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.

Author: Martin North

Martin North is the Principal of Digital Finance Analytics