Source document: https://docs-lawep.s3.us-east-2.amazonaws.com/1697639061825.pdf (Australia)
Submission to The Senate Economics Legislation Committee Comments relating to the Draft Report.

Context – The Policy Challenge A vibrant and competitive financial sector is important for Australia and Australians.

However, the current structure of the industry and the oligopoly enjoyed by the largest players means that the costs of financial services are higher than they should be because large players can dominate (and rely on a quasi-Government guarantee being too big to fail).
Indeed, the much vaunted “superior shareholder returns” are a result not of excellent management, but structural dominance.

The recent Productivity Commission into mortgage pricing illustrated this well, with “discounts” and “rates” disconnected from the headline mortgage offer rate, and the inability for consumers to make true comparisons across the market.

Plus, mortgage brokers are exposed to the risks of conflicted advice.
In addition to the engineered market inefficiency, the accretion of multiple business lines within one organisation has led to structural risks beyond those which are accounted for in the Basel Accords.

For example, failures in the estimated $700 trillion global derivates sector could trigger a run on local banks, and bank deposits are at risk, especially in a “bail-in” situation.
The New Zealand Open Banking Resolution is the clearest articulation of using deposits to save a failing bank, and similar arrangements now exist in USA, Europe and elsewhere, under the direction on the Financial Stability Board (FSB) and the G20.
In Australia, the bail-in risks are less transparent, but still exist (despite the consistent denials from Treasury, and their conflation of a bail-in where a failing bank is saved by converting certain holdings, including deposits to saving a failing bank; and the activation of the $250k deposit protection scheme in a failed bank).

APRA has preferred the supervision of a small number of large players from a financial stability perspective, but this has led to poor customer outcomes.
Again, the Productivity Commission has called this out, quite correctly.

APRA’s approach is myopic.

The recently complete Royal Commission found regulation and changes to the law alone cannot address the issues exposed during the hearings.

The culture within the finance sector needs to be changed, to put customers at the centre of their business.

Whilst talk is cheap however, there is little evidence of substantial change as yet.
In addition, the current capital adequacy rules favour mortgage lending relative to productive lending to business and as a result according to our Small and Medium Enterprise surveys, many businesses are unable to obtain finance (or can only do so by securing their property).

We believe the various risk weights reflect a myopic view of the financial system and they need to be changed.
Too much of the bank’s portfolio of loans – up to 65% - is against residential property – this is extraordinarily high by international standards, and presents a significant risk, to say nothing of the lack of business investment which has resulted.

However, we hold the view that the major financial sector players are too complex to be managed effectively, scale is now a disadvantage.

Thus, we believe there is a case to break up the banks into smaller units.
This would involve both vertical disaggregation (separation of advice, sales and product manufacture) and horizontal disaggregation (separate of wealth, insurance, retail banking Banking System Reform (Separation of Banks) Bill 2019Submission 50 and investment banking).

In addition, there are significant risks from their operations in derivatives, and in an integrated environment, costs, risks and profits are cross linked.
Given the size of the derivatives sector (significantly larger than before the GFC), the systemic risks are significant.

To counter this, we advocate the implementation of a modern Glass Steagall separation, where the high-risk speculative activities are separated from the normal lending, payment and deposit functions within banking.

This would have the added benefit of reducing the potential risks of a bank deposit bail-in in a time of crisis.
Evidence suggests that the existence of a modern Glass Steagall separation would reduce risk and limit systemic risk.

In a post Glass Steagall world, bank lending would be more aligned with the deposits available, so their ability to make loans “from thin air” as in the current system would be curtailed.

They would also be more inclined to make loans for truly productive purposes.

We also need to consider the role of the regulators and the RBA.
Murray’s Financial System Inquiry recommended that the effectiveness of the current regulatory system be monitored.

The Council of Financial Regulators is the peak body, chaired by the RBA, where key policy is set, with the Treasury, ASIC, APRA and others.
However, other than scant minutes (a recent innovation) none of their deliberations are made public, and it appears that all entities have been sharing the same view that growing housing credit was the chosen growth lever of choice following the mining boom.

It appears that the weak supervisory approach from ASIC and APRA stemmed from this policy and was supported by policy rates being set too low.
As a result, the systemic risks have been underestimated, and the economic platform for the country narrowed.

The Royal Commission highlighted the lack of coherence, and alignment.

We also would argue that APRA has myopically focussed on financial stability, at the cost of good consumer outcomes and competition, that the regulations favour large players over small players, that the RBA policy rates are too low, and the ASIC so far is still perceived as a weak and ineffective regulator.
Therefore, from a risk, economic and customer perspective, we need to look at the underlying structure of the industry and its supervision.

The Current Issues We assert that the finance sector in Australia has become too big and complex and as a result: • End customers are paying more than they should be for the banking products and services they use.

• Risk-related activities of banks have become scrambled with more ordinary banking services, creating unacceptable risk of failure and default.
• Horizontal integration (across multiple lines of business, e.g.

banking, wealth management and insurance) and vertical integration (control of the advice, product manufacture, servicing and selling) reduces customer choice, increases the potential for fee and price gouging, and reduces competitive tension in the system, and results in often forced and poorly disclosed product bundling.
• The complexity of the current large multifaceted organisations means management span of control is too extended, and as a result poor behaviour, risky behaviour and customer exploitation often go unnoticed.

• Profitability is supported by the current oligopoly, not superior management.
Banking System Reform (Separation of Banks) Bill 2019Submission 50 The Proposed Bill Is Necessary and Appropriate The Bill would separate retail commercial banking activities involving the holding of deposits, from wholesale and investment banking involving risky activities.

If implemented, the outcomes of the Banking System Reform (Separation of Banks) Bill 2019 would be to: • Protect deposits, and ensure deposits are only used for normal lending, not speculative activities.
• Keep more money in the real economy and available for banks to lend to productive enterprises, especially lending to commercial entities, many of whom today are unable to access finance.

• Separate the sales, advice and manufacturer functions to remove the current conflict of interest, conflicted remuneration, and poor customer outcomes and cross selling between banking, insurance and wealth management.
• Stop banks from securitising mortgages, which is the repackaging and on-selling of mortgage pools to other banks into risky derivatives.

This would put a brake on mortgage fraud and excessive mortgage lending to risky borrowers.

The Consequences There is a compelling case to break up the larger players into smaller more identifiable entities.

• Product and service pricing would be more transparent.
• Risks such as those relating to derivatives and trading would be separated from bank deposits and mortgages, reducing the risk of contagion, or deposit bail-in.

Smaller entities would not be “too big to fail” and would not require the implicit Government support which exists today via the RBA Committed Liquidity Facility and other mechanisms.

• Separation of the sales, advice and manufacturer functions would remove the current conflict of interest, conflicted remuneration, and poor customer outcomes.
The cross-selling of products or bundling of wealth and insurance into banking services would reduce, making the customer purchase decision simpler.

• As a result, we would see the creation a constellation of smaller more manageable and contestable businesses, centred around service to customers.

• There could be a reorientation of lending to more productive purposes which can support the broader economy, rather than the current focus on mortgages, which is economically unproductive.
In the process of separation, considerable value to shareholders could be release, and in addition management structures and accountabilities simplified, leading to cultural improvement and change.

• • Separation offers the potential for more innovation and aligns with the continued development of the “Fintech” sector and beyond.
Banking System Reform (Separation of Banks) Bill 2019Submission 50 • Finally, the Bill would regulate Australian Banks properly, by strengthening Parliamentary oversight of the activities of the Australian Prudential Regulatory Agency (APRA) as the banking regulator.

APRA has previously said they were prepared to trade-away better customer outcomes in favour of financial stability.

But structural separation would enable better customer outcomes AND better financial stability.
We suspect the current regulators, major existing players, and even Treasury would resist such a reform, but we believe the case for the Banking System Reform (Separation of Banks) Bill 2019 is compelling.

In summary, bad behaviour would be easier to identify and manage, productive lending would be encouraged, customer pricing would be more transparent, and systemic risks would be better managed, alleviating the need for bank bail-in during difficult times.
Combined this would re-establish public confidence in the banking system.

Banking System Reform (Separation of Banks) Bill 2019Submission 50 About Digital Finance Analytics Digital Finance Analytics (DFA) is an Australian boutique research, consulting and advisory firm which combines primary consumer and small business research, analysis of both private and public datasets and economic modelling to analyse the dynamics of the finance and property sector.

We have been operating since 2005.


DFA combines primary consumer research, industry modelling, economic analysis and segmentation analytics to offer insight into the dynamics of the mortgage, lending, savings, payments and superannuation sectors.

Using experience derived from more than 25 years of analysis, DFA is able to pinpoint opportunities created by changing customer needs in the evolving market.
Our analysis is based on a rolling 52,000 household survey, with more than 4,000 new data points added each month.

From this we are able to assess the state of household finances, their future property transaction intentions, and their level of debt; and ability to service it.

We provide advisory and consulting services across the Finance sector, both in Australia and overseas.
Banking System Reform (Separation of Banks) Bill 2019Submission 50 About Martin North Martin North is an Australian-based analyst and business consultant, specialising in the Financial Services Industry.

Currently he is the Principal of Digital Finance Analytics (DFA), a boutique research, analysis and consulting firm providing advisory services to Companies in Australia and beyond.

Martin North, its founding Principal and banking sector analyst is often quoted in the media.
Links to recent coverage may be found on the DFA site.

Based near Sydney, Australia, Martin has enjoyed senior roles with National Westminster Bank, Citibank, National Australia Bank, and Fujitsu Australia, as well as senior consulting roles with Booz Allen and Hamilton, Andersen and DMR Consulting.

He has advised more than 100 organisations in aspects of strategy, finance analytics, business transformation, digital business and IT strategy.
He has considerable international experience, working in Australia, UK, USA, Poland, Hong Kong, Singapore and New Zealand.

He taught Capital Markets to bank executives in Europe, Asia and America.

His clients have included Financial Services companies, as well as Retail, Telecommunications, Healthcare and Technology.

Martin North Principal Digital Finance Analytics Web: www.digitalfinanceanalytics.com Banking System Reform (Separation of Banks) Bill 2019Submission 50