Chapter 11
- The prudential supervision of financial
intermediaries and their social
obligations - 2010
11.1 There seems to be a broad consensus that
good supervision played an important role in Australian financial
intermediaries coming through the GFC without the need for the
government bailouts and takeovers seen in many other countries. There
are questions, however, about
whether current or prospective supervisory rules could inhibit
competition.
11.2 The Australian Prudential Regulation
Authority (APRA) described its role in the financial system as follows:
Our
mandate is to promote the sound and prudent management of the
institutions we supervise so that, in the case of deposit taking,
the institutions meet their promises to depositors under all
reasonable circumstances.[1]
11.3 Institutions wishing to raise deposits
from the public require authorisation from APRA. They are hence known as
'authorised deposit-taking institutions' (ADIs). They comprise banks
(domestic banks and subsidiaries and branches of foreign banks),
building societies and credit unions.[2]
11.4 In general, the prudential framework
does not raise issues of competitive neutrality between different types
of ADIs:
...the
prudential framework in Australia applies with few exceptions to
banks, building societies and credit unions equally. Where it does
not, there are prudential policy considerations—long-standing in one
case—that justify a degree of differentiation. Overall, APRA does
not consider that the prudential framework or its risk based
approach to supervision acts as an impediment to a competitive
banking system in Australia.[3]
In sum, APRA does not consider that its
prudential framework for ADIs or its supervisory approach is a
material factor in the competitive balance between different types
of ADIs.[4]
Competition and stability
11.5 A claim frequently made during the
inquiry was that the goals of stability and competition are conflicting.
One stark example was the Westpac CEO's statement:
There is a trade-off between competition and
stability, and getting that balance right is crucial.[5]
11.6 Yet not a minute before, she had
claimed:
...the Australian banking sector is highly
competitive. It is also strong and stable.[6]
11.7 Asked to elaborate, she postulated:
There are examples one can look at where a
heightened competitive environment has led to some very poor
practice and some very poor underpricing of risk, which has led to
instability.[7]
11.8 A perhaps more nuanced version was
offered by some prominent academic economists:
...in the US...that intensity of competition,
together with some issues of regulation, could be argued as a major
cause of the global financial crisis.[8]
...the whole point of financial regulation is
to achieve an appropriate balance between competitive efficiency and
system stability.[9]
Increased competition can also increase moral
hazard incentives for banks to take on more risk. Declining
profitability as a result of increased competition could tip the
incentives of bankers towards assuming greater risk in an effort to
maintain former profit levels.[10]
11.9 At one extreme, there is a trade-off
between competition and stability:
...a monopoly bank would be very profitable,
and therefore robust in a crisis, but would be unlikely to provide
low-cost or innovative products to its customers.[11]
11.10 Treasury warned that competition
concerns need to be balanced with concerns about stability:
...there is going to be a trade-off there
between ensuring a safe, secure and stable financial system versus
competition.[12]
11.11 This seems somewhat at odds with
their earlier view that:
Stability and confidence are important
underpinnings for efficient, competitive markets.[13]
11.12 The competition authority's view is
that:
It is the prudential requirements that bring
about stability, not the adjusting up or down of the competition
level.[14]
11.13 A British consultant not only
claimed there was a trade-off between competition and stability but
purported to quantify it (Chart 11.1):
Bain & Company calculates that the cost borne
by taxpayers from an unstable banking industry is more than £1,000
per annum per head—mainly as a result of reduced output and higher
unemployment. By contrast, regulators inclined to view the UK
banking market as insufficiently competitive would be hard pressed
to identify the cost of this to customers as more than £200 per
annum per head. Those taxpayers and customers are, broadly speaking,
one and the same.[15]
Chart 11.1: Costs of instability versus
suboptimal competition
Source: Bain & Co, 'Getting bank competition right
post-crisis', provided by Commonwealth Bank of Australia, Additional
information no. 7, 23 December 2010.
11.14 Choice opined:
... financial stability does not have to be
pursued at the expense of competition or to the detriment of
consumers.[16]
11.15 A new market entrant suggested:
... stability is fundamental to a properly
functioning banking system, but that is not mutually exclusive with
conditions which foster competition.[17]
11.16 APRA's perspective is that:
We are required under our legislation to
balance this objective of financial safety with efficiency,
competition, contestability and competitive neutrality. Beyond that,
we do not have any specific responsibility for competition in the
deposit-taking sector. Of course, having prudently managed and well
capitalised deposit-taking institutions surely lays the foundations
for sustainable competition. Unless APRA are overzealous—and I do
not believe we have been—there need be no difficult trade-offs
between financial safety and competition over the longer term.[18]
11.17 The reference APRA make to
sustainable competition is important. The type of competition, such
as lending on very thin margins, that occasionally arises and causes
problems for stability is unsustainable competition. It is this
unsustainable competition which regulators such as APRA seek to avoid
occurring. As APRA remarked:
...in the period 2002-03 we did see quite
strong competition in housing lending which took the form of a
dilution of credit standards, and that was a form of competition
which we were uncomfortable with... there was just a competitive
pressure to meet the customer by finessing, overriding or changing
strong credit standards in some cases and it was an issue that we
were vocal about at the time. That is competition which does raise
prudential concerns. And of course if you look at the subprime
experience in United States, you will see that whole problem writ
very large.[19]
Are the major banks 'too big to fail'?
11.18 There is a common view around the
world that large banks are 'too big to fail'. Usually regulators avoid
explicit statements to this effect, but in the US, following the
insolvency of Continental Illinois in 1984, the Comptroller of the
Currency testified to Congress that the 11 largest banks were 'too large
to fail' and would be bailed out so that no depositor or creditor would
face a loss.[20]
11.19 In Australia the major banks appear
to be regarded as 'too big to fail', or more accurately 'too big for the
authorities to allow them to fail'.
I do believe that the four big banks are too
big to fail. There is no government that I could ever anticipate
letting one of those big major banks fail. The devastation to the
economy would be so great that no government could tolerate that. So
that does give those four big banks an implicit advantage—a
considerable implicit advantage.[21]
...no big bank will ever be allowed to fail to
meet any liability to its depositors or anyone else...[22]
...whatever the government might say,
financial markets perceive each of the Big Four to be too big to
fail and so protected by an (implicit) government guarantee.[23]
...they are systemically important and too big
to fail.[24]
The big four banks are able to raise funds
much more cheaply on international wholesale markets. This is, in
large part, due to the perception that the banks are ‘too big to
fail’ and therefore ultimately supported by the Commonwealth
Government. This situation entrenches the market power of the
dominant oligopolistic firms, and they are able to extract
significant returns which are then largely distributed to
shareholders and senior executives.[25]
11.20 The recent report by the UK's
Independent Commission on Banking highlighted the problems caused by
banks too big to fail:
Banks ought to face market disciplines without
any prospect of taxpayer support, but systemically important banks
have had and still enjoy some degree of implicit government
guarantee. This is the ‘too big to fail’ problem. Unless contained,
it gives the banks concerned an unwarranted competitive advantage
over other institutions, and will encourage too much risk taking
once market conditions normalise. It also puts the UK’s public
finances at further risk, especially given the size of the banks in
relation to the UK economy. On top of the taxpayer risk from bank
bail-outs, banking crises damage the public finances because of
their effects on output and employment. Indeed the problem could
arise in future that the banks are ‘too big to save’.[26]
11.21 Similarly a UK parliamentary
committee, inquiring concurrently into banking competition there,
warned:
We believe effective competition cannot take
place in an environment where firms which are perceived as ‘too
important to fail’ are both protected from the discipline of the
market place and derive tangible benefits from this status.[27]
11.22 If banks are indeed too big to fail,
this represents a, potentially very large, contingent liability for the
budget and hence the taxpayer:
The pre-GFC thinking was that banks should
consolidate and become big because there is an advantage in being
big. But the GFC very well demonstrated that a larger size is no
longer a desirable thing. As a matter of fact, larger sized banks
can become a permanent headache for the taxpayer because we do not
know when these guys are going to stuff it up and come back to the
taxpayer. So I have some concerns about the size of Australian
banks.[28]
11.23 The Commonwealth Bank rejected this
argument:
...we are a bank that does not take that view.
We are a bank that is run on the basis that we will not fail and the
‘too big to fail’ part does not come into it.[29]
11.24 Of course, the large banks overseas
that failed would have also said this could never happen.
11.25 There have also been references to
banks being 'too interconnected to fail'[30]:
...what led to the unravelling in the UK
banking market was not initially a large bank. It was Northern Rock,
which was a relatively small bank but had a significant systemic
impact on the UK economy...The issue does not really come down to
the size of the bank. I think any banking situation where a bank
fails has the potential to have flow-on impacts.[31]
11.26 These implicit guarantees may even
be stronger now than before the GFC:
Lehman Brothers—a small bank in the US—was
allowed to fail, and I do not think there is any doubt that, with
the benefit of hindsight, the US regulators and US government would
have bailed out Lehman Brothers had they realised what a
psychological impact it would have on the market for a relatively
small bank to collapse.[32]
11.27 Asked whether the major banks had
become 'too big to fail', APRA responded:
We never ever confess that any institution is
too large to fail. There is a marketplace at work there and we have
seen institutions around the globe that were household names that
have moved into government ownership in other markets. What we seek
to do is to minimise the risk that that will happen with any
institution of any size.[33]
Capital requirements presently
11.28 APRA has broadly adopted the
internationally agreed capital adequacy rules, under which ADIs must
hold capital equivalent to at least eight per cent of risk‑weighted
assets. The rules are developed by the Basel Committee on Banking
Supervision, at which APRA represents Australia. The current set of
rules, known as Basel II, provide for capital requirements to be
calculated using whichever is more appropriate of a default
'standardised' approach or a more complex, 'advanced' approach.[34]
11.29 It is sometimes claimed that the
capital requirements discriminate against smaller banks and mutual
financial intermediaries because the large banks are able to use the
'advanced' approach rather than the 'standardised' approach to
calculating required capital and so need to hold less capital against
home loans:
...we have to hold twice as much capital to
support a mortgage as what the major banks do because of the
different approaches we have to measuring our capital adequacy.[35]
Under Basel II the risk weighting given to
mortgages held by small ADIs is around twice that of the big four
banks...[36]
11.30 APRA responded:
To be able to use the advanced status you need
to have very sophisticated risk modelling, robust risk management
and quite deep extensive databases and then you can manage
housing-lending portfolios using a much more rigorous method. There
is a complete overlay of governance and controls on top of that. You
need to do that not just for your lending to housing but for how you
manage operational risk and how you manage interest rate risk on the
banking books. So to be called an advanced bank requires a very
comprehensive set of requirements... when we look at how it all
washes out, with all the various changes, it is not clear from our
evidence that there is a major difference in the impact of Basel II
between the advanced and standardised banks when you put it all
together.[37]
...approval is based on the ADI's capabilities
rather than its size.[38]
11.31 There are additional imposts
involved with the advanced approach too, not just benefits:
...advanced ADIs are subject to other capital
requirements that are not applied to ADIs adopting the standardised
approaches. For example, APRA requires advanced ADIs to hold capital
against interest rate risk in the banking book. APRA also currently
requires advanced ADIs to hold at least 90 per cent of the amount of
regulatory capital that was required under the original Basel
regime; standardised ADIs are not subject to such a limitation.[39]
11.32 In practice, the major banks as a
group do not appear to have gained a significant competitive advantage
from being able to use the advanced approach:
Broadly speaking, the implementation of Basel
II resulted in reductions of capital for advanced ADIs of between
zero and ten per cent, and averaged around five per cent for
standardised ADIs.[40]
11.33 Notwithstanding such assurances,
Heritage, Australia's largest building society, would like the current
arrangements changed:
Given that mutual building societies and
credit unions typically have significantly lower arrears rates for
their mortgages than those of the big banks, it is recommended that
the risk weighting for mortgages held by mutual building societies
and credit unions be aligned with that of the big four banks. This
initiative levels the playing field for smaller ADIs. It also frees
capital to allow mutual building societies and credit unions to grow
their share of the retail mortgage market more aggressively in
competition with the banks.[41]
11.34 There were also claims that the
capital rules are unduly harsh on small business loans:
...the Australian Prudential Regulation
Authority (APRA) should explore whether the risk-weightings on
business loans secured by residential properties are punitive.
Currently, APRA requires the banks to apply a risk weighting of
50-70 per cent for small business whereas regional banks have to
apply a risk weighting of 100 per cent for small business.[42]
11.35 As was noted in Chapter 6 (see Chart
6.4), small business lending incurs larger losses than do housing loans
and so it is justified for there to be a correspondingly higher amount
of capital held against small business loans than the concessional
amount required for housing loans. The Reserve Bank provides some
quantitative estimates:
...small business borrowers are more than
twice as likely as standard mortgage customers to default...once a
default has occurred, APRA statistics suggest that a lender is
likely to lose close to 30 per cent of the small business loan’s
value, compared with 20 per cent for housing loans.[43]
Other current prudential requirements
11.36 APRA also require ADIs to have an
adequate liquidity management strategy. Some smaller ADIs are exempted
from the more complex aspects of this.[44]
The mutual ADIs benefit from this. If they regard the simpler rules are
more costly, they can just not apply for the exemption.
11.37 APRA also have prudential
requirements covering governance, risk management, fitness and
propriety, large exposures, associations with related entities,
outsourcing and business continuity management; all of which apply
equally to banks and mutual ADIs.[45]
The new Basel III capital and liquidity
requirements
11.38 The international community has
responded to the global financial crisis by tightening the global
prudential standards governing capital and liquidity. The new measures
are known as 'Basel III' and will be phased in from 2013.[46]
11.39 APRA explained the benefits of these
reforms:
Basel III is underpinning the capital of the
banking system globally and it is also strengthening capital and
liquidity buffers in the global system. We are participants in the
global system.[47]
11.40 APRA does not expect the rules to be
unduly onerous for Australian intermediaries:
...APRA does not expect that the more
stringent global capital regime will have significant implications
for ADIs in Australia, which remained well‑capitalised throughout
the global financial crisis...the main impact of the Basel III
capital reforms will fall on the larger ADIs due to (i) their higher
usage of structured capital instruments that will no longer be
eligible as regulatory capital, and (ii) a larger impact from the
tighter definition of capital deductions. Overall, APRA does not
anticipate standardised ADIs being materially affected by the
capital reforms.[48]
11.41 Westpac explain their concerns about
the new Liquidity Coverage Rules (LCR) as follows:
Banks will also need to establish capacity to
survive a “run” on deposits for a month, rather than a week which
applied under the old standards. This will require them to hold more
liquid assets, which may limit funds available for lending to
customers and add to overall costs.[49]
11.42 APRA comment about these new
requirements:
There is no doubt that there are challenges
for our banks in meeting that standard but also it is not as though
our banks sailed through the crisis without any liquidity issues. We
know they needed the wholesale guarantee for offshore funding and
the deposit guarantee. There were various sorts of assistance that
were given to the banking system to help it through the crisis and
to help make sure that it was able to continue to operate in an
orderly fashion during the crisis. What the Basel III liquidity
requirements are about is trying to lessen the need for that public
sector support next time around. So it is not as though our banks
were as robust on the liquidity front as they might have been or
could say, ‘We don’t need any reform whatsoever on that side of
things.’[50]
11.43 The Basel III rules are designed to
restore confidence in global banking systems. In the longer term they
should reduce the cost of funds for Australian banks from those
prevailing since the GFC:
Over time when these new capital reforms are
bedded down globally if that underpins more confidence in global
banking systems you might like to think that some of those more
extreme risk premiums can come down.[51]
The challenge posed by the shortage of government
bonds
11.44 There is a problem that as
Australian governments have been running surpluses and smaller deficits
than most other economies represented on the Basel Committee, banks will
struggle to find enough bonds to meet the liquidity requirements.
11.45 One response would be to allow
highly rated RMBS to be counted as liquid assets. Unsurprisingly, this
idea appealed to the Australian Securitisation Forum and the banks:
...we would put that if residential mortgage
backed securities and certainly the higher rated tranches could be
held as eligible assets under the liquidity tests that Basel III
will introduce for Australian banks.[52]
...by accepting third party AAA RMBS paper
(currently eligible securities for repurchase transactions by the
RBA) as an asset under the new liquidity rules, this reform would
not only assist in rebuilding the primary and secondary
securitisation markets in Australia, but would also assist banks to
meet their obligations under the pending Basel III regulations...[53]
11.46 The problem with this idea is that
in the GFC the RMBS proved not to be liquid.[54]
This was conceded by the Forum and a regional bank:
...there is good liquidity when market
conditions are stable and favourable, and when markets become
stressed and disrupted that liquidity vanishes.[55]
Basel III has outlawed securitisation in terms
of being available for liquidity but you can understand why that
would be the case, because the performance of securitisation in
offshore markets has been abysmal.[56]
11.47 The best they could offer was the
hope that by APRA:
...deeming them to be acceptable as eligible
securities that then can create the liquidity perception that aids
the market.[57]
11.48 Another approach would be for the
Reserve Bank to issue its own paper to create a riskless liquid security
which banks could hold. Asked about this, the Reserve Bank responded:
Any debt issued by the RBA would be very
similar to that issued by the Government. If the RBA were to issue
its own paper to provide banks with additional liquid assets, the
RBA would need to consider which assets to purchase with the
proceeds of that debt issue. This would likely involve purchasing
private securities on an outright basis, thereby permanently
increasing the credit risk that the RBA it is facing. In contrast,
accepting private securities (including RMBS), on a repo basis
provides an extra degree of protection for the RBA. This is why
counting RMBS as an eligible liquid asset in the commercial banks’
portfolios is a less risky option than the RBA holding the paper
outright.[58]
11.49 In the event, there has been an
alternative arrangement put in place by APRA and the Reserve Bank to
deal with the problem:
The Reserve Bank of Australia (RBA) and the
Australian Prudential Regulation Authority (APRA) have agreed on an
approach that will meet the global liquidity standard. Under this
approach, an authorised deposit‑taking institution (ADI) will be
able to establish a committed secured liquidity facility with the
RBA, sufficient in size to cover any shortfall between the ADI's
holdings of high-quality liquid assets and the LCR requirement.
Qualifying collateral for the facility will comprise all assets
eligible for repurchase transactions with the RBA under normal
market operations. In return for the committed facility, the RBA
will charge a market-based commitment fee.[59]
11.50 The size of the fee is yet to be
determined, but the Reserve Bank have described the principles
underlying it:
The fee is intended to leave participating
ADIs with broadly the same set of incentives to prudently manage
their liquidity as their counterparts in jurisdictions where there
is an ample supply of high-quality liquid assets in their domestic
currency. A single fee will apply to all institutions accessing the
facility.[60]
Banking 'licences'
11.51 Within ADIs only those with APRA's
approval are allowed to have 'bank' in their name. The main impediment
to building societies and credit unions being allowed to call themselves
'banks' is now the $50 million minimum capital size that APRA requires
before giving this approval. (Prior to 1998 they also had to relinquish
their mutual status).[61]
11.52 There are currently 25 mutual ADIs—five
building societies and twenty credit unions—that have sufficient capital
to meet this requirement but have not applied to APRA for approval to
style themselves as banks.[62]
11.53 Abacus suggested there may be more
applications:
I think now that some of our institutions will
consider asking APRA to consider their application for a bank
licence.[63]
11.54 APRA explained the policy rationale
as:
...a test of substance, that the community has
a view that banks are intended to be strong, durable financial
institutions...The term does have a cachet of durability and
strength.[64]
11.55 The Government has asked APRA to
review guidelines around use of the term 'bank', and report to the
Government in March 2011.[65]
APRA's chairman explained:
...we have said to the government that we will
review the policy, and I will go into that review with an open mind
and see what the issues are. There are a number of complex issues
involved here, including, most importantly, financial stability
impacts and customer understanding impacts. It will need careful
consideration, and we will do that...The Productivity Commission
also reviewed this issue this year when it was revisiting some of
the regulatory impacts and its report argued, in a sense, for
maintaining the status quo. It could not see a policy reason for
changing that.[66]
11.56 Asked about the value of their
banking licence, the Commonwealth Bank initially replied:
Our business would have very little value if
we did not have a licence. It is not valued in our books, though.[67]
11.57 Perhaps sensing that the questioning
was going towards a possible charge for the licence, the Commonwealth
Bank then sought to downplay its importance:
Senator CORMANN—So, essentially, in a
comprehensive sense, your Australian banking licence contributes to
a lowering of, to a downward pressure on, your cost of funds?
Mr Norris—No, it is that the business is
assessed by the rating agencies as to the strength of the business,
and they have a number of criteria that they will look at. The fact
that we operate in Australia is one part of that, from looking at
the economic situation, but certainly the major issues around rating
are the resilience of the organisation, its sustainability and its
ability to continue to generate reasonable returns and profits;
those are the factors that are most relevant.[68]
11.58 Credit Union Australia have enough
capital that they could apply for a banking licence, but have chosen not
to do so. Asked why, they responded:
...we would no longer be a credit union, which
is also a protected term. We would then be a bank instead of being a
credit union...we very much want to position ourselves as an
alternative, so calling ourselves a bank we believe detracts from
that as well as diminishes from our heritage as a credit union. Our
desire is nonetheless to be able to very clearly represent that we
are in the business of banking, and that is really what we are
seeking.[69]
11.59 A banking licence is related to
having an exchange settlement account (ESA) with the Reserve Bank.
Abacus comment:
...smaller banking institutions, such as
credit unions and building societies, do not need to hold an ESA
with the RBA because they can access settlement services and the
payments system through central ADIs owned by the sector with
specialist expertise such as Cuscal, Indue and ASL. However, a
number of Abacus member banking institutions have exercised their
option to become ESA holders.[70]
Bank shareholding restrictions
11.60 One possible means of increasing the
number of banks would be to ease the requirements in the Bank
Shareholders Act limiting the stake of any single shareholder in a
bank.
11.61 The Vic Martin report favoured
retaining limits on bank shareholdings but put the arguments on both
sides:
A wide dispersion of shareholders is regarded
as offering the following advantages:
- avoids dominance of control of a bank by one
or few interests;
- provides protection to depositors against a
risk that a bank might be operated to serve the needs of
shareholders;
- avoids the interdependence of a bank's
viability with that of a dominant shareholder;
- ensures reasonable independence and
continuity of management; and
- may enhance the bank's capacity to raise any
additional capital required.
Against the above, the following points can be
argued:
- a requirement limiting shareholdings inhibits
entry and hence tends to increase concentration in the banking
industry;
- at least eleven unrelated shareholders (each
of appropriate standing) are required in order to form a bank. This
can be very difficult and a wasteful use of scarce, suitable
domestic participants;
- a body interested in sponsoring a new bank is
not able, under current administration of the Banks
(Shareholdings) Act, to hold a substantial shareholding (ie 10
per cent or above) in a bank and this is a disincentive to
sponsorship;
- a requirement for a wide dispersion of
ownership effectively removes any likelihood of bank takeovers and
may shift power too far in favour of management. The security of
tenure for management may inhibit efficiency and innovation; and
- a few large shareholders may more readily be
able to reach agreement on and to provide capital injections than a
large number of shareholders.[71]
11.62 The Stephen Martin Committee cast
the arguments as follows:
...a dominant shareholder poses the risk that
a bank's deposits might be used for the benefit of such a
shareholder, or that public confidence in the bank would be
compromised by business problems experienced by the dominant
shareholder...The main argument against the ownership rules is that
they remove an important market discipline, by making it more
difficult for an inefficient bank to be taken over...[and] reduce
the capacity of banks to benefit from economies of scale. On the
question of efficiency, it is important to note that while the
ownership rules limit the potential for banks to be subject to
takeover, they do not restrict more efficient banks from taking away
an inefficient bank's market share.[72]
Mutual ADIs and banks
11.63 Notwithstanding that APRA supervises
mutual ADIs to the same standard as bank ADIs, this may not be the
public perception. As one building society explained:
Research conducted by Heritage indicates that,
irrespective of their dislike for the big banks, customers perceive
them to be more secure than the alternatives. This belief relates
both to the size of the banks and to a common belief that they have
an explicit government guarantee that the building societies and
credit unions do not.[73]
11.64 Some mutual ADIs would prefer the
term 'authorised deposit-taking institutions' be changed to 'authorised
banking institutions':
...to reassure consumers that we are regulated
in the same way as banks and to reinforce our core function, which
is banking.[74]
11.65 Rather than being referred to as
'non-banks', with a possible misinterpretation that they are not as
secure or well-supervised as banks, some mutual ADIs would prefer to be
known as 'customer-owned financial institutions'.[75]
11.66 Their industry body argued:
APRA should allow all ADIs the non-compulsory
option of marketing themselves as “banks”. This would enable Abacus
members to exercise the option of marketing themselves as “mutual
banks” to the market generally or to market segments where the terms
“credit union” or “building society” are less effective.[76]
11.67 The Productivity Commission
concluded:
It would seem, prima facie, that there is
little beyond the name ‘bank’ to distinguish some credit unions and
building societies from banks. It would be useful to remove any
unnecessary restrictions which limit the ability of building
societies and credit unions to compete with banks on a level playing
field. The current restrictions on the use of terms such as ‘bank’
by other ADIs could be reconsidered.[77]
11.68 Mutual ADIs are also disadvantaged
relative to banks by institutional investors being less familiar with
them:
...the banking sector is a known quantity in
the investment community as opposed to credit unions. A fund manager
cannot invest in a credit union today, so they have not been
examining them, whereas of course they have a very strong view on
the banking sector.[78]
11.69 Credit Union Australia has
consistently charged less for home loans than the major banks. Asked how
they can do this, they responded:
Firstly, we do not have to generate profit at
the same levels. We need to generate sufficient profits to maintain
strong reserves and to fund the growth and development of the
organisation, but that is the limit of our profit requirements.
Anything in excess of that is returned through better pricing. The
fact that a shareholder based institution would be paying out
something like 60 per cent of its profits in dividends does give us
a significant pricing advantage—or, looked at another way, we return
dividends to our shareholders, who are our customers, through lower
prices rather than in the form of a separate dividend. It does
support that model. We are aided by the fact that we have a
relatively simple business. It is a pure consumer business. It does
not have the volatility of business and corporate banking, which
obviously varies enormously with the economic cycle. Our intention
is to keep it a simple and low-cost business as well.[79]
Recent initiatives
11.70 The Treasurer's December 2010
package foreshadows the introduction of a 'government protected' logo
for ADIs which is intended to build confidence in mutual ADIs and
smaller banks.
11.71 Abacus, the peak body for building
societies and credit unions, welcomed the recent announcements, although
they do not go as far as Abacus hoped:
[based on] ...18 months worth of market
research on the barriers that people have to switching to credit
unions and building societies. We constantly find the view that the
big banks are covered by a separate and better regulatory system,
and that is a barrier to change. So we see the idea of the protected
deposits seal and that link back to government regulation as a very
pro-competitive reform.[80]
...the government protected deposit seal, and
that certainly will go some way to improving the awareness of
consumers around regulated institutions.[81]
11.72 It also attracted praise in other
circles:
So an education awareness program funded by
government around the safety of mutuals is very welcome.[82]
It will encourage competition coming through
there, so I think that measure will be successful.[83]
Recommendation 18
11.73 The Committee recommends
that mutual financial intermediaries be allowed to refer to themselves
as a 'mutual bank' or 'approved banking institution' and use terms such
as 'credit union bank' in their name.
Other financial institutions
11.74 ASIC explained the difference
between the prudential supervision by APRA of authorised deposit-taking
institutions (ADIs) and those financial institutions which raise money
in wholesale markets or by offering a stake more like equity than a
deposit:
The issue about which institutions are subject
to prudential regulation is a government decision, and the
government has decided that the deposit‑taking institutions should
be prudentially regulated by APRA. All institutions, both the ones
that are regulated by APRA and the ones that are not regulated by
APRA, have to have a licence, and that is where we come in. One of
the conditions of having a licence is certain issues which go to the
financial management of the institution, so to that extent there is
some form of monitoring of the financial situation of these
institutions. The government has made a decision that there is
greater prudential risk for institutions which accept deposits and
lend money than there is with institutions which just borrow money
on the wholesale market and lend the money.[84]
11.75 Some non-ADIs felt they were subject
to excessively harsh requirements. In particular there was concern
expressed over ASIC's RG156 rule related to the issue of debentures:
This required that all the advertisements for
debentures should include a prominent statement to the effect that
investors ‘risk losing some or all of their principal and interest’.[85]
11.76 Some non-ADIs also objected to how
they are required to characterise the bonds they issue:
The changing of the naming of the from
'debentures' to 'unsecured notes' will undoubtedly put further doubt
in the investor's minds with respect to the level of risk...[86]
11.77 The regulators have a delicate
balancing act between avoiding terminology that may overstate the
riskiness of investing with unsupervised financial intermediaries (and
so reduce the competitive pressure they can exert on the ADIs) and
ensuring that unsophisticated investors realise that the unsupervised
entities are riskier than ADIs. The Government's introduction of a
'government protected' logo may give an opportunity to allow the non-ADIs
to apply less critical language.
Recommendation 19
11.78 The Committee recommends
that financial intermediaries not supervised by the Australian
Prudential Regulation Authority be required to state clearly that funds
placed with them are 'not guaranteed by government' but otherwise should
not be prohibited from applying familiar terms such as 'debenture' where
this would not be misleading.
Bank holding companies and the 'narrow banking' model
11.79 Professor Davis noted:
...there may be some scope in a proposal that
I have seen from the OECD that says you should get banks to change
to a non-operating holding company structure where one part of it is
sort of the standard banking—taking deposits; making simple
loans—and the other subsidiary part of the non-operating holding
company is the investment bank.[87]
11.80 Professor Valentine observed:
...as a matter of history, at the Campbell
committee we looked closely at the holding company concept and, at
that stage—and that was 30 years ago—it seemed to us that there was
a lot in it.[88]
11.81 Suncorp Group has recently adopted a
holding company structure to separate its banking and insurance
operations:
...it was about transparency and simplicity to
be able to explain the operations of each of our businesses more
clearly.[89]
11.82 The separation of banking and other
operations was also suggested:
...one could start with the divestment of
insurance / wealth management from the Big 4, the fusion of which no
defensible argument has ever been mounted. Share-broking
subsidiaries could readily be hived off. And so on.[90]
11.83 It is noted that in April 2011, the
Independent Commission on Banking in the UK, in its interim report,
recommended the ring fencing of banks' retail activities to minimise the
possibility of losses from the riskier investment bank activities
infecting a bank's retail business:
...a focus of the Commission’s work is the
question of whether there should be a form of separation between UK
retail banking and wholesale and investment banking. Ring-fencing a
bank’s UK retail banking activities could have several advantages.
It would make it easier and less costly to sort out banks if they
got into trouble, by allowing different parts of the bank to be
treated in different ways. Vital retail operations could be kept
running while commercial solutions – reorganisation or wind-down –
were found for other operations...The Commission is therefore
considering forms of retail ring-fencing under which retail banking
operations would be carried out by a separate subsidiary within a
wider group.[91]
11.84 Some leading academic economists
have become increasingly vocal supporters of such an approach since the
GFC:
...a specific, but serious, problem arises
from the ability of conglomerate financial institutions to use
retail deposits which are implicitly or explicitly guaranteed by
government as collateral for their other activities and particularly
for proprietary trading. The use of the deposit base in this way
encourages irresponsible risk-taking, creates major distortions of
competition and imposes unacceptable burdens on taxpayers. Such
activity can only be blocked by establishing a firewall between
retail deposits and other liabilities of banks.[92]
11.85 A harsher version of the approach of
separating riskier activities into a distinct part of a banking group is
banning banks from any involvement in riskier activities. Such an
approach was considered (but not favoured) by the Independent Commission
on Banking in the United Kingdom in its recent report:
Banks must have greater loss-absorbing
capacity and/or simpler and safer structures. One policy approach
would be structural radicalism – for example to require retail
banking and wholesale and investment banking to be in wholly
separate firms.[93]
11.86 The ACTU supports 'narrow banking'
as a response to the problem of banks being 'too big to fail':
A regulatory regime should be considered in
which Australian banks are regulated as public utilities and
forbidden from expanding into risky asset classes and/or
jurisdictions while they enjoy a Government guarantee (explicit or
implicit) of their liabilities...The Australian Government should
make it clear that it will not act to ensure the continued viability
of non‑deposit taking institutions that pursue excessively risky
investments...[94]
Committee view
11.87 The Committee believes that APRA
effectively ensures that Australian banks do not pursue excessively
risky investments. This is an area, however, that could be usefully
addressed by the broader inquiry into the financial system for which the
Committee has called.
Social obligations of banks
11.88 Banks have a special status. For
businesses, 93 per cent of respondents to a recent survey indicated
their banking relationship is important or critically important.[95]
They provide what could nowadays be regarded as an essential service:
...when I first started my working life I
received my wages in a little yellow envelope in cash and it was my
choice if I placed some or all of that money into a bank account.
Today Australian people are forced to accept their wages
electronically into a bank account, we have no choice and are then
charged a fee by the banks to access our own money.[96]
Australians do not have the day to day
capacity to simply opt out of the banking system. Banking is
connected and integrated into our ability as citizens to function
and exist in modern society.[97]
A bank account is a necessity for effective
participation in modern Australian economic life, and should
therefore be regarded as an essential service.[98]
Banks...do have a unique role in our
community...Banks have a special place in our society. They are the
lifeblood of liquidity... Technology and national security laws have
ensured that participation in the banking system has become a
mandatory feature of modern life. The banking system’s crucial role
in supplying the economy’s financial arteries and transforming
savings into investment makes it different from most other
industries.[99]
Everyone knows the financial system—and that
is why the government is concerned—is such an important part of
everyone’s life. Post GFC, international debate has raged: are these
just private sector profit-making entities, as we view them in
Australia, or are they a hybrid, providing an essential service to
the community?[100]
11.89
Many would regard banks as having social obligations in exchange for the
privileges they enjoy:
Nevertheless banks protected by government
insurance of small deposits have some responsibility to return to
the community a level of service
and a responsible level of
profit-taking...Bank management, and most particularly local
bank managers, have responsibilities to the community.[101]
Ultimately financial institutions must have a broader responsibility
for economic development in Australia.[102]
The
Brotherhood [of St Laurence] believes that all Australians have a
right to fair and affordable access to basic services, including
banking services. Fair and affordable access to essential services
helps disadvantaged and low-income people by enabling them to be
part of Australia's mainstream society, and by ensuring corporate,
government and community sectors all take responsibility for
addressing social problems.[103]
The government has recognised the special
place of banks, and it grants banks privileges and benefits that are
not afforded to other sectors...The banks may occasionally chafe
under the restrictions, but they must concede the system of
prudential supervision imparts tremendous benefits to their
operations...I want a Social Compact between our Taxpayer guaranteed
banks, their shareholders and our Government and our Parliament.
This must define the relationship and must include direction on
competition, expansion, expectations of credit and savings,
community service obligations, risks and rates.[104]
The social contract should provide at a
minimum, access to “fee free” credit accounts for wage earners and
for people on regular low incomes, portability of credit accounts,
exit fee free discharges from loans and cost free access to ADR for
individuals and small businesses and a mediation process...[105]
...our banking system has a social obligation
to the Australian community in addition to their economic and
commercial role...we need them to enter into a social and economic
contract for the benefit of all Australians...Australia's financial
service should function in an accessible, affordable and fair manner
reflecting its status as an essential service.[106]
11.90
Some suggested a competitive banking
system may still not meet all social obligations:
...competition alone is not enough to address
the significant problem of financial exclusion for low-income and
vulnerable Australians.[107]
11.91 Westpac considered banks were just
like any other company, except for the fact their deposit taking
function required regulation:
...a bank is a company like any other
company... we are a regulated industry. We have depositors’ funds
and that is why we have the level of regulation that is required...[108]
11.92
As noted in Chapter 14, concerns
have been raised about changes to the products the banks offer more
vulnerable individuals, such as bank customers being pushed into credit
cards instead of being able to access small personal loans.[109]
11.93 Other countries monitor banks'
performance on these matters:
...in the United Kingdom and the United
States, performance monitoring has become widespread in creating
accountability among financial institutions to develop affordable,
appropriate products to address financial exclusion. In the United
Kingdom and elsewhere, competition regulators have powers to conduct
market studies to determine whether competition is benefiting all
consumers.[110]
11.94 A desire to find innovative means of
competing with the major banks has led one smaller bank to offer a
deposit account which pays only minimal interest but instead offers a
prize draw of $20,000 a month.[111]
This has been criticised as encouraging savers to instead become
gamblers.
11.95 The Brotherhood of St Laurence note:
On community service obligations: further
regulation can be used to ensure that financial institutions provide
accessible basic services to all customers. This can be necessary in
markets where policymakers recognise conflict between the profit
motive of firms and the social policy goals of the industry. For
example, in privatised telecommunications, gas or electricity
markets, companies are not able to deny access to less profitable
rural or low income customers.[112]
11.96 The banks reject the idea that they
should be obliged to provide basic banking products:
...the proposal to mandate that banks, as
distinct from other ADIs, offer a free transaction account to all
account holders in Australia, whatever their legal and financial
status, is anti-competitive, and therefore would distort the
provision of retail banking services in Australia...no other
business in Australia is required to provide its services free of
charge.[113]
11.97 Even where banks provide a basic
banking product, it may not be taken up by those customers who could
most benefit:
Especially with our clients, it takes some
time to work with them to ensure that they are thinking about their
finances and their money management issues and to build their
financial literacy so that they are making the decisions that are in
their own best interests.[114]
We think that the banks could do more in
promoting those products and identifying customers who would be
eligible for such products—even make it a default option that they
get put on those sorts of accounts...Generally, those accounts are
available to those who have some form of Centrelink income or have
access to a healthcare card or a pensioner concession card, for
example. Banks generally know if that is the case with their
clients, particularly around Centrelink income because it is
deposited into their accounts.[115]
11.98 Bankers have played a trusted role
as financial advisers in the community, but are increasingly in a
conflict of interest:
When people are asked to make financial
decisions that they do not fully understand, they often rely on
other people for help, particularly people that they regard as
better qualified or informed. In the case of bank products, people
often rely on the advice they receive from bank workers. What is not
well understood is that bank workers in Australia are often paid
commissions to sell their bank’s products. The more products they
sell—in other words, the more debt they convince customers to take
on—the more money they make. In fact, encouraging bank tellers and
call-centre workers to sell debt products is an integral part of a
bank’s marketing strategy. Consumers can no longer be confident that
the advice they receive from bank workers is objective rather than
conflicted.[116]
Committee view
11.99 The Committee recognises that banks are accorded a special
status and given special privileges. In exchange they have social
obligations to provide banking services to the broad community. These
are obligations that the banks should meet voluntarily rather than
compulsorily. In areas where there are unmet demands for basic banking
services which the government believes on social grounds should be
provided to disadvantaged members of the community, the government
should invite banks to tender to provide the services and the government
pay to ensure they are provided.
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