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It's time to start talking: address to the Australian Industry Group Annual National Forum, Canberra

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Joe Hockey, MP  Shadow Treasurer  Member for North Sydney 



The Leader of the Opposition does send his apologies for being unable to attend today’s event. I am sure you will understand that the House is often unpredictable, especially with minority government.

It is my great pleasure to be here with old friends from the Australian Industry Group at the Annual National Forum, and to Heather Riddout and all of the team thank you so much for inviting me today.The theme for today’s conference is:

“What’s Next? New Thinking New Directions for Australia”.

I want to take this opportunity to talk to you about our banking system in a straightforward, honest and practical way that parliamentary colleagues rarely do. I will draw on more than 20 years of experience in and around the industry working with banks, selling banks, regulating banks and dealing with banks.

And it’s a very good time to take up this challenge. The financial crisis looks, thankfully, to be in Australia’s rearview mirror. Yet the risk is that we allow some of the recent lessons of financial history to fade, and focus blindly on the future.

I would put to you that this is precisely the point in our ambitious and young nation’s history when we should be carefully formulating forward-looking reforms that better prepare us for a volatile future.

The debate I called for last week has so far enjoyed thoughtful contributions from a range of people. Banks themselves must now join the debate because they do have a unique role in our community.

We must seize this opportunity to embark on constructive reform.

Banks have a special place in our society. They are the lifeblood of liquidity.

And let me make clear that I think that Australia’s banks generally do a very good job. They are some of the most efficient, highly regarded, and highly rated banks in the world.

Banks are a safe place for Australians to store their savings, a place that provides the comfort for our hard-earned wealth knowing that it is secure and cannot be lost.

Banks take our at-call savings and transform them into long-term credit, or loans, to households and businesses. That is, they transform our savings into investments. Economists call this process “maturity transformation”, and, as the 1997 Wallis Inquiry noted, it defines both the incredibly important role of banks in our communities, and their fundamental vulnerability.

It is this mismatch between short-term deposits and the 3 to 5 year wholesale debt that banks primarily use to fund their credit creation activities, and the much longer term—up to 25 year—loans they extend to their home-buying customers, which gives rise to the liquidity and solvency risks that necessitate an underlying system of public support for all banks.

These risks can take two main forms, both of which materialised domestically during the financial crisis.

The first is a rapid withdrawal of funds by depositors, known as a “bank run”. About half of all Australian bank funding comes from deposits. Local regulators had genuine concerns during the crisis that this problem was starting to undermine our smaller institutions.[1]

A second related risk, also borne from the confluence of panic and risk-aversion, is the refusal of institutional investors to “roll-over” the wholesale funding they supply to our banks. During the worst days of the global crisis, this latter risk threatened even the largest Australian banks. While their balance-sheets were innately very sound, they became collateral damage.

Banks also provide the core of our financial transactions system, affording a safe and efficient means of effecting financial transactions both within Australia and throughout the rest of the world.

Most Australians are now paid through direct credit to a bank account rather than in cash. It is now impossible to drive across the Sydney Harbour Bridge and pay the toll in cash.

It is, therefore, almost impossible for Australians to function in our modern society without an account with an authorised deposit taking institution. The days, which my father as a small businessman was familiar with, when savings could be stored under the bed and all transactions could be made in cash are well behind us. Technology and national security laws have ensured that participation in the banking system has become a mandatory feature of modern life.

The banking system’s crucial role in supplying the economy’s financial arteries and transforming savings into investment makes it different from most other industries.

The government has recognised the special place of banks, and it grants banks privileges and benefits that are not afforded to other sectors.

A publicly-owned “central bank” was first established in Australia in 1924[2] via the Commonwealth Bank Act to supply private banks with liquidity during times of crisis, and to avoid systemic bank collapses like those that occurred in the early 1890s when more than half the note issuing banks suspended payment, and a third of them were to never reopen again.[3]

We now know this institution as the Reserve Bank of Australia. Most people tend to focus on the RBA in the context of its responsibility for monetary policy. But an equally important part of its remit, which came to the fore during the recent crisis, is vouchsafing so-called “financial system stability”. It does this by offering banks access to a range of short-term lending and liquidity facilities.

Banks are also subject to a unique system of prudential supervision that enhances their perception of safety in the eyes of the public and maintains the public confidence in the stability of deposit-taking institutions. The banks may occasionally chafe under the restrictions, but they must concede the system of prudential supervision imparts tremendous benefits to their operations.

More recently, the safety and community confidence in the banks has been strengthened by the Commonwealth Government’s unprecedented offer to lend its AAA-rating to guarantee the banks’ wholesale fund raisings, and by the retail Financial Claims Scheme that resulted in the Commonwealth guaranteeing the banks’ other major source of funding, which is deposits.

Let us not forget the $16 billion of taxpayers’ money which has been pledged to bolster the liquidity of the AAA-rated residential mortgage backed securities market, which the Coalition was the first of the major parties to advocate.

The regulation of banks has evolved through time, as it should.

In 2009 I backed a call for a so-called “Son of Wallis”—a new financial system inquiry.[4] Wallis was completed in 1997 and was predicated on the “efficient markets hypothesis”, which has proven to be an imperfect regulatory

assumption. Even Professor Harper, who I have a high regard for, one of the main authors of the original Wallis Inquiry report, has supported calls for a Son of Wallis and highlighted the frailties in the existing system.[5]

The crisis taught us that financial markets can fail and liquidity can disappear. Entire banking systems can collapse. It would be a mistake to attribute Australia’s good fortune in skirting the worst of the crisis purely to policymaking skill. A lot of providence came into play as well—our terms of trade boom, record population growth, strong domestic demand particularly for residential real estate, a pristine government balance-sheet, antipodal position, and historical accumulation of fiscal surpluses were all important parts of the story.

One of the principal recommendations of Wallis was that we should never guarantee any part of the financial system under any circumstances for fear of inducing “moral hazard” - the risk that you encourage (the) dysfunctional term, “heads bankers win, tails taxpayers lose”. That’s the sort of behaviour we have seen in the United States. [6]

This was one of the central tenets upon which APRA was founded in 1998. It worked well until its first test with the collapse of HIH, which I remember graphically, on 15 March 2001. HIH redefined moral hazard in Australia - or merely reaffirmed the political reality.

We were not alone. A failure to define taxpayer risk was even more obvious in the United States with implicit government guarantees of two private sector organisations, Fannie Mae and Freddie Mac. In the end US regulatory confusion helped to undermine the integrity of the US financial system itself.

Fannie Mae and Freddie Mac were moral hazard writ large.

This confusion was evident throughout the crisis as Lehmann Brothers fell, Citigroup was saved. In the UK as Northern Rock fell, RBS was saved.

Bankers make money out of pricing risk so moral hazard uncertainty allows banks to err on the side of risk. Without a set formula the massive risk of bank failure is a pricing uncertainty that allows individual bankers to call at will. This is unacceptable to taxpayers. And when bonus season comes it leaves taxpayers bewildered and often angry.

Another lesson from the recent calamity has been the efficient markets’ prescription of ‘self-regulation’ simply does not work, as even Alan Greenspan now concedes.[7]

During my term as Financial Services Minister in the Howard Government, the collapse of HIH reinforced in all our minds the need for a proactive, empowered and vigilant banking and insurance arbiter.

APRA is the first to acknowledge that the HIH saga was the best possible preparation for the subsequent financial crisis. And as recent RBA research has shown,[8] the outstanding efforts of Australian regulators in 2002 and 2003, including the RBA, APRA, ASIC and the ATO, to highlight the risks of a burgeoning house price bubble, and imprudent lending practices, was crucial to securing a soft-landing in Australia’s housing market many years in advance of the much more sudden collapses in the US, the UK and Spain to name a few.

While tipping our hats to strengths and resilience of the current regulatory architecture, we also need to be upfront and accept that many of the assumptions upon which it was based were discredited by the circumstances flowing from the Financial Crisis.

The government was forced to offer guarantees of all bank funding sources, including both deposits and wholesale funding.

The RBA was compelled to extend unprecedented ‘lender of last resort services’ to the banks that no other private companies get the benefit of, and which the RBA had never utilised before (for example, lending against mortgage-backed securities).

And more broadly, the ACCC waived through mergers of lenders it would never ordinarily permit, as it has acknowledged.

These actions have irreversibly changed our financial landscape. Once truly independent concerns, such as:

· St George,

· BankWest,

· RAMS, and

· Wizard, are now gone.

That iconic brand, Aussie Home Loans, is now one-third owned, and wholly funded by, Australia’s largest bank, CBA. And what was Australia’s biggest non-bank lender, Challenger, has divested its lending business to NAB.

In short, the four major banks have largely become the Australian financial system. I should add in there the fact that major international players who have reduced their activities in Australia has also contributed to the reduction of competition.

Aspirations to grow more rapidly than that system therefore seem challenging.

We have seen an enormous increase in industry concentration to the benefit of a few. And this has started to raise understandable anxieties about competitive neutrality.

Our competition regulator, the ACCC, has started expressing concerns that the major banks are using their newfound market power to collusively signal pricing intentions. But the ACCC does not currently have the power to respond to these risks.

As late as last week, the central bank and the Treasury have both rejected claims by the banks that they need to further widen their net interest margins in order to recover funding costs. Indeed, the RBA’s latest Financial Stability Review shows that the major banks’ Australian net interest margins are at their highest levels since around 2004.[9]

The events that have transpired since 2007 surely demonstrate that policymakers need to evaluate the case for further reform. And this reform must, by necessity, focus on ensuring that Australia is not the collateral damage in the next financial crisis.

So let me move from the general to the specific, and highlight some of the policy challenges we face.

The four major banks are too big to fail. As Guy Debelle of the RBA recently remarked,[10] ultimately the public has to serve as a ‘backstop’ to financial intermediaries, because we simply cannot afford for the financial system to fail. And the risk of collapse is much greater in the 21st century - with it’shighly interconnected world. Shocks in one country can be quickly propagated to distant isles, creating global contagions.

As I have noted, banks are not normal private companies and should not be regulated like normal companies. All central bankers and regulators accept this.

It is a fact, that has not dawned on some commentators, that our banks are already subject to a heavy regulatory burden. They require licences, they have their own legislation, they have their own prudential regulator and they are bound by rules governing everything from capital requirements to the handling of money.

We have, thankfully, come a long way from the original debate on public versus privateownership and, for the benefit of some commentators, the capping of interest rates by the Parliament. The Coalition does not believe that taxpayers should run commercial banks, nor do we believe that politicians should set lending rates. It was, after all, Robert Menzies who enacted the 1959 Reserve Bank Act that formally created the RBA, and, crucially, forced the central bank to get out of the commercial banking game.[11]

Having said that, there is clearly a case that Australia’s prudential regulations should continue to evolve to mitigate the new moral hazard risks that have been unearthed as a direct consequence of the taxpayer guarantees. This is an issue that I know is exercising some of the best brains inside APRA and the RBA.

In this context, there appears, for example, to be a growing conflict between the high-growth aspirations of bank management teams and shareholders, who are focussed on maximising shareholder returns, and the longer-term interests of taxpayers and regulators, who are much more eager to ensure that this return maximisation does not come with higher ‘non-core’ risks that trigger bank failures and financial system instability. And when I talk about ‘non-core’ risks, I mean anything that is not related to a bank’s central savings and loan function.

This is also highlighted by the question of credit growth. The Government, opposition and regulators like APRA and the RBA are delighted that credit growth--that is indebtedness--has slowed down in Australia in recent times. We applaud the deleveraging of business and household balance-sheets. The RBA welcomes the very low, single digit rates of mortgage growth, and the cooling in housing market conditions.

Yet this is a problem for the banks: lower credit growth to businesses and households means lower profitability. Lower profitability means lower returns. So in response we have the major banks claiming that they need to expand offshore to pursue higher growth opportunities than those they can find domestically, or move into non-core areas of business, like funds management.

But it was precisely the absence of these overseas exposures that the RBA regularly opined was the chief saviour of Australia’s banking system during the Financial Crisis.

It was the fact that our banks had concentrated on servicing the domestic economy, and had not over-reached into foreign countries and non-core investment banking activities where they had no direct expertise, that insulated them from the worst of the US and European crises.

Standing in the ashes of the GFC our world-beating banks are naturally enough searching for every opportunity to make more profit.

With massive taxpayer risk in play we as policymakers need to decide if we want the major banks to be unrestrained growth stocks, like resources or technology companies. Or do we want the industry to be more akin to bullet-proof utilities that are focussed on delivering stable returns to shareholders? One possible solution here is to quarantine the risks that taxpayers will insure, and accordingly quarantine the coverage of our moral hazard.

So for example we might allow banks to expand offshore and engage in riskier business profiles, but ensure that it is impossible for their offshore activities to in any way, directly or indirectly, undermine their Australian operations. Of course, this may run into some cross-jurisdictional prudential supervision problems.

The upside of stable and more focussed growth is far lower risk. This is precisely why conservative investors commit capital to government bonds and other fixed income securities: they are receiving more certain cash-flows. It is one reason why our major banks have such strong credit ratings. And, when you think about, it is presumably one of the main reasons why so many retail investors like bank stocks: they are supposed safe-havens in an otherwise uncertain equities market.

The major banks should welcome stability and security of cash-flows. They should market themselves on the strength of their credit ratings and the integrity and growth prospects of the Australian economy. Since the major banks have “become the system” following the Financial Crisis, it is hard to understand how they can expect to perpetually grow at a rate higher than that system.

To borrow Glenn Stevens words:

The finance industry, certainly at the level of the very large internationally active institutions, needs to seek to be less exciting, less ambitious for growth, less complex, more conscious of risk and more responsible about where those risks end up, than we saw for the past decade or two. And, of course, it does have to be better capitalised.[12]

I want to conclude with a few ideas. Policy reform is a dynamic business. As the world changes, so too must our regulatory architecture.

That is exactly why international regulators are proposing a whole new raft of banking policies in the form of as BASEL III. The Coalition strongly supports the work APRA and the RBA are doing on this front. It will make our banking system stronger and safer, and better able to withstand the financial tsunami when it next comes.

The Coalition also has some positive policy suggestions:

1. Let’s give the ACCC power to investigate collusive price signalling (that is, oligopolistic behaviour), which is exactly what Graeme Samuel has called for;

2. Let’s encourage APRA to investigate whether the major banks are taking on unnecessary risks in the name of trying to maximise short-term returns that conflict with the preferences of those that backstop the system, namely taxpayers;

3. Let’s formally mandate the RBA to publish regular—rather than irregular—reporting on bank net interest margins, returns on equity, and profitability so that we can all determine whether the major banks are extracting monopolistic profits; that is, whether taxpayers are effectively subsidising supernormal returns;

4. Let’s investigate David Murray’s proposal for Aussie Post to make its 3,800 branches available as distribution channels for smaller lenders. To be clear, the Coalition does not endorse Australia Post assuming balance-sheet risk and getting into the banking business itself;

5. Let’s ask the Treasury and the RBA to investigate ways to further improve the liquidity of the residential and commercial mortgage backed securities markets, which are an alternate source of funding for smaller lenders, including consideration of the Coalition proposal to extend the Government’s credit rating to AAA rated commercial paper in those markets to improve liquidity;

6. Let’s explore further simplification of my beloved Financial Services Reform Act, to make the business of actually getting out and doing business easier and simpler;

7. Let’s direct APRA to explore whether the risk-weightings on business loans secured by residential properties are punitive. Many small businesses tell me that they do not receive sufficient financial benefit from pledging their family home to secure their borrowings;

8. Let’s commission a resolution to the debate about whether the banks should be able to issue “covered bonds”, in the same way other jurisdictions allow their banks to, which provides a more affordable line of credit;

9. And let’s wrap up all of this work into a full review of the financial system—a Son of Wallis, or Grandaughter of Campbell, whatever you will.

I want to assure you that this list is not exhaustive.

Out of all of this and more I want a Social Compact between our Taxpayer guaranteed banks, their shareholders and our Government and our Parliament. This must define the relationship and must include direction on competition, expansion, expectations of credit and savings, community service obligations, risks and rates.

As Glenn Stevens observes:

The sort of financial system we should want is what was once described as ‘the hand-maid of industry’: reliably facilitating transactions, fostering trade, bringing savers and investors together, pooling risk and so on. We don’t actually want too many of the financiers to be ‘masters of the universe’. There will always be a risky fringe, but it should stay at the fringe, not be at the core.[13]

I want to finish my remarks today by once again debunking some of the misinformed hysteria on the regulation of banks.

I have not advocated directing the RBA to use Section 50 of the Banking Act to set bank interest rates. I would not do that for two reasons.

Firstly is that it is critically important for the RBA to retain its independence from government in the determination and implementation of policy on interest rates.

I would remind the commentariat that it was the Coalition Government that signed the first “statement” with the RBA formally enshrining its independence in 1996. That was when the Labor Party wanted to take Peter Costello to the High Court to stop the agreement.

That’s because as late as mid 1994 Paul Keating was directly interfering in RBA monetary policy decisions and forcing our central bank to reduce interest rate increases that it would have otherwise made.[14]

This independence has allowed the RBA to effectively target inflation, with Australia now firmly in the group of low inflation countries. Goldman Sachs recently remarked that the RBA is arguably the best central bank in the world.[15] I might add that it is not perfect - and I am sure they would say that as well.

The second reason is that I believe in less and better regulation.

In April this year at the Eidos Institute in Brisbane I gave a speech titled “In defence of Enterprise”. With some measured humility I refer you to it.

Competitive and well functioning markets are best placed to achieve the socially optimum outcomes in terms of the production and distribution of goods and services. But where there is market failure the Parliament must step in.

We must have a debate on whether we have lost adequate banking competition in Australia. Not only have small players been squeezed but international banks operating in Australia have become far less active. This of course further exposes Australian banks to domestic market volatility.

Poor competition in selected markets and empty Government rhetoric at the time of interest rate movements make Australians angry. Massive profits and large bonuses are acceptable only if Australians feel that they are getting a fair go from their banks. At the moment they are not. Australians want action and today I have outlined at least 9 areas where action can be taken to deliver more competition and a more modern banking system.

Ladies and Gentlemen, it is time to talk banking.



[1] Noted in: Uren, D and Taylor, L, 2010, Shitstorm: Inside Labor’s Darkest Days, Melbourne University Publishing, Melbourne.

[2] According to the RBA’s self-penned history, “the [Commonwealth Bank]…gradually evolved its central banking activities, initially in response to the pressures of the Depression in the early 1930s and later by formal, albeit temporary, expansion of its powers under wartime regulations. These included exchange control and a wide range of controls over the banking system (including authority to determine advance policy and interest rates, and to require private banks to lodge funds with it in special accounts)…The new Commonwealth Bank Act and the Banking Act, both of 1945, formalised the Bank's powers in relation to the administration of monetary and banking policy, and exchange control.” Available from:

[3] Cornish, Prof S, 2010, The Evolution of Central Banking in Australia, Reserve Bank of Australia, Sydney.

[4] Martin, P, 2009, People’s bank to break the Big Four Sydney Morning Herald, July 8, 2009. Available at:

[5] Professor Harper (quoted): “Our framework was essentially the efficient markets theory…We thought we had found the ultimate fixed point in the universe, namely the market price, and so we built on top of that the regulatory framework. But then there was no market price…The evolution we expected has stopped, reversed and gone the other way.” Quote contained in: Joye, C, 2009, Preventing another Lehman Business Spectator Blog, 15 September, 2009. Available at:

[6] “The intensity of prudential regulation should be proportional to the degree of market failure which it addresses, but it should not involve a government guarantee of any part of the financial system…It is the Inquiry’s view that any regulatory assurance should be tightly circumscribed…Ultimately, it is the responsibility of the management and board of a financial institution to ensure that its businesses deliver on the promises made, and it is not appropriate for government to underwrite them. Prudential regulation adds an extra layer of oversight beyond regulation of disclosure and conduct, but this should not constitute a guarantee.” Quoted in Financial System Inquiry (Wallis Inquiry), 1997.

[7] Staff writer, 2008, Financial crisis ‘like a tsunami’, BBC News, London, 23 October 2008. Available at:

[8] Bloxham, P, and Kent, C, and Robson, M, Research Discussion Paper - Asset Prices, Credit Growth, Monetary and Other Policies: An Australian Case Study, Reserve Bank of Australia, Sydney.

[9] Reserve Bank of Australia, Financial Stability Review - September 2010, Reserve Bank of Australia, Sydney Available at: RBA’s Graph 26.

[10] “Financial services are a key intermediary input into the production process. A severe curtailment of those services has a material impact on the capital accumulation process, unemployment and the long-run growth prospects of the economy. It is in the interests of society to ensure that the public sector provides a backstop in such circumstances to mitigate the externality caused by the individually rational risk-aversion of financial sector participants.” Debelle, D, 2010, On Risk and Uncertainty, Address to Risk Australia Conference, Sydney, August 31, 2010. Available at:

[11] The 1959 Reserve Bank Act separated the commercial and central banking functions of the Commonwealth Bank of Australia for the first time.

[12] Stevens, G, ‘The Role of Finance’, The Shann Memorial Lecture, University of Western Australia, Perth, August 17 2010. Available at:

[13] Stevens, G, ‘The Role of Finance’, The Shann Memorial Lecture, University of Western Australia, Perth, August 17 2010. Available at:

[14] “Prime Minister Keating summoned the Governor of the Bank and the Treasury Secretary to his official residence. As Kelly tells it: "Fraser's recommendation [notably to the PM] was for a full 1 percentage point increase. The meeting was on Keating's turf. 'The Prime Minister had concerns,' [Treasury Secretary] Ted Evans said in a masterly understatement...The Prime Minister wanted a concession. He argued that the increase was too much, too sharp. In the end, they knocked 0.25 per cent off Fraser's proposal...[Ian] Macfarlane said: 'I was told they brokered it down to three-quarters of the point'...Keating got a concession."” Joye, C, 2010, British cede power over budget. Is Australia next? ABC Unleashed, 26 May 2010. Available at:

[15] Quoted in: Joye, C, Love-in time: Goldmans Sachs--RBA is best central bank in the world. Available at: