This morning the Interim Report of the Financial Systems Inquiry (or 'Murray Inquiry') was issued. In this bulletin we draw out the highlights of the Report and provide contextual commentary from relevant Norton Rose Fulbright experts.
The Report is a substantial document of some 460 pages. It is designed to elicit comments from interested stakeholders to inform the Final Report to the Treasurer in November this year. It does not make recommendations, nor does it describe the final view of the Committee. It primarily contains what it describes as 'observations' which are said to reflect the Committee's current judgement, based on available evidence, but do not cover all the issues raised in submissions or consultations. It offers some options for consideration but as Mr Murray was at pains to make clear in his speech to the National Press Club today, these are not to be taken as draft recommendations.
The Committee will continue to engage actively with stakeholders and, as well as receiving formal submissions, members and staff will undertake a range of consultation processes, including public forums and domestic and international stakeholder meetings, focus attention on those issues which emerge as being of the highest priority.
The Report can be found here: http://fsi.gov.au/publications. The Terms of Reference are set out in Appendix 1 to the Report. The Inquiry received over 280 first round submissions, which are available on the Inquiry's website www.fsi.gov.au.
Overall, the Committee's initial assessment is that, to date, the Australian financial system has performed reasonably well in meeting the financial needs of Australians and facilitating productivity and economic growth. Many areas of the financial system are operating effectively and do not require substantial change.
However, the Committee acknowledges that there is no room for complacency and that our economy will face a number of opportunities and challenges in the coming decades which may have implications for the financial system, including future financial crises; fiscal pressures; productivity growth; changes in technology; and international integration.
The Report identifies nine priority issues facing the system, makes observations in relation to each and seeks further submissions and stakeholder feedback on them. Those priority issues are: competition and contestability; funding Australia's economic activity; superannuation efficiency and policy settings; stability and the prudential framework; consumer outcomes and conduct regulation; regulatory architecture; ageing and retirement incomes; technology opportunities and risks; and international integration.
Below is a summary of the Committee's observations in Part 1, followed by Norton Rose Fulbright expert observations and commentary in Part 2.
Part 1: The Committee's observations
Competition and contestability
The banking sector is competitive, albeit concentrated and the application of capital requirements is not competitively neutral. Larger banks have a costs advantage over smaller competitors due to their size and sophisticated risk management systems and because they are perceived as being too-big-to-fail. This perception was entrenched by significant government actions in a number of countries during the GFC. This perception can be reduced in Australia by making it more credible to resolve these institutions without Government support.
Regulation of credit card and debit card payment schemes is required for competition to lead to more efficient outcomes. However, differences in the structure of payment systems have resulted in systems that perform similar functions being regulated differently, which may not be competitively neutral.
Funding Australia's economic activity
Ongoing access to foreign funding has enabled Australia to sustain higher growth than otherwise would have been the case. The risks associated with Australia's use of foreign funding can be mitigated by having a prudent supervisory and regulatory regime and sound public sector finances.
There are structural impediments for small- and medium-sized enterprises to access finance. These impediments include information asymmetries, regulation and taxation.
Australia has an established domestic bond market, although a range of regulatory and tax factors have limited its development.
Superannuation efficiency and policy settings
There is little evidence of strong fee-based competition in the superannuation sector, and operating costs and fees appear high by international standards, indicating that there is scope for greater efficiencies in the system.
If allowed to continue, growth in direct leverage by superannuation funds, although embryonic, may create vulnerabilities for the superannuation and financial systems.
Superannuation policy settings lack stability, which adds to costs and reduces long-term confidence and trust in the system.
Stability and the prudential framework
Australia generally has strong, well-regarded regulators so the status quo is an appropriate starting point for policy discussion. In particular, the Committee has not seen evidence to suggest a need to reform radically the way government intervenes in or regulates the financial system. However, the current framework is in need of refreshing to better integrate it internationally and to enable the system to meet future challenges. Some areas of possible improvement have been identified to increase independence and accountability and enhance transparency. Australia's financial system and markets have undergone significant change since the Wallis Inquiry in 1997 and this means that Wallis' regulatory philosophy, ie that broadly unfettered financial markets should generally lead to resources being allocated efficiently, is no longer appropriate.
To contribute to the effectiveness of the financial system, sound corporate governance requires clarity of the responsibilities and authority of boards and management. There are differences in the duties and requirements of governing bodies for different types of financial institutions and, within institutions, substantial regulator focus on boards has confused the delineation between the role of the board and that of management.
Consumer outcomes and conduct regulation
Consumers of financial products and services can be subject to information imbalances and behavioural biases that are detrimental to them and the efficiency of the system. The current disclosure regime produces complex and lengthy documents that often do not enhance consumer understanding of financial products and services, and impose significant costs on industry participants.
Improving standards of adviser competence and removing the impact of conflicted remuneration can improve the quality of advice. Comprehensive financial advice can be costly, and there is consumer demand for lower-cost scaled advice.
Financial services should not be politicised to the extent that the government sets prices, or mandates non-commercial financial decisions to resolve government fiscal problems such as requiring banks to hold government debt. If there is a compelling need for government intervention it should be limited to seeking the ideal balance of efficiency, stability and fairness.
Regulators' mandates and powers are generally well defined and clear; however, more could be done to emphasise competition matters. In addition, ASIC has a broad mandate, and the civil and administrative penalties available to it are comparatively low in relation to comparable peers internationally.
The regulatory perimeters could be re-examined in a number of areas to ensure each is targeted appropriately and can capture emerging risks.
Ageing and retirement incomes
The retirement phase of superannuation is underdeveloped and does not meet the risk management needs of many retirees.
There are regulatory and other policy impediments to developing income products with risk management features that could benefit retirees.
Technology opportunities and risks
Technological innovation is a major driver of efficiency in the financial system and can benefit consumers. Government and regulators need to balance these benefits against the risks, as they seek to manage the flexibility of regulatory frameworks and the regulatory perimeter. Government is also well-positioned to facilitate innovation through coordinated action, regulatory flexibility and forward-looking mechanisms
Access to growing amounts of customer information and new ways of using it have the potential to improve efficiency and competition, and present opportunities to empower consumers. However, evidence indicates these trends heighten privacy and data security risks.
The financial system's shift to an increasingly online environment heightens cyber security risks and the need to improve digital identity solutions. Government has the ability to facilitate industry coordination and innovation in these areas.
Coordination of Australia's international financial integration could be improved. Although elements of our financial system are internationally integrated, a number of potential impediments have been identified. Financial system developments in the region will require continuing government engagement to facilitate integration with Asia. Domestic regulatory processes could be improved to better consider international standards and foreign regulation.
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