XXX
Address by Professor Ian Harper
to the
Australian Society of Corporate Treasurers
Melbourne
Tuesday 10 December 1996
As you may know, on 28 November, the Financial System Inquiry published a Discussion Paper detailing the key issues and regulatory options being considered by the Inquiry. It is intended to contribute to public discussion of possible reforms in our financial system.
Our Discussion Paper does not provide preliminary or draft recommendations. It is unnecessary for us to do this at this stage given that the options and arguments are clear from the submissions made to the Inquiry, and that the Committee wants to use all of the available nine months to form our recommendations, and not shorten that already-short period to five months.
I would like to emphasise that we are meeting the Treasurer’s commitment of last May to an open, public process. Our Discussion Paper draws on more than 260 submissions, most of which have been made public, including over the Internet.
The Discussion Paper is the basis for public consultations which we shall be holding in five cities, and for any further written submissions which people wish to make by the13th of January next year. It is available through Government bookshops and through the Internet on the Inquiry’s home page. The paper indicates to the interested public what we in the Committee see as the issues, and where we are focusing our further research before making our recommendations.
The Committee’s recommendations will appear in the Final Report, which we intend to submit to the Treasurer by the end of March1997.
I would like to draw your attention for a moment to the setting in which we are inquiring into Australia’s financial system.
We share the conviction which led the Treasurer to establish this Inquiry, that now is a good time to review Australia’s financial system and its regulatory framework.
The basic objectives of our Inquiry are similar to those of the Campbell Inquiry at the beginning of the 1980s. Both Inquiries address efficiency, competition concerns, consumer interests and the regulatory framework.
However, the situation pre-Campbell was characterised by the fairly obvious ineffectiveness of some price-control regulations, and some fairly obvious structural inefficiencies.
The situation prior to this Inquiry was different. There were less obvious, but still pressing, reasons for review: a rapidly changing environment, the effects of active but insufficiently co-ordinated development of the regulatory framework, and concerns about Australia’s standing in regional and global markets.
Another factor in the situation pre-Wallis was an on-going public debate about the effects of the financial deregulation of the 1980s. They are an important element of our situation in the 1990s, which our Inquiry is addressing. An analysis of the effects of the 1980s deregulation and the lessons to be learnt from it the “stocktake” included in our terms of reference is well advanced and will form part of our Final Report.
Our financial system is undergoing continuous, major change. The Inquiry is charged with analysing the factors driving this change.
For a long time, the financial system has been shaped, or reshaped, by new technology, globalisation, evolving profiles of what consumers need, and new forms of competition.
But in recent years, some of these factors, particularly the rate of application of technology and the competition that technology stimulates, have accelerated in areas of particular importance to financial activities.
The application of new technology may revolutionise our financial system more quickly than some expect. Most of the foreseeable developments involve existing technologies, and their impact in some other countries is already more advanced than in Australia. Not all of them rely on customer acceptance of new technologies: a lot of what is happening is in the “back office”.
This helps us to know the outline of what is likely to happen here as the financial system develops. It is clear that we must respond and ensure that we take the greatest possible advantage from the potential being unleashed.
Another important driver of change in the financial system is change in the profiles of consumer age-groups and needs. Australia is facing an upward shift in the age profile of the population. But unlike most comparable countries, we face this with a relatively low rate of national savings. This presents an obvious challenge to the future funding of a growing proportion of retirees. That funding must rely less on transfers through government and more on people’s own savings for retirement. From this perspective, while it is vital that our savings rate be increased over time, it is also important that the financial system be as efficient as possible at investing superannuation savings, and that investment products be developed that meet the needs of those saving for their retirement.
This is one aspect of a more general fact. The financial system stands between savings and investment, and its cost and performance help to determine the gains we make throughout the economy from the processes of saving and capital accumulation.
Because it’s not readily observed, it may not be widely recognised, but the real costs of financial intermediation are extracted from household and business savings in the course of their being invested. Even a small improvement in cost-efficiency in our financial system can be expected to have substantial, widespread effects.
The experience of a changing financial system is by no means unique to Australia. Other countries with developed financial systems are facing the same changes, and are thinking similarly about the best policies and regulatory responses to address them.
Most countries too are seeking the benefits of increasing exposure to global trade and investment. They realise too that financial systems contribute to the competitiveness of national economies. This parallel process of change and reform in other countries obliges us to strive for world-best practice in the design of the Australian regulatory framework.
We could sum up the situation by saying there are three key reasons for wanting to improve our financial system:
¯ the need to obtain the benefits of new technology;
¯ the need to increase investment returns through more efficient management of financial resources; and
¯ the need to compete globally.
As members of the Inquiry, we see our key goal as the identification of means to increase the efficiency of the Australian financial system, without compromising its safety and stability.
In important areas, Australia is lagging behind the market performance of some other nations:
¯ many products or services are more expensive than those abroad; and
¯ rapid innovation is occurring in some but not all areas.
We suspect this is a result of a policy approach which has emphasised safety and protection, with less regard for the need to promote competition and innovation.
We believe the keys to increasing the efficiency of the financial system are greater competition and contestability,which means more vigorous competition among existing participants and more opportunities for competition from new participants. We are looking for ways to bring this about through more efficient regulation.
Our search for increased efficiency in the financial system is motivated not by the interests of participants in the financial industry, but by the prospect that a more efficient financial system would bring greater benefits to customers.
Improvements in financial system efficiency would benefit customers:
¯ through lower-cost financial intermediation, adding to the returns for savers or reducing the costs for borrowers;
¯ through higher rates of economic growth;
¯ through greater choice in products and services, with improvements in their quality; and
¯ through a wider array of channels for access to financial services.
I said a moment ago that we are looking for ways to bring about a more competitive financial system through more efficient regulation. We have thought carefully about what should be the objectives, methods and principles of regulation, as well as attending closely to the issues and concerns presented in submissions. In other words, we have followed a twin-track process: reviewing regulation from the objectives up, so to speak, as well as from the practical problems down. In this presentation, I shall not describe the review of regulatory objectives but go straight to the views we have formed.
While the Discussion Paper does not contain recommendations, you will find in it a clear identification of the priority issues as we see them. Let me summarise six of these priority issues, and then, for the remainder of this address, say something about each of them.
The priority issues are:
¯ stimulating competition and innovation;
¯ achieving more competitive financial markets in Australia;
¯ achieving more costeffective consumer protection;
¯ preserving systemic stability and clarifying depositor protection;
¯ maintaining industry structures for competition and efficiency; and
¯ achieving better performance and co-ordination of the regulatory arrangements.
We are asking how competition and innovation in the Australian financial system can be stimulated, without undue risk to the safety of the financial system. We have several areas in mind. One is the area of traditional banking activities, including the payments system.
The Discussion Paper asks about the feasibility of a policy of allowing an increased range of institutions to provide some or all of the core financial services.
Our regulatory structure is a creature of history. Its licensing, ownership and prudential rules are largely based on institutions, and separate institutions for banking, insurance and securities dealing. This may be inadequate for likely market developments, with more institutions offering products which combine different services, and more institutions wanting to cross-sell the products or services of different entities.
With this in mind, we are examining the apparent properties of the regulatory system in mitigating competition among the traditional financial institutions, and restricting potential competitors to them, notably the firms which operate globally in providing selective, specialised services.
Australian financial institutions are subject to a range of detailed prudential rules about their structure, manner of operation, and ownership. These are a barrier to entry and may limit competition and efficiency. Such effects need to be weighed against their necessity or helpfulness for prudential purposes.
It may be possible, without compromising safety and stability in the system:
· to allow an increased range of institutions to provide a wider array of financial services, including allowing more scope for global specialist firms; or
· to relax some of the ownership restrictions on banks; or
· to enable branches of foreign banks to compete in the retail deposit market.
Each or all of these possible options could improve the contestability of our core banking markets.
As it happens, all of these options have been canvassed in submissions to the Inquiry. What I mean by saying we wish to explore them more fully is that we need to know about their implications in more detail, to weigh up carefully the arguments for and against them, and to view them in the perspective of other possible options which we might also recommend.
We share the concerns expressed in a lot of recent public discussion about the international competitiveness of the Australian financial services industry.
Accordingly, the second priority issue we have identified is whether we could do more to develop a globally competitive financial market and system.
There are many influences on competitiveness. The components of financial regulation, including prudential regulation, rules for financial markets, consumer protection and competition policy, and whether these are adequate, onerous or unduly expensive, are all things that influence competitiveness.
Other important influences on competitiveness in the financial sector derive from technology, and taxation, and so our Inquiry is considering them as well.
First, technology. Technology as it develops can alter barriers to entry, can change the boundaries of markets for financial services and the range of potential participants, as well as creating opportunities for new anti-competitive structures.
So it’s important that the regulatory framework recognise and be responsive to technological innovation.
Let me give one example. Submissions to the Inquiry have pointed out several legal impediments to electronic commerce which it is taking a good time to remove, such as difficulties in having electronic data admitted as evidence. But until those impediments are removed, regulation will be constraining the rate of innovation in those areas in Australia and, in that respect, our international competitiveness.
Therefore, one central issue we are examining, in regard to the communications technology that supports financial innovation, is that of the appropriate public policy role.
Should the Commonwealth, State and Territory Governments act as facilitators of technological change?
Should there be a specialist unit to promote the communications developments most needed for financial innovation?
Should there be stronger intervention, insisting on a uniform national approach in legislation and standards?
Or should we doubt the ability of government to second-guess the business experts, and simply allow outcomes to be driven by market forces?
We are examining these issues and hope we might get further submissions on them.
A second competitiveness issue is whether the regulation of Australian financial markets is allowing as much constructive innovation as possible. Securitisation is a case in point.
In Australia, securitisation has provided a quick and effective method for funding home loan originators, as new competitors to the banks and building societies.
In other countries, particularly the United States, securitisation has been associated with growth of lending specialists, and more expert identification and management of risks.
If securitisation were to develop faster here in Australia, it might have some of the same valuable corollaries, add depth to the domestic bond market and perhaps in time open new sources of finance for small and medium enterprises.
So we are examining some apparent impediments to securitisation that were identified in submissions. These include elements of the Uniform Consumer Credit Code, the corporations law, and prudential rules for the banks and other deposit-taking institutions.
We are also looking at other possible options for improving financial markets, notably the tradeability of unit trusts, and the possibility of trading at some future time even in superannuation units.
We know that many aspects of market regulation have been under close scrutiny by, for example, the Corporations Law Simplification Task Force, the Companies and Securities Advisory Committee CASAC, and the joint CASAC and Law Reform Commission task force on collective investments. Our Inquiry is not intended to delay or replace any of this work. But we may be able usefully to add some views or some perspective on certain of the issues.