Too big to gaol
The Australian financial system is a mess. Worse, nobody in authority thinks so or cares – save for a professed need for some fine-tuning here or there.
Rather, profound dysfunctionality reigns across the system. Some dimensions follow.
The superannuation system
Superannuation assets, up to June 2014, totaled $1.85 trillion. That sum is extraordinary, and it grows dramatically. Certainly more people are benefiting from superannuation than before the passage of Prime Minister Keating’s Superannuation Guarantee Act of 1992.
The system is beset with inefficiencies, in spite of (and because of) reviews and legislative amendments. On the positive side, a simple ‘no-frills’ MySuper default option was legislated by the Gillard Government, beginning 2013, following the 2010 Cooper Review. On the negative side, in 2007 then Treasurer Peter Costello gave high-income earners a substantial super tax break, the inequity of which essentially remains in place today.
The problems with compulsory superannuation are partly due to its pragmatic origins – conceived in 1987 as a means of restraining wage rises (and to constrain the age pensions burden on general revenue). How the sums would be managed and to what ends they would be put were not thought through.
Thus we have a massively inefficient system regarding administration, with longstanding fee gouging, especially from the private (now bank-dominated) retail funds. And where is the tidal wave of funds going? There is a pathological antagonism to directing a small proportion of these funds into projects of national importance, owing to their presumed riskiness.
Yet, for lack of a sizeable bond market, 45% of the super total (as of 2012) has gone into the stock market (the second highest globally after the US) – not only risky but hugely inflating stock values.
The ‘wealth management’ sector appears to have succeeded earlier communities’ attachment to life insurance as a vehicle for income security in one’s later years. It has become a parasite par excellence. A new profession of ‘financial planners’, typically contracted by or directly employed by banks, has shown itself without scruples. The ill-informed and vulnerable have been relieved of precious savings, or induced to go into debt, with the funds churned into risky outlets – the significance of which the ‘investors’ are typically oblivious. The Storm Financial saga exemplifies this phenomenon. The Trio Capital saga represents the phenomenon at its most intrinsically corrupt.
The power of the Big Four
Concentration of the banking sector is unacceptably high. The Big Four banks dominate most lending segments as well as ‘wealth management’. They also dictate, including through the Australian Bankers’ Association, government banking policy.
That leverage was recently on display when the Abbott Government, elected in September 2013, moved quickly to emasculate Labor’s Future of Financial Advice legislation that sought to expose ‘tied’ financial advisers and oppressive fee structures.
Small business and farmer finance
The financing of small business (SMEs) and family farmers remains completely dysfunctional. There are structural reasons, linked to the banking sector’s predominantly short-term financing sources. The banks, as dominant lenders, have failed to develop appropriate instruments for long-term lending.
There are cultural/ethical reasons. The banks, possessing near absolute power over the borrower, have eschewed the pursuit of sustainable lender-borrower relationships for a culture of indifference and corruption. Unreasonable and corrupt defaults and foreclosures, with the appropriation of customer assets (typically the family home), have left social devastation across the country – a phenomenon that the media declines to report.
The finance sector now has a significant footprint in the Australian economy. National Income statistics indicate that finance sector profits constituted 5% of total corporate income and 3% of total business income in 1980-81. The comparable percentage figures in 2012- 13 were roughly 20% and 15%. We now have an army of finance sector workers engaged in unproductive (but highly remunerated) employment (particularly derivatives trading) and in distorting and preying on rather than facilitating other sector activities.
The origins of this dysfunctionality can be found in uncritical deregulation of the finance sector during the 1980s. There had to be change, of course, from an intensely regulated sector centred on the trading banks. The growing diversity of financial institutions and the inevitable globalisation of finance required financial ‘reform’.
But the 1981 Campbell Report indicated what was to come. Its opening paragraph reads: “The Committee starts from the view that the most efficient way to organise economic activity is through a competitive market system which is subject to a minimum of regulation and government intervention.”
This statement is shocking in its ignorance and prejudice. The Report paid minimal attention to the history of financial institutions in Australia and the good reasons for the regulatory structure that it was instructed to examine.
Instead, the Report’s content was dictated by ideology and vested interests.
Thus all extant regulations were effectively dismantled. Successive governments, Coalition and Labor, neglected to consider what criteria a well-functioning financial system would need to satisfy. The one criterion considered paramount at the time was system stability and thus the only regulation put in place was the ‘prudential’ one. Banks are all required to satisfy a ‘capital adequacy ratio’, whereby equity capital held must as a percentage of its assets (or ‘credit exposures’).
The original rule has proven inadequate, as reflected in the blowout in irresponsible lending in the late 1980s and in the lead up to the 2008 GFC. It is being belatedly strengthened to enforce liquidity requirements on banks. But it has also been gradually loosened in that asset classes are now ‘risk- weighted’, which allows a trimming of capital requirements. In Australia, the lower risk attributed to home loans has driven banks to over-emphasise home loan lending.
Regarding macroeconomic monetary policy, deregulation brought a sole dependence on one instrument – the overnight cash rate – administered by the Reserve Bank. The instrument is blunt, inefficient and discriminatory.
The bipartisan agenda following the Campbell Report has been to allow ‘market forces’ to dictate the allocation and terms of credit. Implicit is the belief that the finance sector is no different from any other sector. (That dogma was contradicted without acknowledgement with the rush to provide government guarantees for needed bank refinancing after the GFC.)
The sole vehicle claimed to assure that private interest results in the public interest being served is ‘competition’.
It’s noteworthy that all publicly-owned financial institutions were to be dismantled, which has subsequently occurred.
Yet even by conventional standards, the so-called necessity for competitive structures has been honoured in the breach. The authorities have tolerated the massive concentration of the banking sector that has resulted in the dominance of the Big 4. In particular, the regulatory legitimation of the Westpac takeover of St. George and the Commonwealth Bank takeover of BankWest remains a scandal.
More fundamentally, no-one has contemplated by what particular mechanisms the rivalry of private concerns can deliver public interest desiderata, and specifically within the finance sector with its peculiar characteristics. Past experience to the 1970s has been ignored. The incompetent rush for market share in some loan segments and in new and dangerous products (e.g. foreign currency loans, margin loans), for example, has had anti-social consequences.
Of substantial concern is the extent of corruption amongst the major banks – clearly reflected in the financial advisory /wealth management segment and the SME/farmer loan segments. Corruption is pronounced in the CBA (the once ‘People’s Bank’) and in the National Australia Bank.
Apart from the damage caused to defrauded investors and unconscionably foreclosed SMEs/ farmers, the corrupt culture feeds through to and corrupts sectors heavily dependent on the banks for their revenues – the legal profession, the insolvency/receiver sector, the property valuer sector, etc. That such corruption can exist, disseminate and survive also indicts the regulatory apparatus. The Australian Securities & Investments Commission and the Financial Ombudsman Service are both complicit in their inaction. The police are strategically negligent in investig- ation of banking and financial fraud.
Behind the inactive regulators lies the political class. Responsible Cabinet Ministers have been informed of sectoral corrupt practices, but remain acquiescent. A 2012 Senate Economics Committee Inquiry, established following pressure from victims of the mass default of BankWest borrowers after the CBA takeover, resulted in a report (the ‘Post-GFC Banking Inquiry’) that totally ignored the reason for which the inquiry was initially mooted.
The same Senate Committee in its 2013 Inquiry into the comprehensive failure of ASIC glibly recommended that ASIC reform itself, while also ignoring the complementary role of FOS in the regulatory impasse.
More generally, there is a both a pervasive intellectual myopia, a political cowardice and a strategic paralysis within the entire political class, and the relevant bureaucracy and regulatory institutions. The fundamental post- Campbell structures are accepted as God-given, so that problems due to those inadequate structures are not perceived as such.
The major inquiries into the finance sector glibly side-step the important issues. The 1991 Martin Inquiry was specifically established to squash dissent. The 1996 Wallis Committee promoted the fusion of segregated financial institutions (banking and insurance), facilitating the rise of allfinanz unrestrainable banks. The current Murray Financial System Inquiry is ignoring fundamental dysfunctionalities. Behind the responsible bureaucracy (the federal Treasury) is a pervasive ill-education and ignorance.
Historically, key progressive changes in banking and finance sector policy were instigated by the Australian Labor Party and the Country Party. The latter’s successor, the National Party, cares nothing for its rural constituents in this matter. The ALP is incapable of re- examining the deregulatory structures fashioned by Hawke/Keating.
The stark reality is that the prospects for a healthy examination of the current problems in the Australian finance sector and for the establishment of procedures to remedy such problems seem utopian indeed.
Source: This article originally appeared in Australian Options (no 78, 2014).
Dr Evan Jones is Research Associate in the Dept of Political Economy, Univ. of Sydney, and is an ERA patron. His research interests include post-WW2 Australian economic history, banking malpractice, and small business subordination to corporate business.