Tag: FSI

Government to act against businesses exploiting credit card charges

From The Conversation.

The Turnbull government will ban businesses from charging consumers excessive surcharges on their credit cards, and move to inject more competition into the superannuation industry, responding to the Financial Systems Inquiry headed by businessman David Murray.

Under planned legislation, the surcharges will not be allowed to be more than the cost to the business of accepting payment by card.

The Australian Competition and Consumer Commission (ACCC) will enforce the regulations to ensure consumers are treated fairly and not overcharged.

The government is also promising action to improve the standards of financial advice, an area that in recent years has been subject to extensive malpractice and controversy, amid deep concern especially from retirees.

The government’s response to the Murray inquiry, which reported last year, was announced by Prime Minister Malcolm Turnbull, Treasurer Scott Morrison, and Assistant Treasurer Kelly O’Dwyer at a joint news conference. Most recommendations have been accepted, and several measures have been added.

The report and response cover the resilience of the financial system; superannuation and retirement incomes; innovation; consumer measures; and the regulatory system. Measures to improve the resilience of the banking system are already in train.

Turnbull said the surcharge issue “has been the subject of considerable consumer concern”.

“Quite plainly, where a merchant says if you use a credit card it’s an extra 2% or 3%, that carries with it an absolutely crystal clear, irrefutable representation that the merchant is seeking to recover his or her costs,” he said.

“In some cases they may be, in other cases they’re not.

“We think that consumers are entitled to a very fair deal here … in other words, to get exactly what they are being represented to be getting, which is an additional charge that recovers no more than the merchant’s costs.”

Morrison said that in some cases surcharges could be more than 10%. In future merchants would have to pass the “fair dinkum test” – “the fair dinkum cost of what someone is actually absorbing and passing on”.

To improve the financial advice industry, advisers will have to have a degree, pass an examination, undertake continuous professional development, subscribe to a code of ethics and undertake a professional year before they can advise clients. There will be some transitional arrangements as the tougher requirements are put in place.

“These higher standards will, for the first time, place financial advising on a similar footing to other professions and in doing so increase consumer trust and confidence in the sector”, the ministers said in a statement.

The Abbott government had its regulations watering down the Labor government’s more stringent rules thwarted by the Senate.

The superannuation measures are to improve competition, efficiency and transparency – which the government says will improve after-fee returns for fund members. The Coalition believes that industry funds have too much of an advantage under present arrangements.

The Productivity Commission will be asked to develop and release criteria to assess the efficiency and competitiveness of the superannuation system. It will “develop alternative models for a formal competitive process for allocating default fund members to products”.

The government says it will work with industry to provide retirees with more flexible and reliable retirement income products and “to extend the choice of fund arrangements to more employees as recommended by the inquiry”.

Last month legislation was introduced to alter super funds’ governance arrangements, requiring at least one-third of trustee boards to be independent directors, including an independent chair.

Morrison said the government was putting “Australians in the driver’s seat of their own money and no-one else, and that’s as it should be.

“It does end the closed shop when it comes to mandatory superannuation contributions and how they are directed off into funds, and it will give Australians greater choice about where they invest their own money for their own retirement.”

Morrison described the Murray report as “a common sense report. It has common sense recommendations, a health check on where our financial system is at.”

In terms of the financial system itself, it makes it stronger by embedding deeper protections within the system, whether it’s on capital adequacy, improved governance and standards right across the system and empowering our regulators to be able to enforce the protections that are in that system, protect consumers and Australians and our economy at the end of the day.

“It does provide Australians with greater choice and greater control over their own money, whether it’s their superannuation or anything else.”

Turnbull acknowledged work done by former treasurer Joe Hockey and former assistant treasurer Josh Frydenberg but stressed “this response is a response of the Turnbull government to this inquiry”.

Author: Michelle Grattan, Professorial Fellow, University of Canberra

Super members the winner in sensible financial inquiry response

From The Conversation.

The government has accepted virtually all of the recommendations of the expert panel behind last year’s Financial System Inquiry. 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.

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.

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.

The one recommendation which was rejected by the government in its response to the inquiry, 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.

The choice not to reject any other recommendations on superannuation is far more important.

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.

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.

Industry funds will struggle with the next two recommendations: on choice of fund and on governance.

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.

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.

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.

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.

Author: Rodney Maddock, Vice Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics, Monash University

FSI Recommendations Backed By The Government

All but one of the Murray Financial Systems Inquiry have been accepted by the Government. The report, released today says that this is to ensure the Australian Financial Services system remains safe and secure.

This is an important step forwards in the development of the finance sector, and to ensure the interests of consumers are safeguarded. Importantly, the journey towards higher capital requirements will continue, with potential consequences for banking competition and product pricing. The obligations of financial advisors will be strengthened. Superannuation system to be reviewed to ensure efficiency, transparency and consumer choice. Excessive credit card surcharges to be banned. Leveraged superannuation borrowing will not be banned.

From the introduction:

The financial sector is the largest in our economy, having contributed $139 billion over the past year and employing around 400,000 Australians.

The financial system has a vital role in commercial activity across the Australian economy, contributing to productivity and growth. The biggest decisions Australians make in life — buying a home, providing for their retirement, or starting a business — are all supported by our financial system.

As the attached response details, the Government has accepted the overwhelming majority of the Inquiry’s recommendations. Our response also includes six additional measures that are consistent with the Inquiry’s underlying philosophy.

The Government’s response sets out an agenda for improving our financial system that builds on existing Government policy. The Government’s financial system program will be implemented in stages over the coming years. The Government’s program will position Australia to respond to the challenges and opportunities of the future.

Our financial system program is made up of five distinct strategic priorities that deal with each of these challenges.

• The resilience measures aim to reduce the impact of potential future financial crises by ensuring we are better able to weather them and lessen their cost to taxpayers and the economy.

• The superannuation and retirement incomes measures aim to improve the efficiency and operation of the superannuation system and in doing so boost retirement incomes.

• The innovation measures will unlock new sources of finance for the wider economy and support competition.

• The consumer outcomes measures are designed to give consumers confidence to participate in the financial system and the confidence that they are being treated fairly.

• The regulatory system measures aim to make regulators more accountable for their performance, more capable and more effective.

Highlights include:

  1. a focus on driving competition within the finance sector
  2. continued lifting capital reserves (which APRA has already started)
  3. a ban on credit card surcharges greater than the cost of processing the payment by the merchant, enforced by ACCC
  4. confirmation of review of interchange fees
  5. a review on the superannuation system by the Productivity Commission to ensure efficiency, transparency and consumer choice. Superannuation is about income in retirement, not generic investment
  6. improved governance for superannuation boards
  7. raise the competency of financial advisors, including professional qualifications and code of ethics
  8. rename ‘general advice’ to improve consumer understanding of financial advice
  9. financial advisers and mortgage brokers to adequately disclose their relationships with associated entities
  10. a focus on innovation (e.g. crowd sourcing equity funding) in the financial sector

They did not accept the proposed ban on leverage superannuation investment.

You can read DFA’s earlier analysis of the FSI report from last December.

Some of the small print areas of disagreement with Murray include:

  1. Direct borrowing by superannuation funds – does not agree with the Inquiry’s recommendation to prohibit limited recourse borrowing arrangements by superannuation funds. While the Government notes that there are anecdotal concerns about limited recourse borrowing arrangements, at this time the Government does not consider the data sufficient to justify significant policy intervention. The Government will however commission the Council of Financial Regulators and the Australian Taxation Office (ATO) to monitor leverage and risk in the superannuation system and report back to Government after three years. This timing allows recent improvements in ATO data collection to wash through the system. The agencies’ analysis will be used to inform any consideration of whether changes to the borrowing regulations might be appropriate.
  2. does not support the creation of a new Financial Regulator Assessment Board.
  3. Conduct post-implementation reviews of major regulatory changes more frequently – does not agree to conduct more frequent post implementation reviews (PIRs), as it has already implemented changes to strengthen the review regime in 2014
  4. Align the interests of financial firms and consumers – agrees more can be done to better align the interests of financial firms and consumers. However, we intend to take a different approach to that recommended by the Inquiry for retail life insurance.

Three additional recommendations were also added in by the Government:

  1. Ensure participation in international derivatives markets –  The Government will develop legislative amendments to clarify domestic regulation to support globally coordinated policy efforts and facilitate the ongoing participation of Australian entities in international capital markets. We will develop legislative amendments in the second half of 2015.
  2. Enhance retail consumer protections for client monies –  The Government will develop legislative amendments to improve protections for client monies held in relation to derivatives. These improvements are needed to ensure that investors’ monies are adequately protected when held by intermediaries.
  3. Clarify the definition of basic deposit products – The Government will develop legislative amendments to amend the definition of a basic deposit product in the Corporations Act 2001. These amendments will provide certainty for businesses and consumers by clarifying how certain term deposit products are treated under the law.

ASIC and FSI Outcomes

In a speech given by Greg Medcraft, Chairman, Australian Securities and Investments Commission at the 32nd annual conference of the Banking and Financial Services Law Association (Brisbane), he looked at the Financial System Inquiry from a regulator’s perspective.

Specifically, he sees three FSI recommendations as complementary. Product intervention powers would complement and reinforce the good practices and controls required by product design and distribution obligations. Where product design and distribution obligations were in place, and were effectively being complied with, there would be less need for ASIC to intervene. Adequate penalties provide a deterrent for gatekeepers against engaging in misconduct, and this in turn influences their behaviour. Gatekeepers who already have a solid culture have nothing to fear from these recommendations. For those who fall short, ASIC will continue to use the right nudge to change their behaviour. The introduction of a product intervention power, design and distribution obligation and appropriate penalties will assist ASIC in providing the right nudge.

Today I would like to talk about three particular recommendations of significance to ASIC.

1. for ASIC to have a new ‘product intervention’ power
2. to introduce a new product design and distribution obligation on product issuers, and
3. that penalties should be increased to act as a credible deterrent, and that ASIC should be able to seek disgorgement of profits gained by wrongdoing.

I would like to spend a little time now speaking about each of these recommendations in turn.

Product intervention power

Globally, regulators are looking for a broader toolkit to address market problems, including moving away from purely disclosure-based regulation. For example, the International Organization of Securities Commissions (IOSCO) has recommended that regulators look across the financial product value chain, rather than simply disclosure at the point of sale. In the United Kingdom, the Financial Conduct Authority has a product intervention power in place. A product intervention power would give ASIC a greater capacity to apply regulatory interventions in a timely and responsive way. It would allow ASIC to intervene in a range of ways where there is a risk of significant consumer detriment. ASIC would be able to undertake a range of actions, including simple ‘nudges’, right through to product bans. I know that some commentators have been worried that ASIC would use its powers to ban products – and that this would affect innovation and competition.

We think that such a power would not stifle innovation that has a positive impact on consumers. In fact, banning products would be very rare and would only occur in the most extreme circumstances. Both industry and regulators have a common interest in seeing innovation that fosters investor and financial consumer trust and confidence – innovation that helps investors, but does not harm them. Most interventions would likely fall well short of product banning. For example, we might be able to require amendments to marketing materials, or additional warnings. In more extreme cases, we might be able to require a change in the way a product is distributed or, in rare cases, ban a particular product feature. We agree that the use of intervention powers by ASIC would naturally need to have transparency, clear parameters and accountability mechanisms.

However, let me say that a ‘product intervention’ approach – that is, regulation that is not purely based on disclosure – is not new in the regulation of retail financial markets in Australia. This kind of regulation has improved investor outcomes in a wide range of markets over many years, for example: the Future of Financial Advice (FOFA) reforms, including the restriction on conflicted remuneration, and more broadly, the prohibition on unfair contract terms for financial products.

The FSI’s recommendation would mean that ASIC itself would have greater capacity to apply such non-disclosure based approaches in a timely and responsive way. This would be an alternative to waiting – sometimes many years – for legislation to address the problem.

Product design and distribution obligation

I will now turn to the recommendation to introduce a product design and distribution obligation for product issuers. For this recommendation, I want to set the context from ASIC’s perspective. There are three cornerstones of the free market-based financial system. These are: investor responsibility, gatekeeper responsibility, and the rule of law.

The ability of the free market-based system to function effectively and efficiently, and to meet investor and financial consumer needs, is greatly influenced by the real behaviour of its participants. Investor responsibility is key in our free market-based financial system. It is important that losses remain an inevitable part of this market system. ASIC will not, and cannot, be expected to prevent all consumer losses. In addition, it is important that gatekeepers take responsibility for their actions. Recently I have talked a lot about the culture of our gatekeepers. The culture of a firm can positively or negatively influence behaviour. Poor culture – such as one that is focused only on short-term gains and profit – often drives poor conduct. Conversely, good culture will drive good conduct. I see a good culture as one that puts the customer’s long term interests first.

So the FSI recommendation – that a broad, principles-based obligation be placed on financial institutions to have regard to the needs of their customers in designing and targeting their products – is a recommendation that puts the interests of the customer at its centre. In my view, the FSI’s recommendation aligns very closely with the theme of culture. Product manufacturers should design and distribute products with the best interests of the investor or financial consumer in mind. This is part of having a customer-focused culture.

In fact, the FSI has noted that the kinds of practices required by a design and distribution obligation would already be in place in many institutions that already invest in customer-focused business practices. Firms that already have a customer-focused culture would not need to significantly change their practices.

Penalties

Finally I would like to turn to the recommendation on penalties. The FSI recommended that penalties for contravening ASIC legislation should be substantially increased, and that ASIC should be able to see disgorgement of profits obtained as a result of misconduct. Comparatively, the maximum civil penalties available to us in Australia are lower than those available to other regulators internationally. And they are fixed amounts, not multiples of the financial benefit obtained from misconduct.

In order to regulate for the real behaviour of gatekeepers in the system, penalties need to be set at an appropriate level. And we need a range of penalties available, to act as a deterrent to misconduct. Penalties set at an appropriate level are critical in the ‘fear versus greed’ calculation of the potential wrongdoer. Penalties need to give market participants the right incentive to comply with the law. They should aim to deter contraventions and promote greater compliance, resulting in a more resilient financial system.

 

Higher Mortgage Risk-Weights First Step to Strengthen Australian Bank Capital – Fitch

Fitch Ratings states that an increase in the minimum average Australian residential mortgage risk-weight for banks accredited to use the internal ratings-based (IRB) approach for regulatory capital calculations was expected, and is only the first step in higher capital requirements for these banks. Greater levels of capital are likely to be required over the next 18-24 months as further measures from Australia’s 2014 Financial Services Inquiry (FSI) are implemented and adjustments to the global Basel framework are finalised.

The announced increase in minimum mortgage risk-weights is the first response to the final FSI report, published December 2014, which also recommended Australian banks’ capital positions be ‘unquestionably strong’. The latter recommendation is aimed at improving the resilience of the banking system given its reliance on offshore funding markets, its highly concentrated nature, and the similarity in the business models of most Australian banks. The change in mortgage risk-weights should provide a modest boost to the competitiveness of smaller Australian deposit takers that currently use the standardised approach for regulatory capital calculations.

The change announced by the Australian Prudential Regulation Authority (APRA) on 20 July 2015 is likely to be the first of a number of changes made to strengthen the capital positions of Australian banks. APRA referred to the higher risk-weights as an interim measure, with final calibration between IRB and standardised models expected once the Basel committee’s review of the framework is completed – this is unlikely to be before the end of 2015.

The move will result in minimum average risk-weights for Australian residential mortgage portfolios increasing to at least 25% from around 16% at the moment. APRA estimates this would increase minimum common equity tier 1 (CET1) requirements by about 80bps for Australia’s four major banks – Australia and New Zealand Banking Group Limited (ANZ; AA-/ Stable), Commonwealth Bank of Australia (CBA; AA-/ Stable), National Australia Bank Limited (NAB; AA-/ Stable), and Westpac Banking Corporation (Westpac; AA-/ Stable). This is equivalent to nearly AUD12bn for the four banks based on regulatory capital disclosures at 31 March 2015. The only other bank to be impacted is Macquarie Bank Limited (A/ Stable) which has estimated a CET1 impact of about 20bps, or AUD150m.

The higher risk weights will be implemented on 1 July 2016, giving the affected banks nearly 12 months to address capital shortfalls. Sound profitability means that shortfalls could be met through internal means – the AUD12bn is equivalent to about 40% of annualised 1H15 net profit after tax for the four major banks. Fitch expects the banks will look at increasing the discount on dividend reinvestment plans, and/or underwriting participation in these schemes to meet shortfalls. However, raising capital in equity markets is also an option to address both the requirement early and in anticipation of future increases in regulatory capital requirements. Banks have already begun increasing capital positions, with a number of the major banks announcing capital management activity at their 1H15 results.

The size of the increased capital requirement will vary across the banks based upon their loan portfolio compositions – CBA and Westpac have the largest Australian mortgage portfolios and therefore their minimum capital requirements are expected to be the most impacted.

RBA on FSI and Quest For Yield

Glenn Stevens spoke at the Australian Financial Review Banking & Wealth Summit “Observations on the Financial System“. He included comments on the implications of the quest for yield on retirement incomes, financial services culture, and remarks on the FSI inquiry.

 The Inquiry has eschewed wholesale changes in favour of more incremental ones. I do not intend to offer a point by point response to all the recommendations. Let me touch on just a few themes.

The first is enhancing the banking system’s resilience. There are a few issues here, the most contentious of which is whether banks’ capital ratios, which have already risen since the crisis, should be a little higher still. The Inquiry concluded that they should.

There has been a lot of debate about just where current capital ratios for Australian banks stand in the international rankings. The reason there is so much debate is because such comparisons are difficult to make. There seems little doubt, though, that most supervisory authorities (and for that matter most banks) around the world have, since the crisis, revised their thinking on how much capital is needed and none of those revisions has been downward. So wherever we stood at a point in time, just to hold that place requires more capital. And it’s likely to be demanded by the market. There’s generally not much doubt about which way the world is moving.

Of course, capital is not costless. If capital requirements become too onerous then the higher cost of borrowing could impinge on economic growth. But more capital brings the benefit of a more resilient system, one less prone to crisis and one more able to recover if a crisis does occur. Crises are infrequent, but very expensive. So there is a cost-benefit calculation to be done, or a trade-off to be struck – higher-cost intermediation, perhaps slightly reduced average economic growth in normal times, in return for the reduced probability, and impact, of deep downturns associated with financial crises. The Inquiry, weighing the costs and benefits, concluded that the benefits of moving further in the direction of resilience outweigh the rather small estimated costs.

The second set of issues surround ‘too-big-to-fail’ institutions and their resolution. The Inquiry is to be commended for grappling with this. These issues are complex and even after substantial regulatory reform at the global level, there is still key work in progress. The stated aim of all that work is to get to a situation where, with the right tools and preparation, it would be possible to resolve a failing bank (or non-bank) of systemic importance, without disrupting the provision of its critical functions and without balance sheet support from the public sector. This is explicitly for globally systemic entities, but the Inquiry has, sensibly enough, seen the parallel issue for domestically systemic ones as worthy of discussion.

Ending ‘too-big-to-fail’ is an ambitious and demanding objective. To achieve it, not only must systemic institutions hold higher equity capital buffers, but more tools to absorb losses are needed in the event the equity is depleted. Typically envisaged is a ‘bail-in’ of some kind, in which a wider group of creditors would effectively become equity holders, and who would share in the losses sustained by a failing entity. For this to work, there needs to be a market for the relevant securities that is genuinely independent of the deposit-taking sector – we can’t have banks hold one another’s bail-in debt. In a resolution, a host of operational complexities would also have to be sorted out. A resolution needs the support of foreign regulators if it is to be recognised across borders. It needs temporary stays on derivatives contracts so that counterparties don’t scramble for collateral at the onset of resolution. And it needs to be structured and governed well enough to withstand potential legal challenges and sustain market confidence.

A proposal for ‘total loss-absorbing capacity’, or TLAC, was announced at the G20 Summit in Brisbane last year. Consultations and impact assessments are under way, and an international standard on loss-absorbing capacity will be agreed by the G20 Summit in Antalya later this year; guidance on core policies to support cross-border recognition of resolution actions should be finalised shortly after.

It is fair to say that in its main submission to the Inquiry, the Reserve Bank counselled caution as far as ‘bail-in’ and so on is concerned. We would still do so. The Inquiry also favours a cautious approach. Again, though, the world seems to be moving in this general direction. It isn’t really going to be credible or prudent for Australia, with some large institutions that everyone can see are locally systemic, not to keep working on improvements to resolution arrangements.

The third set of recommendations from the Inquiry I want to touch on are those related to the payments system. The Inquiry generally supported the steps the Payments System Board (PSB) has taken since its creation after Wallis, but raised a few areas where the Board could consider consulting on possible further steps. As it happens, these dovetail well with issues that the PSB has been considering for some time. The Reserve Bank has since announced a review of card payments regulation and released an Issues Paper in early March. Among other things, it contemplates the potential for changes to the regulation of card surcharges and interchange fees.

Surcharging tends to be a ‘hot button’ issue with consumers and generated a large number of (largely identical) submissions to the Financial System Inquiry. But virtually all of the public’s concern is directed at a couple of industries where surcharges appear to be well in excess of acceptance costs, at least for some transactions. The Bank considers that its decision to allow surcharging of card payments in 2002 has been a valuable reform. It allows merchants to signal to consumers that there are differences in the cost of payment methods used at the checkout. By helping to hold down the cost of payments to merchants, the right to surcharge can help to hold down the prices of goods and services more generally.

The Bank made some incremental changes to the regulation of surcharging in 2013, but to date these have had a relatively limited effect on the cases of surcharging that most concern consumers. Our current review will consider ways we can retain the considerable benefits of allowing merchants to surcharge, while addressing concerns about excessive surcharges. One element of this might be, as the Financial System Inquiry suggests, to prevent surcharges for some payment methods, such as debit cards, if they were sufficiently low cost. This would mean that in most cases consumers would have better access to a payment method that is not surcharged, even when transacting online. Other options being considered are ways to make the permissible surcharge clearer, whether through establishing a fixed maximum or by establishing a more readily observable measure of acceptance costs.

The capping of card interchange fees is also now a longstanding policy and, we think, a beneficial one. Nonetheless, it is important to ensure that it continues to meet its objectives. Caps were put in place in 2003 based on concerns that interchange fees in mature payment systems can distort payment choices and, perversely, be driven higher by competition between payment schemes. As suggested by the Inquiry, the Bank’s review will consider whether the levels of the current caps remain appropriate. We know, for example, that lower caps have now been set in some other jurisdictions.

But there are other elements of the current regime that also warrant consideration. For instance, while average interchange fees meet the regulated caps, the dispersion of interchange rates around the average has increased significantly over time. The practical effect of this is that there can be a difference of up to 180 basis points in the cost of the same card presented at different merchants. This problem is aggravated by the fact that merchants often have no way of determining which are the high-cost cards.

Although the wide range of interchange fees is not unique to Australia, we would want to ensure so far as possible that the regulatory framework does not contribute to this trend or to declining transparency of individual card costs to merchants. The Bank’s review will consider a range of options, including ‘hard’ caps on interchange fees and hybrid solutions, along with setting more frequent compliance points for caps. Options for improving the ability of merchants to respond to differing card costs will also be considered.

While considering interchange fees, it is also appropriate to consider the circumstances of card systems that directly compete with the interchange-regulated schemes. This means, in particular, bank-issued cards that do not technically carry an interchange fee, but nonetheless are supported by payments to the issuer funded by merchant fees.

More broadly, all the elements I have mentioned – interchange fees, transparency and surcharging – are interrelated, which means that there are potentially multiple paths to achieving similar outcomes. I encourage those with an interest to engage with the Bank in the review process in the period ahead.

Turning away from the Financial System Inquiry to other matters, let me mention two.

I said at the beginning that the ‘search for yield’ continues. There is a line of discussion that tackles this issue from a cyclical point of view, thinking about how the balance sheet measures taken by the major central banks are affecting markets, the extent and nature of cross-border spillovers, what happens when the US Federal Reserve starts to tighten policy at some point and so on. I’ve spoken about such things elsewhere and have nothing to add today.

There is another conversation, however, that tends to take place at a lower volume, but which definitely needs to be had. That conversation is about what all this means for the retirement income system over the longer run. The key question is: how will an adequate flow of income be generated for the retired community in the future, in a world in which long-term nominal returns on low-risk assets are so low? This is a global question. Just about everywhere in the world the price of buying a given annual flow of future income has gone up a lot. Those seeking to make that purchase now – that is, those on the brink of leaving the workforce – are in a much worse position than those who made it a decade ago. They have to accept a lot more risk to generate the expected flow of future income they want.

The problem must be acute in Europe, where sovereign yields in some countries are negative for significant durations. But it is also potentially a non-trivial issue in our own country. In a conference about wealth, this might be a worthy topic of discussion.

And the final issue is misconduct. This has loomed larger for longer in many jurisdictions than we would have thought likely a few years ago. Investigations and prosecutions for alleged past misconduct are ongoing. It seems our own country has not been entirely immune from some of this. Without in any way wanting to pass judgement on any particular case, root causes seem to include distorted incentives coupled with an erosion of a culture that placed great store on acting in a trustworthy way.

Finance depends on trust. In fact, in the end, it can depend on little else. Where trust has been damaged, repair has to be made. Both industry and the official community are working hard to try to clarify expected standards of behaviour. Various codes of practice are being developed, calculation methodologies are being refined, and so on.[1] In some cases regulation is being contemplated. Initiatives like the Banking and Finance Oath also can make a very worthwhile contribution, if enough people are prepared to sign up and exhibit the promised behaviour.

In the end, though, you can’t legislate for culture or character. Culture has to be nurtured, which is not a costless exercise. Character has to be developed and exemplified in behaviour. For all of us in the financial services and official sectors, this is a never-ending task.

FSI – David Murray’s Speech

David Murray’s Speech to the Committee for Economic Development of Australia ‘Supporting Australia’s Economic Growth‘ coincided with the release of the Final Report of the Financial System Inquiry.

First let me thank CEDA for being our host, once again, as we release the Final Report of the Financial System Inquiry.

I’d also like to recognise some important people.

  • My fellow Committee members Kevin Davis, Craig Dunn, Carolyn Hewson and Brian McNamee, all of whom have put in an amazing effort to produce a set of expert judgements shared by us all.
  • The International Panel, Michael Hintze, David Morgan, Jennifer Nason and Andrew Sheng.
  • The Secretariat, as named in the Report, led very ably by John Lonsdale.
  • All of those who have made submissions or otherwise taken an interest in our work.

The Inquiry has been conducted in an open manner. We have consulted extensively with industry participants and end users.

The first round of consultation yielded more than 280 submissions and the second over 6,500. Our Interim Report provided a comprehensive review of Australia’s financial system.

The final report is a shorter and more focused document. It makes 44 recommendations to improve the efficiency, resilience and fairness of Australia’s financial system. It also sets out a blueprint to guide policy making over the next 10 to 20 years and makes 13 observations on taxation for reference to the Government’s Tax White Paper.

The Inquiry’s terms of reference required us to examine how Australia’s financial system can be positioned to support economic growth and meet the needs of end users. We were also asked to consider how the system has changed since the Wallis Inquiry, including the effects of the Global Financial Crisis.

This has not been an Inquiry established to deliver or prevent a particular outcome. Rather it has been conducted as a genuine exercise to assess the strengths and weaknesses of the Australian financial system.

We have considered the financial system in the context of Australia’s economy, particularly our status as a smaller, wealthy, open commodity exporter and described the features of a good financial system from Australia’s perspective.

In formulating our recommendations, we have focused on the national interest and the needs of end users. Our report is evidence-based and wherever possible presents cost/benefit trade-offs in support of our findings.

My purpose today is to explain how our recommendations will adapt the financial system to meet Australia’s special circumstances in the interests of its users and the nation as a whole.

I will first address recommendations that flow from two paradigm shifts since the Wallis Inquiry, namely those relating to resilience and consumer outcomes. Then I will deal with our unique and rapidly growing superannuation system. Lastly, I will talk about competition, efficiency, innovation and regulatory improvement.

While many of the Wallis Inquiry recommendations have stood the test of time, there are two areas where this Inquiry has formed a different view.

First, we believe external shocks can and will occur. As a result of the crisis, governments are now assumed to be the backstop the financial system. In contrast to Wallis, we cannot simply rule out the possibility that the Government will be required to backstop the banks in the event of a crisis. However we believe the system should be managed such that taxpayers are highly unlikely to lose money. We have to take practical steps to reduce moral hazard.

Second, we believe that effective disclosure and financial literacy are necessary but incomplete approaches for delivering satisfactory consumer outcomes. For this reason, we have highlighted the need for improved firm culture along with stronger obligations in some areas, especially in product manufacture and distribution.

The Inquiry makes six recommendations which directly address the issue of resilience, and two relating to competition and superannuation which also have consequences for system resilience.

I will discuss competition in the residential mortgage market later.

In relation to capital, the Inquiry believes the capital ratios of Australian banks should be ‘unquestionably strong’. Specifically, they should be ranked in the top 25 per cent of global banks. The major banks are currently somewhere between the global median and the 75th percentile. This means that they are not ‘unquestionably strong’. Accordingly, they should be required to increase their capital ratios so that they are in the top 25 per cent of global peers, and a process for more transparent reporting of comparative capital ratios should be developed.

Also in relation to capital, we recommend the Government should proceed to introduce a leverage ratio as a backstop to ADI’s risk weighted capital positions – in line with the unfinished Basel III agenda.

Proposals for the issuance of ‘bail-in’ debt securities should, however, not move ahead of developing international standards. If issued, this form of debt should conform to the principles relating to legal certainty outlined in our Report. We do not propose that depositors should be bailed-in.

The Report also endorses existing processes to improve pre-positioning, crisis management and resolution powers for regulators.

The Financial Claims Scheme should continue to be funded on an ex post basis, partly because our recommendations on resilience reduce the need for an ex ante levy.

To limit systemic risk and in the interests of fund members, we have recommended a general prohibition on direct borrowing for superannuation funds.

Generally, higher capital ratios and loss absorbency represent a form of insurance. They reduce both the likelihood and cost of failure. The Inquiry believes that the cost of this insurance is low and is significantly outweighed by the benefits of a more resilient system.

The Inquiry has been conducted against the backdrop of ongoing concerns about the quality of financial advice; a parliamentary inquiry into ASIC’s performance; and debate over amendments to the regulatory framework governing advice.

However, it would be a mistake to look at our recommendations in this area only through the narrow lens of the recent debate on FOFA.

Our six recommendations are based on a much broader assessment of the current framework, of which FOFA is only a small component.

We have identified three problems with the current arrangements.

First, firms do not take enough responsibility themselves for treating consumers fairly. This places pressure on the regulatory framework and the regulator.

Secondly, the current framework places too much reliance on disclosure and financial literacy. While these are important, they are not sufficient to deliver appropriate consumer outcomes.

Thirdly, we need a more pro-active regulator but, to be clear regulation cannot be expected to prevent all consumer losses. Our recommendations are not meant to absolve consumers of responsibility for their choices or insulate them from market risk; rather they are intended to reduce the risk of consumers being sold poor quality or unsuitable products.

Consistent with the approach in other industries where information imbalances can cause significant consumer detriment, product manufacturers should be required to consider the suitability of their products for different types of consumers as part of the design process.

Hence we have recommended the introduction of a targeted and principles-based product design and distribution obligation.

We also believe there needs to be a change in the approach of the regulator. ASIC should be a stronger and more proactive regulator that undertakes more intense industry surveillance and responds more strongly to misconduct once identified. Numerous submissions claimed it is under-resourced. We have recommended an industry funding model for ASIC.

We are putting the individual at the centre of the superannuation system and strengthening its focus on retirement incomes, because we believe the provision of income in retirement should be enshrined as the system’s primary objective.

The Inquiry has identified two major issues with the superannuation system.

Fees are too high in the accumulation stage given the substantial growth we have seen in fund size and member balances. And superannuation assets are not being converted into retirement incomes as efficiently as they could be.

The absence of strong consumer driven competition remains a significant problem in the accumulation phase. MySuper aims to improve efficiency and competition by mandating simple low cost default products and by encouraging funds to become larger. It has only been in place for around 18 months. However, we are not confident it will drive the efficiency improvements required. We have therefore laid down a challenge to the superannuation industry.

We have recommended a review of MySuper by 2020 to assess whether or not it has delivered sufficient improvements in competition and efficiency. If it has not been effective, we recommend the Government introduce a competitive mechanism under which only the best performing funds would be selected to receive default superannuation contributions. This would allow all default members to benefit from the type of purchasing power that currently delivers lower fees to employees of large firms that have negotiated bulk discounts for their employees.

The retirement phase of Australia’s superannuation system is under-developed.

Members need more efficient retirement products that better meet their needs and increase their capacity to manage longevity risk.

We therefore recommend that all fund members should be offered what we have called a Comprehensive Income Product for Retirement when they switch from accumulation to retirement. This would combine an account based pension with a pooled longevity risk product.

Retirees would benefit from these products because they would have higher incomes and would not be exposed to the risk of outliving their savings.

The trade-off would be that less money saved through superannuation would be available for bequests, reflecting our view that the system should be about retirement incomes.

Collectively, the Inquiry’s superannuation recommendations have the potential to increase retirement incomes for an average male wage earner by around 25 to 40 per cent, excluding the Age Pension.

Competition is the cornerstone of a well-functioning financial system, driving efficient outcomes for price, quality and innovation. Some parts of the system have experienced increased market concentration, especially in the wake of the financial crisis. Our aim has been to ensure there will be an adequate focus on competition in the future.

In the residential mortgage market we have recommended narrowing the gap between IRB and standardised model risk weights for housing loans by increasing the former to between 25 and 30 per cent. This corresponds with a small funding cost increase for the major banks. However, competition will limit the extent to which these costs are passed on to consumers.

In some industries, competition has not resulted in reasonable prices for card transactions. The largest number of submissions we received related to customer surcharging for credit card transactions. We have recommended the Reserve Bank should ban surcharging for low cost cards and cap surcharges in relation to credit cards. This should address concerns about excessive surcharging in some industries.

More than a quarter of our recommendations are designed to enhance competition. For example, we have recommended giving ASIC a competition mandate; three-yearly external reviews of competition in the financial sector; and regulation that is more technologically neutral to facilitate full on-line service delivery.

To facilitate continued innovation in the financial system, we have emphasised the need for regulatory frameworks to be more flexible and adaptable. Graduated frameworks are important to ensure that new entrants are not over-regulated and to provide scope for innovation.

We have made several recommendations to reduce structural impediments to SME access to credit and facilitate innovation in this area. Our focus has been on boosting competition, for example by encouraging the emergence of rival lenders and new techniques such as crowdfunding and peer-to-peer lending. Some of these recommendations will also assist development of the venture capital market. We have also identified issues with the fairness of SME loan contracts in relation to non-monetary default clauses.

Our emphasis on competition is designed to create a more efficient system. In considering allocative and dynamic efficiency, we have identified several aspects of Australia’s tax settings that distort the flow of funds, especially differential treatment of savings vehicles and barriers to cross-border capital flows. Because our terms of reference do not allow us to make recommendations on tax, these observations will flow into the Government’s Tax White Paper. The Report also addresses issues relating to the corporate bond market.

The regulatory architecture developed after the Wallis Inquiry is reasonably effective. Our recommendations aim to build on the current arrangements. We want regulators that are strong, independent and accountable. Our recommendation for a Financial Regulation Accountability Board will ensure our financial regulators are subject to regular systematic scrutiny and instil a culture of continuous improvement.

In approaching our task, the Committee has emphasised Australia’s need for a high quality financial system, setting out the roles and responsibilities of its participants.

The unique characteristics of Australia’s economy demand high quality in the eyes of the world because we want to continue to be successful at augmenting our own savings with foreigners’ savings to develop the economy.

We have a good track record at this and a generally reliable system of law and public administration. However, as a commodity driven economy we experience higher cyclical volatility in national income and we have very high net foreign liabilities at more than half our GDP. These factors cause the rest of the world to monitor closely the quality of our settings.

The Report assesses the potential costs of serious disruption to the financial system. The Basel Committee has estimated the average total cost of a financial crisis at around 63 per cent of a country’s annual GDP. For Australia, this is $950 billion, with 900,000 additional Australians out of work. The economic cost of a severe crisis is much higher – around 158 per cent of annual GDP. For Australia, this is around $2.4 trillion. And this is just the annual cost.

Our experience during the Global Financial Crisis makes it very difficult for Australians to empathise with the depth of the economic and social loss in other countries. Yet the circumstances that shielded Australia from the crisis will not recur.

We had very high terms of trade, negligible net government debt, a Budget surplus, a triple A credit rating, a record mining investment boom, and a major trading partner growing in real terms at an annual rate of around 10 per cent and able to throw immense resources at a stimulus program that favoured our exports.

For all these reasons we need to maintain credibility among foreign investors and have an unquestionably strong banking system. The marginal cost of achieving this is small relative to the economic and social cost to the country and to taxpayers when a crisis occurs in less favourable circumstances than the last one.

We also need to ensure the Government maintains a strong fiscal position. The crisis demonstrated how quickly government finances can deteriorate and how damaging this can be for the relevant country. Deterioration in the Government’s credit rating would have a direct effect on the cost of credit in the system.

We have designed our report and its recommendations to put Australia’s financial system in the very highest quality position. My colleagues and I simply ask that you embrace our recommendations in the national interest.

Reflections on FSI

The final report of the Financial Systems Inquiry was released on Sunday. We already provided a summary of the 44 recommendations and discussed some of the specific proposals. It is of course a report to Government, so still a political process will run before we see what translates into policy, though some recommendations – for example changed capital rules – are outside the political processes, being the responsibility of the regulators. However, DFA wanted to reflect on the overall 350 page report.

  1. We think this it is a fine, balanced and independent piece of work. Given the complex task, the various powerful lobbies involved, and the short time frame, this is a landmark study, and should provide direction for the financial services industry in Australia for the next few years.
  2. The underlying philosophy, that the markets should be allowed to work, with regulation used where necessary to balance the various stakeholder capabilities in appropriate. More regulation is not always better. The emphasis on consumers is welcome.
  3. The capital buffer recommendations are appropriate, and should be adopted by APRA. Capital levels need to be brought up to best global practice, and given the likely continued global push to lift capital higher, this process will continue for some time. Clearly there is a cost to do this, and the easy route will be for banks to trim deposit rates and lift loan rates to protect their margins and shareholders. The right course would be to expect the banks to drive greater efficiency to partly offset, at least, the costs of holding more capital. The bail-in bonds route will also provide additional buffers. The extra disclosure recommended is helpful.
  4. The move to lift the capital ratios of banks with advanced IRB capital calculations will help to make the playing field more level than it is, but it will not necessarily be sufficient to fundamentally change the competitive landscape. We will continue to have four large, vertically integrated players dominating the market.
  5. We believe the recommendation to rebalanced the regulatory focus towards competition is appropriate, as until now financial stability was the main game. As a result we have high industry concentration, and limited competition. This has led to super-profitable banks, which costs Australia Inc dear.
  6. The financial services regulatory environment in Australia is complex, with ASIC, APRA, ACCC and RBA all stakeholders. The FSI report has not recommended major changes, though ASIC’s role will be enhanced to focus on products, and enhanced consumer protection. Will this be adequately funded by charging industry participants more? A body to review the Regulators is proposed (another layer of cost?)
  7. The superannuation system was condemned as inefficient, and the proposals to drive fees lower, provide greater choice and have a default income structure on draw-down, are appropriate. We agree that the majority of directors in a super fund should be independent. Lets be clear, mandatory saving for retirement is a good policy, but the industry has been milking this for years, and changes need to be made. MySuper should be given a chance to work, but we like the idea of providers bidding for savings. The prospect of returns rising by 25% or more reflects the powerful impact the annual fees have on performance. Fees need to come down substantially.
  8. The support for SMSF is appropriate, as is the emphasis on saving for retirement, not generic wealth creation. The removal of leverage in SMSF’s makes sense, given the rise in property investment, but it is worth remembering the shares are issued by companies who are often  leveraged, so risk exists here too in a down turn!
  9. The changes to advice are appropriate. Advisers need to declare their alignment to product providers, be better trained, and the concept of general advice should be tuned.
  10. Card surcharging should be brought under control. There is no justification of consumers paying more than the cost of the transaction, yet some businesses are charging a percentage of transactions. We agree there is further work to do on interchange fees, and especially making the use of debit cards easier (thus avoiding card service fees).
  11. The Treasurer will find several ways to lift taxes, including potentially revising the tax treatment of superannuation, and negative gearing. In addition, the report comments on GST in relation to financial services products, leaving the door open for GST to be extended.
  12. The report recognises the impact of new technologies, and the comments on technology neutrality are appropriate. The report recommends a federated digital identity strategy that involves the Government setting up a framework under which private and public sectors compete to supply digital identities to consumers and businesses.  This is needed because of increasing consumer preference for online, fraud concerns and efficiency. We think it understates the importance of P2P.
  13. The main area of weakness relates to the SME sector, which is disadvantaged by the current banking environment. No significant recommendations were made in this important area.

FSI – Rebalance Regulatory Focus Towards Competition

The FSI report discussed the roles of APRA, RBA and ASIC, commenting that Australia’s institutional structure is relatively informal and decentralised.The most critical observation is implicitly that competitive tension has been traded away for in preference for financial stability. The acquisition of St George by Westpac, and Bank West by CBA would be two relative recent examples. Now there is an intent to redress the balance, with more focus on competitive aspects. This is important because thanks to lack of competitive tension our banks are amongst the most profitable in the world, whilst end users of banking services are effectively paying more than they should (as demonstrated by the higher margins in operation in Australia).

While the Inquiry does not recommend major changes to the overall regulatory system, it believes action should be taken in the following five areas to improve the current arrangements and ensure regulatory settings remain fit for purpose in the years ahead:

  • Improve the regulator accountability framework: Australia needs a better mechanism to allow Government to assess the performance of financial regulators. The Inquiry recommends establishing a new Financial Regulator Assessment Board (Assessment Board) to undertake annual ex post reviews of overall regulator performance against their mandates. It also recommends that Government should provide more clarity around its expectations of regulators, including its appetite for risk in the financial system, while regulators should develop better performance indicators. These new arrangements should ensure, among other things, regulators give stronger and more transparent consideration to competition and compliance cost issues.
  • Improve the effectiveness of our regulators: Australia’s regulatory system will continue to be challenged by the pace of technological change. Especially in payments and financial markets, new business models are challenging existing regulatory frameworks. The emergence of new technology is placing demands on regulators to be more flexible, and raising issues relating to identity, privacy and cyber security. Australia’s regulators need the funding and skills to meet these challenges into the future, including encouraging innovation through appropriately graduated approaches. The Inquiry recommends that ASIC and APRA should both be strengthened through increased budget stability built on periodic funding reviews, and greater operational flexibility. ASIC, APRA and the payment systems function of the RBA should also commit to six-yearly capability reviews. These exercises should ensure they have the required skills and culture to maintain effectiveness in an environment of rapid change, as will the recommendation in Chapter 3: Innovation that Government create a new public-private collaboration mechanism to facilitate regulatory change in response to innovation.
  • Strengthen ASIC: Instances of misconduct and consumer loss in the financial system have prompted questions about the effectiveness of consumer protection, as well as the adequacy of ASIC’s resources and the design of the regulatory framework in which it operates. The public expectation is that ASIC will act as a pro-active watchdog in supervising all financial services providers. However, in practice, ASIC has a very wide remit but limited powers and resources. The Senate Economics References Committee’s report on ASIC’s performance was released just before the publication of the Interim Report. The Interim Report indicated that the Inquiry would consider the Senate Committee’s recommendations in the lead-up to its Final Report. Several of the recommendations in this Final Report are consistent with those of the Senate Committee. The Inquiry has recommended some fundamental changes to the regulatory framework governing the financial services industry. These measures are part of a broad shift in Australia’s approach to consumer protection in the financial sector — away from primarily relying on disclosure and financial literacy. The Inquiry has also recommended changes in how ASIC approaches its consumer protection role. In particular, the Inquiry considers that ASIC should devote more attention to industry supervision, including more proactively identifying and weeding-out misconduct. It has also recommended several measures to strengthen ASIC, including better funding, enhanced regulatory tools, stronger licensing powers to address misconduct, and substantially higher criminal and civil penalties. In light of the significance of these changes, the Inquiry recommends that ASIC should be the first regulator to undergo a capability review, along with the funding review that would take place under the recommendation for increased budget stability. This would help to ensure ASIC has the appropriate skills and culture to adopt a flexible risk-based approach to its future role. Its overall performance would also be subject to annual review by the proposed new Assessment Board.
  • Rebalance the regulatory focus towards competition: Not surprisingly, regulators have increased their focus on resilience in the wake of the GFC. However, the Inquiry believes there is complacency about competition, and that the current framework does not systematically identify and address competition trade-offs in regulatory settings. Although the ACCC is responsible for competition policy in the financial sector, this is part of its broader economy-wide responsibilities. Furthermore, the ACCC is not responsible for reviewing how decisions by other regulators affect competition. It is not always clear how APRA and ASIC balance their core regulatory objectives against the need to maintain competition. Policy makers and regulators need to take increased account of competition when making regulatory decisions, while ASIC should be given an explicit competition mandate. Periodic external reviews of the state of competition should be conducted, including assessing whether Australia can reduce barriers to market entry for new domestic and international competitors.
  • Improve the process of implementing new financial regulations: Since the GFC, Australia’s financial system has been influenced by new global standards and the increasing scope and complexity of cross-border financial regulation. Substantial regulatory change has resulted from international developments and decisions made in major offshore financial centres, concurrent with a large number of domestically driven changes, especially in financial advice and superannuation.
    Although there is no evidence to suggest Australia’s compliance burden is substantially larger than in jurisdictions overseas, work commissioned by the Inquiry suggests that improved regulatory processes could reduce industry costs and lead to better outcomes. Specifically, the Inquiry recommends that Government and regulators adhere to minimum implementation lead times and monitor impacts more thoroughly post-implementation.

The Reserve Bank of Australia (RBA) and APRA each have responsibility for financial stability. However, most macro-prudential tools can only be deployed by APRA. This places a strong premium on cooperation between the two agencies. The RBA should continue to monitor risks in the non-prudentially regulated sector. The Inquiry believes the compulsory nature of superannuation justifies ongoing prudential regulation by APRA, including the availability of compensation in the event of fraud or theft. The Inquiry has not recommended giving the ACCC sole responsibility for consumer protection because these powers are an important part of ASIC’s enforcement toolkit. The Inquiry sees value in an integrated consumer regulator for financial services.