Outline. The Changing Financial System Causes Implications

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2 Financial System Reform: Current Issues and Prospects Professor Kevin Davis University of Melbourne Australian Centre for Financial Studies Monash University Outline The Changing Financial System Causes Implications Specific Topics Borrowing: costs and options Changing options and risks for retail Investors Superannuation and Retirement Taxation and the Financial Sector Consumer Outcomes and Financial Advice Technology and Innovation 2

3 Drivers of Change Global regulatory agenda driven by northern hemisphere concerns about financial stability (and bank culture) Domestic implementation of recommendations of Australian Financial System (Murray) Inquiry Fintech Zero-interest rate world Tax debate Towards a zero-rate world? 3

4 Towards a zero-rate world? Consequences for: long term wealth accumulation an retirement; incentives for risk taking in search of yield Bank Capital Requirements and Borrowing Costs Basel 3 and 4 regulatory changes Much higher bank total capital requirements Some minor upward effect on bank cost of funds But increased bank safety, lower required return on equity, and less taxpayer risk of bailouts Banks attempting to protect margins and roe s by increasing loan interest rates 4

5 Bank Capital and Borrowing Costs Higher capital requirements for major banks for residential mortgage loans Reduces their competitive advantage vis a vis others Particularly at low risk end of market In conjunction with overall capital requirement changes may cause majors to be less focused on mortgage lending Should lead to more differential pricing of old and new loans and more borrower switching Bank Capital and Borrowing Costs Impetus to other forms of credit provision enabled by technology Peer to peer lending small unsecured loans Trade finance e.g. Paypal merchant finance Funds provided for repayment of a fixed amount (Loan plus fee) over unspecified time as an agreed percentage of revenues from merchant sales through paypal. 5

6 Retail Investment Opportunities: Fixed Interest Markets Push for simple corporate bonds market aimed at retail investors Provide alternative source of funding to bank loans for companies, and bond market as a spare tyre in crisis Yield gain attractive in near zero interest rate world, but Lack of investor diversification a major risk How to assess appropriate credit spread 2008 experience shows market price risk and illiquidity risk (even in absence of default) Australian Corporate Bond Spreads 6

7 Retail Investment Opportunities: Fixed Interest Markets Peer to Peer Lending Many new entrants in Australia Society One, ThinCats, Money Place etc Claim to make better use of technology for credit assessment, risk based pricing, loan management than banks In principle, retail investors can have large diversification across many small loans and better low risk returns than deposits &corporate bonds US/UK experience not inconsistent with this But recent Chinese Ponzi scheme P2P case illustrates need for good regulation and oversight Retail Investment Opportunities: Fixed Interest Markets Bank Capital Requirements have spawned major market in bank hybrids with bail-in provisions If a trigger event occurs, securities convert to a fixed value of ordinary shares Trigger events are breach of specified capital ratio or APRA declaration of non-viability Assessing probability of bail-in and cost, if it occurs, all but impossible value of shares received based on pre-announcement share price Some evidence that a risk premium applied by investors, but is it appropriate? 7

8 Bail-in issue yields relative to alternatives 14.00% ANZ div yield A n n u a l y i e l d Half-year % 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% NAB div yield CBA div yield WBC div yield BEN div yield Average bail-in issue yield 3 yr term deposit start of half year Retail Investment Markets: Equities and Managed Funds Technology enabling significant change ASX M-funds enabling investors to have investments in unlisted managed funds integrated with equity holdings through CHESS Exchange Traded Funds (ETFs) Massive growth enable low cost investments in portfolios which track specified indices 8

9 Taxation Tax debate a mess white paper process has faltered. Issues under consideration include Superannuation tax concessions Dividend Imputation Negative Gearing / Capital Gains Tax GST Structure of personal income tax scales Differential tax treatment of saving/investment types Outcome will affect future financial system structure Super and Retirement AFSI - Recognition of plethora of changes still working through system from MySuper and SuperStream. Issues under government consideration include Objectives of the superannuation system Relevant to contribution rates and tax concessions Efficiency in the accumulation phase Allocation of new members to default funds Retirement Products and managing longevity, investment, and sequencing risks preselected CIPRs Also Leverage and Superannuation Governance 9

10 Innovation and Technology Technology - fundamentally changing finance Digital identities Data access and sharing comprehensive credit reporting Payments system interchange fees & surcharges participants Graduated, functional regulation Peer to peer lenders Crowd sourced equity funding Technology neutral legislation Consumer Outcomes Disclosure, Education, Advice approach hasn t worked Product issuer/distributor accountability ASIC product intervention powers Align interests of financial firms, advisers, consumers Remuneration arrangements, penalties/banning Disclosure of ownership structures Adviser competency standards, registration Clarify/rename personal/general advice Innovative disclosures 10

11 Regulatory Change: The Likely Outcome? Thank you Questions? 11

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