian interest rate benchmark, the Bank Bill Swap Rate (BBSW). </p>
<p>We know the BBSW was manipulated as evidenced by an <a href="http://www.asic.gov.au/about-asic/media-centre/find-a-media-release/2014-releases/14-014mr-asic-accepts-enforceable-undertaking-from-bnp-paribas/">enforceable undertaking</a> by the French bank BNP-Paribas almost one year ago. What we don’t know yet is whether there was any evidence of involvement by Australian banks and, if so, to what extent? But it would not come as a complete surprise if <a href="https://theconversation.com/dont-believe-the-hype-our-own-libor-scandal-could-be-in-the-wings-12652">local banks had been involved</a>.</p>
<p>However, the question of whether Australian banks were involved or not in manipulation is irrelevant. There was indeed manipulation and it went unreported to ASIC until overseas regulators began to investigate manipulation of the widely used <a href="https://theconversation.com/watching-the-dominos-fall-in-the-libor-crisis-11358">LIBOR</a>benchmark. There are two scenarios. First, local bankers (as the major players in the BBSW market) knew there was manipulation and did nothing, benefiting from the outcomes. Alternatively, they did not know of the manipulation, in which case they come across as provincial dopes. Either way the Masters of Martin Place do not come out of the scandal very well.</p>
<p>After strenuously denying for years that the BBSW could possibly be manipulated, the Australian Financial Markets Association (AFMA) changed the BBSW <a href="http://www.afma.com.au/standards/market-conventions/Bank%20Bill%20Swap%20%28BBSW%29%20Benchmark%20Rate%20Conventions.pdf">calculation methodology</a> in July 2013 to one which collected live rates from the market, rather than expert opinion, to calculate the benchmark. Supposedly this would be <a href="https://theconversation.com/is-there-egg-on-the-rbas-face-13136">less prone</a> to manipulation. How wrong they were.</p>
<p>Just last November, in what was obviously a coordinated effort, regulators in three countries <a href="http://www.bloomberg.com/news/2014-11-12/banks-to-pay-3-3-billion-in-fx-manipulation-probe.html">announced fines</a> of more than US$4.3 billion on six banks found to have manipulated the most widely used benchmark in the global Foreign Exchange (FX) market. As with LIBOR, manipulation of the London “WMR 4 o’clock FIX” was long running, widespread and profitable. But unlike LIBOR, the “FIX” was calculated from live market rates, and supposedly manipulation-proof. But human ingenuity and greed finds ways around such trivial obstacles.</p>
<p>The regulators found that traders from the world’s largest banks colluded, through conversations in internet chat rooms, to “nudge” the FX market in a particular direction to benefit their own positions rather than their customers. Traders found that it was sufficient to manipulate the market for only about 60 seconds “around the FIX” to generate illicit profits. </p>
<p>In its <a href="http://www.bis.org/publ/rpfx13.htm">latest triennial survey</a> of activity in the FX market, the Bank for International Settlements (BIS) found that the Australian dollar was one of the top five most traded currencies accounting for some 8.6% of overall volume. Although the initial fines concentrated on manipulation of the major currencies (the US dollar, the Euro and the British Pound) it stretches credibility to believe that traders did not also manipulate the Aussie benchmark rate. In fact, because of the time at which the benchmark was calculated (4pm GMT), the local markets would have been closed and hence, because there was less competition, the benchmark would have been easier to fudge.</p>
<p>Why is such manipulation important? Australian superannuation funds that have an international component, such as US shares, are regularly revalued against the market, often on a daily basis. Any manipulation will then directly affect the value of the funds, sometimes up and sometimes down, but most often to the benefit of the banks rather than pensioners.</p>
<p>Under Chairman Greg Medcraft, ASIC has announced <a href="http://www.ft.com/intl/cms/s/0/51e79260-af26-11e3-bea5-00144feab7de.html#axzz3NusDo4TK">an investigation</a> into possible manipulation of FX benchmarks, which is due to complete sometime early this year. And in a recent chat with journalists, Medcraft declared that Australia was a “<a href="http://www.afr.com/videos/national/medcraft-australia-paradise-for-white-collar-criminals-4yadc5ctryjjokkc4gd3biiv2dka_a0q.html">paradise for white collar criminals”</a> a comment he <a href="http://www.abc.net.au/news/2014-10-23/asic-backtracks-on-corporate-crime-paradise-comments/5835194">then backed away from</a> after being contacted by the finance minister Mathias Cormann.</p>
<p>At this stage it would be customary to call for an in-depth inquiry into the banking industry and its ethics, but in the wake of the toothless tiger that was the <a href="http://fsi.gov.au/publications/final-report/">Murray Inquiry</a> which had only one reference to LIBOR (in relation to Withholding Tax), such a suggestion would fall on deaf ears. Medcraft has repeatedly made a strong push for additional funding for ASIC and heeding him, the Murray Report has recommended that an “industry funding model” be introduced - that is, “abuser pays”.</p>
<p>If the ASIC inquiry finds evidence of misconduct (and arguably even if it doesn’t in this particular case), the government should promptly allocate all of the funding that the corporate regulator needs. And, more controversially, ASIC, because it is too thinly spread, should be broken up to allow it to concentrate on preventing misconduct in the Australian financial system, if indeed it is such a paradise for white collar criminals.</p>
<p>Less controversially, AFMA is a trade association, governed by its members, the largest banks in Australia and the world. There is an obvious conflict of interest in also being the administrator of the BBSW benchmark. As in the UK, that responsibility should be delegated to <a href="https://www.theice.com/iba">an independent body</a>.</p>
<p>It is also a conflict of interest for any industry body to set the code of conduct for its members’ employees. Though AFMA’s <a href="http://www.afma.com.au/afmawr/_assets/main/lib90010/afma%20code%20of%20ethics%20code%20of%20conduct.pdf">code of conduct</a> specifically forbids market manipulation, the Board contains senior representatives of banks that have been fined for both FX and LIBOR manipulation. Furthermore, the AFMA code has not been updated since the revelations of wide-spread market manipulation; it is bland and ineffectual. ASIC should ensure that proper conduct including financial benchmarks is part of each firm’s corporate code of conduct and is strictly enforced by them.</p><img src="https://counter.theconversation.com/content/35851/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>The wheels of justice grind exceedingly slow and nowhere slower than in the Sydney headquarters of the Australian Securities and Investments Commission (ASIC). A recent report appears to show that ASIC…Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie 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/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>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=265&fit=crop&dpr=1 600w, https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=265&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=265&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=333&fit=crop&dpr=1 754w, https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=333&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/59376/original/jr6x8mm8-1411016277.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=333&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
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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>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=219&fit=crop&dpr=1 600w, https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=219&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=219&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=275&fit=crop&dpr=1 754w, https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=275&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/59384/original/nb4qbqdd-1411017450.png?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=275&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
</figcaption>
</figure>
<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.tag:theconversation.com,2011:article/295472014-07-24T20:29:31Z2014-07-24T20:29:31ZSuperannuation: make income the outcome<figure><img src="https://images.theconversation.com/files/54704/original/6w2wcg35-1406162533.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The emphasis on the lump sum in superannuation unfairly moves risk to individuals.</span> <span class="attribution"><span class="source">Image sourced from www.shutterstock.com</span></span></figcaption></figure><p>Having led the world in the 1990s in embracing defined contribution retirement plans, Australia now is rightly reviewing whether the design of its retirement income system is meeting the needs of Australians living in retirement.</p>
<p>David Murray’s interim report into Australia’s financial systems noted the particular strengths of this three-pillar system, which comprises the age pension, compulsory superannuation guarantee and voluntary private savings. With more than A$1.8 trillion of assets under management, Australia now has the fourth largest private pension pool in the world. The questions, as the Murray report identified, are around the complexity, efficiency and efficacy of the system. </p>
<p>The fact is Australians are not only living longer, they are seeking greater choice and control in managing their retirement arrangements and need cost-effective products that meet their income needs over many decades after stopping full-time work.</p>
<p>The problems with the current system, as I see it, are two-fold: One is around the lack of meaningful information given to consumers and the other is around the stated lump sum goal of most superannuation plans. Unlike the old employer-sponsored defined benefit plans, the defined contribution (DC) plans that dominate in Australia and in the US market transfer the investment and other risks from companies to employees. </p>
<p>My view is that putting relatively complex decisions in the hands of individuals with little or no financial expertise is problematic. While some say the answer is increased financial literacy, it is simply unrealistic to expect people to make decisions about strategies that challenge even seasoned investment professionals.
To use an analogy, when we service our cars, the mechanic does not expect us to be able to understand how the fuel injection system works. Most of us just want a vehicle that gets us safely and reliably to our desired destination.</p>
<p>It’s the same with our retirement plans. It really makes no sense to ask individuals to make complex choices about risk exposures and asset allocation, for instance.</p>
<p>The second problem is the goal itself. The language around DC investment is about asset value. People are trained to see the key metric as the size of their fund pool, when what really matters to them is whether they will have sufficient income in retirement to live the lives they want to live.</p>
<p>If an individual’s pension savings are invested to maximise capital value at time of retirement and her personal goal is to achieve a reasonable level of retirement income, there is a clear mismatch involved.</p>
<p>In the view of the superannuation fund, the relevant risk is portfolio value. But the risk for the individual is uncertainty around retirement income.
How do we solve this dilemma? The answer is to adopt a liability-driven investment strategy that is equivalent to how an insurer hedges an annuity contract or how pension funds hedge their liabilities for future retirement payments to members.
Nearly a quarter of a century since Australia moved to compulsory super, the financial technology now exists to invest individual super contributions this way.
Each fund member would still get a pot of money at retirement and would still have the same choice over their savings they have under current DC arrangements. The difference is the value of the pot would be obtained through a strategy meant to maximise the likelihood of achieving the desired income stream.</p>
<p>Moving to this income-focused strategy would require changes not only to the way super plans actually invest their members’ money but also to how they engage and communicate with savers.</p>
<p>Instead of being asked complex (and meaningless) questions about asset allocation, members would be asked three simple questions – their retirement income goal, how much they can contribute from current income and how long they plan to work. Of course, the asset allocation is important, but this only a factor for achieving success. It is not a meaningful input for the choices the consumer actually makes.
Once these variables are known, the fund need only regularly communicate to the member the probability of reaching her goal. To increase that probability, the fund member has only three choices – save more, work longer or take more risk. There are no other ways. </p>
<p>The gap between what exists and what Australians need was highlighted by the Murray inquiry interim report, which noted that the current focus on lump sum balances in the superannuation system is evident in the absence of retirement income projections from annual statements to members.</p>
<p>“For many people, income projections, while difficult to calculate, would be far more useful than total accrued balances,” Murray said.</p>
<p>As someone who has spent much of his professional life researching this issue, I can only agree. Ultimately, what Australia needs is an approach to superannuation that uses smarter products rather than trying to make consumers smarter about finance.</p><img src="https://counter.theconversation.com/content/29547/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alongside his academic positions at MIT and Harvard, Professor Merton holds the post of resident scientist with global asset management firm Dimensional Fund Advisors. This article is drawn partly from his recent essay in the Harvard Business Review on the retirement planning challenge.</span></em></p>Having led the world in the 1990s in embracing defined contribution retirement plans, Australia now is rightly reviewing whether the design of its retirement income system is meeting the needs of Australians…Robert C. Merton, Nobel Laureate, Professor of Finance, School of Management, Massachusetts Institute of Technology (MIT)Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/292742014-07-16T20:20:57Z2014-07-16T20:20:57ZTurning super into income: inquiry opens retirement funding debate<figure><img src="https://images.theconversation.com/files/53972/original/5mry7k34-1405490070.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The focus is shifting to how Australians access their super to fund retirement.</span> <span class="attribution"><span class="source">Wendy House/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc-nd/4.0/">CC BY-NC-ND</a></span></figcaption></figure><p>A good proportion of the Financial System Inquiry’s 460-page <a href="http://fsi.gov.au/files/2014/07/FSI_Report_Final_Reduced20140715.pdf">interim report</a> is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the conversion of super into retirement income.</p>
<p>Currently, <a href="http://www.cepar.edu.au/media/129955/cepar_submission_to_the_financial_system_inquiry_-__final_final.pdf">the system does poorly</a>. It does not meet the risk management needs of retirees. They have few options if they want a stable income after retirement that is insured against longevity, investment and inflation risk.</p>
<p>Indeed, existing rules impede the development of such products. It may make sense in principle for a retiree to insure against outliving her savings by buying a “deferred annuity” consisting of an income stream that only starts paying out in 20 years’ time. But this would not be a wise move if (as is currently the case) the Age Pension means test deems that she is receiving that income in the intervening 20 years, and lowers her interim pension as a result.</p>
<p>The inquiry correctly identifies these issues as part of a wider problem of policy inconsistency: on the one hand, tax-advantaged retirement savings and default fund and portfolio allocations are mandated because we recognise we are subject to under-saving and behavioural biases. The majority never have to interact actively with superannuation during their working lives. On the other hand, retirement income decisions and risks are left entirely with individuals at the moment of retirement.</p>
<h2>Four options to tackle the problem</h2>
<p>The report puts forward four options, some of which are expected to become solid recommendations when the inquiry submits its final report in November 2014. These range from the full flexibility but limited risk management of the status quo (where individuals use super savings as they see fit, with some improvement in financial information, advice and education) to the limited flexibility but full risk management of compulsion (where some savings must be used to buy a longevity-protected product).</p>
<p>In between these extremes are two other options. The inquiry flags the possibility of incentivising longevity-protected products via tax or the Age Pension means test. But benefits from super are already tax-advantaged so incentivising longevity-protected products may require raising taxes on other income streams and lump sums.</p>
<p>This could tie in with addressing another concern noted by the inquiry: that the tax arrangements within the superannuation system are being used for estate planning rather than for providing retirement incomes. Super taxes may be an area that the government’s proposed tax review will also look at.</p>
<p>Finally, the inquiry opens the door to a full discussion of instituting a default for decumulation of super. A single default would not suit everyone and there are fiduciary concerns about automatically committing individuals to a given decumulation product, but an opt-out would be available and elements tailored to individual circumstances could be included. </p>
<p>Also only a proportion of savings above a certain threshold may be subject to the longevity-protected product default. These can guide those who are less engaged and offer flexibility to those wanting to make their own decision.</p>
<p>We know from <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1943599">research</a> that defaults have a strong behavioural effect – often more so than financial incentives. A recent online <a href="http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2409519">experiment</a>, led by the Centre of Excellence in Population Ageing Research, showed that in a decision to allocate assets between an account-based pension and an immediate annuity individuals were most likely to choose the default (see figure).</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=437&fit=crop&dpr=1 600w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=437&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=437&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=550&fit=crop&dpr=1 754w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=550&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/53960/original/hmr5qycx-1405488087.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=550&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Proportion of assets taken as an annuity with different defaults.</span>
<span class="attribution"><span class="source">Bateman, H, Eckert, C, Iskhakov, F, Louviere, J, Satchell, S and Thorp, S 2013, ‘Default and 1/N Heuristics in Annuity Choice’, School of Risk and Actuarial Studies Working Paper 2014/1, UNSW</span></span>
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<p>Such products, perhaps combined with a tendering process (seen in countries such as Chile and Singapore) for the most competitively priced, may yet provide value for money with the right mix of flexibility and risk management, regardless of a person’s level of financial capacity, engagement or superannuation balance.</p><img src="https://counter.theconversation.com/content/29274/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rafal Chomik works for the ARC Centre of Excellence in Population Ageing Research which receives funding from the Australian Research Council.</span></em></p><p class="fine-print"><em><span>Hazel Bateman receives funding from the Australian Research Council Discovery Grant Scheme, DP1093812. </span></em></p>A good proportion of the Financial System Inquiry’s 460-page interim report is dedicated to a discussion of superannuation and, in particular, to making the financial system better at facilitating the…Rafal Chomik, Senior Research Fellow, ARC Centre of Excellence in Population Ageing Research, UNSW, UNSW SydneyHazel Bateman, Associate Head of School, UNSW SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/279832014-07-16T00:48:44Z2014-07-16T00:48:44ZThe future of financial advice is set to remain conflicted<figure><img src="https://images.theconversation.com/files/53940/original/thkyqs8d-1405468786.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The big four banks have a well-entrenched sales culture.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/fuzzhead/6341339709/in/photolist-3jziWi-cddMB-aEn2ng-rV71f-8bRn1U-HSRmM-8CqcMN-or29m-or29n-sQMEZ-pFSaE-rMd2N-rMd2U-bLLGpH-2d1aEF-9gFXKF-4U2mRF-exy1CH-9nGHW-8JYL7Q-9GvZ8p-5ztPjM-6UZdCC-6UZd51-5zz4Gu-mxBEM-mxBF4-9jiJXW-eP3GRX-ePgH3C-3pWBqG-fUDYAJ-Ms92D-6A3Gdj-drcg3X-dtPuX2-66oiZY-9bVW1e-dpnJic-ex1Cuz-4RU2zh-66okBA-55mvhn-ex1Cgn-ex4N3s-5uyWPF-nesko-8WujeC-7yeCUy-kcX7Ei">deepwarren/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-sa/4.0/">CC BY-SA</a></span></figcaption></figure><p>Reading between the lines it appears the panel behind Australia’s wide-reaching Financial System Inquiry believes all is not well in the financial advice industry, despite last year’s implementation of the Future of Financial Advice Reforms, and subsequent <a href="http://www.abc.net.au/news/2014-07-15/coalition-strikes-deal-with-pup-on-financial-advice-laws/5598738">amendments</a> which are currently before parliament. </p>
<p>The interim Murray inquiry report found access to quality advice is being undermined by the existence of conflicted remuneration structures in the sector.</p>
<p>The inquiry is seeking input into several options for improving financial advice including the establishment of an enhanced public register of financial advisers, increasing ASIC’s powers to ban individuals from managing a financial services business, raising minimum education and competency standards for personal advice (with a national examination), and the renaming of general advice as “sales” or “product information”, with the term “advice” being restricted for use in relation to personal advice.</p>
<p>While the majority of these possible directions can only benefit both the industry and consumers, it is the last point that is most contentious.</p>
<p>As the interim report points out, there are around 54,000 financial advisers in Australia. Only around 15% of these advisers are independent, over half are owned by large vertically integrated financial institutions such as banks, and the remainder belong to dealer groups which have varying minority holdings by the large institutions. So the potential for conflicts of interest where advice is given by the same entities, or related entities, remains a major issue for the consumers.</p>
<p>While recent publicity concerning the Commonwealth Financial Planning cases has elevated the conversation about potential conflicts of interest, it is not entirely clear whether consumers are able to distinguish between independent advice and advice which is aligned with a product manufacturer.</p>
<p>The sales culture of vertically integrated organisations, wishing to cross-sell as much product as possible to their wealth management clients, is well entrenched. </p>
<p>As a consequence there has been an on-going campaign to water down the FOFA legislation, removing the “opt-in” requirement where clients of financial advisers must indicate annually that they wish to continue the service, removing the need for an annual fee disclosure for clients engaging before 1st July 2013, and a watering down of the “best interest” duty and provisions directed at removing conflicted remuneration, that is the payment of commissions, on general advice. </p>
<p>Indeed, it was lobbying by the banks that led to the amendment of the FOFA legislation regarding to “general” as opposed to “personal” advice, that is, advice relating to products as opposed to advice which is tailored for individual needs. </p>
<p>The suggestion in the Financial System Inquiry’s interim report is that there should be even greater clarification of advice, with the renaming of general advice as “sales” or “product information”, with the term “advice” being restricted for use in relation to personal advice. The inquiry seems to reject the suggestion that such sales oriented activity should be exempt from licensing and coverage of FOFA requirements. </p>
<p>There may well be merit in such a direction as it would be advantageous to ensure that consumers are aware that the process of “sales” is different to “advice”. However, if the individual performing this task is acting under the FOFA legislation anyway, where is the gain?</p><img src="https://counter.theconversation.com/content/27983/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Deborah Ralston is the Chair of the Investment Committee for Mortgage Choice Financial Planning.</span></em></p>Reading between the lines it appears the panel behind Australia’s wide-reaching Financial System Inquiry believes all is not well in the financial advice industry, despite last year’s implementation of…Deborah Ralston, Professor of Finance and Director, Australian Centre for Financial Studies Licensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/292102014-07-15T05:02:15Z2014-07-15T05:02:15ZInfographic: the financial system inquiry at a glance<p>The last financial system inquiry held in Australia happened in 1997. More than a decade and a global financial crisis later, the sector is <a href="https://theconversation.com/financial-system-inquiry-sets-sights-on-super-experts-react-29194">under scrutiny</a> again. </p>
<p>The inquiry delivered its <a href="http://fsi.gov.au/files/2014/07/FSI_Report_Final_Reduced20140715.pdf">interim report</a> today, outlining observations and options that will affect your payments, investments and wealth.</p>
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The last financial system inquiry held in Australia happened in 1997. More than a decade and a global financial crisis later, the sector is under scrutiny again. The inquiry delivered its interim report…Charis Palmer, Deputy Editor/Chief of StaffEmil Jeyaratnam, Data + Interactives Editor, The ConversationLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/291942014-07-15T02:04:41Z2014-07-15T02:04:41ZFinancial system inquiry sets sights on super: experts react<p>Australia’s financial system is competitive and well regulated, but more work is required to boost superannuation competition, according to the <a href="http://fsi.gov.au/files/2014/07/FSI_Report_Final_Reduced20140715.pdf">interim report</a> of the Financial System Inquiry, led by former Commonwealth Bank chief David Murray.</p>
<p>The report comes as the Senate prepares to debate the <a href="http://www.smh.com.au/business/banking-and-finance/mathias-cormann-introduces-fofa-rollback-regulations-20140630-zsr2q.html">rollback of the Future of Financial Advice reforms</a>, and following a Senate inquiry that was highly critical of the financial planning operations of the Commonwealth Bank.</p>
<p>The inquiry, the first of its kind in 17 years, was kicked off by Treasurer Joe Hockey last November.</p>
<p>The 460-page interim report, released today, offers no direct recommendations, but instead makes observations and offers “policy options” for further consultation. More than 280 submissions were received from industry, academia and the public.</p>
<p>The report is the first output from the inquiry panel, which argues the financial system must satisfy three principles: efficiently allocate resources and risks, be stable and reliable, and be fair and accessible. </p>
<p>The panel suggests some change is required in order to boost productivity and deal with future financial crises, fiscal pressures, technology changes and global integration.</p>
<p>Major observations from the committee include the inconsistent regulation of payment systems, the structural impediments standing in the way of small businesses seeking finance, the lack of fee-based competition in the superannuation sector, and the entrenched perception that some banks are “too big too fail”.</p>
<p>The report also highlights the overly complex documents consumers of financial products are lumped with, and the role of removing conflicted remuneration or commissions in improving the quality of financial advice. It says the retirement phase of superannuation is underdeveloped and fails to meet the risk-management needs of many retirees.</p>
<p>It suggests while Australia’s regulators are “well-regarded”, there is room for improvement to increase their independence, transparency and accountability.</p>
<p>The committee also advocates for a technology-neutral approach to regulation, arguing the government is well placed to promote innovation via regulatory flexibility.</p>
<p>Some major options for industry reform include developing a small and medium-sized business finance database for lenders and borrowers, considering auctions for default superannuation fund status, ring-fencing critical bank functions (such as retail banking), improving disclosure requirements to enhance consumer understanding - with more powers for ASIC to intervene or ban products, raising minimum education and competency standards for advisers on more complex products (such as self-managed super funds), renaming general advice as “sales” or “product information”, mandating the use of particular retirement income products, and allowing payment scheme providers to reintroduce “no surcharge” rules.</p>
<p>Other options presented include government support for the securitisation market to help boost the competitiveness of smaller banks, and enhancing the role of the Council of Financial Regulators, to improve coordination and co-operation between regulators.</p>
<p>The final report of the committee is due in November.</p>
<p>Our panel of experts respond below.</p>
<hr>
<p><strong>Michael Peters, Lecturer at the Australian School of Business</strong></p>
<p>The long-awaited Murray interim report highlights concerns as to competition in the banking sector, fee-based competition in the financial planning sector, the use of technology and access to the sector.</p>
<p>The big four banks dominate banking, the financial planners are on good earners picking up the fees as we all rush towards self-managed superannuation and the mortgage pressure faced by many seems here to stay with clear impact on the sector’s long-term performance and risk appetite.</p>
<p>It’s an expensive and yet thorough exercise into what has been known for a long time, and yet governments of both persuasions seem to be shy to tackle the elephant in the room.</p>
<p>The big four dominate to the extent that they are too big to fail, as illustrated by the previous government’s rush to their call for a deposit guarantee. They are so big that they will simple shift their dominance from banking to anything else just like we are seeing in the supermarket sector.</p>
<p>The report does outline the impact technology is having and will have on the sector to the extent that physical money will disappear over time.</p>
<p>Perhaps Google or Apple can enter the sector and provide alternative suppliers, since traditional competitive forces have been less successful. Perhaps regulation could encourage this move. Don’t put money on it.</p>
<p>The entrenched interests will prevail. The report does not examine the fact that the banking sector accounts for well over 50% of all profits from ASX-listed corporations. The economy is dominated by these players, but there was no clear indication what this means for the health of economy to rely on such concentration.</p>
<p>Fee-based or even diversity of offerings from the financial planning/retail sector is of great concern.</p>
<p>Today this sector accounts for more cash than the total savings held by all deposit-taking institutions.</p>
<p>True reform will need to deal with this sector as we had dealt with the banking sector prior to the global financial crisis. It will require much political will to tame the merchant banks and other financial product factories and their legions of advisers, planners and resellers.</p>
<p>It appears the value given to deposit holders and customers in general is of concern. However, the inquiry’s thoughts are elsewhere on protecting all Australians from mortgage stress and its impact on the sector’s performance in the long term.</p>
<p>For those seeking the reforms of the 1980s, chances are, don’t bank on it yet.</p>
<hr>
<p><strong>Rodney Maddock, Vice-Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics at Monash university</strong></p>
<p>The inquiry’s interim report is amazingly sensible. They’ve essentially said competition is not the central issue, and instead small business, payments and wealth are, as well as how money is channelled through the superannuation system.</p>
<p>Instead of focusing on mortgages all the time, they also seem to be suggesting that it’s far more important for productivity that we have money flowing to people who want to innovate and build businesses. It’s not clear the inquiry committee has got any solutions, but it’s clear they’re asking the right questions.</p>
<p>The data discussion is also interesting. There are quite a few important issues where they haven’t decided what to think. How to trade off new business models against data protection is one area where they have not decided what to do.</p>
<p>On the issue of “too big to fail” the discussion is good. Rather than impose extra taxes on people, the committee is suggesting we should take away the assumption that government will support institutions if they fail. That applies to both big and small institutions.</p>
<p>On wealth, the debate is about whether when you walk into a bank you are buying a hamburger or establishing a fiduciary relationship. The ability to buy bank products from people in bank branches and in bank uniforms makes sense, but this is quite separate from being advised about how to run our personal finance. We have to make a distinction between the hamburger and the financial advice - to distinguish general advice as not being advice in that sense.</p>
<p>On the regulatory front I’d prefer to have macro prudential policy run by the RBA and that being really clear, rather than having the Council of Financial Regulators resolving disputes between APRA and the RBA. It seems to me that the committee risks weakening the RBA by sharing responsibility.</p>
<p>I am still not convinced they have regulation right. There are different ways you can do financial transactions - one is through markets, the other is institutions. At the moment they’re regulated by different people so boosting the council might be one way of solving that problem as institutions become less important and markets become more important. But whether that is the best solution is again unclear.</p>
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<p><strong>Jerry Parwada, Head of School of Banking and Finance, UNSW</strong></p>
<p>The inquiry’s report calls attention to the fact that the whole wealth-management industry needs a bird’s eye view. We need to carefully sift through the issues as a collective, not on a piecemeal basis.</p>
<p>Given the report acknowledges there are outstanding questions that still need to be answered, then it’s tricky for anybody to go ahead with any legislative or regulatory changes before the conclusion of the inquiry. They touch on FOFA reforms and say it is too early to assess the effect of these reforms on competition. So if it’s too early to assess the effects, then why should we be changing them?</p>
<p>There’s a strong link between competition in the industry and fees - whether we’re looking at retail investment advice in general or super advice - and the competitive framework in the whole industry needs to be looked at carefully.</p>
<p>The policy makers, regulators and the market need to ask the question: is it going to be beneficial for an industry that has been identified by the inquiry as having high fees which are sustained by the current competitive model to keep that model forever?</p>
<p>The inquiry makes it very clear the competitive model had been driven by consolidation in the industry, so 80% of the financial advice industry is now linked with banks. The differentiation that’s taking place now is at the product level and in terms of distribution but not at the fee level, and yet access to financial planning services is very fee sensitive. That’s the main concern.</p>
<p>All the research we have done shows that there’s limited value to be obtained from active management. It just raises fees for one segment of the market and more index-like products will benefit the market.</p>
<p>Recent research in the US showed that when fund managers offer investment services directly to clients there is value added, but when the investment advice is intermediated by brokers there is value destruction. If we abstract from that research into the Australian market we need to look at options that rely less on intermediation and more on a default index-type arrangement.</p>
<p>I think the financial system inquiry is well within its rights to at least carefully consider the type of Chinese walls that exist in investment banking.</p>
<p>We need to think about separating banking from distribution or financial planning advice in terms of ownership and control. This is not a popular sentiment but the Commonwealth Bank debacle of recent weeks clearly demonstrates this is not a left-field idea that just comes from academics.</p>
<p>We can argue for the need to cut red tape and simplify regulation, but similarly you would be hard pressed to find a financial planning group or outfit that has gone out of business because of FOFA regulations. You can trace millions of dollars of losses to investors who have been poorly handled in this increasingly concentrated industry. We need to separate emotive issues from what’s best for the safety of the industry.</p>
<hr>
<p>More to come.</p><img src="https://counter.theconversation.com/content/29194/count.gif" alt="The Conversation" width="1" height="1" />
Australia’s financial system is competitive and well regulated, but more work is required to boost superannuation competition, according to the interim report of the Financial System Inquiry, led by former…Charis Palmer, Deputy Editor/Chief of StaffLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/287252014-07-14T10:00:22Z2014-07-14T10:00:22ZThree financial system flaws David Murray can’t ignore<p>At the current frequency of financial system inquiries (Campbell 1982, Wallis 1997, Murray 2014) there will not be another until 2030. That makes this week’s interim report from David Murray all the more critical.</p>
<p>By far the biggest problem with Australia’s financial system is the retirement savings system. Its fundamentally flawed structure is damaging the welfare of millions of Australian households. </p>
<p>There are three closely related problems. First, Australia’s retirement system forces households to make complex decisions that most households are not well placed to make. </p>
<p>Households in Australia have more freedom in managing their retirement savings than in any other developed country. That freedom would be terrific if it was matched by a world-leading level of financial literacy, but it is not. So the putative freedom is really more a burden to the majority of households who cannot navigate a complicated system without help from advisers.</p>
<p>The second problem is the poor quality of financial advice provided to households. The certification required to be employed as a financial adviser is an RG146. A person of average ability takes a few weeks to meet the RG146 requirements. That is, with a few weeks’ training almost anyone can be employed in a financial advisory group and advise households on their lifetime savings. </p>
<p>The knowledge hurdle for financial adviser certification is not low because the requisite knowledge is small. It is low because of political pressure not to make it too high. In the 1980s and 1990s the life insurance sales sector morphed into the financial advice sector. Financial advice deals with much more complicated questions than insurance but the sector was able to resist regulation that would force its members to be properly trained.</p>
<h2>Lobbyists have won</h2>
<p>To this day the financial advisory firms have successfully resisted attempts to raise the bar on the expertise required by their employees to provide financial advice. Because most financial advisers are so poorly trained they cannot provide quality advice solutions to the problems of their clients. Most financial advisory firms simply have a set of cookie-cutter solutions for clients and the financial adviser’s job is to decide which cookie cutter goes with which client. </p>
<p>The third problem is by the far the most important. Most financial advisers have a substantial conflict of interest – the interests of their employer are at odds with the interests of their clients. </p>
<p>To make the point imagine the following situation. Your doctor is an employee of the Acme Drug Company. Acme has a suite of drugs covering many but not all medical conditions. For some conditions the Acme drug is the best, but for many conditions there are better drugs.</p>
<p>You pay for medical advice by the hour, but your doctor is paid by Acme. Your doctor can prescribe whichever drug she chooses, but her compensation depends on the volume of Acme drugs she prescribes, not other drugs. </p>
<p>Even though the medical profession has a well-deserved reputation for putting patients first, drug companies are not allowed to own medical practices. It is obvious that vertical integration in the medical system, where drug companies employed doctors, would corrupt the system. Sadly, this is exactly the situation we have in the retirement savings sector in Australia.</p>
<h2>Conflicts remain</h2>
<p>Over 80% of financial advisers work for firms that are either directly owned by, or very closely affiliated with, firms that provide a suite of financial management products. When a household goes to a financial advisory firm they will most likely be talking to a financial adviser who works for a firm that is vertically integrated with a provider of financial products. The financial adviser may or may not be free to select whichever financial products he chooses for the client’s solution, but he will only be compensated for recommending his own product provider (investment management firm). </p>
<p>This obvious conflict of interest is leading to dreadful outcomes in Australia. Households are being put into retail funds when they would be better off in industry funds. They are being put into very high-fee investment products when low-fee products would deliver the same expected returns before fees. They are being encouraged to borrow money to invest, to be underdiversified, to make the wrong decisions all around. </p>
<p>The financial system inquiry should address each of these three problems. First, it should recommend the federal government implement a long-term program of public education about fundamental ideas in retirement savings: save while you are young, don’t put all your eggs in one basket, and get a second opinion from an adviser who is certified as independent. </p>
<p>Second, it should insist on a proper level of training for all financial advisers. </p>
<p>Third, it should insist that financial advisers cannot be affiliated with financial product providers in any way – using the medical sector as its template.</p>
<h2>The missing institution</h2>
<p>There is another retirement savings problem that is of first order importance but unrelated to financial advice. Elderly households need a way of releasing the equity in their homes without the uncertainty that they will lose control of their residence. </p>
<p>The largest form of saving that most Australian households undertake over their lifetimes is that they buy homes that appreciate in value. The equity that Australian households have in residential real estate (value minus debt) is about A$2.8 trillion. That is nearly twice the A$1.6 trillion that Australian households have in retirement savings. Yet, there is no direct connection between these great pools of value. </p>
<p>There is a missing institution in the Australian financial system. What is needed is a financial organisation that will allow Australian households to borrow against their homes without any fear of losing control of the home and at an interest rate close to government treasury rates. </p>
<p>There are reverse mortgage products in the market. But those products are too expensive and poorly structured for most households. Releasing the equity in the homes of retirees is essential for solving the fiscal problems of the ageing of the Australian population. </p><img src="https://counter.theconversation.com/content/28725/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Sam Wylie 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>At the current frequency of financial system inquiries (Campbell 1982, Wallis 1997, Murray 2014) there will not be another until 2030. That makes this week’s interim report from David Murray all the more…Sam Wylie, Principal Fellow, Melbourne Business SchoolLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/255872014-04-14T20:42:00Z2014-04-14T20:42:00ZLooking for a home loan? Choose from one of these four options…<p>Over 40% of mortgages in Australia are sold by mortgage brokers, not by their manufacturers - an issue that has the CEO of Australia’s fifth largest bank, Suncorp, <a href="http://www.theaustralian.com.au/business/suncorp-chief-patrick-snowball-lashes-dominance-of-big-four-banks/story-e6frg8zx-1226881287464">arguing</a> the sector is skewed towards the big four banks.</p>
<p>There are two distinct components of the mortgage market: a retail market with a wide variety of sellers, and a wholesale market.</p>
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<span class="caption">Value of housing loans advanced by lender.</span>
<span class="attribution"><span class="source">Australian Securitisation Forum</span></span>
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<p>The four big manufacturers of mortgages in Australia are the big four banks. One of the key issues for the <a href="http://fsi.gov.au/">Murray inquiry</a> into the financial system will relate to competition, or the lack thereof, in the manufacturing of mortgages. Does it matter that some 90% of mortgages are manufactured by four producers?</p>
<p>There are a number of ways of answering this.</p>
<h2>Oligopolies reign…</h2>
<p>The first is that there are many industries in Australia with fewer than four major manufacturers of goods and services. Telephone services, domestic airlines, energy supplies, postal services, cars, steel etc. all come quickly to mind. In fact, most Australian industries are characterised by a small number of manufacturers. Any industry with economies of scale, like banking, seems likely to be relatively concentrated given the size of the local market.</p>
<p>The second is to ask whether the concentration is temporary or entrenched.</p>
<p>There were a lot more manufacturers of mortgages before the financial crisis. Most of them were funded not from deposits but by securitising their mortgages and obtaining funding from the wholesale markets. During the crisis this market contracted sharply, mainly because of problems in the US market for securitised product, which made the business model unviable. The government stepped in under Treasurer Swan and subsidised securitisation by the smaller banks during the crisis to enable them to stay in the business. This was a subsidy from taxpayers directed exclusively towards the smaller banks.</p>
<p>As the securitisation market returns, as it should because there were no problems with the market in Australia, then this will return to be a secure funding source for the smaller banks. The rebuilding of market sentiment will allow the smaller banks to re-enter the market as manufacturers of mortgages.</p>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=254&fit=crop&dpr=1 600w, https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=254&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=254&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=319&fit=crop&dpr=1 754w, https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=319&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/46337/original/qx6vgx59-1397454478.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=319&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Residential Mortgage Backed Securities by issuer type.</span>
<span class="attribution"><span class="source">Australian Securitisation Forum</span></span>
</figcaption>
</figure>
<p>Macquarie Bank too has shown a willingness to depart from the mortgage market when times are difficult but to re-enter aggressively as it has recently. Again this is another indicator that the market concentration is high but the market remains contestable.</p>
<h2>Price competition</h2>
<p>The third broad concern is whether there is price competition for mortgages at the wholesale level. At the broadest level the Reserve Bank has concluded:</p>
<blockquote>
<p>the available evidence suggests that the average spread to the policy rate on variable-rate mortgages in Australia is within the range of those in other advanced economies - RBA submission to the Murray inquiry.</p>
</blockquote>
<p>So the overall level of mortgage margins does not appear to be out of line with prices in other countries.</p>
<p>The remaining issue is whether there is price competition between the four manufacturers, and whether market share changes when price changes. The normal test used in industrial economics is to ask whether an incumbent would lose significant market share if it raised prices by 10% above the level of its competitors.</p>
<p>With mortgage rates currently around 6%, the question is whether a bank would lose significant market share if it offered a standard variable rate of 6.6%, while the other manufacturers had prices around 6%. There really seems little doubt that the high price would cost an incumbent significant market share, suggesting that no provider really has market power in mortgages. Just by cutting its mortgage list price by 0.10 to 0.15 of 1%, NAB increased its market share significantly during its break-up marketing campaign.</p>
<p>Since the financial crisis the big four banks have become the principal manufacturers of mortgages in Australia. They market some mortgages directly, some through second tier brands, and some through brokers. Their leading position in manufacturing since the crisis is mainly the result of the wind back of second tier banks which were funded through securitisation in the wholesale market, and partly because of the changed status of St George and Bankwest when they were taken over by majors.</p>
<p>Such a high level of concentration is not unusual for an Australian industry. Nor is it clear that prices are out of line. The situation is also likely to prove temporary as re-emergence of the securitisation market will enable alternative manufacturers to fund their lending, and new vigorous competitors like Macquarie have already re-entered the market.</p><img src="https://counter.theconversation.com/content/25587/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock consults to a range of financial sector institutions. Some of his current research on financial regulation is funded by the Centre for International Financial Regulation. </span></em></p>Over 40% of mortgages in Australia are sold by mortgage brokers, not by their manufacturers - an issue that has the CEO of Australia’s fifth largest bank, Suncorp, arguing the sector is skewed towards…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/251992014-04-13T20:39:30Z2014-04-13T20:39:30ZSuperannuation is too costly, so bill me<figure><img src="https://images.theconversation.com/files/46208/original/k7ggycqp-1397201091.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">Superannuation: you give, they take.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/itspaulkelly/3786156256/in/photolist-6Lz3m9-b5VS8M-co2iA-X9EAc-bxGyAR-84yYnq-26u5B-6asuKS-KbTPN-bwLQoe-2Fuawp-2FuiqR-2Fuoex-2Fuqx2-2FuuZe-2FuByR-2FuDzt-2FyyBb-yPQ5B-aqhbib-6LgsHA-7YqrBn-7YqrET-7YtFjj-7YtFo5-7YtFrm-2FyG7Q-2FyP3U-2FyTh5-2FyVoL-2Fz2mA-fgxG31-8tWsBv-bCsG5j-8hUACC-69AvD-85Kfx4-4mWAoW-boHDS5-boHEYC-boHFsf-bBCyCM-bBCA5X-86YJMo-CpEPX-CpEQe-CpEQx-CpEQR-657U-8qcYtW">Paul Kelly/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span></figcaption></figure><p>The main reason superannuation costs are too high in Australia is both simple and horrendously complex: it’s the only service we buy where we give the service provider our money to look after.</p>
<p>It’s true that we also give our money to banks, but mostly, especially when we’re young, the banks give us money as loans.</p>
<p>The fact that super funds, and the investment managers and wealth advisers who run them, hold our money for us allows them to simply take some of it every month as their fee.</p>
<p>Everyone else has to send us a bill.</p>
<p>This might sound too obvious to even bother mentioning, but that system has two very powerful hidden effects:</p>
<ol>
<li><p>The providers of investment services get to charge a percentage of the money, and almost nobody understands percentages and even fewer understand the power of compounding;</p></li>
<li><p>Since the fee is usually a fixed percentage of the client’s account balance, it increases at the same rate as the balance, which is in turn being fed by the sum of investment returns and all contributions – mandatory and voluntary.</p></li>
</ol>
<figure class="align-center ">
<img alt="" src="https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&fit=clip" srcset="https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=1884&fit=crop&dpr=1 600w, https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=1884&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=1884&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=2368&fit=crop&dpr=1 754w, https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=2368&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/46256/original/wbzddg8b-1397351382.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=2368&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption"></span>
</figcaption>
</figure>
<h2>Compounding fees</h2>
<p>As a result, super and investment fees compound at several times the rate of inflation but the customers barely see what’s happening, and those that do, don’t understand it.</p>
<p>Say you’re 25, earning $50,000 and you start with $1000 balance in super. And say the fee is 1% (actually by the time you add in advice and investment management it’s probably more like 2%, but let’s stick with 1% for simplicity).</p>
<p>That 1% produces a $10 fee. In the following 12 months you contribute 9% of your salary, or $375 per month. On top of that the fund manages a return of 10% on the average balance.</p>
<p>At the end of the year your balance will be $5950 – marvellous. New fee: $59.50 – a six-fold increase.</p>
<p>Next year you got a pay rise of 5%, which means your contributions increase to $393.75 per month, or $4725. Once again the fund earns you 10%, so at the end of the year your new balance is $11,506. New fee: $115.06 – nearly twice last year’s fee.</p>
<p>Obviously that escalation in fees is dramatic because the balance started from a low base. That means, by the way, that people with low balances who are just starting out are subsidised by those with more money in their accounts, and that’s the best thing about the percentage fee system.</p>
<p>So let’s look at the same metrics for someone more established in the workforce, with $100,000 in super and a salary of $100,000 a year.</p>
<p>First year fee is $1,000 (1% of $100,000). Next year, assuming 9% of salary in contributions and a 10% return on the average balance, the fee is $1,194.50 – an increase of 19.45%.</p>
<p>Next year’s fee, assuming a 5% salary increase and another 10% investment return, is $1336.25, 12% more than last year. And the year after you get a promotion! Salary goes to $120,000 and contributions to $10,800 for the year. Your new super balance is a very healthy $158,270. New fee: $1582.70 – an 18% increase over last year.</p>
<h2>And yet we comply…</h2>
<p>Do you ring and complain about being gouged? Well, no, because the fee is still 1% – it hasn’t changed. And you’re feeling good about the rising balance, so why complain? And anyway, you probably don’t even know. The fee statement is there somewhere, but you never pay much attention to it.</p>
<p>There are two things to think about here. First, your salary is increasing by 5% so it’s a fair bet that the super fund’s staff are also getting the same sort of pay rises, possibly less.</p>
<p>Yet the fees are increasing at 2-3 times that rate because the law requires us to contribute 9% of salary and because investment returns usually average about three times the inflation rate as well, simply as a result of the rising stockmarket (not the super fund’s brilliance). That’s the whole point of investing in shares – they return 2-3 times inflation over time.</p>
<p>Second, with $150,000 in super you’re probably paying 2% in management and adviser fees (not 1%), which is $3000 a year, or $250 a month. Some people have account balances of $500,000, especially when they retire, and pay fees of $10,000 a year, or $833 a month.</p>
<p>Think about how many services you pay $800 a month for, month after month, year after year, or even $250 a month for that matter.</p>
<h2>What can be done?</h2>
<p>Super funds hate this description, but superannuation is a utility, like gas, electricity or the phone; in fact it’s more so - a government-mandated utility.</p>
<p>What’s more you don’t get much for the money – basically super funds put the money into large companies and ride the market up and down. This year’s winner is next year’s loser, and vice versa, and there’s no way of telling the difference between them.</p>
<p>Yet not only is it almost certainly the most expensive service you buy, the cost of it compounds at several times the inflation rate every year and the providers don’t have to send you a bill like the other utilities – they just quietly take some of your money each month.</p>
<p>And remember that the prices charged by gas, electricity and communications companies are regulated by the ACCC, which actually determines what return on capital they’re allowed to make. Super fees are not regulated at all.</p>
<p>So to control the ballooning cost of super, three things should happen:</p>
<ul>
<li><p>super funds and their advisers must be told to stop skimming the accounts for their fees, and to send a bill instead that we have to actually pay</p></li>
<li><p>the costs of compliance and regulation need to be brought down, which the government is trying to do</p></li>
<li><p>the fees that super funds charge, and the profits they make, should be regulated, just as other utilities are regulated.</p></li>
</ul>
<p>On second thoughts, perhaps only the first of those would be needed.</p>
<p>If we started getting a bill for $500 a month from our super fund, the price would quickly come down because customers wouldn’t pay it … especially when the share market was falling and along with it all the account balances.</p>
<p>Yes, stop making the super funds disclose the fees they skim, make them send us a bill instead.</p><img src="https://counter.theconversation.com/content/25199/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Alan Kohler is the founder of the Eureka Report, a subscription-based newsletter that gives general advice related to superannuation.</span></em></p>The main reason superannuation costs are too high in Australia is both simple and horrendously complex: it’s the only service we buy where we give the service provider our money to look after. It’s true…Alan Kohler, Adjunct Professor of Business, Victoria UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/254862014-04-13T20:39:20Z2014-04-13T20:39:20ZTime for bankers to have a capital rethink<figure><img src="https://images.theconversation.com/files/46158/original/rb238q8s-1397178426.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">US bankers like JPMorgan's Jamie Dimon fear increased bank regulation.</span> <span class="attribution"><a class="source" href="https://www.flickr.com/photos/secdef/10615410416/in/photolist-hb3KFw-chKE9Y-chKEyU-chKFVu-chKF5q-chKGo9-chKHtQ-chKGJC-chKEbw-chKFsm-chKH5E-chKEaQ-gKizft-gKhSKS-8UEAhr-eESfhH-eES6p2-eEYh2G-eEYGhJ-eESnAi-eEYpmy-eF1Mv3-eEAT5u-eES46t-eEY3Hf-eEY5EY-eF1ULL-eEXQE7-eEXSuC-eF1P8f-eF2fnY-eES8Zn-eF1Q6w-eEuJWR-eEXP6L-eEYD1d-eEYBwU-eEY1d7-eEYrSC-eEANUA-eERW1x-eESsmi-eERVDV-eEYx7j-eES2G6-eESb2H-eEXUJY-eEYa9f-eEVbic-eF22Fo">Chuck Hagel/Flickr</a>, <a class="license" href="http://creativecommons.org/licenses/by/4.0/">CC BY</a></span></figcaption></figure><p>A plan by US regulators to impose greater capital requirements on the nation’s eight biggest banks has prompted <a href="http://www.reuters.com/article/2014/04/08/us-financial-regulations-leverage-idUSBREA3709B20140408">complaints</a> it will put the banks at a global disadvantage.</p>
<p>The proposal is that the banks - Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street and Wells Fargo – would have to meet a <a href="http://lexicon.ft.com/term?term=leverage-ratio">leverage ratio</a> (the rate of lending to equity) of 5%, rather than the 3% to be required of their smaller local and international peers. A 5% ratio implies in essence that at least 5% of bank assets have to be funded by equity, that is bank capital. </p>
<p>The ratio is proposed by the Basel Committee on Banking Supervision for global implementation, and is likely to be closely watched by Australia’s bankers as they debate regulation levels as part of the current <a href="http://fsi.gov.au">financial system inquiry</a> being led by David Murray.</p>
<h2>Will it really harm the banks?</h2>
<p>Despite the US banking sector’s complaints, it’s not clear to what extent this change could challenge them. An alternative to raising additional capital would be to reduce their offerings of banking products such as loans, loan commitments, and letters of credit. That choice will particularly depend on the state of the economy during the four years of transition that would be involved. Banks might close the gap between the actual and the target leverage ratio by reducing their asset exposure in a recession, but seek additional capital during good times.</p>
<p>The leverage ratio is part of the Basel III banking regulations that are being implemented globally. For most institutions the leverage ratio requires a minimum of 3% capital relative to total assets (and asset equivalents for off-balance sheet exposures such as derivatives, loan commitments and financial guarantees).</p>
<p>Next to the leverage ratio, Basel III proposes an increase in the quantity and quality of risk-based bank capital. Banks will be required to hold more Tier 1 capital (such as paid-up capital and retained earnings) in absolute terms and relative to Tier 2 capital than they had to under Basel II. The risk-based Basel III capital increase might include a counter-cyclical capital buffer that banks would be required to build during economic booms. Basel III also proposes minimum ratios for short-term and long-term bank liquidity.</p>
<h2>In a post-GFC world, isn’t more regulation a good thing?</h2>
<p>The US proposal comes at an interesting time for Australia. The International Monetary Fund has <a href="http://www.asic.gov.au/asic/pdflib.nsf/LookupByFileName/cr12308.pdf/$file/cr12308.pdf">recommended</a> that Australia’s top four banks should be subject to heightened supervision, strong recovery and resolution planning, and higher potential to absorb and cover future losses. </p>
<p>In addition, the financial system inquiry will be looking at the trade-off between bank efficiency and resilience, given capital and liquidity regulation, as part of its considerations.</p>
<p>Recent <a href="http://press.princeton.edu/titles/9929.html">research</a> has suggested banks have nothing to be concerned about from capital regulation as it doesn’t affect the value of a firm.</p>
<p>They conclude that capital regulation in general, and the increase of regulatory capital in particular, has no impact on financial institutions’ performance or operations such as lending. Increases in capital requirements can increase financial system stability without creating additional costs, they say.</p>
<p>However, the banking sector has not supported this theory and the interaction between capital and bank efficiency remains unclear.</p>
<p>The risk-neutral leverage ratio complements risk-based capital ratios and liquidity ratios as a third key regulatory tool. The leverage ratio is very controversial in the industry for a variety of reasons. </p>
<p>For capital requirements, the leverage ratio introduces a relative floor and hence fixed costs for banking assets. Risk-reducing, risk-free and low risk activities may be charged with higher capital than indicated by the risk-based capital ratio, which may set counter-intuitive incentives for banks. In other words, because the leverage ratio doesn’t take into account risk profile, banks may have an incentive to hold riskier assets. </p>
<p>Also, the leverage ratio conflicts with liquidity ratios. This is because banks often hold assets for liquidity reasons and would face an extra charge, from the leverage ratio, for having these risk-reducing investments. The same would apply to other risk-offsetting but asset-positive - and hence capital increasing - strategies.</p>
<p>Banks argue that regulation, and in particular the leverage ratio, limits their efficiency with the result being a lower supply of credit and/or higher prices on consumer and corporate loans.</p>
<p>Trade letters of credit have been identified as an areas that may be most impacted by the increased leverage ratios. It comes to no surprise that Jamie Dimon, chief executive of JPMorgan Chase, estimates the cost of trade finance would increase by up to 75 basis points. This number is extremely large relative to current bank spreads and may be interpreted as a direct cost of regulation. </p>
<p>If other products incur similar costs of regulation, then the additional annual cost on the US financial industry may be in the area of US$100 billion (based on total banking assets of approximately $17 trillion). These costs would have to be balanced with the benefits of a more resilient financial system. The recent global financial crisis has led to major costs for financial institutions, their stakeholders and last but not least taxpayers.</p>
<p>With the trade-off between efficiency and the resilience of banks unclear, careful consideration will be needed.</p><img src="https://counter.theconversation.com/content/25486/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>A plan by US regulators to impose greater capital requirements on the nation’s eight biggest banks has prompted complaints it will put the banks at a global disadvantage. The proposal is that the banks…Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/254372014-04-10T20:42:08Z2014-04-10T20:42:08ZIs Australia’s financial system a zero sum game?<p>Governments seem to be enamoured with financial markets, judging by the support they give them around the world to encourage their growth. The assumption seems to be that there’s always a positive relationship between the size of the financial system and its contribution to the economy.</p>
<p>This assumption that bigger is always better is one that Australia’s <a href="http://fsi.gov.au/">financial system inquiry</a> would do well to test as it considers “how the financial system could be positioned to best meet Australia’s evolving needs and support Australian economic growth”.</p>
<p>Among the questions that could be asked are whether the growth of the financial system has worked to the betterment of anybody other than those working in the industry – the answer to which is, perhaps not.</p>
<p>Therefore the starting point for the inquiry, led by former Commonwealth Bank of Australia chief David Murray, should be to evaluate the current state of Australia’s financial system and to focus on how it can be made “leaner and keener”.</p>
<h2>Unfettered growth</h2>
<p>Early analysis of a link between the growth of the financial system – something now referred to as “financialisation” – and economic growth was mixed, but by the mid-90s <a href="http://www.cedeplar.ufmg.br/economia/disciplinas/ecn933a/crocco/Teorias_neoclassicas_financia%20mento_desenvolvimento/LEVINE,%20R.%20Financial%20development%20and%20economic%20growth%20views%20and%20agenda.pdf">it was accepted</a> that there was a positive correlation between financial development and economic growth.</p>
<p>In the two decades since then, however, there has been unprecedented growth in the financial sector, both in terms of size and in the remuneration of those working within the industry and questions have begun to be asked about whether this financialisation has been to the betterment of anyone other than those working in the industry.</p>
<p>In the United States, the sector’s share of GDP <a href="http://www.people.hbs.edu/dscharfstein/Growth_of_Modern_Finance.pdf%20">grew from 4.9% in 1980 to 8.3% in 2006</a>, while its share of total corporate profits grew from 14% in 1980 to 40% by 2003.</p>
<p>As for the size of the finance sector in Australia, <a href="http://www.theaustralian.com.au/business/opinion/bis-warns-australias-finance-sector-is-too-big-for-our-economy/story-e6frg9qo-1226453650458">the Bank of International Settlements estimates</a> it now accounts for 11.5% of total “value add” in the national economy, a figure that has doubled since the mid-1980s. </p>
<p>This compares with the 2008 peak of 7.7% in the US and 10.4% in Ireland – and of course we all know what happened to those economies. The BIS researchers believe 6.5% may be the point where the financial system’s size <a href="http://www.bis.org/speeches/sp120625.pdf">“turns from good to bad”</a>.</p>
<p>This growth in size of the financial sector has been matched by the growth in remuneration of those working in the sector. Until the 1980s, salaries in the financial services industry <a href="http://people.virginia.edu/%7Ear7kf/papers/PR_JEP_publlished.pdf">were comparable to those in other industries</a>, but now the average salaries of those working in finance in the US are on average 70% more than those in other industries.</p>
<p>It was in 2005 that Raghuram Rajan – then chief economist at the International Monetary Fund but now Governor of the Reserve Bank of India – first publicly posed the question of whether economies were actually benefiting from financialisation. He suggested the development of the financial system was in reality causing economies to be more risky.</p>
<p>Rajan was dismissed at the time, but subsequent events suggest closer attention should have been paid to what he was saying.</p>
<p>A number of studies since then have added to the concerning picture he began to paint. Perhaps the most <a href="http://sirc.rbi.org.in/downloads/4Cecchetti.pdf">telling study</a>, published in 2012, found that the large and fast growing financial sectors in developed economies were having a clear, negative impact on productivity and economic growth. </p>
<p><a href="http://courses.umass.edu/econ711-%20rpollin/Orhangazi%20financialization%20in%20CJE.pdf">Other research has concluded</a> there is a negative relationship as “real” investment is crowded out by the increasing size and profitability of financial investment.</p>
<p>Even in Australia, Reserve Bank Governor Glenn Stevens has <a href="http://www.rba.gov.au/speeches/2010/sp-gov-170810.html">pondered</a> “whether all this growth (in finance) was actually a good idea; maybe finance had become too big (and too risky).” Similarly Andy Haldane from the Bank of England has questioned the financial sector’s economic contribution, pointing to “its ability to both invigorate and incapacitate large parts of the non-financial economy”.</p>
<h2>Efficient, or just big?</h2>
<p>What of the supposed benefits of the growth in financial markets? It could be expected that larger markets would mean lower unit costs for financial services, as happens with efficiencies of scale in other industries. Instead, it seems unit costs have actually increased over the last three decades <a href="http://pages.stern.nyu.edu/%7Etphilipp/papers/Finance_Efficiency.pdf">and are higher now than they were in 1900</a>.</p>
<p>Researchers such as Thomas Philippon of Stern Business School have also examined whether financialisation has resulted in “better” pricing and therefore more efficient allocation of capital. </p>
<p><a href="http://pages.stern.nyu.edu/%7Etphilipp/papers/BaiPhilipponSavov.pdf">They found</a> that despite a four-fold increase in spending on “price discovery” and a large decrease in the costs of information processing, there is absolutely no evidence that pricing in markets is more informed. Despite US funds management fees rising 141 times between 1980 and 2010, there is <a href="http://www.umass.edu/preferen/You%20Must%20Read%20This/MalkielJEP2013.pdf">no evidence</a> of an improvement in pricing in equity markets or of added value for clients.</p>
<p>The bulk of the submissions to Australia’s financial system inquiry, <a href="http://www.bankers.asn.au/Media/Media-Releases/Media-Release-2014/Financial-System-must-support-Australia-s-continued-economic-growth">like this one from the Australian Bankers’ Association</a>, will undoubtedly seek opportunities for further growth and greater subsidies for the financial sector.</p>
<p>Who is more likely to be heard? Economics writer Ross Gittins <a href="http://www.smh.com.au/business/less-fancy-financial-footwork-please-20140330-35rrg.html">fears the financial institutions will win out</a>, especially with the inquiry being chaired by someone who led an institution that benefited so greatly from the financialisation of the Australian economy, and who has a history of opposing what is not in the direct interests of these institutions (like removing the <a href="http://www.theaustralian.com.au/business/financial-services/inquiry-chair-david-murray-backs-four-pillars-policy/story-fn91wd6x-1226827686755">four pillars policy</a> and <a href="http://www.afr.com/p/business/financial_services/bank_levy_tax_on_whole_economy_says_Arbu3M9kVMRER0RnGKrl7K">a levy on banks</a>).</p>
<p>The fear is that the starting premise for the inquiry will be that everything is fine and more is better.</p><img src="https://counter.theconversation.com/content/25437/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>Governments seem to be enamoured with financial markets, judging by the support they give them around the world to encourage their growth. The assumption seems to be that there’s always a positive relationship…Ronald Bird, Professor of Finance, University of Technology SydneyJack Gray, Adjunct Professor of Economics, University of Technology SydneyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/253802014-04-09T20:44:04Z2014-04-09T20:44:04ZThe case for the Reserve Bank to swallow APRA<figure><img src="https://images.theconversation.com/files/45912/original/2thgdzhb-1397006875.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">The Reserve Bank's mandate is much broader than that of prudential regulator, APRA.</span> <span class="attribution"><span class="source">ArchivesACT/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span></figcaption></figure><p>One of the major recommendations made by the 1997 Wallis Inquiry into banking was to establish a prudential regulator for the financial sector separate from the Reserve Bank of Australia. The new regulator, APRA, became the prudential regulator for banks, superannuation funds and insurers.</p>
<p>APRA’s subsequent track record has been mixed. There have been two major regulatory failures, the collapses of HIH and Bankwest. On the other hand APRA is usually given an important part of the credit for the robustness of the Australian financial system during the financial crisis.</p>
<p>While there would be no argument today over a role for prudential regulation, the case for having a separate prudential regulator is less clear. It is hard to know whether the outcomes during the crisis would have been different if APRA had been established within the RBA rather than outside.</p>
<p>Some of the disadvantages of having a separate, specialist regulator are clear. </p>
<p>To start with, APRA’s terms of reference are much narrower than the Reserve Bank’s.</p>
<p>APRA’s function is to promote financial system stability in Australia, balancing “the objectives of financial safety and efficiency, competition, contestability and competitive neutrality”.</p>
<p>The expectations for the Reserve Bank go further:</p>
<blockquote>
<p>It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:</p>
<p>a. the stability of the currency of Australia;</p>
<p>b. the maintenance of full employment in Australia; and</p>
<p>c. the economic prosperity and welfare of the people of Australia.</p>
</blockquote>
<p>As I elaborate in my <a href="http://fsi.gov.au/files/2014/04/Maddock_Rodney.pdf">submission</a> to the Murray inquiry, APRA takes many decisions which it feels are justified on prudential grounds, but which have significant impacts on competition, efficiency, transparency, distribution and economic growth. These arise quite directly from its narrow terms of reference. It seems likely that it would make different decisions if it had a broader set of objectives. </p>
<p>And obviously having two regulators rather than one adds to the direct costs of their operations, and increases the compliance cost for institutions having to liaise with two separate institutions. There are probably economies of scale in regulation.</p>
<p>What are the benefits of having a separate prudential regulator? The most obvious is that we get more focus on prudence than we might in a generalist regulator. Quite possibly we get better quality decisions as a result, but it is very hard to tell. The UK has actually moved prudential regulation back into its central bank because of the poor quality of the decision making in its specialist prudential regulator. Separation does not appear to guarantee quality.</p>
<p>As we look to the future it’s not clear that having an institutional regulator like APRA is the most appropriate. Technology seems to be working to divert an important set of transactions away from (prudentially regulated) institutions, and activity has long been expected to migrate from banks and similar institutions towards financial markets. An institutionally-focused regulator might be fighting the last war.</p>
<p>For me the strongest argument for maintaining a separate prudential regulator has to do with the potential for appeals against its decisions. Many regulated firms have the scope to appeal the decisions taken by their regulators. While it does not seem desirable that the Reserve Bank’s interest rate decisions should be appealed, there is clearly scope to have appeals against decisions taken by APRA.</p><img src="https://counter.theconversation.com/content/25380/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Rodney Maddock consults to a range of financial sector institutions and has a grant from CIFR for work on regulation in finance.</span></em></p>One of the major recommendations made by the 1997 Wallis Inquiry into banking was to establish a prudential regulator for the financial sector separate from the Reserve Bank of Australia. The new regulator…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/252752014-04-08T20:09:02Z2014-04-08T20:09:02ZWhy your bank account should come with a risk rating<figure><img src="https://images.theconversation.com/files/45753/original/5hkxtwxx-1396852018.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=496&fit=clip" /><figcaption><span class="caption">All banking comes with risk, but it could be better disclosed.</span> <span class="attribution"><a class="source" href="http://www.shutterstock.com">Shutterstock</a></span></figcaption></figure><p>What is the interest rate on your savings account? If you don’t know, you can easily find out. Banks advertise their rates prominently. They want you to know what they’re offering. After all, the interest rate is the price a bank pays you for your savings.</p>
<p>Now ask yourself: What level of risk is your bank taking in order to generate these interest payments?</p>
<p>Banking is an inherently opaque industry. Even credit rating agencies struggle to reach a consensus when it comes to pricing bank risk. This is why the banking sector is subject to an additional layer of regulation, known as prudential regulation.</p>
<p>It is the Australian Prudential Regulatory Authority’s (APRA) job to examine the books of each Australian bank, assessing its overall risk of failure. We never learn the outcome of APRA’s investigations. APRA uses its statutory powers to prevent its assessments from becoming public. Instead, APRA prescribes minimum standards for banks, and helps a bank to restructure its assets if its risk of failure is too high.</p>
<p>The existing system of prudential regulation results in a “one size fits all” banking system. The regulator determines the maximum level of risk that a bank can carry. Because banks generate returns by taking risks, the regulator is effectively capping the interest rates available on savings accounts. As a consequence, there is little difference between the products being offered by Australia’s banks.</p>
<p>So, what is the alternative?</p>
<h2>APRA should empower savers</h2>
<p>In a recent <a href="http://fsi.gov.au/files/2014/04/Byford_Martin_submission.pdf">article</a> published in Economic Papers, Sinclair Davidson and I argue that APRA should use the information it gathers to empower depositors. We propose that APRA assign each bank a “Financial Stability Rating” (FSR) — a number out of 100 — based on its overall risk of failure. Under our proposal the FSR would be linked to the Deposit Insurance Scheme. In the event of a bank failure, the scheme would guarantee a percentage of each deposit equal to the bank’s FSR. If, for example, you had A$10,000 deposited in a bank with a rating of 87, $8,700 of your funds would be protected.</p>
<figure class="align-right ">
<img alt="" src="https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=237&fit=clip" srcset="https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=600&h=600&fit=crop&dpr=1 600w, https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=600&h=600&fit=crop&dpr=2 1200w, https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=600&h=600&fit=crop&dpr=3 1800w, https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=45&auto=format&w=754&h=754&fit=crop&dpr=1 754w, https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=30&auto=format&w=754&h=754&fit=crop&dpr=2 1508w, https://images.theconversation.com/files/45754/original/tcn28kf6-1396852055.jpg?ixlib=rb-1.1.0&q=15&auto=format&w=754&h=754&fit=crop&dpr=3 2262w" sizes="(min-width: 1466px) 754px, (max-width: 599px) 100vw, (min-width: 600px) 600px, 237px">
<figcaption>
<span class="caption">Bank statements don’t tell the full story.</span>
<span class="attribution"><span class="source">Finnur Magnusson/Flickr</span>, <a class="license" href="http://creativecommons.org/licenses/by-nc/4.0/">CC BY-NC</a></span>
</figcaption>
</figure>
<p>Our proposal links the returns a depositor receives to the risks a bank takes on the depositor’s behalf. If a bank wants to increase the interest rate it offers on deposits, it must increase its holdings of risky assets such as unsecured loans. In turn, this results in a lower FSR, meaning that depositors will lose a greater fraction of their saving in the event that the bank collapses. In this way, depositors are given an incentive to consider both sides of the risk-reward trade off when selecting a bank.</p>
<p>Of course, the incentives work both ways. Banks requires deposits. Therefore, our proposal provides banks with the incentive to tailor their products to match the preferences of depositors.</p>
<p>Depositors who are primarily concerned with the security of their savings will favour banks with high FSRs. In order to compete for these deposits banks would have to reduce their risk above the minimum standard dictated by the regulator. In effect, competing to be safe.</p>
<p>Of course, there will be other depositors who are willing to risk a portion of their savings in return for a higher interest rate. It’s likely some banks will structure their products to target these consumers. Overall, we would expect to see a greater variety of products on offer.</p>
<h2>Benefits for all</h2>
<p>Our proposal has a number of other advantages. First, it would likely reduce the cost of the <a href="http://www.guaranteescheme.gov.au/qa/deposits.html">deposit insurance scheme</a>. On the one hand, banks competing to be safe are less likely to fail. On the other hand, the insurance scheme has reduced liability when a bank decides to carry a higher level of risk.</p>
<p>The scheme also has benefits for individuals and institutions who hold bonds or shares issued by a bank. Bondholders and shareholders are not protected by deposit insurance. Nevertheless, their investments are on the line if the bank fails. Providing investors with greater certainty about a bank’s behaviour would help financial and stock markets to better price the associated risk.</p>
<p>Finally, we believe our proposal would help free up credit to marginal borrowers. Our scheme allows banks to match depositors with a preference for high-risk/high-return investments, with borrowers with limited access to credit. In this way, we expect our proposal would promote the establishment and expansion of small businesses, in particular, with the consequent advantages to employment and economic growth.</p><img src="https://counter.theconversation.com/content/25275/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Martin Byford 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>What is the interest rate on your savings account? If you don’t know, you can easily find out. Banks advertise their rates prominently. They want you to know what they’re offering. After all, the interest…Martin Byford, Lecturer, Economics, RMIT UniversityLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/250802014-04-03T19:49:08Z2014-04-03T19:49:08ZBuilding a financial system for a cashless age<p>If the Financial System Inquiry is to achieve its aim of helping to promote growth and productivity in the Australian economy it will need to focus strongly on electronic payments. </p>
<p><a href="http://fsi.gov.au/consultation/">Submissions</a> to the inquiry will be officially released today, offering several pieces of advice for FSI chairman David Murray on how to promote competition in the system and how technology is affecting and changing it. </p>
<p>Electronic payments is one area where both increases in productivity and promotion of competition could be achieved via the FSI, but to do so Murray will need to guide the sector towards true competitive neutrality.</p>
<p>The increased use of electronic payments and consequent reduction in the use of cash facilitates economic growth, according to recent <a href="http://mastercardcenter.org/article/2014/03/E-payments-and-Economic-Activity-in-Australia.pdf">research</a> from Melbourne University. This is because electronic payments are less costly then non-electronic payments, and this applies for all participants in the payments value chain including consumers, businesses and government. </p>
<p>This Australian research is reinforced by similar studies conducted in Canada, Germany, South Africa and the US, which all underline the costs of cash in both developed and emerging economies and highlight the positive role that electronic payments play, in both increasing economic activity and heightening levels of consumer empowerment and choice. </p>
<p>Daniel Mminele, deputy governor of the South African Reserve Bank has <a href="http://www.gov.za/speeches/view.php?sid=43818">claimed</a> that every 1% increase in payment card use would increase consumption by 0.06% and GDP by 0.03%, as this would mobilise household savings and hence productive opportunities.</p>
<h2>The NBN of payments?</h2>
<p>In Australia the Reserve Bank has encouraged the development of a real-time payments infrastructure, which will be the banking equivalent of the National Broadband Network in that it will allow fast electronic payments for both consumers and business and hence more immediate availability of funds. </p>
<p>It has been described as the “rail tracks” which will provide the infrastructure upon which instant payments can be made. It is also designed to lower the network barriers to entry, opening up competition in payment services, particularly for new payment startups. These could include Apple and Google, who could use their brand recognition to potentially enter the retail banking market, without having to build a branch network.</p>
<p>The possible entry of new players into the financial services market has the industry debating the regulatory framework under which all participants, both new and existing, will have to operate. </p>
<p>The <a href="http://fundingaustraliasfuture.com/regulatingtheaustralianfinancialsystem">Funding Australia’s Future Project</a>, released in July 2013 by the Australian Centre for Financial Studies (ACFS), considered the appropriate balance between stability and efficiency within the Australian financial sector. It concluded that “regulation should not impede competition and the efficiency of markets”, that “the regulatory system should also have a brief for neutrality” and that “one sector is not favoured over another at the expense of competitive forces”.</p>
<h2>Differing agendas</h2>
<p>In their submissions to the FSI, Australia’s regional banks and non-bank lenders have called for a “level playing field”, to reduce the advantages that the big banks have gained from the regulators’ focus on stability in the system.</p>
<p>They also argue that consumers should be empowered to switch deposit accounts and mortgages more easily between providers. The Consumer Owned Banking Association (COBA), which represents credit unions and building societies in Australia, has also argued for “competitive neutrality” and has described regulation of the financial sector as being, “overly prescriptive and inconsistent”.</p>
<p>One example of this inconsistency is in the payments system market where the regulator, the Reserve Bank of Australia, has intervened extensively since 2002. These interventions have been largely focused on the payment card acceptance marques of MasterCard and Visa and they are described in detail in a paper, Regulatory Interventions and their Consequences in the Australian Payment Card System, released by the ACFS in October 2013. </p>
<p>Other payment card acceptance marques, such as American Express and Diners Club have received far less regulatory attention and this has led to distortions in the market, which it could be argued have driven up the costs of paying by payment cards for consumers. </p>
<p>An additional aspect of this absence of competitive neutrality is the lack of any meaningful regulation of new and emerging entrants into the payments market. As an example, PayPal now competes against the traditional payment card players and yet it is not regulated as regards the fees that it charges, nor does it have to bear the same compliance costs of regulation. </p>
<p>The FSI therefore represents a good opportunity to achieve competitive neutrality in all the financial services markets, and achieve the economic growth and productivity gains that are embedded in its terms of reference and which would benefit all sectors of Australian society.</p><img src="https://counter.theconversation.com/content/25080/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>Steve Worthington 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>If the Financial System Inquiry is to achieve its aim of helping to promote growth and productivity in the Australian economy it will need to focus strongly on electronic payments. Submissions to the inquiry…Steve Worthington, Adjunct Professor, Swinburne University of TechnologyLicensed as Creative Commons – attribution, no derivatives.tag:theconversation.com,2011:article/250222014-04-02T19:46:55Z2014-04-02T19:46:55ZBanks want you to pay less tax on interest, but why?<p>Australia’s big banks want the government to give their customers tax breaks on interest income, <a href="http://www.afr.com/p/business/sunday/tough_bank_rules_may_hit_growth_pNJaEIG9tHAWZdOd9JnqwJ">having told the Financial Systems Inquiry it would encourage more savings</a>. In turn, the banks will have access to greater deposits to lend as the economy recovers.</p>
<p>But this isn’t selfless concern for their customers. Deposits from savings are by far the cheapest source of lending capital for banks. The winners will be taxpayers who have money to place in a bank deposit, and the banks themselves. </p>
<p>The loser is the government, especially at a time when it would appear to need every tax dollar it can obtain.</p>
<h2>A long time coming</h2>
<p>The 2010 Henry Tax Review <a href="http://taxreview.treasury.gov.au/content/downloads/final_report_part_1/15_AFTS_final_report_chapter_12.pdf">recommended</a> that income tax treatment of household savings could be improved by applying a 40% discount to most interest income. </p>
<p>The review identified the fact inflation erodes the real return on interest paid to deposit holders, and that income tax would further reduce the real return, would be a disincentive for savings.</p>
<p>For instance, if $10,000 is placed in a term deposit with a bank and the interest rate paid on the deposit is 4%, then the return is $400 per year. With inflation at 2% and income tax at 20%, the real return is 80% of $200, $160 or a 1.6% return. This isn’t a great incentive for taxpayers to deposit money with banks.</p>
<p>A 40% discount on tax payable on interest would place the taxpayer in a position where the return on their investment would be adjusted for the effects of inflation. </p>
<p>But if the Australian Bankers’ Association had its way, the interest would be tax free and investors would have an incentive to deposit money with the banks. The government could also adopt the Henry Tax Review’s less generous recommendation, which would also provide taxpayers with an incentive. </p>
<p>Short lived tax savings measures for bank deposits were introduced by the Howard government, but at present, the only tax benefit for saving is with first home buyers saving deposits with banks where the government co-contributes up to a certain level. </p>
<p>These earlier attempts to attract savings failed because of a combination of restrictions on the amount deposited and competition from shares and property as an investment option.</p>
<h2>A question of capital</h2>
<p>Australian banks are finding themselves borrowing from overseas to have sufficient capital to lend. They pay interest on those funds at the LIBOR rate plus a margin depending on their credit rating, which by world standards is very high. The current borrowing rate for one year is approximately 2.7%. This money is then lent to domestic customers at various interest rates which reflect the risk associated with the customer and the project to be undertaken. </p>
<p>And the process is expensive, far more so than simply lending capital raised through bank deposits made by Australians, where the rate is approximately 2.6%. So if the Australian Bankers’ Association’s proposal is taken on board by the government, banks could save a great deal of money.</p>
<p>Still, there are a number of issues to be considered. First, the amount of revenue collected by the government in the form of income tax will be reduced and this could be substantial if many people deposited money with banks and no tax was paid on the interest. </p>
<p>Reserve Bank <a href="http://www.rba.gov.au/publications/bulletin/2012/dec/3.html">figures</a> show Australian households have around $700 billion in directly held interest-bearing deposits. This would make yearly interest around $17.5 billion (at a rate of 2.5%). A very rough calculation shows that if the assumed tax rate was 30%, then the revenue loss would be around $5 billion a year. This may be a hard sell when the budget is in deficit.</p>
<p>Second, non-taxpayers such as self-funded retirees and those investors earning less than $18,200 will obtain no direct advantage from the tax free interest. </p>
<p>And third, would the banks be prepared to compensate the government for the loss of revenue by paying a super profits tax on the economic rent gained from this extra money that has been deposited into their bank accounts? Probably not.</p>
<p>All of the recommendations made by the Henry Tax Review deserve to be considered by all governments in Australia. A tax incentive to save money is a very worthwhile objective. Giving Australian banks access to the best form of capital available to them, namely bank deposits, is again a worthwhile objective. </p>
<p>But why not require the banks to give something back to the community and the investors by imposing a rent tax on their super profits along the lines of a resource rent tax, another worthwhile recommendation by the Henry Tax Review. </p>
<p>Could it be that big Australian banks are just blatant rent seekers and this is another method by which they can extract even more “super profits”? </p><img src="https://counter.theconversation.com/content/25022/count.gif" alt="The Conversation" width="1" height="1" />
<p class="fine-print"><em><span>John McLaren 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>Australia’s big banks want the government to give their customers tax breaks on interest income, having told the Financial Systems Inquiry it would encourage more savings. In turn, the banks will have…John McLaren, Senior Lecturer, University of WollongongLicensed as Creative Commons – attribution, no derivatives.