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9 January 1997

Mr G J Smith
Financial System Inquiry
Treasury Building
Parkes Place

Dear Mr Smith

                                         FSI DISCUSSION PAPER

We have examined the Inquiry's Discussion Paper in the context of our submissions and general
comment since that time. Industry sees no need to change its original submission and we note
our views have been included in the issues the Inquiry will be considering.

There are several areas where additional comment may be of assistance to the Committee; RSA,
Ownership, Deposit Insurance, Depositor Protection and Implementation.


The emergence of this new product designed to meet some of the retirement savings needs of
consumers at the same time as the Inquiry is undertaking its examination, provides a case study of
the practical and confusing difficulties of introducing a simple low-cost product by banks and
building societies.

The AAPBS in an additional submission, provided the Inquiry with details of the difficulties
presented by the product as outlined by the Minister and the ISC. Since then a package of three
Bills has been tabled in Parliament. A start-up date of 1 July 1997 is planned. A significant
number of technical concerns of industry have been met, however others remain and further
analysis of the legislation may reveal more.

The fundamental problem of RSA is their "dual personality". The Minister has said RSA will be a
superannuation product and from that flows the burden and complexity of the SIS system.
However RSA will also be on balance sheet deposits of banks and building societies hence the
burdens of the RBA/AFIC systems will also apply. To illustrate current levels of confusion, Anne
Lampe, (SMH 18.12.96) reported "Mr George Trumbull, Managing Director of AMP suggested
that to put consumers straight, banks should make it clear that the greater safety margin only
applied to bank deposits and not to other financial products and services they sold, including
retirement savings accounts."

                                              A.R.B.N. 003 716 201
RSA have been opposed by superannuation funds, the life industry and others. However
substantial expert studies have advocated simple, low-cost savings products which would qualify
for taxation assisted retirement savings. That RSA be a "superannuation product" regulated by
the ISC, meets the demands for a level playing field but promotes inefficiency and undermines

The Explanatory Memorandumto the RSA Bill makes it clear that the regulation of RSA will
consist of (a) prudential supervision in terms of the institutional soundness of the RSA provider;
and (b) functional supervision in relation to compliance with retirement income and other
superannuation standards.

In the case of building societies, prudential supervision will reside with AFIC. Functional
supervision will be undertaken by the ISC. It might be noted that this is in the model proposed by
the ISC to the Financial System Inquiry for future regulatory arrangements. We are concerned
that such an arrangement neither promotes efficiency in the financial system nor facilitates cost-
effective consumer services.

By way of example, the first draft of the RSA Bill required RSA providers to arrange for a
compliance audit of the fund. Clause 64 of the RSA Bill has not shifted from this position.
AAPBS had argued that this would increase the cost of administering RSA. Building societies
and credit unions are already subject to stringent prudential supervision and compliance audits.

Clause 64 is clearly an overlap with the present legislative requirements imposed on building
societies and credit unions.

The first draft of the RSA Bill set out the monitoring and investigative powers of the ISC. The
investigation could relate to the "whole or part of the affairs of the RSA provider". Part 10
Division 3 of the RSA Bill is in similar terms. We had argued that this is a duplication of the
functions of the RBA (for banks) and AFIC (for building societies and credit unions). In terms of
building societies and credit unions, a more sensible and cost-effective approach would be for
State Supervisory Authorities to conduct the relevant investigations.

In summary, RSA illustrate the current system seeking to adapt to a financial product
which cuts across regulatory jurisdictions. It may well fail to achieve its full purpose as a
result of regulatory requirements. We suggest the Committee review the current RSA

OWNERSHIP(Ref 7.130)

In the mid-80s AAPBS recognised the need for building societies to have the option to access
capital for the purposes of future growth and minimum capital requirements. This received
official impetus in 1986 when a New South Wales Government Review Group recommended
changes to legislation to permit co-operative societies to issue permanent shares with voting
rights of one person one vote. The New South Wales principles of permanent share capital, a
world first, were subsequently incorporated in the Financial Institutions Code which commenced
nationally on 1 July 1992.

    "Towards a National Savings Strategy" , V W FitzGerald, The Allen Consulting Group June 1993.

As a result of AAPBS representation and a specific application to list from a building society in
1990, the Australian Stock Exchange Listing Committee formally agreed to list building society
permanent shares including the co-operative voting principles. This decision was a watershed for
the industry and a departure from the general listing rules of the ASX. It recognised the
traditional structure of co-operative building societies and acknowledged that a significant
number of the public would wish to use the service provided by ASX to trade shares.

Importantly not all building societies have the need to issue permanent shares, however industry
regards the option to do so as a very necessary one. The avenue facilitated quite a number of
building societies to meet the new and high capital requirements contained in the FI Code and
retain their co-operative status under the Code.

As a result of these and other developments, the capital structure in the permanent building
society industry is diverse. The Association's original submission stated that at 30 June 1996 co-
operative mutuals represented 30% of assets, co-operatives ASX listed 17%, co-operatives
unlisted 10% and wholly owned by conglomerates 43%. Since that time the Suncorp Building
Society has left the industry and Bendigo Building Society has converted to a bank. The shares
are now mutual co-operatives 47%, co-operatives listed 19%, co-operatives non-listed 17% and
wholly owned 17%.

As noted in the Committee's Discussion Paper, building societies wishing to become banks have
been compelled to give up their co-operative structure, and inevitably their old culture and
traditions (even when as societies they had permanent shares) and adopt a corporate structure.
This reflects Reserve Bank policy in relation to banking. It is distinctly possible that some
building societies which became banks would have preferred to have done so and remained a co-
operative thus really preserving the cultural and philosophical differences between banks and
building societies.

The AAPBS submission has made it clear that the industry's unanimous view is for a single
prudential regulator at the national level and that the AFIC system and the FI Code could be
transferred to the auspices of the Reserve Bank with Ministerial responsibility with the Federal
Treasurer. This proposal does not envisage building societies necessarily becoming banks or
losing the option to remain a co-operative. It is a framework which would see the continuation
of building societies subject to prudential supervision of the highest intensity administered by a
national supervisor.

AAPBS does see however, considerable virtue in facilitating community based financial
institutions in Australia. The prospects and benefits of community banks which include co-
operative structures should be contemplated by the Committee. In terms of RBA's long
established prudential concerns about access to additional capital in extremis, our view is that
provided the permanent shares option remains available to building societies (and credit unions),
such fears ought to be substantially less than they have been. Other prudential standards,
inspections and controls undertaken by the regulator are available to ensure the capital of a
community bank/building society remains adequate in relation to the nature of its business.
Importantly the depth of the subordinated term debt market, domestically and overseas, in terms
of pricing and certainty with which an institution can seek Tier 2 debt, has developed significantly
over the last five years.

Concerning the spread of ownership, the current general requirement of no one shareholder of a
society holding more than 10% of any class of shares is endorsed by AAPBS and accepted as a
desirable prudential standard which should remain. Current arrangements for 100% ownership of

a building society by a prudentially supervised conglomerate is an acceptable arrangement and
should remain. AAPBS does not support part ownership by a conglomerate ie less than 100%.

In brief, there is a desirable flexibility and diversity in co-operative ownership in building
societies and this should facilitate the national prudential framework we suggest for the


In 1977 the then Prime Minister announced his Government would establish an industry based
deposit insurance scheme for building societies. It was not until 1984 after protracted negotiation
with Treasury and the Reserve Bank, that a private scheme was established. The Commonwealth
and the States each nominated a director to join a board of building society executives. The
scheme was voluntary and funded by societies which joined. It also provided, on a commercial
basis, stand-by facilities with banks.

The scheme had success in facilitating exits and preventing claims but this was handicapped in the
absence of uniform high quality prudential supervision in all States. The scheme was voluntary
and failed to get full industry support. In particular the Farrow Group of societies declined to
join. Given their ultimate condition this was probably a fortuitous decision since it is doubtful the
scheme could have met the deposit insurance outcomes applicable. Of course it may have been
that the collapse could have been averted by the deposit insurer discovering at an early stage how
the operations were being conducted. A further weakness of the private scheme was that it
operated without effective support of some State Governments and the deposit insurer had no
statutory powers to force a wayward institution to mend its ways.

Against the background of the establishment of the FI Scheme with its liquidity support scheme
plus the costs of the new uniform scheme (and the conversion of significant building societies to
banks), private deposit insurance for building societies was phased out, effectively by 1991. The
industry does not support a voluntary or industry based deposit insurance scheme for the future.
If however a concept was officially established compulsorily for all deposit taking institutions
including banks, credit unions and building societies and administered by the prudential
supervisor, industry would clearly need to be part of such an overriding arrangement but AAPBS
does not recommend or support such an approach by the Committee.


AAPBS agrees that there is such a widespread expectation in the community that deposits are
safe that it would not be possible to alter the depositor protection provisions that apply to banks
and to ensure competitive neutrality, stability and public confidence. These provisions should be
extended to all deposit taking institutions.

The public perception, especially by small depositors, that deposits in private banks are
guaranteed by the Federal Government has purposely been left vague by the monetary authorities.
Unfortunately in competitive conditions bank employees have from time to time promoted the
perception as fact vis-a-vis the standing of non-banks.

Public perception of banks and other deposit taking institutions can at times be brittle and on
these occasions it is essential the prudential supervisor has the standing and wherewithal to
maintain confidence. More explanation could be undertaken to educate depositors that whilst

they have preference over other creditors of banks, building societies and credit unions, no
Government guarantee of deposits exists.

The concern of industry is that failure in one DTI usually results in some measure of liquidity run
off (contagion) in other but nevertheless well managed institutions. Individual institutions need to
be sufficiently strong to withstand contagion, however on occasions strong and well managed
institutions with adequate assets have been in danger of being overwhelmed. In these
circumstances the prudential supervisor needs to have the capacity to manage public confidence.
The Reserve Bank is best able to undertake that task.


The Discussion Paper acknowledges that State Governments currently have a significant role in
the financial system, however in B16 the paper records that  "the review task is limited to
Commonwealth legislation and whilst the comparability of requirements imposed on like
products or institutions by State/Territory legislation will be taken into account, the Inquiry is
limited to making recommendations about Commonwealth laws affecting the financial systems."

The Campbell Report took a similar approach to the reform of the financial system. A key
message in our primary submission was the failure of all the States to deregulate and establish
appropriate prudential mechanisms in line with changes which were taking place at Federal level
post Campbell. This failure in Federal-State co-ordination contributed substantially to adverse
developments and failures in state banking, building society and credit union sectors. AAPBS
takes this opportunity to reiterate again the absolute necessity for State Premiers and Treasurers
to be enjoined in the Committee's recommendations. Just how this can best be done deserves
very close consideration by the Committee. Firm recommendations for Federal and State
Government co-ordination will be essential to achieve the reforms we think are required.

Yours sincerely



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