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Can we have financial reform when banks are too big to regulate?

The demonstration of bank power on the FOFA repeal illustrates the challenge of effectively regulating a sector that is beginning to dominate the Australian economy, write Bernard Keane and Glenn Dyer.

It’s been a mixed week for the big banks. Clive Palmer handed them a huge win on financial planning and wealth management by agreeing to support the Coalition’s gutting of the Future of Financial Advice consumer protections — one that will add at least $300 million to $500 million a year to their collective bottom lines from hapless “clients”.

But the interim report of the David Murray inquiry into financial services proved to be rather less pro-big bank than expected from a review led by a former bank CEO. As we discussed on Wednesday, the interim report made an effort to tackle an issue the banks had tried to downplay in their neutering of the inquiry terms of reference — whether they were too big to fail, and what to do about it.

The extent to which this rattled the banks is illustrated by the way the cartel’s most bellicose chief executive, ANZ’s Mike Smith — the bloke who disgustingly compared Joe Hockey in opposition to Hugo Chavez — to pre-emptively attack the idea of requiring the big banks to hold higher capital reserves. ANZ is the bank that has most aggressively used the implicit guarantee of its “too big to fail” status as leverage to expand offshore into riskier, less well-regulated regional markets that increase the threat of external contagion to Australia’s banking system.

Smith would have been mortified to hear that a senior Australian Prudential Regulatory Authority official yesterday expressed sympathy for higher capital buffer requirements for the big banks.

The banks have been unsuccessful at thwarting prudential and stability regulation in recent years, with regulation driven by the international regulatory response to the financial crisis, which has proven impossible to resist despite Australian bankers’ insistence that they’re different to their international colleagues.

But on consumer protections, the big banks have proven not merely too big to fail but too big to regulate. Despite successive financial scandals, the relevant regulator, the Australian Securities and Investments Commission, has repeatedly proven entirely unwilling to actually regulate the big banks. So loath was ASIC to regulate the banks that even when the Commonwealth Bank, already the subject of an enforceable undertaking about its shonky financial planners, confessed to ASIC that one of them had been forging client signatures, ASIC managers literally binned the report and ignored it.

This is our own home-made potential sub-prime disaster, which, if something nasty happens, could devastate the economy and financial system.”

When Labor finally moved comprehensively to address the systemic problems created by the vertical integration (aka big bank takeover) of our wealth management sector, the banks and their front groups in wealth management moved heaven and earth to get the Coalition to undo the reforms that removed conflicted remuneration, ended secret fees and required financial planners to act like the professionals they purport to be. The banks, and the Coalition, proved far too strong for consumers and retirees, whose interests Clive Palmer happily helped bin.

The Coalition, which has refused to accept the need for any inquiry into the Commonwealth and ASIC, has also slashed ASIC’s budget, meaning the “regulator” will, by its own admission, be forced to do less active investigation of the banks’ dodgy wealth management activities. When it comes to consumer interests, the big banks simply have too much power to be regulated. The extent to which the Murray inquiry leads to prudential and stability reforms will therefore be a fascinating test of how, six years on from the financial crisis, the banks’ power now also extends to a capacity to defeat prudential regulation.

The inquiry has also sided with the key regulators, the Reserve Bank and APRA, plus Treasury, in identifying the super industry as a an emerging weak point for the banks, the economy as a whole and potentially for retirees and taxpayers. It identifies the growing concentration of risk between the banks lending money for home buying and self-managed super funds, which are collectively big shareholders and depositors in those same banks. Big retail and industry funds are also large shareholders in the big four banks.

This increasing correlation between the banks, home lending, investment and super funds is worrying the regulators and worries Murray, who for all his flaws, fully understands the risks (the current managements of the banks surely do so as well, though they wouldn’t dare say so publicly). Unfortunately the risks are not being acknowledged by the federal government or by super funds, and especially not the SMSF sector. This is our own home-made potential sub-prime disaster, which, if something nasty happens, could devastate the economy and financial system. It could be the key area of recommended change in Murray’s final report.

Unfortunately, the interim report, unexpectedly strong in some regards, is weak in another. There is a growing consensus — which we discussed late last year — that the remarkable growth of Australia’s financial services sector since the Wallis inquiry in the 1990s has been accompanied not by growing economies of scale, but by deteriorating efficiency. A report from Industry Super last year identified a long-term downward trend in the efficiency of capital formation, while the Productivity Commission found that productivity growth in the finance sector had slumped. The Murray Inquiry would have been the ideal vehicle to examine this issue in depth. It does note both the huge growth in financial services and the consolidation of the sector since the Wallis inquiry and the shift of the big banks into the wealth management and superannuation sector.

Commendably, it does tackle an issue (flagged as important by the RBA) that might be related to the sector’s growing inefficiency: the high cost of superannuation management. And, as everyone but the supporters of FOFA repeal have noted, it identified conflicted remuneration and poor-quality financial advice as major problems in financial planning. But the opportunity to tackle inefficiency hasn’t been taken up.

It may sound esoteric, but this is an issue of considerable economic significance. Stability is a critical issue, of course, but ultimately that’s about insurance against a financial catastrophe. An inefficient financial sector costs us all, day in and day out, and when you have a finance sector the size of Australia’s and it controls a pool of wealth that will eventually be twice as large as our entire GDP, that cost is substantial. The fact that it is absent from economic reform debates says much about the motives of many participants in those debates. It may also reflect the fact that reform in financial services only happens when the big banks say it will happen.

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    Ray Butler
    Posted Sunday, 3 August 2014 at 12:36 pm | Permalink

    Economic interests are the most effective ways to avoid being accountable to the law; we tend to associate progressive standards of living to economic strength, but to encourage business ventures we allow larger and larger pieces of the pie to go towards investors, ultimately draining the potential for a strong economy to benefit standards of living across the board, not to mention environmental shortcuts.

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