Bank war cries lack a battlefield

The calls for a ‘Son of Wallis' inquiry into the banking system that have been prompted by a paper commissioned by the mutuals sector miss the point that there has been a massive and continuing investigation of the system, and a quite radical overhaul of it, in the wake of the global financial crisis.

The paper, commissioned by Abacus, which represents building societies, friendly societies and credit unions, was written by Professor Ian Harper, one of the members of the Wallis inquiry, a decade and a half ago. That inquiry lead to a wholesale restructuring of the regulation of the financial system that, with hindsight and on balance, has served the system and economy well.

It was conducted, however, at a time when financial markets and systems were just starting to become part of a global system and therefore it was reviewing a system that was fundamentally domestic in character. While the core of our system remains domestic, it is open to the world, increasingly international in scope and plugged into global capital flows.

The crisis provided a stress test of the Australian financial system and the core banking system and, with one obvious exception, it performed well. The exception was the revelation of the vulnerability of the major banks to shut downs in global wholesale funding markets, particularly short-term wholesale funding markets.

That vulnerability has been significantly reduced, both by the very substantial decrease in the wholesale funding exposures of the banks – and consequent increase in the proportion of deposits they hold – and by increased levels of capital and liquidity.

Some of those measures have been mandated by the Australian Prudential Regulation Authority – a creation of Wallis – but are also part of a set of new global prudential standards emanating from a review by global banking regulators of the lessons learned during the worst of the crisis.

The system is already quite different to that which entered the crisis and with the full impact of the reforms gradually being introduced over the rest of this decade there is more to come.

Perhaps the most interesting and relevant new dimension to the global discussion is that of ring-fencing the core traditional banking operations of the modern financial conglomerates deemed systemically important from their other operations. That is, however, a discussion the regulators are already having.

It is instructive that when the Senate Estimates Committee conducted its own review of the system last year, its 374-page reported produced very few recommendations and none that could be considered major – other than a recommendation for another inquiry.

The most common post-crisis complaints from politicians and non-banks relate to the consolidation of banking during the crisis and the implications for competition. There is an associated issue of access to funding for non-banks, particularly now that the mutuals are competing with the majors for deposits.

There is no evidence that the system isn't competitive, although the point of competition has moved somewhat from lending to deposits. In an environment where credit growth and demand for credit is far lower than it was pre-crisis and the banks are responding to the wake-up call they received when wholesale markets closed, that's rational and desirable.

While smaller banks and non-banks are finding it harder to access non-deposit funding on competitive terms, with securitisation markets not functioning as they did pre-crisis, that is a particular issue that governments and market participants could focus on.

One could argue, of course, that the access smaller institutions had to cheap funding pre-crisis, that allowed them to compete with the major banks on price, was an aberration generated by the credit bubble and was therefore both unsustainable and ultimately undesirable.

Given the weight and cost of the post-crisis regulation the major banks are now subjected to, that by itself has tilted the playing field towards non-banks although it may require some abatement of the new-found post-crisis conservatism of consumers before that advantage can be properly exploited.

In any event, given that there has been a continuing series of global inquiries into the banking system and a raft of reforms introduced and more under consideration – and that APRA and the banks were stress tested by the crisis, performed relatively well but have lowered the risk profile of the domestic system anyway – there is no obvious or pressing need to contemplate further major changes.

The smaller players might want a forum to promote the further handicapping of the banks, or some form of subsidy that improves their own competitiveness, but it is not clear how that would produce consumer benefit (the ultimate aim of competition policy) or increase the security of the system.