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Taking stock: The Financial System Inquiry’s Interim Report
The Murray Inquiry’s Interim Report, released on 15 July 2014, is a comprehensive overview of the key themes emerging from the 280 first round submissions from March 2014. The Interim Report is available here.
The Interim Report makes a number of observations on the Australian financial system, which reflect the Murray Inquiry’s current views (based on available evidence). Its initial prognosis is that the Australian financial system has performed “reasonably well in meeting the financial needs of Australians and facilitating productivity and economic growth” but cautions that “there is no room for complacency” due to the opportunities and challenges facing the Australian economy over the coming decades.
Our detailed report in May identified key themes emerging from the initial submissions that have informed the Interim Report in relation to aspects of competition, payment systems and associated developments in technology and innovation. This note provides an update on these key themes based on the findings in the Interim Report, and considers next steps in relation to each.
Competition and vertical integration
The Murray Inquiry’s preliminary position is that the banking sector is competitive, reflecting a number of indicators such as low net interest margins of the major banks and increased customer satisfaction. Although the Murray Inquiry also observes that the sector is concentrated, that concentration is said to be a by-product of competition in that “more efficient firms grow at the expense of their less efficient competitors”.
The Murray Inquiry also discusses policy suggestions relating to competition in the SME lending sector, including options to improve funding in that area.
A key focus for the Murray Inquiry is what it perceives to be increased vertical integration in the banking sector, particularly in areas such as mortgage broking, wealth management and superannuation. The Murray Inquiry notes that “vertical integration may have the potential to distort the way in which mortgage brokers direct borrowers to lenders” though also notes that “the extent of this issue is not clear”. It is also concerned that “[c]ompetition in the wealth management sector appears to be focused more on securing distribution channels and improving product features, rather than reducing fees”.
The Murray Inquiry observes that entrenched perceptions of institutions being too-big-to-fail need to be reversed by “making it more credible to resolve these institutions without Government support”. To that end, a number of policy options are being considered, including:
- increasing the ability to impose losses on creditors of a financial institution in the event of its failure;
- strengthening regulators’ resolution powers for financial institutions, and investing more in pre-planning and pre-positioning for financial failure;
- further increasing capital requirements on the financial institutions considered to be systemically important domestically; and
- ring-fencing critical bank functions, such as retail activities.
The Murray Inquiry puts forward the view that existing capital requirements lack competitive neutrality. It observes that banks that use Internal Ratings-Based (IRB) risk weights have lower risk weights for mortgage lending than smaller ADIs that use standardised risk weights, giving the IRB banks a cost advantage. In that regard, the Murray Inquiry has proposed a number of policy options to neutralise that advantage:
- assisting ADIs that are not accredited to use IRB models in attaining IRB accreditation;
- increasing minimum IRB risk weights;
- introducing a tiered system of standardised risk weights;
- lowering standardised risk weights for mortgages; and
- allowing smaller ADIs to adopt IRB modelling for mortgages only.
The Murray Inquiry also canvasses the consumer protection framework in financial services and options of splitting consumer protection functions from ASIC’s conduct and market integrity functions. Those options include narrowing ASIC’s current mandate by moving consumer protection functions to the ACCC or creating a new financial consumer protection agency. Another option is to create a new financial services and conduct regulator.
ASIC competition considerations
The Murray Inquiry observes that whilst regulators’ mandates are well defined and clear, more could be done to emphasise competition matters. It queries whether this could be achieved by refining the scope and breadth of ASIC’s mandate (as ASIC had proposed in its initial submission to the Murray Inquiry) or strengthening competition considerations through other mechanisms.
Payment systems and the digital economy
Debit and credit card systems
The Murray Inquiry suggests that regulation of credit card and debit card payment schemes is required for competition to lead to more efficient outcomes, and that differences in the structure of payment systems have resulted in systems that perform similar functions being regulated differently, which may not be competitively neutral. The Murray Inquiry is seeking views in relation to:
- potential changes to regulations relating to interchange fees and customer surcharging;
- whether acquirers should be required to enable merchants to choose the payment scheme through which to route transactions; and
- whether merchants and customers should be provided with real-time pricing information regarding interchange fees and merchant service fees.
Retail payments systems
The Murray Inquiry notes that technological advances and payment products innovation are expected to continue, and that it is important that regulatory settings are well calibrated to prevent disruption but also allow for continued innovation. It observes, by way of preliminary assessment, that there may be a need to:
- simplify or streamline the current regulatory framework; and
- establish a level playing field for retail payment systems and participants by treating like products in a similar manner.
The Murray Inquiry notes that it is seeking views in relation to a graduated framework for retail payment system regulation with clear and transparent thresholds as to when an activity or participant would become regulated. Such a framework would align risk and the scale of activities with compliance requirements, and would apply to payment systems and participants in a technology-neutral manner.
Technology and innovation
The Murray Inquiry observes that Government and regulators face ongoing challenges from the need to apply existing regulatory frameworks to new participants and products in a rapidly changing environment. It notes that, where possible, future regulation should aim to be technology-neutral to provide flexibility to adapt to the future and reduce the need for constant change, but recognises that doing so can result in ambiguity and interpretation difficulties.
To better understand these matters, the Murray Inquiry is seeking views in relation to:
- amending regulation that specifies the use of certain technologies with the aim of becoming technologically neutral (including to enable electronic service delivery to become the default, though with opt-out provisions to manage access needs for segments of the community); and
- adopting a principle of technology neutrality for future regulation (while recognising the need for technology-specific regulation on an exceptions basis).
The Murray Inquiry observes that challenges are raised as firms outside the regulated financial sector perform financial-type functions, giving rise to new participants and new products. It notes that whether new entrants should be brought within a regulatory perimeter depends on the nature and scale of the risk they present and who bears the risk, and that the Government needs to strike a balance that allows the benefits of innovation to flow through the financial system while maintaining stability.
The Murray Inquiry notes that Government is well-positioned to facilitate innovation through coordinated action, regulatory flexibility and forward-looking mechanisms. It is seeking views on:
- establishing a central mechanism / body for monitoring and advising Government on technology and innovation; and
- establishing a whole-of-Government technology strategy to enable innovation.
The purpose of the Interim Report is to elicit comments from stakeholders to inform the Final Report to the Treasurer. This includes gathering further evidence, checking the validity of the observations made by the Murray Inquiry, and testing the potential policy options provided.
To that end, a last round of submissions in response to the Interim Report is due on Tuesday, 26 August 2014. It is expected that a final report by the Murray Inquiry, including its policy recommendations, will be published in November 2014.