Murray's blueprint highlights the financial sector's resilience and risks

The Financial System Inquiry's interim report highlights the stability of the financial system while recognising the challenges that new technology will pose for the incumbents and regulators.

The Financial System Inquiry’s interim report isn’t a radical document. It was never likely to be given that the system has been severely stress-tested by the global financial crisis and its continuing aftermath, and has been found to be quite resilient.

That doesn’t mean the final report won’t contain recommendations for meaningful change in pockets of the system. However, unlike its predecessor, the Wallis Committee inquiry, it isn’t occurring against the backdrop of the large-scale bank and non-bank losses and failures and the revealed institutional shortcomings of the early 1990s.

Because it is an interim report, the Murray Committee doesn’t contain recommendations, only "observations" and options. None of these include any material changes to the regulatory architecture of the system that was so significantly re-designed by Wallis.

There are "observations" that will frustrate critics and competitors of the major banks, who have been hoping that the inquiry could be used to handicap the four big banks, using the increased concentration of the system post-crisis and their 'too big to fail' status against them.

The inquiry, however, says that while the system is more concentrated, it is competitive. The net interest margins of the majors are around historic lows and their returns on equity comparable to those of most major Australian companies.

Levels of competition within individual banking markets, however, vary. The inquiry is interested in views on whether risk-weightings of mortgages could be manipulated to enable smaller banks to compete more effectively and whether the residential mortgage-backed securities market should be directly supported by government to reduce their funding costs.

The majors will be concerned by the discussion about their 'too big to fail' status, which canvasses the possibility of increased capital requirements (beyond the 1 per cent surcharge the Australian Prudential Regulation Authority has already said will be imposed on domestic systemically important institutions). It raises the possibility of increasing that surcharge as well as asking whether there is a case for 'ring-fencing' critical bank functions (like their retail activities), as is occurring in some jurisdictions offshore.

The inquiry canvasses the ability to better impose losses from a failed institution on its creditors but dismisses proposals that would see either the major banks charged to offset their funding advantages or the deposit guarantee extended to all authorised deposit-taking institutions. There is also a discussion about whether there should be a fee for the guarantee and whether or not the $250,000 limit on the guarantee is appropriate or should be lowered.

In recent months there has been a lot of discussion about whether APRA should use macroprudential tools to defuse the perceived risk of the current housing market. New Zealand introduced a ceiling on loan-to-valuation ratios for mortgage lending.

The Reserve Bank has long held the view that it is difficult to identify asset bubbles until after the event and that pre-emptive intervention can create unintended consequences. The inquiry noted that but is still seeking the opinion of third parties on whether there should be a mechanism for direct interventions to adjust the "prudential perimeter".

In the wake of the Commonwealth Bank’s financial advice scandal and the Abbott government’s proposed changes to the Future of Financial Advice regime, the inquiry has come up with an interesting approach to distinguishing between independent financial advice and 'general advice' -- which is really just commission-incentivised selling of an institution’s own products.

The committee suggests that general advice could be simply re-named 'sales' or 'product information' and the term 'advice' mandated to be used only in relation to personal advice. It makes sense to label those who are selling a product as salesmen or women while reserving the term advice for those genuinely providing independent and informed advice.

Between the interim and final reports from the inquiry members there will obviously be another round of submissions that are more directly targeted to the observations they have made and the options they have canvassed.

There is potential for a large number of quite meaningful changes to the various corners of the system, including the sensitive superannuation system where there was discussion about costs, leverage and mandated annuities.

It is not apparent from the interim report, however, that the committee thinks there is anything of substance within the system that is actually broken and therefore requires radical intervention.

That’s as it should be. The system is stable, reasonably competitive in the context of its stability. The regulatory functions, while not perfect (hence the controversies around the Australian Securities and Investment Commissions’ role in the CBA financial planning scandal) have performed relatively well under the pressure of the financial crisis.

There does need to be some updating of some aspects of the post-Wallis system to recognise that a lot has changed since 1997 and some of the developments that Wallis foresaw haven’t played out quite as expected.

It is also apparent, and the inquiry recognises it, that we are on the cusp of a major change in the role and impact of technology within the financial system. This could (and indeed already is) bringing a range of new players and risks into it and creating new and different challenges for the incumbents and the regulators. That alone makes the inquiry worthwhile.