Keynote lunch address to the Committee of Economic Development of Australia

'Conduct of the Financial System Inquiry'

Mr David Murray, AO Chairman of the Financial System Inquiry

14 February 2014

Check against delivery

Good afternoon ladies and gentlemen. Let me start by thanking CEDA for hosting this event and for the work they do to promote economic discussion and debate.

This is the first of a series of addresses I intend to give during the Financial System Inquiry to inform the community of the work of the Inquiry and its importance to Australia’s future economic development.

It’s now over 16 years since the Wallis Committee published its final recommendations.

The intervening years have seen Australia’s economy and financial system undergo some major and unforeseen changes.

The economy has expanded consistently for more than two decades and its terms of trade have been at their highest level in over 50 years.1

Globally, there has been the shift of economic weight to emerging economies and Asia. Developing economies of Asia have increased their share of world GDP by approximately 12 percentage points since 1997 and now account for about one quarter of world GDP.2

Within Australia, since the Wallis Report, we have seen a substantial increase in household indebtedness and a noticeable rise in Australia’s net foreign liabilities, and more recently, some deleveraging by the corporate sector and the Government’s net fiscal position go from being out of debt to being back into debt.

These changes serve to remind us how much we rely on the financial system to continually adapt to changing patterns of fund flows and the fundamental importance of the system to the Australian economy.

Through this time span the Australian financial system too has undergone changes. Some of those changes, of course, were a product of the global financial crisis.

For example, one of the key tenets of the Wallis Report was that the Australian Government should not guarantee financial institutions.

Then, who of us would have thought, before 2008, that the Australian Government would one day have to guarantee Australian bank deposits and wholesale funding?

Some of the other changes we’ve seen in the intervening years have been slower in coming about, yet they still have significant implications for the way the financial system operates.

The growth in financial assets of Australian Governments, businesses and households has averaged 9 per cent since 1996; growth in banks’ holdings of financial assets has averaged nearly 11 per cent over the same period.3 Over the same period, the average annual growth in nominal GDP has been about 6.5%4.

We have also seen the rapid growth of superannuation funds, especially self-managed funds. As at 30 June 2013, superannuation assets totalled $1.6 trillion (average annual compound growth of 12% since 1996) and of this amount $506 billion was in self-managed superannuation funds (average compound growth rate of 19% since 1996).5

Some of these trends in the financial system, of course, were becoming apparent at the time of Wallis. But the passing of time has emphasised their significance for the financial system.

And so a key challenge for my colleagues and me will be to evaluate the impact of these developments, as well as to identify major drivers that will shape our system and its contributions to the economy for the foreseeable future.

In turn, the quality of the work of the Inquiry will very much depend on the nature and breadth of its consultation with industry and end users of the financial system.

Thus, I want, above all, today to encourage submissions on the issues in the terms of reference. I also want to explain why they are so important by outlining the context of the Inquiry, giving examples of some major issues for the Inquiry and explaining the Committee’s plans for the conduct of the Inquiry6.

In relation to the context, the Treasurer, in Opposition, proposed a comprehensive financial system inquiry in October 2010 as part his intention to reform banking policy.

This was prompted, to some extent, by concerns about the adequacy of competition in the domestic banking industry following increases in interest rates over and above changes in the official cash rate.

But it also reflected more general concerns about the legacy of the global financial crisis.

As the Treasurer has since noted, experience during that crisis challenged some of the key assumptions underlying the Wallis Report.

One of them included the assumption that failure of financial institutions is a normal part of a market-based system and that governments should not guarantee them.

While this may have been undermined, to some degree, by the Government’s response to the collapse of HIH Insurance, the financial crisis highlighted the difficulty of applying this principle and the extent to which taxpayers effectively underwrote the stability of financial systems.

Other assumptions were also undermined by the financial crisis.

For example, it had been implicitly assumed that crises and failures were more likely to emanate from within Australia, rather than externally.

It had also been assumed that markets are self-equilibrating and less prone to failure than individual institutions.

One legacy of the crisis has been to question these assumptions – although it is not clear we have landed on viable alternative positions.

Another legacy of the crisis has been a global wave of regulatory change with significant implications for Australia, for example, we have -

  • revised our own standards in some areas to reflect new global standards (for example Basel III);
  • had to adjust to major regulatory changes in Europe and the US, both of whom have become much more emphatic in asserting their jurisdiction over foreign market participants; and
  • witnessed long-term structural changes in the global economy and financial system, including a shift to emerging economies and the Asia-Pacific region.

The effects of the crisis were also felt by many Australian retail investors who suffered substantial losses associated with the failures of financial firms or misselling of financial products. These consequences have called into question whether disclosure is effective.

So, it is against this background, the Government has asked the Inquiry to do four main things:

Firstly, we have been asked to work out how our financial system has changed since 1997 including the global financial crisis. For example, what have these changes revealed about the strengths and weaknesses of Australia’s financial system – remembering that the Australian financial system has served us relatively well.

Secondly, we have been asked to consider what the developments since 1997 mean for Australia’s ‘regulatory philosophy’ and framework. For example, do we still believe that the Government should not intervene to guarantee financial institutions? If not, what do we now believe?

Thirdly, we have been asked to identify the likely drivers that will shape the financial system over the next decade or so and assess their potential implications. We know it is notoriously difficult to forecast the future or even develop credible projections. However, it should be possible to assess the potential implications of some different scenarios.

Finally, the fourth thing we’ve been asked to do is to develop policy recommendations that ensure our financial system builds on its strengths and remains appropriate for the Australian economy. In this area, the Committee is particularly keen to ensure we have a system that balances competition, innovation, efficiency, stability and consumer interests and meets Australia’s needs from the perspective of both end users of the system and financial institutions themselves.

I mention all of this context to emphasise the importance of the Inquiry in developing a policy blueprint for the Australian financial system in a post-Wallis and post-GFC world.

Such a blueprint needs to take into account the broader role and many interdependencies in the financial system which explains why a broad terms of reference for the Inquiry is both necessary and valuable. The blueprint is intended to ensure that the financial system is ‘fit for purpose’ to promote growth and productivity in the Australian economy over the foreseeable future.

Inevitably, there will be many themes the Committee will need to consider, but I would like to discuss three of these by way of illustration, that will attract the Inquiry’s attention.

The first of these is the funding of Australia’s economy.

One view is that the economy will fund itself one way or another. Another view is that there may be circumstances where funding of the economy may be at risk with issues of contagion and loss of confidence potentially causing structural damage to the economy.

Irrespective of which view you take, what matters is the quality of the funding of the economy. In that regard, the Committee will be interested in the efficiency of the financial system itself and how it can improve productivity in the Australian economy.

Equally, and perhaps more importantly, the Committee will be interested in the allocative efficiency of the financial system in funding the economy. For example, we will be interested in how well the economy funds small and large businesses, households, Governments, agriculture, industry, infrastructure and new and developing ventures whether these be in urban or regional areas. An issue will be whether there are distortions in the system that favours the funding of some users and/or providers of capital over others.

The Committee will also be interested in the dynamic efficiency of the financial system. In other words, is the system continuously adapting with new types of claims and obligations better suited to the issuers and holders of financial securities. For example, there has been discussion for some time on the development of Australia’s bond markets; venture capital markets and mechanisms for funding infrastructure. Also, there has been interesting innovations in the not-for-profit sector such as social bonds.

One aspect of this issue is the growth of superannuation funds that I referred to earlier. For example, the manner in which these funds are invested is very important to these questions of allocative and dynamic efficiency.

In considering these questions for the financial system, as stated earlier, the Committee will have to balance stability, competition and efficiency objectives.

As part of this process and as my second illustration, the Committee will need to examine the state of competition in banking, payments, insurance, funds management and financial markets and whether it drives or impedes efficiency (both administrative and allocative) in the financial system.

A key issue in this area will be the impact of regulation on competition, including whether firms face a ‘level playing field’.

Moreover, regulation can promote competition, for example by helping consumers make more informed decisions.

However it can also create barriers to entry and increase compliance costs, with varying outcomes for financial institutions of different sizes.

More broadly, we need to consider whether we have the right balance between competition, stability and efficiency.

In the wake of the financial crisis, it is not surprising that the focus of regulators and global standard setters has been on stability rather than competition.

Accordingly, we will be very interested to examine the extent to which stability objectives might hinder competition, or even perhaps in some cases, promote more competition and reduce systemic risks.

Inevitably, the object of regulation for stability creates a cost to the economy and we would welcome views on the trade-off between these objectives.

One particular matter I want to mention in relation to competition and efficiency is technology. This is my third illustration.

Much of the work performed to operate the financial system involves the keeping of books and passing of messages on behalf of clients. Then it should not be surprising therefore that the development of computing and communication technologies in recent history should have a profound effect on the system.

Perhaps we should bear in mind this is one of the greatest generally applicable technological developments that we have seen and it is still working through all aspects of industry.

Some of the more obvious impacts involve high volume payments; trading and settlement systems.

One example is the decline of cheques and the popularity of mobile or contactless options. At the end of 2013, the use of cheques was around one-third of the use ten years earlier.7 This may mean that we will stop using cheques in material numbers by 2020.

Another example is the ascendency of automated trading on our equity markets where trading is now in microseconds. In just the last three years to the end of December 2013, the order to trade ratio on our main equity markets has risen from 5.8 to 8.6; the number of orders has nearly doubled from 3.2 million to over 6 million per day and the average trade size has dropped from $9,300 to $5,3008.

However, the overall impact is much wider than these types of activities. Technology opens up the prospect of self-service. It also facilities more effective management of highly complex asset liability management systems with large volumes of data in short periods of time and it assists to manage large volumes of client data to continually hone financial product offerings (sometimes for better and sometimes for worse).

But, of course, new technology carries adjustment costs and new risks. One such risk is cyber-security which the Committee would like to also consider.

I hope today’s reference to technology and some selected themes helps understanding of the complexity of the financial system and importance of our work.

But there is a more exciting opportunity. The work of the financial system is necessarily intangible, addressing such concepts as the intermediation of time, amount and default in banking, adverse selection in insurance or the social discount rate that encourages superannuation savings. Because these concepts are not easily understood, the mismatch between the true value of the system and the perception of its value adds pressure for policy decisions and more costs and risk to the detriment of the community.

Because our terms of references are broad, because the Treasurer wants us to consult widely and because there has been so much written since the crisis, we have a unique opportunity to close that gap between the perception and true value of the financial system.

Taking that opportunity will be much easier if we get submissions of high quality and thoughtful argument with realistic suggestions to back them up.

I also wish to emphasise that the Inquiry intends to be as consultative and open as it can be and will be taking a proactive approach to seeking views from the community and encourage debate. The Committee and Secretariat expect to hold ongoing meetings with the community during the Inquiry. Our consultation will include international engagement and gaining perspectives and ideas from the Inquiry’s International Advisory Panel foreshadowed by the Treasurer.

We intend to produce an interim report mid-year, in which we will describe the system, summarise views and present the issues with different ways of managing them. We will then call for further submissions before completing our final report and recommendations to the Treasurer in November.

I am privileged to have such an expert group on the Committee, aided by the International Advisory Panel and an expert Secretariat. That said, our work will only be as valuable as the breadth and quality of submissions allows. Accordingly I encourage as many submissions as possible to our Inquiry.

1 Source: Australian Bureau of Statistics, Australian National Accounts: National Income, Expenditure and Product, September 2013, Cat 5206.0

2 Source: International Monetary Fund, World Economic Outlook Databases

3 Source: Australian Bureau of Statistics, Australian National Accounts: Financial Accounts, September 2013, Cat 5232.0

4 Source: Australian Bureau of Statistics, Australian System of National Accounts 2012-13, Cat 5204.0

5 Source: Australian Prudential Regulation Authority, Superannuation Bulletin, June 20134 (revised 5 February 2014)

the Annual Superannuation Bulletin page of the APRA website and APRA Insight, Issue 2, 2007

APRA Insight, Issue 2 2007.

6 Initial submissions are due by 31 March. Submissions should be preferably provided online at the Inquiry’s webpage address at

7 Source:

Reserve Bank of Australia, Statistical Table C6

8 Source: ASIC: Equity market data report for the quarter ending December 2013