The Financial System Inquiry led by David Murray (Murray Inquiry) released its final report on 7 December 2014 (Final Report) with the aim of outlining a blueprint for the Australian financial system over the next decade.  To this end, the Final Report makes 44 recommendations to improve the efficiency, resilience and fairness of Australia’s financial system.

The Government intends to consult with industry and consumers before making any decisions on the recommendations. This consultation will occur up until 31st March 2015.

This update provides a summary of some key points arising from the Murray Inquiry’s observations and recommendations as they relate to competition payment systems, innovation and the digital economy.

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.

The Final Report observes that competition in the financial system is “generally adequate” although some parts of the system have experienced increased market concentration, especially in the wake of the financial crisis.  The focus of the Murray Inquiry’s competition-related recommendations is to remove impediments to the development of competition in the future.  Some of these measures are outlined below.

Regulatory architecture – ASIC mandate to consider competition issues

The Murray Inquiry does not recommend any major changes to the overall regulatory system.  However, it notes that “ACCC is not responsible for reviewing how decisions by other regulators affect competition” and “it is not always clear how APRA and ASIC balance their core regulatory objectives against the need to maintain competition”.  To address this, the Final Report recommends that the Government:

• update ASIC’s mandate to include a specific requirement to take competition issues into account as part of its core regulatory role in order to avoid broader competition issues falling between the cracks of the financial system; and
• commission periodic external reviews of the state of competition in the financial system every three years (Recommendation 30).

Vertical integration

Although the Final Report notes steady increases in vertical integration within certain sectors, the Final Report suggests transparency measures would be adequate to resolve any perceived conflicts of interest flowing from vertically integrated business models.  This would include requiring advisers and mortgage brokers to disclose ownership structures (Recommendation 40). 

Residential mortgages

To improve competitive neutrality, the Final Report recommends narrowing the gap between IRB and standardised model risk weights for housing loans by increasing the former to between 25-30% (Recommendation 2). Whilst this would correspond with a small funding cost increase for the major banks, the Final Report suggests that competition would limit the extent to which these costs are passed on to consumers.

Superannuation

The Murray Inquiry calls for a review of MySuper by 2020 to assess whether it has delivered sufficient improvements in competition and efficiency, recommending it should otherwise be scrapped and replaced by a competitive mechanism under which only the best performing funds would be selected to receive default superannuation contributions.  Such a mechanism 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”.

Consumer protection

The Final Report recommends 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.  This is to be achieved through better funding, enhanced regulatory tools (eg, a proactive product intervention power) (Recommendation 22), stronger licensing powers to address misconduct, and substantially higher criminal and civil penalties where there is a risk of significant consumer detriment.

The Final Report also makes recommendations to improve the ways in which disclosures of fees and risks are communicated to consumers (Recommendation 23).

Stability and resilience

More can be done to strengthen the resilience of Australia’s financial system to avoid or limit the costs of future financial crises.

A key question for the Murray Inquiry was whether government guarantees to avoid systemic fallout from the global financial crisis have distorted competition between banks and reinforced the perception that systemically important banks enjoy a competitive advantage over rivals.  Implicit guarantees arise when creditors believe that, if a bank were to fail, the government would step in to rescue the institution.

Capital requirements

The Final Report recommends raising capital levels such that Australian authorised deposit-taking institution capital ratios are unquestionably strong (Recommendation 1).  The Murray Inquiry found that the largest Australian banks were not currently in the top quartile of internationally active banks and that they should therefore be required to have higher capital levels.  Increased capital levels would provide “insurance against the large losses that can be caused by financial crises through reducing the likelihood of such crises”. 

Government guarantee schemes

The Final Report recommends that the Financial Claims Scheme should continue to be funded on an ex post basis, partly because its recommendations on resilience reduce the need for an ex ante levy (Recommendation 6).

Payment systems, innovation and the digital economy

A dynamic and efficient payments system is an important component of the broader financial system because it underpins most transactions in the economy.  At present, payments regulation is complex and fragmented.  Developing clearly graduated functional regulation would facilitate innovation in the payments system.

The Final Report notes that the impact of recent technological advances has been truly transformative for the financial sector.  The financial sector has invested significantly to respond to and take advantage of such technological change, for example through increased self-service and evolving infrastructure delivery models (such as online and mobile payments services) and through the development of fast, frictionless payments such as contactless terminals and the use of biometrics.

To clarify and synthesise regulation with respect to payment systems and innovation more generally, the Final Report makes a number of recommendations as outlined below.

Retail payments regulation

The Final Report observes that retail payments regulation should maintain confidence and trust in the payments system, enable better understanding by industry and particularly new entrants, accommodate rapid market development, provide adequate consumer protection, and provide competitive neutrality for purchased payment facilities (PPFs).

To this end, the Final Report recommends the following:

Enhance graduation of retail payments regulation by clarifying thresholds for regulation by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority.

Strengthen consumer protection by mandating the ePayments Code.  Introduce a separate prudential regime with two tiers for purchased payment facilities. (Recommendation 16)

In particular, the Final Report recommends the following changes:

•  ASIC, APRA and the RBA’s Payments System Board (PSB) should publish a clear framework guide in relation to payments systems that outlines thresholds and regulatory requirements;
•  consumer protection regulation should be simplified and improved for retail payment service providers, including the following:

-   the Australian Financial Services Licence (AFSL) regime for non-cash payment facilities should be narrowed so that only service providers which provide access to large, widely-used payment systems require an AFSL.  The terms ‘large’ and ‘widely used’ could cover system providers with annual transaction values over $100 million and more than 50 payee groups (as defined from the customer’s perspective), or annual transaction values over $500 million and more than five payee groups;

-  thresholds should be designed to provide clear guidance for new entrants, rather than to substantially alter the current regulatory perimeter;

•  the basic consumer protection regulation provided for under the currently voluntary ePayments Code should be extended to all service providers;
•  APRA, in consultation with other regulators, should develop a separate, two-tier prudential payments regime for PPFs to replace the current single-tier regime, offering PPFs a choice between two tiers: the lower tier would maintain the current 100% liquidity ratio requirement but reduce other prudential requirements to lower compliance costs, whilst the higher tier would reduce liquidity requirements but strengthen other prudential requirements; and
•  ASIC, APRA and the PSB should review the extent to which their current powers enable them to regulate system and service providers using alternative media of exchange to national currencies, such as digital currencies.

Interchange fee and surcharging regulation

The Final Report recommends the following:

Improve interchange fee regulation by clarifying thresholds for when they apply, broadening the range of fees and payments they apply to, and lowering interchange fees.

Improve surcharging regulation by expanding its application and ensuring customers using lower-cost payment methods cannot be over-surcharged by allowing more prescriptive limits on surcharging. (Recommendation 17)

This recommendation aims to clarify the regulation of interchange fees and surcharging with a view to enhancing competitive neutrality between system providers and improving the efficiency and effectiveness of price signals.  It also seeks to reduce the potential for cross-subsidisation between customer groups and merchant groups.

In line with this recommendation, the Final Report suggests that the PSB should consider:

• broadening interchange fee caps to include all amounts paid to customer service providers in payment systems, including service fees in companion card systems. This would prevent alternative payments from avoiding caps and would also provide competitive neutrality for four-party and companion card payments system providers;
• lowering interchange fees by reducing interchange fee caps, with consideration given to lowering them even further in the future (rather than banning interchange fees altogether, since this would likely result in very high transitional costs). The Final Report suggests that consideration might also be given to replacing three-year weighted-average caps with hard caps (so every interchange fee falls below the interchange fee caps) and applying caps as the lesser of a fixed amount and a fixed percentage of transaction values (instead of only one of these components);
• providing merchants with clearer surcharging limits, which could reduce over-surcharging and improve enforceability. This could be achieved in the following ways:

-   low-cost system providers, such as systems subject to debit interchange fee caps, would prevent merchants from surcharging;

-   medium-cost system providers, such as systems subject to credit interchange fee caps, would apply surcharge limits set by the PSB; and

-   higher-cost system providers would continue to apply reasonable cost-recovery rules.

The Murray Inquiry also considered imposing the current “reasonable cost surcharging” rules through Government regulation.  However, regulators indicated this would involve considerable administration costs, since reasonable acceptance costs would need to be determined on a case-by-case basis, regulators’ powers to seek documents to prove over-surcharging would require strengthening, and further, new penalties would need to be created to discourage over-surcharging.

Innovation

The Final Report recommends the establishment of a public-private sector collaborative committee called the ‘Innovation Collaboration” to facilitate financial system innovation and enable timely and coordinated policy and regulatory responses (Recommendation 14).  The Innovation Collaboration would consist of a mix of stakeholders that would look to merge industry and policy expertise with a view to identifying innovation opportunities.

Other recommedations related to the digital economy

The Final Report also makes the following recommendations relevant to the digital economy:

• develop a national strategy for a federated-style model of trusted digital identities (Recommendation 15);
• review the costs and benefits of increasing access to and improving the use of data, taking into account community concerns about appropriate privacy protections (Recommendation 19); and
• update the 2009 Cyber Security Strategy to reflect changes in the threat environment, improve cohesion in policy implementation, and progress public–private sector and cross-industry collaboration (including establishing a formal framework for cyber security information sharing and response to cyber threats) (Recommendation 38).

The Final Report also notes its support for industry efforts to expand credit data sharing under the new voluntary comprehensive credit-reporting regime being developed by the Australian Retail Credit Association but that the Government should consider legislating mandatory participation if, over time, participation is inadequate (Recommendation 20).

*Thank you to Michael Tong for his research assistance.