On Wednesday, 7 February 2018, the Productivity Commission (Commission) released a draft report for its inquiry into competition in the Australian Financial System (Inquiry).

The Commission’s draft findings reveal that Australia’s regulation of the financial system has favoured stability over competition, particularly since the global financial crisis.

The Commission views competition and stability in the system as equally important to ensuring economic growth.

The Commission’s preliminary recommendations are intended to reset the balance between stability and competition in Australia’s financial system.

This Inquiry forms part of a number of reviews into the financial sector, including the Australian Open Banking Review.

The Commission commenced the Inquiry under Part 3 of the Productivity Commission Act 1998 (Cth), which empowers the Commission to make recommendations by way of a report if requested by the Minister.

The Commission does not have any power to implement any of its recommendations. Rather, Australia’s Federal Government may reject or accept in whole or part the Commission’s recommendations.

If accepting in whole or part any of the Commission’s recommendation requires legislative or regulatory change, the Federal Government must go through the usual legislative processes to implement its decision.

In this article, we explain why the Commission is conducting this Inquiry, the focus of the Commission’s Inquiry, who might be affected by the outcomes of the Inquiry, the Commission’s preliminary findings and recommendations, who will be the new “competition champion” in the financial system and when the Commission’s recommendations are likely to take effect.

What is the focus of the Inquiry?

The Inquiry is focussing on competition in Australia’s financial system as a means of improving consumer outcomes, enhancing the productivity and international competitiveness of Australia’s financial system and economy and supporting ongoing innovation while maintaining financial stability.

Why is the Commission conducting the Inquiry?

In December 2013, the Hon Joe Hockey MP released the terms of reference for the Financial System Inquiry (known as the “Murray Inquiry”) to make recommendations on how the financial system could be positioned to best meet Australia’s evolving needs and support Australia’s economic growth. The Murray Inquiry was completed in December 2014.

One of the recommendations of the Murray Inquiry was for the Federal Government to strengthen the focus on competition in the financial system, including by reviewing the state of competition in the sector every three years. The Government agreed with this recommendation and tasked the Commission to conduct the Inquiry.

Who might be affected by the outcome of the Inquiry?

The Commission’s recommendations are potentially far reaching. If adopted, they will likely impact many industry participants in Australia’s financial system – some in a detrimental way and others in a positive way.

In addition to the “big four” banks, the outcome of Inquiry will likely have implications for all providers, customers and intermediaries who participate in retail banking, payment systems, residential home loans, credit for small to medium enterprises (SMEs), motor vehicle loans, warehouse funds (i.e. small, revolving lines of credit provided to smaller lenders) and general insurance.

What are the Commission’s preliminary findings?

The Commission’s preliminary finding is that Australia’s financial system has a number of characteristics indicating it is not workably competitive, including the following:

  • Regulation has favoured stability over competition. The Commission’s overarching finding is that Australia’s regulatory framework has favoured stability over competition since the global financial crisis. The Commission called out some of the Australian Prudential Regulatory Authority’s (APRA) recent interventions in the market as “excessively blunt and is concerned that they have either ignored or harmed competition”.

  • The Australian financial system is highly concentrated. The four major banks dominate the retail banking sector (accounting for a combined share of 70%), while four major insurers dominate general insurance (holding a combined share of 100% of the market for lenders’ mortgage insurance, and over 70% in the markets for general, home, domestic motor, travel and reinsurance).

  • Australia’s major banks have some of the strongest brands in the Australian economy. They benefit from the perception that they are “safe, stable institutions”, which customers are very loyal to.

  • Customers are very “sticky”, which allows providers to keep prices high. The stickiness of consumers to their current bank, insurer or adviser explains, at least in part, the ability of these providers to keep prices high and maintain profits without losing market share.

  • Product proliferation has inhibited consumer choice. There is a very large number of products on the market (e.g. over 4,000 residential property loans) sometimes with very little differentiation. This vast array of apparently similar products creates confusion for consumers and deters information-gathering and comparison shopping.

  • There are high barriers to entry and expansion. There are onerous prudential regulations in Australia’s financial system. Fintechs and other smaller institutions have focussed on less-regulated areas of the financial systems, rather than retail deposit-taking.

  • There is no competition champion in the financial system. The responsibility for competition in the financial system is “loosely” shared across APRA, the Reserve Bank of Australia (RBA), the Australian Securities and Investments Commission (ASIC) and the Australian Competition and Consumer Commission (ACCC). The Commission is concerned that “in a system where all are somewhat responsible, it is inevitable that (at important times) none are”.

What are the Commission’s preliminary recommendations?

The Commission has made a total of 25 draft recommendations in its report to address the lack of competition in Australia’s financial system. These are summarised in the table below.

The draft recommendations are designed to reverse the over-emphasis on stability and facilitate the introduction of workable competition to Australia’s financial regulatory framework. In particular, they are intended to empower the consumer’s ability and incentive to switch providers in response to more competitive offers and to reduce the cost of entry and expansion for smaller institutions and/or fintechs.

Affected Segment

The Commission’s draft recommendation

Industry-wide – greater reporting and increased transparency

  • Financial institutions undertaking mergers or acquisitions to notify the ACCC and ASIC of the nature and size of the acquisitions as they undertake them, and on an ongoing basis

  • ASIC to maintain publicly available database of the relationships between parents and subsidiary companies

  • The Corporations Act 2001 (Cth) to be amended so that ‘general advice’ is renamed and the term ‘advice’ is only used in association with ‘personal advice’ that takes into consideration personal circumstances

  • The Federal Government to implement the Open Banking system

  • An existing regulator (either ASIC or the ACCC) to receive a mandate to champion competition in the financial system

  • The Council of Financial Regulators to implement a process of review prior to implementing regulatory interventions and to publish this analysis

  • APRA to conduct and publish annual quantitative post-implementation evaluations of its macro-prudential policies, including costs and benefits to market participants and the effects on competition

  • The Federal Government to implement the Regulator Statements of Expectations and Statements of Intent, as agreed in response to the Murray Inquiry

Retail banking – facilitating entry

  • APRA to finalise and implement its phased approach for licencing ADIs, including the introduction of a new restricted banking licence

  • APRA to revise its policies and guidelines to remove restrictions on the use of the term “Bank”

  • The Federal Government to revise ownership rules under the Financial Sector (Shareholdings) Act 1998 (Cth) to improve access to capital for both new entrants and existing banks

Residential home loans - acting in the best interests of borrowers

  • ASIC to impose a clear legal duty on mortgage aggregators owned by lenders to act in the consumer’s best interests

  • ASIC to require mortgage brokers to provide certain information to clients prior to recommending loans, such as the types of products offered by different lenders, how mortgage brokers are paid, and the existence of any ownership relationship between lenders and the aggregators

  • APRA to collect monthly data from mortgage lenders on median interest rates for different categories of new residential home loans

  • Using data collected by APRA and ASIC to develop an online tool that promotes interest rate transparency for home loans

  • Lenders to offer refunds to home loan customers for the cost of lenders mortgage insurance when customers choose to refinance or pay out their loan

  • APRA to commence and complete a review of the risk weights for residential mortgages set out in Prudential Standard 112

Credit provision to SMEs – re-balancing risk

  • APRA to provide a broader schedule of risk weights in Prudential Standard APS 112 with consideration of different risk profiles and types of lending to better reflect the Basel Committee’s standardised risk weightings

More freedom for warehouse funds

  • APRA to revise Prudential Standard APS 120 and limit its effect on warehouse funds provided to ADIs

Payments system – reducing barriers to growth

  • APRA to design a tiered prudential regime for Purchased Payment Facilities (PPF) to reduce barriers to growth

  • ASIC to amend the ePayments Code to make subscription to the code mandatory for any entity that intends to send or receive electronic payments

  • The Payments System Board to introduce a ban on card payment interchange fees, with any remaining fees to be directly related to the costs of operating the system

  • The Payments System Board to ensure merchants are able to choose the default network to route contactless transactions for dual-network cards

  • Payments System Board to impose an access regime for the New Payments Platform

General insurance – greater transparency

  • Insurers to publish a list of any other brands they underwrite on their website

  • Insurers to provide an up-to-date list of the brands they underwrite to ASIC; ASIC to publish this information as a transparent list on its website

  • Insurers to include the previous year’s premium and the percentage change on renewal notices for general insurance products

  • ASIC to proceed with its proposal to mandate a deferred sales model for all sales of add-on insurance by car dealerships

  • The Federal Government to establish a Treasury-led working group to extend the deferred sales model to all add-on insurance products

Who will be the new “competition champion” and what powers will they have?

One of the Commission’s draft recommendations is to make an existing regulator the “competition champion” by providing it with the mandate to conduct transparent analysis of the impacts of prudential and other regulatory measures on competition and, where those measures impose barriers to competition, recommend action.

In the draft report, the Commission has favoured ASIC over the ACCC for this role for a number of reasons, including because ASIC operates primarily in the financial system. Further, unlike the ACCC, ASIC is already a member of the Council of Financial Regulators and taking on the role of competition advocate would flow naturally from ASIC’s existing mandate on consumer outcomes. In the United Kingdom, the Financial Conduct Authority has the role of “competition champion” in the financial system.

Notwithstanding that ASIC seems likely to take on the “competition champion” role, we consider that the ACCC will have an increasingly significant role in regulation in financial sector for the following two reasons.

Open Banking system to be administered by the ACCC

Under the Commission’s draft recommendation to implement an Open Banking system, customers will be given access to and use of the data held by financial institutions relating to the customer, including a right to access and use their consumer data, receive a copy of their consumer data, request edits or corrections to it for reasons of accuracy, be informed of the trade or other disclosure of consumer data to third parties and direct data holders to transfer data to the individual or a nominated third party. This draft recommendation follows the Federal Government’s final report of the Australian Open Banking Review, which envisages that the Open Banking system will be implemented through the Competition and Consumer Act 2010 (Cth) and be administered by the ACCC.

Compulsory notification regime for mergers and acquisitions in the financial sector

One of the Commission’s draft recommendations is to require any financial institutions undertaking a merger or acquisition to notify the ACCC and ASIC of the nature and size of these acquisitions. Under this draft recommendation, ASIC will be required to maintain a publicly available database of the relationships between parent and subsidiary companies.

In Australia, other than in a very limited set of circumstances, it is not mandatory to notify the ACCC of a merger or acquisition and clearance from the ACCC is not technically required before the merger can close.

However, the ACCC can review a transaction regardless of whether or not it is notified by the acquirer and, if it has concerns, can apply to the Federal Court for remedies.

If the transaction is notifiable to the Foreign Investment Review Board under the Foreign Acquisitions and Takeovers Act 1975 (Cth), FIRB will often consult with the ACCC as a matter of course and will delay its decision until the ACCC has informed it that it does not have competition concerns with the transaction.

Further, the ACCC “encourages” parties to notify transactions where the parties supply products that are either substitutes or complements and they will together have a share of 20% or greater in a market.

Consequently, should the Commission’s draft recommendation ultimately be implemented, it will establish a mandatory notification regime with respect to certain transactions in the financial sector and give the ACCC oversight of all transactions in this sector.

When will the Commission’s recommendations take effect?

The recommendations contained in the Commission’s draft report are preliminary.

Before the Commission releases its final report, interested parties may:

  • participate in the Commission’s public hearings, which will occur in Sydney and Melbourne between 28 February and 6 March 2018; and/or

  • make a public submission to the Commission by 20 March 2018.

The Commission’s final report is due to the Federal Government by 1 July 2018.

The Commission does not have the power to implement any of its recommendations – it will ultimately be up to the Federal Government to adopt and implement any final recommendations.

For some of its preliminary recommendations, the Commission has proposed a specific implementation timeframe (some as early as mid-2018). Consequently, it is possible that some of these recommendations, if accepted by the Federal Government, will be implemented within 12 months from the publication a final report.

The figure below sets out the preliminary recommendations where the Commission has proposed a specific timeframe for implementation.

Figure 1: Proposed timeframes for selected draft recommendations

For other recommendations, the Commission has not specified a timeframe for implementation or has recommended that implementation occurs “as soon as possible”. In our experience, it could take several years before a final recommendation by the Commission is implemented through legislative change. For example, the Commission’s recommended changes to the national access regime took over three years to implement.