How will the shape of Australia’s financial sector evolve over the coming decades? How will the demand for finance change? Where will the supply of funds come from? Can we be confident that available funds will be allocated to their best uses to promote economic growth and wellbeing? Will the current spate of regulatory change help or hinder in this process?
These are the sorts of questions that the Funding Australia’s Future project launched by the Australian Centre for Financial Studies seeks to answer. Of course, forecasting the future is hazardous. While some might call it a mug’s game, if you’re wrong at least that won’t be found out for some time.
But there are some clues to what might happen, which can be found by examining recent trends and asking whether they are likely to continue. And while the recent history of the financial sector has been tumultuous — more so overseas than here — there are several fundamental changes that will help shape the future evolution of the sector.
A major one, on which I will focus here, is the growing importance of the superannuation sector and the potential changes that may bring or necessitate. Compulsory super (and other tax incentives) mean that household savings are being channelled away from banks and into super. That is a long-run trend affecting the composition of household asset portfolios, but one which is somewhat hidden in the short run because of the role of bank deposits as money. (For example, if part of my wages is paid into a super fund the super fund holds those funds temporarily in a bank deposit rather than them being in my bank deposit account). And the nervousness induced by the global financial crisis (GFC) certainly caused short-run disruptions to longer run trends – and diverted our attention from those trends.
The long-run growth of super relative to bank deposits has several significant implications. We tend to think of banks as facilitating wealth creation and creating new financial assets by making loans and assisting businesses to raise funds through issue of debt and equity securities. Super funds, on the other hand, have tended to be investors in existing financial assets.
But if banks are getting are fewer funds by way of deposits, how will they create the financial assets needed for super funds to invest their growing pool of savings in? What adjustments to the roles of banks and super funds and what new financing techniques might we see?
One possibility might be for banks to reverse the post-GFC trend and raise more funds from wholesale financial markets, including overseas. However, both regulatory developments (the Basel 3 capital and liquidity requirements) and greater recognition of the risks in such strategies are likely to inhibit such a development, suggesting a decline in traditional intermediation (banks taking deposits and making loans) relative to other financing techniques.
Another possibility is for banks to raise the funds needed for making loans from super funds, either via offering new deposit-type products or other investment options, such as debt and hybrid securities or covered bonds). This will happen, particularly in dealing with the rapidly growing self-managed super funds sector. But recent regulatory developments regarding bank liquidity requirements (albeit still subject to change) militate against banks relying on deposits from institutional super funds because they are seen as a less stable source of funding.
However, such “traditional” intermediation seems likely to decline in importance relative to capital market alternatives for facilitating financing – partly because of the impact of regulatory changes, but also because advances in technology and information are likely to reduce past advantages of the intermediation approach. So, we should expect to see some of the following. Banks will take on a larger “investment banking” role – taking business customers to the capital market to raise funds via equity or bond issues. Banks will also originate loans, but on-sell them as capital market instruments (such as what occurs in securitisation) to investors.
And a more fundamental change is possible. Superannuation funds could move more into the business of creating new financial assets for their own investments by, for example, making loans. That could be done either by developing in house expertise, or partnering with other specialists. Indeed, it could be asked whether super funds might not become home mortgage lenders.
Except in the case of small business relationship lending to customers it is not clear what absolute advantages banks retain in this activity over other potential providers of such loans, given developments in technology and information.
Possibly the greatest development that is yet to play out is prompted by the fact that super savings represent a very large and growing pool of illiquid savings. Traditionally, one of the economic functions of banks has been seen to be the provision of liquid deposits for savings, which are then used to make illiquid loans. But now we have the large supply of illiquid super savings which, paradoxically, is invested primarily in liquid investments. While there are reasons for super funds to need some liquidity, this anomaly warrants attention and presents opportunities.
That is particularly so, given that one of the major perceived areas of inadequate economic investment is in infrastructure – long run illiquid assets with return characteristics arguably suitable for super fund portfolios. Identifying ways of facilitating funding of such illiquid investments via illiquid savings in super funds, and capturing the “illiquidity premium” on such investments for superannuants, without reducing expected super fund returns or increasing risk, is one of the challenges to be taken up in the next stage of the Funding Australia’s Future project.