Executive summary
Australia's banks weathered the turbulent events that shook
the international financial system in 2007 and 2008 relatively well. While the
Australian government did have to act during the global financial crisis to
shore up the sector and crisis-related acquisitions took place which have left
the sector more concentrated, lending continued and the government did not have
to take an ownership stake in any financial institution. Today, Australia's
financial sector continues to demonstrate its resilience in the face of ongoing
uncertainty in international markets.
Much has already been written about the impact of the crisis
on Australia. This inquiry differs from others in that it examines the state of
the sector a number of years after the key events of the crisis. This allows
the developments that have proven more sustained to be identified and examined.
The major international regulatory response to the crisis, which will further
change how Australian banks operate, is also examined. The committee has made a
number of recommendations that it considers will facilitate the further
strengthening of the sector and, more immediately, will address some
consequences arising from the imbalances that exist in the relationship between
certain borrowers and banks.
An independent inquiry is needed
The key finding of the committee is that an independent,
well-resourced and comprehensive inquiry into the Australian financial system
is required. It has been fifteen years since the previous such inquiry reported
(the 1997 Financial System Inquiry, better known as the Wallis Inquiry). While
the onset and ramifications of the global financial crisis provided an argument
for a new inquiry to be postponed, this argument is now less compelling. The
shape of the future international regulatory environment is becoming clearer
with the Basel III reforms agreed to and being implemented in Australia from
2013 onwards. The overall stability of Australia's banking system compared to
other economies has been demonstrated, but has the impact of the crisis and the
emphasis on stability weakened competition in the sector and limited the
benefits that strong competition provides for consumers? While Australia
avoided the worst of the crisis, this should not be allowed to result in
complacency about the structure and performance of our financial system. There
is now an opportunity to conduct a comprehensive examination of the banking
sector and to debate what the post-crisis sector should look like and whether
it is delivering what Australians want from it.
The crisis demonstrated the volatility of the international
debt markets to which Australian banks remain significantly exposed. In
response to this unstable environment, Australian banks have shifted away from
short-term wholesale funds towards more reliable, but more expensive, long‑term
wholesale debt. A key feature of the new funding mix is that Australian banks
are seeking to obtain greater amounts of term deposits. Competition among banks
to attract these more stable funds has noticeably intensified since the crisis,
increasing the interest rates banks have to offer depositors, relative to the
cash rate, and therefore the cost of these funds. While this is a welcome
development for deposit holders, the sustainability of it and the implications
for competition in the sector need further consideration. Further, there is a
clear disconnect between Australia's growing pool of superannuation savings and
the significant amounts of funds that banks need to raise in offshore markets.
Whether there are policies that can encourage greater interaction between the
banks and superannuation funds, in a way that is viable and in the interests of
both sectors, also warrants examination by an independent inquiry.
The implementation of Basel III in
Australia
Important changes to how regulators require banks to be able
to absorb shocks are underway. These changes are driven by Basel III, the
latest iteration of international standards on capital adequacy and banking
supervision and the major international regulatory response to the global
financial crisis. This inquiry facilitated a constructive public discussion
about these technical changes and how they will be implemented domestically by
the Australian Prudential Regulation Authority (APRA).
The committee supports APRA's overall approach to Basel III
at this stage. Assuming the reforms are widely implemented internationally, and
the committee acknowledges that Australia is ahead of many other countries in
this regard, they will improve the stability of the international banking
sector and will address some of the issues evident from the global financial
crisis. Australian banks are well-placed to comply with the capital
requirements of Basel III within the timeframe being followed by APRA. Some of
the liquidity requirements under Basel III may be more challenging for
Australian banks to comply with; however, the banks will have to work towards
this. Being just one component of the global banking system, coupled with the
need for Australian banks to raise funds offshore, it is clear that Australia
cannot deviate significantly from what other international financial centres
are doing. Any significant changes to Basel III will occur at an
international level and the implications for Australia will have to be
considered at that time.
The committee does consider that APRA could be more
proactive in some areas. A particular issue is that Australian banks may
appear less capitalised than their peers as a result of the different
regulatory capital calculations that APRA requires. While the banks have a role
in explaining this difference to international investors themselves, and the
standardised reporting template developed by the Basel Committee may also
assist, in the meantime APRA should facilitate the publication of headline
capital ratios that are calculated according to the Basel Committee's standard
requirements. The committee also encourages APRA to look at other ways that it
could improve the understanding internationally of the Australian banking
sector's underlying strength to ensure that Australians receive the full
benefits of this.
There are some additional issues that have been identified.
Given the increasing prevalence of internet-based accounts and the apparent
differences between how APRA proposes to treat these accounts for liquidity
purposes compared to the treatment applied by regulators in other
jurisdictions, the committee suggests that APRA reviews its approach in this
area. Also, the committee recommends that APRA addresses the unique issues that
Basel III may pose for mutual ADIs as a result of their corporate
structure without further delay, and that it publishes a document which sets
out how these problems have been addressed.
Funding challenges and implications
for stability and competition
As a result of the disruption
in international markets triggered by the crisis, banks reassessed the risks
associated with their funding mix and have moved towards more stable sources of
funds. Investors also reassessed the risk of banks globally and repriced the
risk associated with wholesale bank debt. Consequently, there have been
multiple upward pressures on the cost of funds since the crisis and it is
likely that costs will remain elevated. Banks continue to adjust to higher
post-crisis funding costs as they compete for available deposits and rollover
longer-dated wholesale funds obtained at lower pre-crisis prices. However, the
overall increase in costs appears to have stabilised recently (although
developments in Europe provide ongoing uncertainty).
The independent inquiry referred to above would consider the
consequences of these developments. In the interim, steps can be taken to
address policy inconsistencies that distort behaviour in the marketplace and
which may impact the stability of the banking system and the ability of smaller
financial institutions to compete with the major banks. Two issues examined by
the Henry Review remain particularly relevant. First, the taxation of interest
earned from deposits held in ADIs differs unfavourably to the taxation
arrangements applied to various other methods of saving. These arrangements
should be made more consistent to remove any distortions affecting saving
decisions. In addition to these efficiency benefits, this would enable banks to
compete more effectively for household savings helping ensure that lending
activity can be funded when demand for credit increases and if other means of
savings become more attractive. Second, the interest withholding tax that
applies to financial institutions operating in Australia distorts funding
decisions and is an impediment to foreign banks competing in the Australian
banking sector. The tax burden may also be simply passed on to borrowers.
Although removing the application of this tax to financial institutions creates
a direct financial cost to the government, by providing an impetus for greater
competition in the banking sector such a reform would have wider long‑term
benefits for the economy. Accordingly, the committee supports the removal of
the application of interest withholding tax to financial institutions although
it acknowledges that such action would need to be sensitive to the government's
budget position.
An additional challenge for competition and funding mix
diversity is the state of the securitisation market. Prior to the global
financial crisis securitisation played a key role in supplying funds for
smaller lenders. It therefore helped enable stronger competition in the sector.
The securitisation market is recovering from the crisis with the support of the
Australian Office of Financial Management's RMBS program, but the recovery
could be further assisted if foreign currency bonds collateralised by
Australian assets were again accepted by key foreign central banks in their
repurchase agreements. This could strengthen investor demand and enhance the
liquidity of Australian asset‑backed securities. While this is a matter
for the central banks concerned—the European Central Bank was put forward as an
example—the Australian government could push for wider acceptance of Australian
securitisation.
Changes to lending practices and
the attitudes of the banks
The inquiry also examined the impact of the crisis on
lending practices. As an overarching observation, the committee considers that
the regular collection and publication of additional information about market
developments could provide a useful and timely indication of the state of the
lending market for regulators, policy makers, market participants and market
observers. The committee notes that a senior officer loan survey is conducted
by central banks in a number of other countries and recommends that the Reserve
Bank of Australia conducts one in this country on a quarterly basis and
publishes the results. The committee also recommends that, following the
Australian Small Business Commissioner's appointment becoming effective, the
Commissioner provides an annual report to the Senate on small business finance
issues.
The experiences of certain Bankwest
small business customers since the crisis
A particular focus of the inquiry was whether there have
been any changes in the attitude of lenders to certain categories of borrowers
and whether these borrowers were treated unfairly. Most of the evidence
received by the committee was from aggrieved borrowers of Bankwest who alleged
mistreatment by the bank after Bankwest was acquired by the Commonwealth Bank
of Australia in 2008 at the height of the global financial crisis. The inquiry
provided an opportunity to air grievances about particular actions of banks and
to consider whether the regulatory settings governing lending by the financial
sector are appropriate. It is, however, fundamentally important to recognise
that this committee is not a court. Disputes between individual parties to a
contract that cannot be resolved through other means need to be dealt with
through the judicial process. The committee has accordingly reviewed the
evidence from a broader, systemic perspective.
It is not automatically the case that a collection of
disputes, even if they share certain characteristics, should trigger regulatory
change that would impact entire groups of borrowers. While there are many sad
and distressing stories now on the public record, the committee cannot help but
observe that, in some cases, although the aggrieved borrower may have been able
to operate successfully during periods when the business environment was
relatively good, the more challenging times presented by the global financial
crisis placed extra stress on less robust and more speculative projects. In
many cases, loans were sought for ventures that were a considerable risk even
during the more stable economic environment that existed prior to the global
financial crisis. This of course does not apply to every case, nor does it
excuse Bankwest—under its previous owners Bankwest was willing to enter into
these loans. When its small business borrowers are experiencing difficulties,
Bankwest has a duty to make genuine attempts to work with the borrower, to
clearly explain what is happening and why, and to treat them with courtesy.
Nonetheless, while most dealings between small businesses
and banks are not problematic from a regulatory perspective, the evidence
received by this inquiry and previous inquiries indicates that there are still
issues with current arrangements. Small business owners are busy individuals
focused on the day-to-day operations of their business. They may not have the
time or expertise needed to fully consider how certain actions, such as changes
to facility terms, will impact them. Small businesses are also confronted with
a significant imbalance in negotiating power with large financial institutions
and face difficulties in seeking to have any disputes with these institutions
considered.
The committee wishes to ensure that the regulatory settings in
the financial sector relating to small business lending encourage
entrepreneurial activity and allow sufficient flexibility for parties to enter
into agreements that best suit the particular circumstances of the commercial
operation. Rather than government intervention for small business finance, the
committee considers that it would be preferable for the industry to commit to
solving the evident problems. The committee calls on the Australian Bankers'
Association (ABA) to meet with small business representatives to develop a code
of practice specifically relating to lending to small businesses. At a minimum,
the code should require:
- changes to facility terms to be accompanied by a document that
clearly explains the changes to the borrower;
- any initial valuation reports associated with the purchase of a
small business be relied on by the bank for a reasonable amount of time, such
as for the first two years of the loan, unless a major defined shock or event
occurs;
- borrowers to be automatically provided with copies of valuation
reports that they have paid for or which the bank intends to rely on to
demonstrate that the borrower is in default, and that all instructions given by
banks to valuers be provided to the borrower on request;
- notices of demand from lenders to small business borrowers
include a minimum deadline of 14 days for repayment, but that a further
reasonable period of time should also be available to allow for the
finalisation of necessary contracts if refinancing has been secured, or to
allow negotiations to continue if an offer of finance is reasonably likely;
- banks to cooperate with any reasonable requests for information
made by the borrower that would assist the borrower secure refinance; and
- default interest rates to be clearly specified in the facility
terms, not linked to other documentation.
Failure by the ABA and the banks to develop an appropriate code
of conduct for small business lending may strengthen the case for more
prescriptive government regulation in this area. Given the arguments from the
sector about the cost and burden of added regulation in general, the committee
is of the view that if banks genuinely have these concerns they have both the
obligation and opportunity to demonstrate that the sector takes concerns about
small business finance issues seriously and is willing to proactively develop a
stronger self‑regulated solution.
The options available to small business owners for seeking
redress is another area of concern to the committee. While the sector's
external dispute resolution scheme, the Financial Ombudsman Service (FOS), may
consider small business disputes there are a number of limitations on FOS which
limit its relevance and effectiveness for these disputes. Accordingly, the
committee recommends that the caps on the value of the claim and maximum
compensation for small business disputes considered by FOS be increased to
$2 million.
The committee also considers that there is a specific flaw in
the current external dispute resolution framework as when a receiver is
appointed by a secured creditor, FOS cannot review their actions or require
them to stop enforcement action such as selling the company's assets. This is
not to say that FOS should be required to review the conduct of receivers—a receivership
is a fundamentally separate issue to the provision of a financial
service—however, the current arrangements could be improved if borrowers have,
and are aware of, the opportunity to seek a review of the substantive matters
of a dispute by FOS before the lender takes enforcement action. Further to the
committee's recommendation that notices of demand should include a reasonable
minimum deadline for repayment, such a notice should also be required to
include information about FOS.
The committee is also concerned about some outcomes that can
arise once a receiver is appointed. While legislation is in place that imposes
an obligation on receivers to take all reasonable care to sell properties of a
company at market value or the best price that is reasonably obtainable, it is
inherently difficult for borrowers to challenge such actions. The committee
considers that when a business is placed in receivership, the receiver should
be required to demonstrate to the borrower that they have considered every unconditional
offer when exercising their power of sale in respect of a property. If the
borrower can produce sufficient prima facie evidence that indicates that the
sale process may not have been in accordance with section 420A of the Corporations
Act 2001, the receiver should bear the burden of proof for demonstrating
that they fulfilled their obligations. The committee also considers that
further investigation of the challenges that small businesses face in pursuing
review of actions taken by banks, receivers and other bodies is warranted.
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