Latest financial inquiry will fall short of what is needed

John Hermann

Judging by recent comments made by prime minister Turnbull, the terms of reference of the forthcoming Royal Commission into the operation of the Australian financial system, forced upon the federal government by the actions of some disaffected backbenchers, will fall far short of what is required. It is unlikely to adequately investigate the extent and prevalence of the scandals and misdemeanours that have plagued the big four banks in recent years, given the decision to limit the inquiry’s time-frame to one year.

I strongly suspect that this inquiry will be an expensive whitewash and that the extension of the inquiry to include superannuation is little more than a diversion designed to obfuscate, and to direct attention away from the behaviour of the major banks.

ERA made a submission to a previous Financial System Inquiry held in 2014, which inquiry unfortunately achieved little in terms of useful outcomes. It is worth reviewing some of the points made in that submission:

1. Too big to be allowed to fail

The “too-big-to-be-allowed-to-fail” aspect of modern banking mega-corporations, and the non-prosecution of banking executives for their white collar crimes because they are considered “too-big-to-be-allowed-to-jail”, are well recognised by well informed economic opinion to constitute a threat to democratic institutions and good government. We share this view. There were other options than bailing out the private banks who failed at the time of the global financial crisis, owing to their irresponsible behaviour in lending to those in the high risk category and in taking on excessively risky investments. Arguably governments would have done better to have declared the failed banks insolvent, wiped out their boards and shareholders, and immediately taken those banks into public ownership for at least as long as it would have taken to recoup (in an accounting sense) the outlays of public money used for repairing their equity losses and stabilising their balance sheets.

2. The case for public sector banking

The only valid argument for maintaining a private commercial banking sector is that it might be able to do a better job than would a state-owned one in identifying good credit risk for borrowers. If this advantage cannot be demonstrated to be the case, then what is essentially a public service offered by institutions which cannot be allowed to fail arguably should be in the public sector.

Bail in

We regard recent “bail in” proposals, which are a blatant attempt by banks to grab the savings of the public in any possible crisis scenario and currently being lobbied for by powerful banking interests, as an unacceptable practice and breach of trust for bank customers and depositors, who are entitled to expect that their money will be secure. If governments were foolish enough to allow banks the privilege of command- eering any part of their retail customers’ holdings of bank bonds, term deposits or transaction deposits, then they would expose the banking system to great additional risk and eventual collapse, and also ensure abandonment of the conventional banking system by the public in droves, with a strong likelihood of alternative depository systems being set up. In other words, we would lose the banking system, as it is currently constituted.

Separating commercial and investment banking

It is important for the sake of financial stability to maintain a firm demarcation between retail commercial banking operations and investment banking practices. And although we support the reasoning which underpins recent proposals for ‘ring-fencing’ of the trading operations of banks from their retail banking operations we prefer to go further than this. Simple ring fencing allows inventive financial manipulations under the cover of the financial institution’s operations. Thus regulatory oversight would be limited to the capability of the regulators and their capacity for over-sight – i.e. their ability to access all relevant information, which in reality is not possible. It is much better to fully separate the two functions, along the lines of the original U.S. Glass-Steagall Act (implemented under U.S. president Roosevelt in 1933).

Other proposals

As a matter of interest, the following are some recent banking reform proposals made by Mitchell and Fazi [1]:

“banks should only be permitted to lend directly to borrowers … all loans should be kept on banks’ balance sheets … banks should not be allowed to accept any financial asset as collateral to support loans … banks should never be allowed to trade in credit default insurance … banks should not be allowed to underwrite contracts in foreign interest rates nor issue foreign- currency denominated loans … banks should not engage in any other commercial activity ”

1. William Mitchell and Thomas Fazi, Reclaiming the State (Pluto Press 2017, pp 257-258)

I am grateful to Dr Steven Hail for drawing the existence of this book to my attention.