DFA Makes Submission to the Financial Services Inquiry

DFA today made the following submission to the Inquiry.

  1. We believe that whilst the current financial system in Australia is robust and well regulated, there are a number of factors which means it is having a significant negative impact on the economic performance of the country.
  2. Banks have grown their balance sheets in-line with growth in demand – especially supporting high levels of investment loans, and as a result they are not adequately providing reasonable lending services to a considerable number of small and medium enterprises, who could create economic value to the country. This is influenced by the relative capital costs of housing lending versus commercial lending under the Basel rules. (Many smaller ADI’s are unable to take advantage of the advanced methods, therefore smaller players require more capital per loan than the big four). Lending ever more loans to households to purchase property does not create real growth, it just inflates prices. Our surveys of Small and Medium Enterprise Businesses (SME’s) indicates that since 2007, and after the GFC, availability of finance options has diminished, the costs of borrowing are significantly higher, and the compliance demands placed on them by lenders has increased significantly.
  3.  Whilst competition amongst the big four is genuine, the range of products and pricing is more homogenous than before the recent consolidation of regional players including Bank West and St George into the majors. Smaller regional banks, building societies and credit unions are unable or unwilling to compete, so we have “the rest” of the market loosing share and concentration increasing. Non-Banks remain under pressure post the GFC. Lower levels competition leads to higher prices and less need for innovation.
  4. In addition, the big four have extended their business footprint, to include wealth management, investment platforms, insurance, commercial banking and other areas. This concentration is not necessarily best for Australia, as it creates a structure where individual large players are able to control too much of the market, and may become too big to fail. Whilst they may trade under an umbrella of different brands, such concentration has the potential to reduce competition and exclude new or smaller players from the market. Whilst the regulators report piecemeal on elements across the financial services landscape, there is no holistic measure of total market influence of any one of the large players.
  5. All banks are being confronted by a tsunami of new technology, which is driven by consumers now familiar with smartphones and tablets expecting ever more services delivered direct to them. This migration is not uniform, so some older less profitable customers are still reliant on branches, but overall distribution economics are changing fast. We could see a “last man standing” problem as banks close branches and invest more online. The most profitable customers are ahead of the banks in their online expectations.
  6. The potential for new technology based competitors to enter the financial services market is significant. In a recent piece of research, DFA undertook a thought experiment, which highlighted that some of the more digitally aware bank customers have stronger loyalty to technology companies than for traditional banks.
  7. Peer-to-peer lending has the potential of offer new solutions. We believe that P2P Lending has the potential to become a significant and disruptive force in banking, for unsecured credit and as an alternative to credit card debt. However, as this is a relatively small share of total borrowing (~$150bn), the overall impact on the banking system is likely to be quite small initially.  We should expect new-to-world models of lending to proliferate, and this should be seen as a positive opportunity, not a threat. We note that the UK Government has placed funds via peer-to-peer lenders to assist small business there.
  8. Shadow Banking in Australia may not be as contained or isolated as regulators portray. The wider question is the extent to which the prudentially regulated entities and the non-prudentially regulated entities are connected (either locally or globally). The data is hard to pin down. Perhaps 5% of Australian bank assets are exposed to shadow bank intermediaries, and 18% of shadow banking assets in Australia are exposed to the banks. The challenge is to better understand these connection, and begin to tease apart the links and risks.

Details of our research have been published in our report “The Quiet Revolution” which is attached as appendix 1. There we go into significant detail by customer segment, leveraging our primary research. We focus specifically on digital banking, and how consumers are responding. Appendix 2 covers our recent research on peer-to-peer lending. Appendix 3 covers Shadow Banking in Australia.

B.    Suggested Policy Options

  1. DFA recommends the consideration of the following to help ensure Australia benefits from the Financial Sector into the future.
  2. Banks need to be encouraged to lending more willingly to businesses, especially SME’s. In an environment in which on most measures, housing is less affordable than it should be, and where interest rates are low, we need mechanisms to redirect lending away from inflated housing towards productive investment in the commercial sector. The options to do this are to change the capital adequacy rules under Basel III, or implement macroprudential strategies; or both.
  3. The Bank of International Settlements (BIS), using research analysis covering multiple markets , reached an interesting conclusion. Whilst there may be some benefits in capping Loan-To-Value ratios (as New Zealand has done, and the IMF advocated), the best mechanism to manage house prices is to target debt service to income ratios. The logic is because LVR controls won’t impact borrowing in a rising market, (as house prices rise, borrowing can grow). On the other hand a debt service to income ratio is not impacted by rising house prices, so consumers would not be in a position to borrow any more even if house prices did rise. Therefore it is a more effective control.
  4. Smaller players are disadvantaged, and it is hard to see an easy way to change this. However, one mechanism which might prove interesting is for the government to offer funding available only via smaller banks for SME lending. This could be run on a commercial basis, at no net costs to government, and would provide a platform for smaller players to grow. It would also increase competition on this important sector. Possibly this could be linked with peer-to-peer lending innovation.
  5. We recommend the development by the regulators of a cross-business unit assessment of the footprint of our major banks. This should chart, in one place their total market influence and report trends over time. In addition, we recommend limits be designed to protect against “too big to fail”. APRA’s D-SIB’s assessment  recognizes domestic systemically important banks, but does not seek to measure the overall influence of any particular bank, and whether any one player has too much influence across the market. ACCC seems to focus on specific transactions or acquisitions. There is therefore a gap in the regulatory framework. Reporting would be a good first step.
  6. Provision of a branch outlet will become less a strategic asset, more a social requirement as digital adoption continues. Consideration should be given to creating a bank branch utility, to ensure that socially important aspects of branch banking remain. This might be provided by Australia Post or some other entity. This would avoid the “last man standing” problem.

 

Author: Martin North

Martin North is the Principal of Digital Finance Analytics

1 thought on “DFA Makes Submission to the Financial Services Inquiry”

Leave a Reply