Defined Terms and Documents 

Overview of Financial Services Post-Deregulation - 2002

by (Dr) Diana Beal,

 Director, Centre for Australian Financial Institutions,

University of Southern Queensland, Toowoomba.

Introduction

This paper deals with deregulation in the banking sector and its effects on financial services delivery. It firstly discusses the drivers for change in the early 1980s, and then briefly lists selected events in the deregulation process. It examines the consequences of reform, especially in relation to financial services delivery. It discusses briefly rural and remote community delivery channels and experiences and finally examines some service delivery means currently in place and likely to be expanded in the near future.

In order to appreciate the scope and effects of reform in the banking sector since deregulation, it is necessary to understand the banking environment in the early 1980s. Banks in 1980 still operated in a highly regulated environment which was an artefact of previous economic and social conditions. Indeed, an extensive collection of controls remained from regulation introduced under the National Security Regulations in 1941.

The decade preceding the outbreak of World War II was extremely turbulent for the banking industry. The banks weathered the 1930s Depression and the consequent spate of bad debts by severely restricting credit. This no doubt intensified and prolonged the economic downturn and was viewed by the community as doing so. A Royal Commission held during the middle part of the decade recommended in 1937 that banks be licensed and that the central banking section of the Commonwealth Bank be given wider powers to fix interest rates and to demand that some of the banks’ funds be held with the central bank. The banks resisted such reforms, but many of the recommendations of the Commission were put into operation while the government enjoyed wartime emergency powers.

Interest-rate ceilings on deposit accounts restricted the banks’ ability to attract funds particularly during the 1970s when inflation was rampant. In the June quarter of 1975, inflation rose to 16.9% pa. At the same time, interest payable on amounts held in savings accounts offered by savings banks, for example, was restricted to 3.75%[1] (Foster, 1996). In contrast, the interest rates offered by non-bank financial institutions (NBFIs) were not controlled and they were able to pay around 10% on passbook accounts.

Apart from interest-rate ceilings on deposits, the banks were prevented from paying interest on deposits held for less than 14 days. This constraint presented an opportunity for merchant banks (not licensed banks at the time) to offer cash management trusts, which paid high rates of interest on short-term at-call funds, with additional features such as personal cheque book facilities attached.

On the lending side of their businesses, interest rate ceilings on loans dampened banks’ enthusiasm to lend to less credit-worthy clients so that they tended to ration credit to only the best clients and projects. More risky business was channelled off to their own subsidiary unlicensed finance companies, such as AGC, Custom Credit and Esanda.

The results of these restrictions were that banks’ growth was stifled, NBFIs grew strongly, credit was rationed, credit squeezes became a regular occurrence and financial innovation in the form of new products and the adoption of new technologies was subdued. Chart 1 shows the shares of total assets of financial institutions (FIs) held by banks, NBFIs and others such as insurance offices and public offer trusts. The strong growth enjoyed by NBFIs at the expense of the banks is evident. The banks’ share of total assets dropped to its nadir in 1983; conversely the NBFIs’ share reached its zenith in 1982, before deregulation and reform changed the financial landscape.

The banks’ freedom to operate was additionally curbed by the requirement to place a proportion of their funds in special accounts [later statutory reserve deposits (SRD)] with the Reserve Bank of Australia (RBA) which was established in 1960. The payment of low interest rates on these accounts was in effect a special tax on banks. Further, banks were required to hold some of their funds in cash and Commonwealth Government securities (LGS). Savings banks were tied down with even more stringent regulation. Their special preserve was housing finance and they were prevented from offering some term and investment products. As well, they were hobbled with higher LGS requirements.

This then was the banking environment in 1980. Licensed banks were over-regulated and were losing market share. NBFIs were substantially unregulated and were growing strongly. Regular credit squeezes stifled economic growth. Product and other innovation was hampered. The situation was ripe for change.

Drivers of Change in 1980

High inflation and high interest rates during the 1970s sowed the seeds for change. The RBA had used credit controls and the SRD system forcefully but unsuccessfully to try to curb banks’ lending to dampen inflation and economic growth. Monetary policy was ineffective in a climate where high interest rates were encouraging massive inflows of foreign capital. This was so, because the exchange rate was fixed and the RBA was forced to stand in the market and purchase all foreign currency offered to it at the fixed price. The resultant injection of cash into the Australian economy increased money supply significantly. The prices of both consumer and investment goods were then forced up (inflated) to ration the inadequate level of production among buyers.

In addition, the governments of the day were running large budget deficits. Deficits of $500 million (just over 1% of GDP) common in the early 1970s grew to peak at $6.6 billion (6.1% of GDP) in 1978-79 (Foster, 1996). The funding of these deficits also impacted on the efficiency of monetary policy and weakened the usefulness of monetary policy significantly (Kenwood, 1995). Governments essentially had to rely on fiscal policy as the tool, albeit inadequate, with which to manage the economy and financial system.

Selected Events in the Evolution of the Financial System

The following table gives a selection of events which have been significant in the on-going development of the Australian financial system since 1980. The events from 1980 to 1996 are substantially drawn from Wallis (1997: 571-574), while the entries from 1998 to 2002 are selected from various Reserve Bank Bulletins.

Table 1 A Selection of Important Events in the Evolution of the Financial System

Consequences of Reform

The Campbell Committee (Campbell, 1981) was set up to examine the Australian financial system and was concerned to promote efficiency in the system without jeopardising stability.

Thus it recommended the removal of regulation which undermined efficiency, such as the interest rate controls and lending directions, and the strengthening of prudential oversight to bolster stability.

The Campbell Committee identified three forms of efficiency – operational, dynamic (or innovative) and allocative – that it hoped deregulation would improve for the benefit of all Australians. Operational efficiency is the ‘normal’ concept of efficiency, a given output at the lowest cost.

Thus an increase in operational efficiency would be reflected, for example, in a reduction in operating costs and a consequent ability of the banks to reduce their interest rate margins – the margins between the cost of funds and the return from funds lent.

Dynamic efficiency is the capacity of the financial system to generate financial innovations to meet the changing needs of customers. Allocative efficiency is achieved when funds flow to the highest-yielding projects and thus generate the greatest return to the economy.

Did deregulation achieve the Committee’s expectations? The Martin Committee (the House of Representatives Standing Committee on Finance and Public Administration) in 1991 found that:

 It is evident that deregulation had led to a significantly more competitive environment within the banking industry and financial sector as a whole. There is a far greater number of institutions competing for market share than was the case prior to deregulation. Also the substantial erosion of traditional lines of demarcation has allowed banks and non-bank financial intermediaries to compete across a wide range of activities for a more varied spread of business (Martin, 1991).

The Wallis Inquiry set up in 1996 and reporting the next year (Wallis, 1997) was an administrative reaction to the sweeping reforms which had taken place since the presentation of the Campbell Committee Report. The Wallis committee was charged with reviewing past reforms, considering factors likely to drive further change and making recommendations for further improvements to streamline regulation to ensure an efficient, responsive, competitive and flexible financial system (Wallis, 1997: vii). Wallis came to similar conclusions to those of the Martin Committee.

There is no doubt that the community enjoys a greater choice and availability of finance at almost all levels, that there is improved cost efficiency in domestic markets and institutions, and that greater dynamic efficiency is manifested as continuing capital investment in the financial system and increased product innovation. However, the effects on individuals and communities of the changes in service delivery methods have been variable. Arguably, while almost all have enjoyed the greater choice and availability, some changes have penalised rural and remote communities.

Face-to-face services have been withdrawn from local areas through branch and agency closures. In June 1990, there were 6,921 bank branches and 7,712 bank agencies. By June 2001, there were 4,712 bank branches remaining open and 5,043 agencies (at June 2000) (APRA data). Building societies and credit unions have also reduced their face-to-face outlets over the same period.

Service delivery has been increased through electronic channels (phone, internet, ATMs and EFTPOS) and hybrid services (giroPost and RTCs). Unfortunately for members of small communities and those who live in remote areas, busy areas such as major shopping centres have enjoyed increased services while others have suffered changes or reductions in services.

The installation of ATMs for the withdrawal of cash has facilitated payments. Initially, most ATMs were programmed to accept deposits as well. However, to reduce costs, many ATMs are programmed no longer to accept deposits. This leaves customers with the misfortune to have received a cheque or having too much cash little option but to drive to the nearest branch to make deposits. The number of ATMs has risen steadily but not spectacularly from 4600 in 1990 to 13 300 in 2002 (RBA, 2002; Cashcard, 2002). FIs have pursued a policy of trial and error for locating ATMs. However, few have been established in more isolated rural or remote areas, because of the high cost of regular servicing.

Businesses of all descriptions, supermarkets, hardware stores, fuel stations, speciality stores, doctors, dentists, veterinary surgeons, hospitals, lawyers, funeral directors and even mobile businesses like taxis, have installed the equipment to make EFTPOS a viable payments mechanism. Whilst this has been a valuable development for facilitating payments, the installation of EFTPOS terminals in rural and remote areas has been the lifeblood of commerce as other more traditional banking services have been withdrawn. Chart 2 shows the growth in EFTPOS terminals.

 Drawing on a European model of financial services delivery, Australia Post developed giroPost in 1995. giroPost is a personal banking network with services available in 2001 at 2821 electronically-linked outlets. The service allows consumers to withdraw and deposit funds, check balances and open personal accounts with two of the major banks including Commonwealth, seven of the second-tier banks, three building societies, RAMS Home Loans and 57 credit unions (RBA, 2002). In addition, giroPost outlets accept payments for accounts, for example, for electricity, gas, vehicle registration, telephone and the Australian Taxation Office. The establishment of giroPost filled a vital need for payment services for individuals but, because it initially has not accepted business transactions, there has been pressure for the service to be expanded especially in rural and remote areas. In 2001, it was announced that the service would be expanded on a trial basis to 150 selected areas to include business payment services.

Conclusion

This paper has examined deregulation of the banking and finance industry which has taken place in Australia since the early 1980s. The deregulation process was started because it was obvious to informed observers that regulation had run its course. Monetary policy was no longer an effective tool for regulation of the financial system and regulation of the banking industry was impairing the development of the Australian economy.

The consequences of reform have been many. While there have been increases in the range, choice and quality of financial products and increases in efficiency in its three major forms, some changes have had adverse effects for some communities. Rural and remote communities have lost face-to-face outlets, but in some cases have gained electronic service delivery channels. Such delivery mechanisms are not always appropriate for every community or indeed for individuals lacking effective levels of literacy, technical ability, manual dexterity or sight. The establishment of Centrepay, RTCs and the Traditional Credit Union in the Top End are all solutions which are helping to fill the service void.

References

Campbell (Committee of Inquiry into the Australian Financial System) (1981), Final Report, AGPS, Canberra.

Cashcard (2002), Cashcard web site, www.cashcard.com.au  (accessed 4/4/02)

Foster, R.A. (1996), Australian Economic Statistics 1949-50 to 1994-95, Occasional Paper No. 8, RBA, Sydney.

Kenwood, A. G. (1995), Australian Economic Institutions since Federation: An Introduction, OUP, South Melbourne.

Martin (House of Representatives Standing Committee on Finance and Public Administration), Martin, S. (chair) (1991), A Pocket Full of Change, AGPS, Canberra.

RBA (Reserve Bank of Australia) (2002), Reserve Bank of Australia Bulletin, March, RBA, Sydney.

Wallis (1997), Financial System Inquiry Final Report, AGPS, Canberra.