In the post-financial crisis environment, two of the most obvious issues submissions to the financial system inquiry will highlight are competition and funding. There are no easy or obvious solutions to either.
Post-GFC the banking system, indeed the financial system, is more concentrated than ever with the four majors now controlling about 80 per cent of the banking system.
One could argue about whether or not it is less competitive -- the erosion of the major banks’ net interest margins would suggest that it is competitive -- but clearly there are fewer smaller banks and non-banks and therefore a smaller range of competitors. It is of course possible that new technology-based competitors with different types of competitive advantage will emerge.
The most obvious flaw in the domestic financial system, exposed at the onset of the financial crisis, is the major banks’ over-reliance on offshore wholesale funding.
While that reliance has been reduced by the big banks’ hoovering up of domestic deposits and the significant reduction in the rate of credit growth within the economy and therefore of the scale of the bank funding required, it is a vulnerability that persists and that would increase if demand for credit strengthened.
The regional banks’ submission to the inquiry highlights another issue: the proportion of credit that has been channeled into the domestic housing sector post-GFC and the relative paucity of credit for small and medium-sized enterprises (although that may reflect a lack of demand from SMEs in their current defensive, risk-averse mode).
The exposure of the system to housing is an increasingly topical issue as prices continue to rise, affordability continues to fall and investors continue to pour funds into a sector that has supply-side issues.
On competition, the regional banks have a reasonable case to make that the regulatory regime is tilted away from them and towards the major banks.
The majors have all achieved ‘advanced’ status under the Basel regime which in practice means they need to hold far less capital against a housing loan than their regional counterparts. For every dollar of capital they can lend more than twice as much as the regionals and generate returns on equity more than twice those of the smaller banks.
The regionals are asking for the same treatment so that they can better compete -- a high quality housing loan has the same credit risk no matter who the lender is -- although it could be argued that to reduce the appeal of home loans it might be more useful to increase the risk-weightings of the majors rather than reducing those of the smaller banks.
The regulatory settings currently in place create massive incentives for the banks to lend against housing relative to other types of assets. They generate returns on equity in the mid-30 per cent range on housing loans.
Changing the risk weightings or playing with loan-to-valuation ratios would be a form of the macroprudential regulation some commentators have been calling for to avert the threat of a housing bubble and bust, but fine-tuning the weightings could both create a more level playing field and reduce the scale of the large skew within the system towards housing.
The smaller banks -- and non-banks, among others -- have also focused in on the ‘’too big to fail’’ argument, that the majors are effectively guaranteed by the taxpayer and from that gain an advantage in funding costs that exposed taxpayers to risk and moral hazard and that also distorts the competitive playing field.
There are those who want the big banks to face a tax surcharge (and a competitive handicap) to pay for the effective taxpayer underwriting of their risks and that is one of the options the regionals put forward, although they also suggest that an alternative would be to allow smaller banks to pay for a guarantee.
The big banks do have a form of too-big-to-fail levy looming in return for their ‘’domestically systemically important institutions’’ status, with the Australian Prudential Regulation Authority planning to apply a one percentage point capital surcharge on them.
It would help, in terms of a competitive playing field, if there were a deeper and full-functioning securitisation market. That would effectively level the playing field for home loans in particular, given the market primarily assesses the credit quality of the loans that have been securitised rather than the issuer.
That might also help, at the margin, the funding issue, as would development of a domestic corporate bond market (which would also be a source of competition to the majors).
The inquiry will hear a lot of submissions on those issues as well as proposals to alter the tax treatment of bank deposits and other forms of fixed-interest savings to make them more attractive and in the process enlarge domestic funding sources.
There will inevitably also be some proposals to tinker with or abolish the dividend imputation system to reduce the appeal of domestic equities to retail and institutional investors relative to fixed interest securities like corporate and infrastructure bonds, and bank term deposits.
In the submissions made public so far, including that of the Australian Bankers’ Association, the simple point that the financial system was stress-tested by the financial crisis and emerged unscathed -- it wasn’t and isn’t broken -- has been made.
That tends to argue against radical reform, although the coincidence of post-GFC factors driving the housing market, both in terms of supply of credit and demand for it, are making a lot of people uneasy and could make the case for some tinkering with a system that provides particular and large incentives for borrowing for housing.