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Economics References Committee
09/08/2012
Effects of the global financial crisis on the Australian banking sector

HODGES, Mr Graham, Deputy Chief Executive Officer, Australia and New Zealand Banking Group

NASH, Ms Jane, Head, Financial Inclusion and Capability, Corporate Affairs, Australia and New Zealand Banking Group

CHAIR: Good morning and welcome. I invite you to make an opening statement.

Mr Hodges : Thank you. We last appeared before this committee in December 2010 at the inquiry into competition in the banking sector. At the time, we noted that Australia's banks had maintained the flow of credit to the Australian economy, aided by swift action on the part of the government and by regulators to deal with the systemic risk that threatened the banking system globally. We also noted the nature of competition had changed, with competition in the deposit market reaching an intensity not seen before. At the time, the government announced a banking package which was aimed at supporting competition. The inquiry took place around that time and I will make a few brief remarks about how that has played out since.

It is important to try to separate what I might call the structural effects from the cyclical noise of what has been a really deep and fairly prolonged downturn in the business cycle, especially overseas. The emerging economies will continue to be an engine of growth, with Asia likely to account for over half the growth of emerging economies in the next five years. That is really good for Australia. The advanced economies in which the global financial crisis originated will remain in a slow recovery with low levels of business and consumer confidence. In Europe in particular, there is susceptibility to further shocks. Investment spending has replaced what we would call the Western consumer boom as the driver of growth. The consumer leverage really needed to be reduced, and that has happened rapidly in some markets with adverse effects, but, importantly, it has not happened that way in this market. Factors driving investment include infrastructure, which is supporting continuing growth in the emerging markets, but also catch-up investment in the Western economies to improve productivity and competitiveness. Financial markets will experience ongoing volatility as European economies in particular work through their deep-seated problems. Investors globally have become more cautious or risk averse, with the certainty of return preferred over the promise for growth.

What does that mean for Australia? Australia did not have the crisis in the same way as other developed economies and the effects have been more moderate. We have, nonetheless, been impacted in some significant ways and the economy is going through an adjustment period. Many of the changes that have flowed from the GFC are structural and there is no going back to the good old days, as they are called. We see a degree of anxiety in the behaviours of our customers. This reflects concerns over what is happening overseas. There has been job shedding in some sectors in Australia and what we call the negative wealth effect—in other words, the fall in house prices and share prices but also superannuation. But, as the Governor of the Reserve Bank recently noted, things are still relatively good in Australia. Businesses and consumers are cautious, with a significantly reduced appetite for borrowing. Almost half of our variable rate mortgage customers are ahead of their repayment schedules, and that is a very unusual number. A structural deleveraging has occurred and is set to continue. Actually, we think that is a good thing for a period.

Senator MARK BISHOP: What is structural deleveraging?

Mr Hodges : It means people are actually reducing the leverage that they have in a structural sense. If they were too leveraged, not so much business—

Senator MARK BISHOP: They are repaying their home loans earlier?

Mr Hodges : Yes, but not just home loans; other credit as well. In contrast to the pre-GFC period, the strongest growth in the financial system today is not credit; it is household deposits. In the year to June, household deposits grew 12 per cent, business lending grew eight per cent and mortgage lending grew seven per cent. Competition for deposits has remained intense. Reductions in the cash rate have not been fully passed through into deposit rates and deposit rates are higher relative to cash rates than before the global financial crisis. Similarly, and as a direct consequence, loan rates are higher relative to the cash rate than before the global crisis. This will be a feature of the interest rates in our system for the foreseeable future.

Like other businesses, banks are adapting to market settings that are very different from before the global financial crisis. Banks recognised and reacted to the risks of too high a dependence on offshore funding to support lending growth. In response, ANZ has increased the proportion of its total bank funding coming from customers, largely through deposits, from 50 per cent to 60 per cent. As a result, competition for deposits—in other words, deposit rates—is as high as it has been in a generation. We have reduced our reliance on short-term wholesale funding from 22 per cent to 14 per cent of our funding and only three per cent of that short-term funding is now from offshore. We have also increased the tenor, or the duration, on our term wholesale funding, which was assisted by the introduction of covered bonds, which came in as a program as part of the banking package. While these actions have improved the sustainability of our funding, they have also increased the cost of funding.

In addition, our regulatory environment has undergone its most significant change since the series of deregulatory changes that occurred through the 1980s. This has been part of the wider global rebasing of banks' capital and liquidity positions under Basel III. We have increased our common equity, or core tier 1 capital, from around five per cent pre-crisis to 8.9 per cent under a Basel II measure. It is 7.8 per cent under the APRA-Basel III measure. Banks have also increased their liquidity holdings and increased the prime liquidity or the highest quality of liquidity in those liquidity holdings. ANZ has now just under three times the liquidity it held in September 2008 and its total liquid assets now exceed its total offshore wholesale debt.

These actions and continued prudent management of the bank has seen us maintain our AA rating, while most banks globally have been downgraded. There are now only 10 banks in the world with a stable AA rating and, obviously, four of those are Australian banks. This is the context in which we discuss the post-GFC banking sector and we would be pleased to take questions from the committee.

CHAIR: Thank you for that introduction. One of the things that is of interest to the committee is the cost of funds, which you touched on in your opening statement. I think it is fairly clear from your evidence, evidence from the other banks and submissions we have received, including from Treasury and the RBA, that there has been a repricing for risk and that it is unlikely that we will go back to the pre-2007 position, where the spread between the official cash rate and your costs and, ultimately, the lending price return to the level they were back then. We all acknowledge that that spread is larger now. What I am interested in is the degree to which it is going to stabilise. I know that the volatility in respect of the wholesale funding will continue for such time as the instability continues overseas, but you are now more reliant on deposits, which, although more expensive, are less volatile. I am interested in the degree to which that margin will stabilise and the degree to which changes in the official cash rate will more greatly reflect the cost base that you face.

Mr Hodges : On page 14 of our submission we have a chart which shows you the relative contribution to the increasing costs of our funding. You can see that, despite the debate we have sometimes had, interestingly the deposits are the biggest contributor to the rise in our cost of funds. That is not dismissing the cost of borrowing offshore, of course. Really, the key issue which will help determine that is the way the deposit market plays out. While we continue to see volatility in the global markets, in the interests of maintaining stability and certainty of our funding we expect the banks to continue to work very hard to raise domestic deposits. We would see those being at least at current level or, if we can achieve it, slightly higher levels as a proportion of our total funding than where they are today. I do not see that intensity for competition in the domestic deposit market easing off in the near term at all. I think, therefore, the likelihood that you are going to see an easing in those costs is small.

CHAIR: It is not so much the easing in costs that I am inquiring about. I understand that we are probably going to be facing a sustained high level of costs. It is more the volatility or the degree to which that is going to change. Looking at the graph you have referred to, it has gone up and down a bit since October 2008, but it has generally been between 0.8 per cent and one per cent over the RBA cash rate, in terms of the deposits. So it is sort of plateauing with a slight rise.

Mr Hodges : I think it has done and I think the periods of volatility are probably when the international markets are most volatile or people are most concerned about it and therefore you see increased competition happening in the local market. I would expect that to be a continuing trend. My sense is that it is going to drift up a little more but not dramatically. Then you have the second component of that, which is the international cost of borrowing. We are seeing that we are still replacing maturing debt, which we did three or four years ago, with new debt, and that is coming on at a higher cost. So we are continuing to see an increased cost of funding coming from our international borrowings and that will still be the case for another couple of years.

CHAIR: That is something I wanted to clarify. During this committee's inquiry into competition, because they were at that point rewriting debt that had been taken out during the height of the crisis, when things were very high, the big banks were saying they expected over the coming couple of years that that would peter down as they write stuff at a lower level. Are you saying that, when you are rewriting that wholesale debt now, you are writing that at a higher level than what it was during the worst of the GFC?

Mr Hodges : On average, our costs are still rising, so there would have been periods in the worst of the GFC where our costs were higher, but the broad average costs are still rising. You can see a chart indicating that on page 18 of the submission. If we looked at the reasons for that, it is not just reflecting those markets; it is also reflecting the fact that the banks, in order to ensure the stability of our funding, have also increased the tenor of funding—the term of funding.

CHAIR: So it is the mix as well.

Mr Hodges : Yes. ANZ has moved from an average funding duration on our term wholesale of four years to five years. Typically, that means you are paying more for a longer duration. It is partly that duration effect, but it is also partly the refinance effect still coming through from earlier, lower cost finance than where it is today. The costs do go up and down a little. We saw that there was a recent peak in the cost of funding in the second half of last year after the US was downgraded from AAA status and there were real concerns about Europe and where they were going. Then those costs eased off a bit in the first few months of this year. So, relative to where we were this time last year, costs are probably still marginally higher, but they did peak in the latter part of 2011. As banks, we are now trying to time the funding to the better times in the markets to try to reduce the overall impact of these rising costs of funds. That is something which our bank treasurers are very adept at doing.

Plus we have had the benefit of covered bonds. Covered bonds, because of the additional security and their rating at AAA rather than AA, means there is a different investor base who seek the covered bonds—who because of their investment mandates can only invest in AAA investments. So you are tapping a different market and, because they are AAA rated, they tend to come in at a lower cost. We have tended to use the covered bonds for the longer duration borrowing, which would otherwise be more expensive, and do the senior unsecured borrowing in the shorter duration—so, three to five years for the seniors and then five years to 10 years for the covered bonds, which is trying to bring down our average cost of funding as well. There are a combination of factors in here. It is really up to the banks to manage that in the best way they can to minimise the cost of funds. The overall impact at this stage looks like we have another two years or so where those costs will continue to rise step by step.

CHAIR: Of the four major Australian banks, you have probably pushed into Asia more than any of the others.

Mr Hodges : Yes.

CHAIR: Has your push into Asia had any impact on your ability to access funding? Asian countries are generally pretty good savers. Do you ring-fence the money that you get there for on-lending in Asia or does it give you an ability to average your costs across the nations?

Mr Hodges : One way of looking at that is to think about your loan deposit ratios—that is, the ratio of how many loans you have for your deposits. In the Australian market, our loan deposit ratios of the Australian banks are all over 100 per cent. We sit at 134 per cent at a group level, which means we have more loans than deposits, which is why you go into the international markets to supplement the deposits. In our Asian business it is 60 per cent, so we have many more deposits than we have loans, and that is typically what the Asian banks look like, too. Just as you said, Asians are very good savers and, in fact, one of the strategies for the Asian economies is to encourage somewhat less saving and more spending and consumption. Our balance sheet in Asia looks exactly like that. We have a surplus of deposits over loans.

Many of those are in local currencies and they are there to support the local business, and we use that. So we are not funding constrained, if you like, within that Asian region. We raise those funds in Asia for our use in Asia. There are times when we have surplus funds in Asia and we have, on occasion, remitted those back to Australia—we have done the swap, as we would normally do, and covered off the exchange rate risk—swapped those back into Australia, when the markets have been particularly fragile or volatile. It has been an additional facility that we can use, should we need to, but our strategy is not to fund our domestic bank, if you like, from our Asian business; it is really to fund our Asian expansion through the deposits in Asia.

CHAIR: Very good. Onto another subject: Basel III. Your submission deals with this quite pointedly. I just note here that you say:

The ANZ and the Australian Bankers’ Association submissions to APRA argued that Basel III represented a global compromise which had many shortcomings, and that it would create further distortions if not implemented in a globally consistent fashion.

You go on to say:

These suggestions have not been adopted in APRA’s draft standard released in April 2012.

Would you care to elaborate on what you see as the issues there?

Mr Hodges : Yes. We have a very good dialogue with APRA around this. They released their discussion paper in September last year and we obviously put in a submission. We met with APRA at various levels and put our views forward. They have since announced the capital rules and obviously we work within the rules. Our comments to the regulator and more broadly would say that Australia has adopted a non-pure Basel III approach, with a more conservative approach around a number of areas, and it is the regulator's discretion to do that. That means that the direct comparisons of Australia's capital ratios with those of other banks in other jurisdictions are more difficult. It is not just APRA; other jurisdictions are implementing their own rules within their own countries as well. Instead of having the plan as it was, with uniform application of the Basel rules so you have global comparability, we have a process which does not have that. For us, with a more conservative approach, it means that if you just took our capital ratios at face value they look lower than if you were in a different jurisdiction.

CHAIR: Less conservative at a glance, because they are more conservative.

Mr Hodges : I think APRA's point is, 'That's fine. Explain that.' I guess we do. I do a lot of visits to international bond investors as we raise funds. So we can explain it and we do. We show our capital ratios in the context of what they would look like in other jurisdictions so investors can understand that, but when you see some of these investors—and they are managing up to 100 banks—you have to actually cut through and show your credentials and how strong you are. It just adds to the challenge of doing that. That is one broad issue.

Secondly, we are imposing our rules more quickly than other jurisdictions. Again, there are pluses and minuses around that. If you can do it now, do it and show how strong you are. I think that is the regulator's approach. Our view is that we will incur some of those costs ahead of other jurisdictions. There is a difference of view around that. Finally, some of the rules which are being applied—for example, the rule around associates—mean that, if we are looking to expand into Asia, the capital treatment in the approach that we would take in expanding into that market would be different to competitors who are operating in different jurisdictions, and we would see that potentially we could be at a competitive disadvantage.

CHAIR: Everybody agrees that what Basel III is trying to achieve is desirable and necessary at an international level, so to what extent are the issues that you raise important to the ANZ? What weight do we as a committee need to give to these?

Mr Hodges : I think some of them are more on the surface. The issue around giving zero benefit for capital in associates has a material business impact and therefore does affect both the strategy and the cost of doing business. I think it ranges from the more superficial to actually material.

Senator MARK BISHOP: Welcome, Mr Hodges and Ms Nash. I have two quick questions. Chart 6 on page 19 of your submission, about the composition of ANZ's group funding for the period 2008 to March of this year, says that wholesale funding has been reduced to 50 per cent from 60 per cent, so a 10 per cent reduction. Is there an optimal figure that you are aiming at, firstly for your bank and secondly that the industry aims for more generally in terms of wholesale offshore borrowings?

Mr Hodges : I do not think there is an absolute number. What we have in our mind in terms of the way we look at that is: what is the impact on the stability of the bank and how might that be reflected in the way investors see the bank? That is critically important to the cost of our funding but also ratings agencies as well. We take a broad range. We look at it from an internal risk perspective, in terms of the stability of our funding, we look at it from an investor perspective and we look at it from a ratings agency perspective. Then it is the mix of wholesale funding. The more you are reliant on short-term wholesale funding, the more you are subject to the volatility of markets immediately, the more you put term wholesale funding in place, the more you are able to look through those periods of volatility and have stability of your funding. There is no magic formula here, but we took the view very early in the financial crisis that we needed less reliance on wholesale funding and we needed to increase the tenor of our funding to give us a more stable maturity profile, and that would ensure that, from an investor point of view, they would be more comfortable in lending us the money that we need to lend out to businesses in Australia.

Senator MARK BISHOP: I understand that response. In the last four years, you effectively reduced your wholesale borrowing from 60 per cent down to 50 per cent. In the context of your three-part response earlier—the three constraints you have—would it be fair to say that you are heading for another 10 per cent reduction, down to 40 per cent, over the next four years?

Mr Hodges : I do not think so. We feel reasonably comfortable where we are at the moment. At the moment we have about $100 billion of wholesale funding, of which we have about a five-year tenor, as I said earlier, so that is about $20 billion a year that we have to raise. Of that $20 billion, about $10 billion gets done in the domestic market and/or through private placement. They are big institutions that come directly to us and say, 'We would like to buy some of your bonds.' So we do not actually go into the international markets; they come to us. About half of that gets done through domestic issuance, which is obviously safe for us and it is easy, and through private placements, and then the $10 billion gets done in the international markets through public placements, of which half again is being done approximately through covered bonds and half through senior unsecured bonds. So what we have been able to do is diversify our funding both by geography and by product to a point where we feel comfortable that we can actually fund that amount on a consistent basis. We see that structure as consistent with our AA rating and we are in close liaison with the ratings agencies and with investors. At this stage they feel quite comfortable about the structure of our funding.

Senator MARK BISHOP: You referred in your remarks to international bond visits where you seek to raise funds—you are one of 100 banks—as part of this wholesale offshore fund raising. We had a discussion with Westpac earlier and they were of the view that the risk premium of about 150 points, give or take, would continue into the future. Are you finding any suggestion from the bond providers that the risk premium might come down in the near future because of the greater financial strength of the four big banks when they are going into the marketplace to borrow?

Mr Hodges : There is a prospect that we could see the premium come in a little. It has obviously come in from where it was in the worst parts of the crisis. If you are an international bond investor, in your mind is: 'I'm looking at return for risk.' They have really moved the pendulum to be lower risk but still reasonable return. I think they see the Australian market as being a lower risk market but not without risk. The sorts of concerns that you hear about from the bond investors include: the housing market here—whether it is sustainable, and we have heard for a number of years international concerns about whether we are going to see a sharp decline in the value of mortgages; we do not think that is the case and we tell them that—and Australia's dependence on China and the growth of China, so if China were to suddenly slow, what might that mean for Australia? There are those sorts of issues. There are some questions around the commercial property market here, particularly in some states where it has been particularly soft.

Senator MARK BISHOP: On the east coast?

Mr Hodges : Yes, on the east coast. There is talk about the strength of the dollar and what that might be doing to the economy. Most bond investors worry a lot and they are always finding new things to worry about, but, in the range of worries they have, Australia is a relatively small worry. My sense is that, as we continue to perform, as the economy here continues to work its way through and adjust to the issues that it is adjusting to, there could be some further improvement in the spread. We have been taking advantage of that, too, by using covered bonds, obviously. We were one of the last systems to come into covered bonds and use them, and we are using that when we can. I would hope that we will see some reduction, but I do not believe it will not be a dramatic reduction, because investors are saying that the world has changed from where it was pre-GFC and they want a high premium.

Senator MARK BISHOP: The central banks of a range of the major countries are heavily buying our government paper and they have apparently made a structural decision within their individual countries to diversify the portfolios they hold, so they are buying our paper in a big way. Their thinking suggests one line of security. The discussion I have just had with you suggests different concerns at the bond market that lends into you. Why are the two so different in their approach?

Mr Hodges : I do not think they are different, but what you are finding is that the central banks are buying Australian government paper which is AAA rated. Australia through successive governments has maintained fiscal discipline from which we are now reaping the rewards. We have low government debt and sound systems, and they recognise that. Also, the Aussie dollar and the Australian economy are well positioned to take advantage of Asia. All of those things are a real substantive positive. The difference for us is that we are a bank operating within the economy. We are AA rated, not AAA rated. The central banks take long-term views to diversify their portfolios. Now they have decided that the Aussie dollar is part of their investment portfolios, this will remain in force for quite some time. It is partly a reflection of the need for them to diversify, with the Australian dollar quite a highly traded currency in the world and one that flows fairly freely. I do not think they are necessarily different, it is just that bond investors, when they are lending to the banks, are watching all the other risks as well. We are both well rated, frankly.

Senator MARK BISHOP: Do you believe that the thinking of the central banks in making long-term investments in Australian government paper would start to permeate into the thinking of the bond people that you deal with?

Mr Hodges : I do not think their thinking is that far apart. What we see really is that the Commonwealth, as the premium sovereign here, gets a much preferred rating in terms of its spread, as it should do.

Senator MARK BISHOP: Thank you.

Senator WILLIAMS: I want to take you through the wholesale guarantee the government imposed on funds. How much has this cost your bank? I ask you on the grounds that the Commonwealth Bank said in its submission that it had paid over $600 million in fees for the use of the Commonwealth guarantee on wholesale borrowings and expects to pay a further approximately $300 million to the Commonwealth government over the remaining life of the borrowings that were guaranteed at the time and have yet to mature. That is about $900 million as a cost to the Commonwealth Bank. What has it cost the ANZ roughly?

Mr Hodges : I cannot give you the exact number, but it might be slightly less than the Commonwealth Bank, although not dramatically so. We would be in the high hundreds of millions of dollars. We used the Commonwealth guarantee from when it came in around November 2008, after Lehman, when all countries were applying these guarantees. But by June 2009 our investors were saying they were not really interested in having Commonwealth guaranteed paper issued anymore because they knew that our systems were safe and sound and that they would prefer to take our own senior unsecured paper which gave a higher spread. The investors were the ones who told us not to issue those anymore, but to issue senior unsecured paper. It was only a six-month window when we issued Commonwealth guaranteed paper, but it was a substantial proportion of our issues within that period. At a guess, I would say it would be above $500 million—say, between $500 million and $800 million.

Senator WILLIAMS: No doubt that would add to the cost of running your business? We are talking about the cost of wholesale funds. When you run a business and costs are imposed, it is not unusual to pass those costs on to the consumer, is it?

Mr Hodges : That is true.

Senator WILLIAMS: We are looking at a case of some $5 billion as a windfall to the federal government as there has never been a claim.

Senator CAMERON: It was a windfall to the global financial crisis.

Senator WILLIAMS: I have obviously hit a nerve with the lefties.

Mr Hodges : We estimate the Commonwealth will get out of this about $5½ billion over the life of these maturities. Some of them are still going and will go until about 2014. But there is a counterfactual here, that if we did not have that and we had not raised the funds or we had had to go to the market and pay some really exorbitant fee for funds, the impact on the Australian economy would either have been less credit lent and therefore real damage to the economy and/or paying an enormous amount more to access lending through senior unsecured and the cost would have been dramatically more. The way I would see this is it is a relatively small cost for us to have paid to have been able to ensure funding in a very difficult time. At a strategic level, from a systemic point of view for the government, it was a very good move because it meant that Australian banks could continue to access funds and continue to lend to Australian businesses. In the end, the way the authorities—the government, the central bank and APRA—dealt with that crisis in a fairly fluid area was very good, and it has been recognised internationally as being very good.

Senator WILLIAMS: You are saying that even though it cost you money it actually could have saved you money as otherwise your costs of borrowing overseas with the risk factor would have been higher?

Mr Hodges : Absolutely. The counterfactual would have been a lot worse.

Senator WILLIAMS: It is also called a $5 billion windfall for the government

Mr Hodges : The issue there is the Commonwealth has not lost, unlike other jurisdictions where the taxpayers have had to pick up large bills. That is the really important issue.

Senator WILLIAMS: As a word of praise, I get a lot of bank problems in my office and I am sure the Nationals member for Mallee, John Forrest, would agree with me that you are a very good bank to deal with when we have problems. I thank people like Michael Johnson, Ms Nash and those who work for your bank for working through the issues instead of having to come to conflict. I thank you for your approach on that.

Mr Hodges : Thank you. It is really nice to hear that. If there are issues, we would rather hear about them early and deal with them.

Senator CAMERON: It is good to see the National Party expressing some concern for the banks' welfare. I will come back to macro issues, but I want to deal with a micro issue that I am sure you are aware of. I have had another look at your submission. On page 20 you say:

ANZ is committed to lending responsibly and giving consideration to the financial health of our customers, the economy and the banking system in Australia.

I have had representations from one of my constituents who has outlined a series of developments with ANZ and an ING property securities trust that are really concerning. It would seem to me that this case is completely opposed to the submission you make in terms of the culture in some areas of ANZ. This constituents is saying that ANZ representatives—I will not name them but I am happy to give you the names—a relationship manager, an assistant manager and a financial planner for a region, conducted themselves in a way that my constituent describes as using bullying tactics and high-pressure tactics. All of the constituent's funds went into a product for debt reduction. The constituent was asked to sign blank documents and told not to date documents. The constituent was advised conditions the constituent was not happy with could not be changed, but the constituent had to sign and the bank would fix things up. The bank said if the constituent did not sign the document, the file would be bundled up, sent to Melbourne and Melbourne would deal with the credit request which would mean a less favourable result. This client of yours and constituent of mine said it was common for the bank to send blank documents for the constituent to sign with advice that the bank would fill the documents in later. We have had plenty of lectures from Mike Smith containing political advice. I would like to give Mike Smiths some banking advice—that is, if this type of behaviour is tolerated even in one aspect of the operation of ANZ then this is a big problem for ANZ. You know I raised these issues yesterday with the regulator. What is your position on this and these types of allegations?

Mr Hodges : I cannot condone this. If what you say happened then clearly we need to deal with it. Jane has done a quick investigation since you raised this case yesterday.

Ms Nash : There are probably two aspects of what you raised. One is this specific case and the other is the broader question of how we might deal with such cases with our people in terms of training, processes and so on. I am not across all of the specifics of the case, and it is probably not the right place to talk about the specifics either. But I do understand that that case is going to mediation in a month or so.

Senator CAMERON: Did you say litigation or mediation?

Ms Nash : Mediation. The broader issue is around our processes and training. I am sure that ASIC said yesterday that there are requirements for financial planners and they are trained to a certain level. There is also a regime that will come in under the FOFA reforms which raises the bar on training. We supported that and we think that is an appropriate way to go. Internally, how do we look at this? We have an internal audit process essentially whereby the advice that our financial planners give and the way that they deal with customers are reviewed. If there are shortcomings in that process against their obligations then they undertake remedial training where we think that training is the appropriate solution. While they are undergoing that training, any dealings that they have with customers are vetted in the sense that their advice is read by a more senior person and okayed before it goes to the customer. Where very serious matters are detected that are not amenable to training, in the worst case, that person's employment with us would be terminated.

Senator CAMERON: Do you advise the police of any illegal activity?

Ms Nash : Absolutely, we do so as a matter of course.

Mr Hodges : Our approach would be to do that and to have people prosecuted. Consequence management is an important part of making people understand that if they do things that are wrong they will be dealt with.

Senator CAMERON: Yesterday the issue of systemic problems in the banking industry was raised. I am not arguing that there are systemic problems, but there are enough problems that Senator Williams and other senators have raised in this inquiry and in previous inquiries to say that you have a problem and we need to deal with it. Ms Nash, you indicated to me earlier this morning that you would be prepared to organise a meeting with this constituent. Has that changed now that you have heard there will be mediation? I have been in contact with the constituent who would be pretty keen to have a meeting as soon as possible. This constituent has suffered significant financial loss and there is huge personal stress. I would be keen to try and resolve this as quickly as possible. I would like it to be done at a high level within the bank, not given a low-level approach.

Ms Nash : It sounds like an unfortunate and quite serious situation and we will have a further discussion about it.

Senator CAMERON: Thank you. I now go to some of the macro issues. The submission from the Australian Bankers Association, which was somewhat resonated in your submission, was that a huge amount of legislation will be coming through and we need time to digest it. Your submission said let us get this lot of legislation through. The costs of legislation to the banks has been raised by the chair. Do you accept that legislators have to look at the costs to society of not getting legislation in place and that we have to balance the costs of Basel III and other initiatives to the banks against the costs to society of the global financial crisis which was substantially caused by poor or no regulation in some administrative areas?

Mr Hodges : I absolutely agree with you, with maybe one qualification, and that is that my reading of the crisis was that in many jurisdictions there might have been regulations but there was not much supervision around the regulations. So actually I think what you need is a combination of appropriate regulation and a strong supervisory regime as well to make sure that those regulations are followed, because I think that one of the issues was that in many jurisdictions people had regulations but just stepped back and did not make sure that those regulations were being followed up. One of the differences between the Australian model and some of the models in other countries is that we have a relatively 'intrusive'—I use that word in a kind way—regulator, who is regularly in at the organisation asking questions of middle management to senior management and the board.

Not everything can be done through regulation. I think supervision is an important part of it. Our request would be to have careful and thoughtful regulation which is appropriate, and also time for us to implement it—time frames that are reasonable—because many of these require both technology changes and retraining for staff. So I would be the last to say that we should not be looking, where it is appropriate, to change regulation.

Senator CAMERON: Your submission is that it was not really the banks that were the problem, it was not greed or illegal behaviour by the banks and the finance system; it was really poor regulation and poor regulatory overview. That is not the submission you are making, is it?

Mr Hodges : No; I think what I am saying is that there was a combination of factors. One was poor behaviour. I think there was absolutely poor behaviour in certain markets in certain—

Senator CAMERON: Isn't 'poor behaviour' a bit of an understatement?

Mr Hodges : You used the term; I just said, 'Absolutely.' Criminal behaviour is what has happened in some jurisdictions. Then I think the question is: were the regulations too lax in some areas? And then it was the question: were the regulations supervised? Even if you had them were they effective, because no-one was monitoring them. So there was a combination of factors which were responsible.

Senator CAMERON: IOSCO are looking at a range of issues right now. They have issued another discussion paper. That is, the International Organization of Securities Commissions. Obviously, if some of these ideas are accepted that would lead to further regulation. You do accept that if a body like IOSCO raises concerns that if we are going to operate in the international banking area we would have to be in that regulatory change—as a government and a banking industry?

Mr Hodges : Yes, the real issue for us in Australia is that when people are looking at what regulatory change to put through, they are actually looking to Australia to see whether there are lessons to be learnt from this market as to what happened. I think we ought not just take regulation from international markets because they think it is good for their markets. I think we need to look at how it impacts on our market and what the cost of it is. This is a sort of iterative process. We see that through the G20, where Australia went to negotiate for change in the way the Basil rules were being implemented, because they did not work in this jurisdiction, and we have carve-outs, which allow us to do things in certain ways.

So my sense here is that there is good regulation and there is not-so-good regulation. You have to look at both the costs and benefits of what you are doing here. You would be silly to try to argue that we should not be continuing to review what is being done and how we could do things better.

Senator CAMERON: I have raised with most of the witnesses the views espoused by Professor Joe Stiglitz in his recent book, The Price of Inequality. On page 269 he outlines a range of areas that need to be implemented to curb the financial sector. I will just go through them and maybe get your comments on them.

Mr Hodges : Sure.

Senator CAMERON: I will have one question after this. Professor Stiglitz says that, firstly, we should curb excessive risk taking in the too-big-to-fail and too-interconnected-to-fail financial institutions and that there should be restrictions on leverage and liquidity; secondly, we should make banks more transparent, especially in their treatment of over-the-counter derivatives; and, thirdly, we should make the banks and credit card companies—this is in the context of the US—more competitive and ensure that they act competitively.

Mr Hodges : I would say that the Chinese regulator is a very tough regulator. I guess we are used to that, because of our own. The Singaporean regulator is very tough too. So we see a bunch of regulators in the region who are very across what is going on in their jurisdictions.

One of the concerns that we had about the fragmentation that was happening around Basel III, and the different rules, was that we were starting to see different regulatory regimes across many countries. We operate in 32 countries. So, if you have to build a bank across multiple regulatory regimes, it increases your costs and the complexities of doing business—which is not good.

I think one of the benefits we have seen is what we call a 'regulatory college'—we have seen this over the last two years—which is where regulators from the region get together for a couple of days to talk about us as a bank and to share ideas and thoughts and then come back to us, as a group of regulators, and tell us what we should be doing more of or less of. So we are starting to see a more integrated and cooperative approach to regulation across the region, which is positive, but I see that as something we could see more of.

CHAIR: Thank you to the ANZ for assisting us today; your time is very much appreciated.