Outline of Colonial’s Supplementary Submission to Wallis Inquiry by weep00p

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									13 January 1997


Mr G J Smith
The Secretary - Financial System Inquiry
Federal Treasury Building, Parkes Place,
Parkes ACT 2600




Dear Sir

We refer to the detailed discussion paper issued by the Inquiry and compliment the
Committee and the Secretariat on its comprehensive nature. Colonial also
congratulates the Inquiry on the open minded approach it has taken to the numerous
suggestions and recommendations that have been made and we are confident that the
final recommendations of the Inquiry will play a significant role in the future
development of Australia‟s financial system.

We have quite consciously kept our second submission to the Inquiry very brief, and
concentrated our comments on what Colonial regards as the two core issues of how
we reform the financial system to enable consumers changing needs to be better met,
while at the same time maintaining or enhancing the stability of the financial system.


Stability of the Financial System

The financial system and its accompanying regulatory framework is critical to
Australia's wealth accumulation, as well as being the medium through which
economic transactions occur. As such, in our first submission while Colonial
recommended some areas of substantial change, we also noted that any changes must
be implemented in a manner that ensures the fundamental stability of the financial
system is maintained and reinforces Australia's international competitiveness. It is
also important that any changes to the financial system enable Australia‟s
Government to continue to promote broader policy interests, as well as meet the more
specific objectives of financial stability and consumer protection.
A number of key elements of the financial system including access to the payments
system, depositor protection, the prohibition of mixed conglomerates and the
prudential regulation of the system in general, could if modified inappropriately,
jeopardise the integrity of Australia‟s financial system. Colonial‟s views on these
issues are summarised below, with more detailed commentary included in Appendix
1.




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Access to the Payments System
The stability of the financial system is dependent on the integrity of the payments,
clearance and settlement systems, which maybe subject to a number of destabilising
events such as mechanical failures, major market shocks, natural disasters and
impaired financial institutions. Colonial believes that any changes made to improve
the competitive nature of financial services in Australia should not threaten the
systems financial stability. Systemic stability is best achieved by restricting access to
the payments system to those financial institutions with undoubted technical
capability and financial integrity. In particular, direct access to the settlement systems
should be restricted to banks, and other financial institutions subject to the same
prudential supervision as banks.

Depositor Protection
Depositor protection should be a specific objective of the regulatory system, as it
helps protect runs on banks and it ensures a “safe” form of investment for risk-averse
small savers. These advantages are judged to offset the problem of moral hazard,
which can be best managed by discouraging the impression of a guarantee.

It would appear that the Committee is considering the option of explicit deposit
insurance in Australia. Colonial is opposed to the introduction of an insurance
scheme as it believes the moral hazard and other disadvantages inherent in such
schemes more than offset any perceived advantages such schemes may bring. In
addition, the current model has historically served the economy well and therefore “if
it‟s not broken, don‟t fix it.”

While Colonial supports amending the Banking Act to clarify the powers of the
Reserve Bank of Australia (RBA) as a means of dealing with the perception that
deposits are guaranteed, the RBA would still need to retain relevant reserve powers in
order to assist the smooth exit of institutions who may be in difficulty.

Colonial believes that the RBA‟s authority should be extended to also cover building
societies and credit unions as many consumers do not differentiate between these
financial institutions and banks.

Prudential Regulation
The objective of prudential regulation is to maintain the integrity and stability of the
financial system through management of systemic and contagion risk. Ideally,
prudential regulation should also avoid imposing undue costs through excessive
regulatory intensity, be consistent with the approach adopted internationally, and pass
the competitive neutrality test, i.e., place a similar regulatory burden on similar
financial promises independent of the institution providing them, where appropriate.
Australia‟s system of prudential regulation works well and Colonial believes
regulatory supervision should not be replaced with a system of increased disclosure.
The institutionally-based approach to prudential regulation should continue, but it
should be enforced by a new super-regulator to ensure a harmonised regulatory
approach is adopted across institutions and to respond to the unique regulatory
requirements of integrated financial service providers.




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The combination of prudential supervision, depositor protection and restricted access
to the payments system are all interdependent and have historically, performed well as
a package of measures used to protect the financial system from systemic and
contagion risk. Due to the interdependency of these measures any alterations to one
of these has the potential to undermine the effectiveness of all of the others. Colonial
believes, therefore, that any proposed changes to these measures should not be done in
isolation but rather in the context of ensuring the full package of measures continues
to be effective.

Ownership Concentration
There is a real risk that certain merger and acquisition activities in the financial
services market could result in a substantial lessening of competition, which could
offset any potential enhanced efficiencies that could be generated from industry
rationalisation. If a merged entity can effectively dominate the market, it would
appear that there would be little incentive for that entity to pass on the benefits of
reduced costs to consumers. It could also be argued that excessive concentration in
the market could potentially undermine the stability of the financial system by
concentrating ownership and, therefore risk, in a small group of shareholders.

Mixed Conglomerates
Colonial believes that mixed conglomerates should not be allowed to own financial
institutions as there are significant practical problems associated with minimising
systemic and contagion risk and, therefore, their existence may undermine the
stability of the financial system. For example, it is difficult in a practical sense to
“quarantine” or isolate the risks associated with industrial activities from a financial
institution within the same group, and it may not be possible to apply the same
supervisory rules and practices to industrial activities and financial institutions.

Perhaps more importantly, significant potential for conflict of interest exists in respect
of managements‟ objectives for gearing in industrial companies and their relationship
with banks. Many industrial companies hold a significant level of debt as this is the
most cost effective method of funding operations. This could potentially lead to a
conflict of interest between the industrial parent and the bank subsidiary providing
funding to it or a competitor. This conflict of interest could potentially jeopardise the
stability of the financial system due to the unique role banks play in the payments
system.


Changing Consumer Needs

The financial services market is being affected by a number of major change drivers:
technology and marketing advances; growing international competition and the
integration of financial markets; more intense domestic competition; and changing
consumer needs and demands.
Consumers want financial services which are better attuned to their needs including a
broader range of products which can be specifically tailored to suit their requirements,
and access to these products through the method of delivery which is most convenient
to them.




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Colonial‟s Allfinanz strategy is a natural outcome of the impact of these change drivers
in the market today. Domestic competition is increased by broadly-based financial
services organisations (such as Colonial) that want to access cross-selling opportunities
by combining activities in different financial services sectors. Organisations such as
Colonial can offer a complete range of financial services in ways that were not
previously possible and innovatively deliver real financial solutions to consumers.
Allfinanz is about packaging and delivering products and services in an integrated and
convenient way that provides customers with meaningful solutions across their life-
time. Colonial believes its Allfinanz strategy is what consumers want and the
increasing globalisation of markets will accelerate this trend in Australia, particularly as
new entrants from overseas adopt similar approaches in our market.
If Australia is to compete in this increasingly global market and to respond to
consumers needs for Allfinanz solutions it must be prepared to develop a uniform and
concise consumer disclosure regime, provide simple and consistent privacy legislation
and encourage the existence of financial services groups utilising a holding company
structure that is free of regulatory duplication and overlap.


Consumer Protection
In the area of consumer protection, Colonial sees great potential for a fundamental
restructuring of the existing regulatory framework, with a functional approach to
regulation. This should be organised by function or product group and be enforced by
a single (super) regulator. Colonial believes existing consumer protection regulations
do not adequately meet the criteria of efficiency, effectiveness and competitive
neutrality. Regulations are highly complex, making compliance costs high and
compliance difficult.

Separate compliance and disclosure systems make problematic the provision of
integrated financial solutions to consumers and the ability to respond to consumer
demands for a „one stop shop‟. Without industry-wide competency based licensing,
the ability to clearly define, strengthen and harmonise adviser and product selling
competencies is necessarily constrained.
Importantly, consumers are not benefiting from the existing system. Consumers are
overwhelmed and confused by the quantity of information that is often disclosed with
products. Ultimately, the consumer bears the costs incurred by unwieldy company
compliance systems.


Privacy
Increased use of electronic delivery for financial services is likely to heighten
concerns about protecting consumers‟ rights to privacy. At the same time, competitive
pressures and greater customer service expectations will underscore the need for
financial service providers to develop much better on-line customer information files.
In such an environment, it will be incumbent on legislators to strike a balance between
responding to legitimate privacy concerns, providing some degree of consumer choice
and ensuring the flow of information necessary for the efficient delivery of customer
services.



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A number of Commonwealth and State laws now govern the right of consumers to
privacy. A coherent national approach to privacy regulation, based on co-operation
between Federal and State governments, is critical. A consistent approach to privacy
must be adopted nationwide that enables the sharing of appropriate customer
information across the same financial services group, unless the customer specifically
requests otherwise.

Holding Company Structures
Colonial maintains a holding company structure which in turn owns the major
operating entity/entities of the group. Colonial reiterates its view that a true single
purpose holding company of financial institutions should not be subject to specific
prudential regulation of a bank or life company. Instead, the regulation should occur
at the individual operating entity level and be undertaken by the prudential super-
regulator as mentioned above. While a clear objective of the prudential super-
regulator is to be able to step back and take a complete view of the prudential
management of a financial services group, it would seem inefficient to establish a
further regulatory framework for a true, single purpose holding company.

A related issue which regulators have focused on in their monitoring of holding
companies is the level of gearing or debt that the holding company itself has, as
opposed to the debt contained in the operating subsidiaries. It is Colonial‟s view that
the regulation of holding companies is a duplication that can be removed and that the
monitoring of debt levels in the holding company is irrelevant to the prudential
regulation of operating subsidiaries.

Consumer Credit Code
After a protracted period of debate and modification, the Consumer Credit Code (the
“Code”) was introduced in late 1996. Since its implementation, Colonial has
identified a number of issues which if resolved would improve the practical
application of the Code and would more fairly reflect the interests of debtors,
mortgagors and guarantors in an efficient and fair manner, without imposing costs of
compliance which do not have a clear compensating benefit. These issues are fully
described in Appendix 1. Colonial‟s specific comments on the Code should not
undermine our view that there is the need for a more substantive overhaul of all
consumer regulation in an effort to develop an efficient, competitive and practical
system of regulation.


Conclusion

Reform of Australia‟s financial system must lead to more efficient and effective
services for consumers, but in a manner which preserves financial stability, consumer
confidence and competitive neutrality.




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Colonial welcomes the discussion the Financial System Inquiry has stimulated and is
happy to provide further comments or assistance to the Inquiry in formulating its
recommendations.



Yours faithfully




P J Smedley
GROUP MANAGING DIRECTOR AND CEO




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                                                                         Appendix 1.

Colonial Supplementary Submission to the Financial System Inquiry
Access to the Payments System
The stability of the financial system is dependent on the integrity of the payments,
clearance and settlement systems. Colonial believes that the stability of the financial
system should take precedence over any desire to increase unrestricted competition.
Systemic stability is best achieved by restricting access to the payments system to
those financial institutions with undoubted technical capability and financial integrity.
In particular, direct access to the settlement systems should be restricted to banks, and
other financial institutions subject to the same prudential supervision as banks.

The introduction of technology such as stored value cards (SVCs) means that non-
prudentially supervised institutions can potentially gain access to the payments
system. Although the use of SVCs is unlikely to create systemic risk, it may
adversely affect consumers and consumer confidence in the system in the event of
institutional failure.

The unrestricted provision of stored value cards could impose risks on both sides of
the transaction if a non-regulated provider fails, as both customers and retailers
involved in the transaction stand to lose their money. It has been suggested by some
that SVCs are not functionally different from traveller‟s cheques and whilst it is true
that they share some functional similarities, they differ in that traveller‟s cheques are
not reloadable and traveller‟s cheques are cashable only in so far as the person
accepting the cheque is confident of being able to redeem the value, which in practice
almost always means from a bank. That is, traveller‟s cheques are perceived to be
“backed “ by banks, and this is what gives the public confidence in their use. Hence,
the potential confidence problem with SVCs issued by non-prudentially regulated
institutions remains and Colonial reiterates its view that SVCs should only be issued
by prudentially supervised institutions. Furthermore, to allow non-prudentially
supervised organisations to issue SVCs goes against the key objective of promoting a
financial system based on competitive neutrality.

Depositor Protection
Depositor protection should be a specific objective of the regulatory system.

While Colonial supports amending the Banking Act to clarify the powers of the
Reserve Bank of Australia (RBA) as a means of dealing with the guarantee problem,
the RBA would still need to retain relevant reserve powers in order to assist the
smooth exit of institutions who may be in difficulty.

It is not clear that a legislative change would alter the perception in the community
that bank deposits are guaranteed. Irrespective of legislative change the community
may continue to believe that, if the situation ever arose where depositors in a failed
bank would lose some or all of their money, the government of the day would still
guarantee the deposits. It is very difficult if not impossible for a government to
credibly commit that it or a future government will not bail out depositors, even with
a change to the Banking Act.




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It would appear that the Committee is considering the option of explicit deposit
insurance in Australia. Colonial is opposed to the introduction of an insurance
scheme.

A significant disadvantage of these schemes was illustrated in the Savings and Loans
crash in the United States. It could be argued that the presence of deposit insurance
encouraged depositors and creditors to exert little discipline in investing or lending.

Another disadvantage of the insurance scheme is that if it is a voluntary scheme it will
actually attract bad risks, unless combined with some other form of prudential
regulation. The presence of deposit insurance also has the potential to delay the
closure of troubled banks, in that without insurance the regulator would step in when
the bank becomes book value insolvent. However, with insurance in place the owners
of the bank would potentially continue to trade on until the market value of the bank‟s
assets plus the value of the insurance option and any residual value of the bank‟s
license fell below the face value of the liabilities.

In the event that the Committee recommends the introduction of a deposit insurance
scheme, there are a number of issues which would require careful analysis and debate,
not the least of which is the interaction of such a scheme with the RBA‟s existing
prudential supervision powers. Other issues which would need to be reviewed include
the lack of depth in the Australian insurance market for such a scheme, the relative
complexity of the schemes and their limited success overseas. A robust cost benefit
feasibility analysis should be undertaken before such a significant initiative is
considered for implementation.

Consumer Credit Code
Colonial has identified a number of issues which if resolved would improve the
practical application of the Code, and would more fairly reflect the interests of
debtors, mortgagors and guarantors in an efficient and fair manner, without imposing
costs of compliance which do not have a clear compensating benefit. These issues
include:

      Amending the Code to make it uniform across all of Australia to ensure
       consistency of approach.
      The removal of the imposition of civil penalties on a credit provider acting in
       breach of the Code and replacing these penalties with a system of fines and orders
       for compensation. Part 6 of the Code contains a range of civil penalties which
       Colonial believes are onerous and have the potential to penalise a credit provider
       in an unprecedented way, which is disproportionate to the gravity of the offences
       or the economic loss suffered by the consumer and is inappropriate in light of the
       competitive forces in the retail credit market.
      The lack of encouragement in the Code for parties to avail themselves of the
       industry based dispute resolution schemes which currently exist and are both cost
       and time efficient. Colonial believes alternate dispute resolution should be
       provided for in the Code.
      Where Commonwealth legislation exists on a particular issue credit providers
       should not be subject to further State legislation which deals with the same matter.
       This will help eliminate inconsistencies between jurisdictions. Provisions of the
       Code covered by other legislation, especially Commonwealth legislation should
       be repealed.


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