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

BURKE, Mr Anthony John, Policy Director, Australian Bankers Association

MUNCHENBERG, Mr Steven, Chief Executive Officer, Australian Bankers Association

STAMOLIS, Mr John, Director, Statistics, Australian Bankers Association

CHAIR: Welcome, Mr Munchenberg, and representatives of the Australian Bankers Association. Do you have an opening statement?

Mr Munchenberg : I do, and I will keep it as brief as possible. Thank you for the opportunity to present to the committee this morning. I am accompanied by Mr Tony Burke, ABA policy director, and Mr John Stamolis, our director of statistics. The global financial crisis, while having its origins elsewhere, has had a significant impact on Australia, and we believe that impact continues today or has perhaps moved to a new stage of development. For example, the continuing uncertainty in certain European countries not only affects asset prices in all of the world's markets but has a direct impact on the cost and availability of funds our banks borrow in order to maintain the supply of credit to households and businesses in Australia. As many have observed, however, to this point we have suffered less than many of our key trading partners. This has been the result of a combination of factors and circumstances, not the least of which include the relative strength of our well-managed domestic financial system and the regulatory framework which supports it.

There are some key points we would like the committee to bear in mind throughout this inquiry. The financial services industry makes a substantial contribution to the national economy. For example, in 2011 the finance and insurance industry contributed $129.8 billion to Australia's $1.2 trillion economy and has been the largest contributor to the economy since 2006. The industry as a whole employs nearly half a million Australians and the retail banks paid out $22.5 billion in wages in 2011. The industry will continue to make a major contribution and there are also many opportunities to generate more business offshore and further develop Australia as a regional financial services centre. In this regard, we note the recommendations of the Henry and Johnson reports and look forward to continuing engagement with the government on the further reforms which we believe to be desirable.

To finish up, I have a couple of points to make on regulation. Ours is a highly regulated sector. There is a wave of international regulatory reform coming out of the G20 and Financial Stability Board processes and extraterritorial regulations from the US and the EU. We really need to bed that down before embarking on any new reforms. We ask, therefore, that the committee consider that there be a suitable period of consolidation before any new regulation on the banking industry is contemplated; that new regulation be costed and have regard to regulation already in place, including self-regulation or regulation imported from offshore for problems that did not occur in Australia; and that a suitable balance be found between the cost of regulation to industry and the benefits of increased stability. The marginal utility of stability decreases as more and more regulation is layered on.

CHAIR: You talked in your opening statement about the impact of the GFC on the cost of funds. As a broad opening question, is there anything that government can do, whether it be in a positive sense or in a negative sense by getting things out of the way, that could assist your members to access funds more economically?

Mr Munchenberg : Unfortunately, there is no simple answer or silver bullet to that problem. As I am sure you are aware, the issue for us in large part stems from the reliance that the Australian economy places on attracting investment from overseas to fund its economy. That has been a longstanding situation. Most of that is intermediated through the banks, particularly the major banks here in Australia. The banks themselves have been looking at how they can moderate that reliance on overseas markets, not least because those markets have now just had five years of volatility. That affects both the price at which we can raise money and also its availability at all. We are very cognisant of that as a risk to the banking system and to the Australian economy. We have been looking at what we as banks can do to manage that and the banks have been putting in place measures to minimise that reliance. Nonetheless, that reliance remains.

In terms of government policy, we have had various discussions with the government over the last few years about what can be done in those areas. We have seen things like covered bonds introduced, for example, which allow us to tap a more diverse range of markets to raise that money. We would be very keen to see government policy that removes tax distortions against people saving and investing through deposits. At the moment, of course, we are seeing very strong savings rates in Australia and incredibly strong competition for deposits as banks seek to try to minimise that reliance on overseas money. But, in the longer term, Australia does not have a strong record of saving through the banking system and we think part of the answer lies there. This is extremely problematic in practical terms, but we also need to look at the amount of savings in the superannuation industry and whether there are appropriate ways of encouraging some of those savings into the banking system to then feed the demands for credit from households and businesses in Australia.

CHAIR: This committee looked at the issue of competition in banking a couple of years ago. I think it is true to say that the main thing it found was that the biggest impediment to competition was access to funds at a reasonable cost by all participants. So it is, I think, an important issue—

Mr Munchenberg : Absolutely.

CHAIR: in terms of whether the government can either get out of the way or provide incentives to do it. Regarding the tax distortions, to fully understand it, are you talking their about the tax advantages that savings and superannuation has vis-a-vis savings in banks?

Mr Munchenberg : We are not suggesting changing the—

CHAIR: No, but that is the distortion.

Mr Munchenberg : The distortion is created. If you provide a tax incentive, and it may well be an appropriate incentive in one area, it invariably creates a distortion away from other areas.

CHAIR: So you are proposing that it be balanced up.

Mr Munchenberg : We need to try to minimise that distortion so that it is not affecting people's investment decisions.

CHAIR: Regarding the savings in super, are you talking there about the trustees of the $1.2 trillion that is currently sitting there viewing investment in banks as an attractive option?

Mr Munchenberg : We know that the Australian super industry for whatever reason is heavily weighted towards equities by international comparison and underweight things like fixed income products. Were super funds to invest in some of those products, it would mean money flowing through the banking system into the economy rather than chasing further returns in the equities markets here or overseas. What we are not suggesting in any way is that the trustees of those super funds be under any direction or requirement to do that.

CHAIR: I do not think we would be entertaining those suggestions even if they were made. You say that, for whatever reason, they are not doing it—and I guess that is the question: why isn't it an attractive option? Is it because the banks themselves are presenting that investment option in a way that is attractive to trustees? Or is it because of tax distortions? In your assessment, what is the reason that that huge potential source of funds is not finding its way into banks in the degree it could or should be?

Mr Munchenberg : There are probably a number of factors. For whatever reason, in our superannuation industry—and this may just be the circumstances within which the superannuation industry in Australia grew through the nineties, when we saw a lot of demutualisation and a lot of interest in the share market and equities—there is a cultural tendency towards equities. But I think there is also an element of 'chicken and egg' with things like fixed income, for example, because, I think, there has not been the demand, so banks and others have not tended to push the products, which means that those who might develop a demand for those products are not familiar with the product. So there is an element of the chicken and the egg there as well.

As superannuation funds look at the performance of equity markets, as banks look to innovation and as other lenders look to innovate in the fixed income area, we will see some shifts in that area, but I think we also need to look at whether there are tax barriers or whether tax incentives should be provided to shift some of that focus. So I think there is a role for public policy, but we obviously have to be very careful to not unduly influence the investment decisions of our retirement funds.

CHAIR: Ultimately, investment decisions have to be made in the best interests of the retirees who will benefit from those, but that is not to say that the banks, maybe with the assistance of public policy changes, cannot offer attractive options that are in the best interests—I guess that is what you are saying.

Mr Munchenberg : Yes.

CHAIR: You mentioned also—though you did not use these words—that the banks are effectively suffering regulation fatigue with the changes that have occurred in recent times. A lot of new laws certainly have been passed in the last few years that impact domestically on banks. The terms of reference of this committee really look at international changes, how decisions that have been made around the world are impacting on Australian banks and, to use my own words, whether we are paying the price for addressing problems that we did not necessarily experience in Australia. Would you care to make some comments on the impact of international regulatory changes, how that is playing out here and what impact that is likely to have on Australian banks and their competitiveness.

Mr Munchenberg : One of our key points, I suppose, is just that we want to continue to highlight that. We are a highly regulated industry, and that is an appropriate thing, but, when we have domestic regulators or policy makers looking at our industry, we like to remind them that we are not only regulated at a federal level here in Australia; we are regulated at a global level and that is becoming an increasing reality—I will come back to more directly address your point—and increasingly we are also regulated by the US congress. The US is passing a lot of laws in our area and is not particularly worried about the extraterritorial application of those laws. We spend a lot of time dealing with the ramifications of things like the Dodd-Frank act and various elements of that.

On international regulation, at one level it is fair to say that Australia is wearing the solution to problems that it did not have. It is not entirely unreasonable, because, obviously, if we learnt anything out of the global financial crisis it is the extent of the harm that can be caused by instability and collapse in parts of the financial system. It would be a mad world where we did not respond to that in some way. I actually think our government and particularly our regulators, the Reserve Bank and APRA, have done a very good job in balancing the influence on where the international regulation is going, to the extent that they are able to do that, and its application here in Australia. By and large, we have been accepting of the impact of those changes here in Australia. We have reservations about the speed of those changes; APRA feels that it is important to move quickly and we will no doubt continue to discuss and debate that with them.

There is a price to enhanced stability, however. One of the things that policy makers need to continually bear in mind is that stability, as desirable as it may be, does come at a price. What the banking system is really about is managing risk. At its most simple level, we take the risk of lending money to people and the risk of being able to pay money back to those who have given us money to look after for them. You cannot remove risk from the banking system—that is what it is about. The more that you try to do that the more you are going to have these impacts around the availability of credit, the price of credit and the willingness of banks to fund marginal parts of the economy particularly—and in marginal I am including things like the entrepreneurial parts of the economy. We have to constantly check that balance between very desirable stability and the consequences of pursuing that stability.

CHAIR: I recall reading that a highly competitive banking industry, which ultimately delivers keener prices for products for consumers, can undermine the stability and solvency of the participants. What you are saying is that you must get that balance right.

Mr Munchenburg : You do.

CHAIR: You mentioned the speed in which APRA is undertaking this. What are your concerns in that respect?

Mr Munchenburg : Really our concern is that Australia is moving quickly, particularly on the capital side. I understand APRA's argument, which is that the banks can get there. It is a very good way of sending a signal to the rest of the world about how well capitalised banks in Australia are if we comply with the Basel III capital requirements early. Our concern is when we look around the rest of the world we do not see the same levels of enthusiasm for implementing Basel III as we see here in Australia. A number of jurisdictions are less well advanced with developing their regulation than we are, including most notably the US which is yet to release—

CHAIR: It has not even implemented Basel II properly yet, has it?

Mr Munchenburg : Indeed. And it is yet to indicate in any clear way how it proposes to implement Basel III whilst maintaining that it will. Again, the issue for us is one of balance. We are not disputing the need to move to Basel III. Our own banks would not want to be not Basel III compliant because, when they go out to raise funds overseas, that is a box that investors would want to see very firmly ticked.

CHAIR: Does that not raise the advantage though? If we do it more quickly, will we have that advantage with investors upfront and should be able to raise funds at a lower cost?

Mr Munchenburg : That is an argument. But I understand from my discussions with the banks that it does not quite work in the sense of you are well advanced with Basel III so therefore we will give you an extra tick. It is more the case you will be penalised if there was no evidence that you were going to be Basel III compliant. It is well known that the Australian banks are well capitalised. It is well known around the world that Australia, Canada and a few other jurisdictions came through the GFC relatively unscathed. It is easy to overstate the extent to which early adoption of Basel III gives a competitive edge or a price edge in raising money internationally. The reality at the moment is Australia is seen as a safe haven for money anyway so it is only going to have a marginal impact.

CHAIR: At the moment wholesale funding is pretty keenly sought anyway, is it not? There is a price premium because it is a hard thing to access regardless?

Mr Munchenburg : I am not sure I understood the question.

CHAIR: Mr Burke understood the question.

Mr Burke : There is a supply issue. It is not only restricted access but also that the banks are reporting very short windows of opportunity in which they can tap the market. The other thing I note in relation to your previous question is that the rating agencies play a very significant role here. Ratings do not correlate one-on-one with speed of adoption of Basel III.

CHAIR: As you raised the rating agencies, the big Australian banks were all recently slightly downgraded. Has that had any impact on their cost of funds?

Mr Munchenburg : Not in any material way. There was a very specific reason for that, which was the reliance on overseas funding and the concerns that does expose Australia and Australia's major banks to the volatility in those markets. They are still AA rated albeit AA-minus now rather than just AA. The impact was immaterial but—

CHAIR: Have markets been looking past that because they understand the reasons for it all?

Mr Burke : They are still in a very exclusive club of AA rated banks. The most important point out of it is we cannot take those ratings for granted. We are now AA-minus. It would be a significant step down from there, which would have a material impact on their ability to raise funds simply because there are some investors who will not touch anything below a AA-rated investment. It was a warning to Australia not to be complacent about the stability of our banking system or to assume that because we came through the GFC so relatively well that somehow our banks are Teflon or bullet-proof or whatever.

CHAIR: Do the Basel III, capital and liquidity requirements actually assist us to maintain the AA status?

Mr Burke : In so far as everyone is meant to be doing it. It does not have any relative effect. I am not aware of any view in the industry that said early adoption will sure that up. APRA has a different view.

CHAIR: You mentioned the US Congress's impact on Australian banking. Is that because when they look at participants in the US market, they look at their activities wherever it might be including in Australia? If you are doing something here which is acceptable here but has an impact or would be considered in certain ways in the US, do they then take that into account? Explain to me how US laws are impacting on us here.

Mr Burke : It is probably even more indirect than that. They can only legislate if you have a connection with the US. Our major banks have got to have a connection to the US in these globalised time so they would invariably be caught. The US is constructing very complex laws and is determined that smart bankers and their lawyers will not find ways around those laws. So it cast them very widely and inadvertently captures a whole range of activities outside of the US's borders or unrelated to US entities. The laws have quite strong punitive clauses as well and it effectively brings in operations overseas. Without taking up too much time, an example is the recent anti-tax avoidance laws the US brought in where, because of connections that Australian banks have with the US, it requires us-we are still sorting it out—to identify American citizens here in Australia and report directly from the banks to the Inland Revenue Service in the US the banking activities of US citizens. We run into all sorts of difficulties with going to Customs and asking if you are a US citizen or not. Of course, there are big penalties if we do not find all the US citizens. It is that sort of thing. It is inadvertent but is very problematic for us. It is fair to say the US administration does not the rate the concerns of other countries terribly highly in its own issues at the moment.

CHAIR: And it adds additional layers of compliance your members need to comply with in addition to domestic Australian laws and in addition to those that are signed up by Australian regulators internationally and imposed and so on.

Mr Burke : A key point we make to policymakers here is do not forget we are not just dealing with all the changes you are making, which have been substantial and frequent over the last few years, but are also dealing with all these US laws as well as the global regulation, so we have got a very high rate of regulatory change.

Senator MARK BISHOP: I had a discussion earlier with Treasury officials about a matter concerning the cost of borrowing in wholesale markets overseas. They made the point that something like the extra margin now being charged post GFC is about 1.4 per cent or 1.5 per cent, give or take, in the major banks purchasing funds from overseas to lend out here. I look at what is going on and note from the briefing paper here the four major banks are very profitable and are in the top 10 in the world. I see a range of reputable foreign countries, Germany, Switzerland, Sweden, Canada, Russia and others all purchasing heavily into government bonds as part of their strategic diversification of their own investment practices. I see in the paper today that a range of cashed-up major American corporates are investing in Australian government bonds, because they see it as a safe haven, to the tune of billions of dollars.

There seems to be an approach from overseas of one heavy investment into Australian paper. It seems to be growing and continuing because we are seen as a relatively safe haven. Accept that as read. In that context, all the foreign governments, foreign countries and foreign corporates that are all heavily investing in our paper and your members that are borrowing heavily overseas are required to pay 1½ per cent or thereabouts more than they used to. A lot of other banks and governments can no longer borrow in those markets. In that context, are your members, the four big banks, price takers or price setters in that market?

Mr Munchenburg : I think they are still going to be price takers because they are still risk pricing. This is not what you are suggesting, but if I can take an argument to an extreme, I occasionally get told the central bank in Japan has got money out for 0.2 per cent and the US is close to zero—

Senator MARK BISHOP: All those arguments.

Mr Munchenburg : Yes, exactly. The answer to that is you can get a mortgage here in Australia cheaper than the Spanish government can raise money in those markets at the moment. There is still risk pricing. Yes, Australia is a good place for money to go. There will still be a risk price for that. The 140 or 150 basis points is about right. Interestingly in Australia we are paying around two per cent more deposits than we were pre-GFC so we have increased deposits by much more than we have mortgages. You are still paying a risk premium and you also have exposure limits as well. Even though Australia is one of the attractive places to park your money, they will still have limits as to how much they will send here. They will manage their exposure to Australia notwithstanding Australia is a safe haven at the moment. You do not want to be too long in Australia in case something does go wrong there as well.

Senator MARK BISHOP: You say the margin of 1½ per cent that the banks have to pay when they borrow is basically down to the risk premium that the suppliers of money, the wholesalers, identify in this country. Is that the risk premium?

Mr Munchenburg : Yes, basically.

Senator MARK BISHOP: That being the case, if mortgage rates and the like in the United States approach zero, why is there a distinction of a risk premium margin between the wholesale providers of finance to banks and essentially everyone else in the finance market? Corporates, governments, treasuries, Asian countries and European countries are buying our paper to such an extent that I read in the press that the dollar is currently overvalued by 10 or 15 per cent because of sustained high levels of demand for our paper. Why is the wholesale lending market on its own setting such a high-risk premium when every other part of the finance investment market has a risk premium much lower?

Mr Munchenburg : I do not think that is the case at all. As I said, look at the Spanish government and a lot of the European governments. They are paying more for their risk premium.

Senator MARK BISHOP: You misunderstand. Russia, Japan—

Mr Munchenburg : There is a lot of money flowing into Australia. About 80 per cent of our government bonds—and we have a very limited government bond market here because of successive fiscal discipline by governments—are held by overseas investors. There are only so many of those. I am not sure what the current government bond rate is.

Senator MARK BISHOP: You are right that 80 per cent are held by overseas entities. But in buying those government bonds, they are effectively saying the risk premium for government bonds out of Australia is minimal.

Mr Munchenburg : No, what they are saying is the 10-year government bond rate is around 3½ per cent. Spain is around seven per cent. We have seen extremely high levels in other countries.

Senator MARK BISHOP: Spain has an economy the size of Victoria, with due respect.

Mr Munchenburg : And we can talk about relative profitability of banks as well in a minute. There is still a risk premium. Ultimately what you really have to look at are the margins. Just because the central bank in the US is offering money at close to zero does not mean that mortgages are close to zero. I think US mortgages still sit around three or four per cent. So it is a three or four per cent mortgage—

Senator MARK BISHOP: The last time I was there, a month ago, they were nowhere near three or four per cent.

Mr Munchenberg : You are more up to date than I am.

Senator MARK BISHOP: It was the retail prices in banks as you go through the big cities.

Mr Munchenberg : It is the margin that matters. We earn around one per cent on our assets in Australia—

Senator MARK BISHOP: But you say there is a risk premium of 1½ per cent when the banks borrow—

Mr Munchenberg : No, an additional risk premium.

Senator MARK BISHOP: Okay. There is an additional risk premium of 1½ per cent when banks borrow from here, but I do not understand where that is when everyone tells us this country's financial systems are so well run.

Mr Munchenberg : Yes. The risk premium for everyone has gone up compared to pre the GFC. Ours has gone up a lot less than others, but it has still gone up. There is a much higher price on risk per se at the moment. Everyone has moved up and we are in the fortunate position not to have moved up anywhere near a lot of other countries and a lot of other banking systems because relative to those other banking systems we are seen to be less risky.

Senator MARK BISHOP: If this government or successive governments continue to run this country at a fiscal level in ways that are highly regarded and a range of European countries continue their unsatisfactory practices and harm is visited upon them by the markets, would you anticipate that that differential risk premium that Australian banks pay to borrow offshore would come down over time?

Mr Munchenberg : In relative terms. Take that as a good example. If something dramatic were to happen in Europe—and we cannot rule this out, unfortunately—the risk premium for everyone would go through the roof. If Greece were to exit or if the Spanish government were to suddenly demand a bailout, or whatever event may occur in Europe, the risk premium for everyone would go up. The price of money for Australian banks goes off up because everyone becomes much more risk averse. But it remains a relative thing, and the relative thing is an important thing for us. Careful management of the Australian economy is critical to giving us that relative advantage compared to overseas.

Senator CAMERON: You have mentioned Spain a couple of times. Why do you keep mentioning Spain? What is the point of Spain in this?

Mr Munchenberg : The Spain is the current point of vulnerability in a very vulnerable situation in Europe. We are still in the Greek episode, if you like. We have seen the Portuguese and the Irish episodes. The attention of policymakers, central banks and markets is on whether Spain is the weak link. The situation in Europe is a bit like a house of cards in a hurricane—you know it is an unsustainable situation, you just are not sure whether it is going to collapse or what is going to cause it to collapse, and you hope that it will not collapse. But that is a situation that we are in.

Senator CAMERON: What was Spain's fiscal situation prior to the GFC?

Mr Munchenberg : The core of the European problem has been spending more money than they earn and funding their investments and expenditure through debt. Countries like Spain, and we particularly saw it with Greece, that were bundled in with the rest of Europe in regard to the exchange rates and interest rates were able to access money a lot more cheaply than they would have been able to on their own two feet. As a consequence, with hindsight they have exploited that opportunity to run up large debts, which they are now not in a position to be able to repay.

Senator CAMERON: You know that is a completely wrong analysis of Spain.

Mr Munchenberg : Is it? Why?

Senator CAMERON: Spain had a fiscal surplus. Aren't you aware of that?

Mr Munchenberg : In the case of Spain, it was through the banking system—like Ireland, it was through the banking system. The Irish government—

Senator CAMERON: So the banking system was the problem; it wasn't the fiscal position of the government.

Mr Munchenberg : Sorry, I stand corrected on that. In the case of Spain, in the case of Ireland and in the case of Greece, it was government spending. In the case of Ireland and Spain, they were not able to sustain the bailouts of their banking systems.

Senator CAMERON: How can you say it was excessive government spending in Spain when they had a fiscal surplus?

Mr Munchenberg : I just accepted your correction on that.

Senator CAMERON: All right, I hope the rest of your evidence is more accurate than that. If you cannot get it right that the problem in Spain was a huge amount in the banking system and not the fiscal position of the government, I am worried about your analysis.

Mr Munchenberg : We have the situation in Europe that is a combination of governments running up debts that are now unsustainable directly—

Senator CAMERON: Maybe you shouldn't keep digging if you don't know the issues.

Mr Munchenberg : and governments being put in unsustainable positions because their banking systems had run up debts that were unsustainable and investments that proved to be unsustainable.

Senator CAMERON: Okay. So you do not really know what is happening in Europe. You do not know the history of it, that is clear. The role of banks in broad terms, I suppose, is to provide a payment mechanism, manage risk and make loans. That is broadly what banks do. Your recommendation to this committee is that we should not take any steps too quickly, we should basically put a freeze on further legislative change on banking accountability—is that correct?

Mr Munchenberg : No. We have asked the committee to consider the fact that we have and continue to deal with a lot of regulatory change at the moment. It would be naive of us to expect that there will be no further regulatory change if further regulatory change is merited on its own individual circumstances. But we to believe that there is merit in allowing the large amount of regulatory change we have seen from those three levels over the last few years to work through the system before we feel the need to make further fundamental change.

Senator CAMERON: Are you aware of the paper that has been prepared by IOSCO in relation to securitisation?

Mr Munchenberg : Only in broad terms.

Senator CAMERON: Who in the banking industry looks at these things in detail? To whom can we ask questions about IOSCO in the banking industry? If you are only aware of things in broad terms, who is actually monitoring this?

Mr Munchenberg : There will be a lot of people who are experts in these areas. If you have questions specifically on securitisation or the IOSCO work in this area, we are happy to take those on notice and get those experts to look at those. If you wish to discuss the matter with experts, we are happy to put you in touch with those experts.

Senator CAMERON: IOSCO have indicated that there should be a more effective alignment of interests regarding securitisation. The banks had to have some skin in the game. Is that a reasonable proposition?

Mr Munchenberg : That has been regulated here anyway.

Senator CAMERON: What about disclosure standards? IOSCO are also looking at disclosure and improving disclosure standards.

Mr Munchenberg : Our regulators here have looked at the securitisation market and the performance of the securitisation market, conscious that it was securitisation that spread the risks from the US subprime situation around the world. I am sure they have made changes in that area. ASIC will continue to be engaging in those securitisation discussions through IOSCO. The chairman of ASIC next year will become the president, I think, of IOSCO, so they will be very aware of it. They will look at the extent to which the international discussions are pertinent to Australia and I am sure that if they feel that further changes are needed in those areas, they will put forward propositions for change.

Senator CAMERON: And if there are further changes required through IOSCO, government should move to legislate fairly quickly on those?

Mr Munchenberg : I do not think that just because something is determined at an international level we have to automatically assume that it is appropriate to Australia's circumstances. A lot of those discussions internationally are heavily influenced by occurrences in the US and Europe. I think it is very important, and our regulators have done well with this, to make sure that in looking at those discussions and at the conclusions of those discussions, we look at the appropriateness of those conclusions to the Australian context. We do not need to continue to solve problems in Australia that we do not actually have because there have been serious problems in other jurisdictions.

Senator CAMERON: People like the Nobel prize-winning economist Joe Stiglitz, with many of his colleagues, has done an analysis of the problems of the global financial crisis. In fact, it was Stiglitz who pointed out that the Spanish government were running a fiscal surplus as distinct from what your position that they were fiscally—

Mr Munchenberg : Senator, you have very cleverly picked me up on a small but not insignificant factual matter.

Senator CAMERON: It is a big fact, I think.

Mr Munchenberg : I hardly think it is going to change the nature of the world, but—

CHAIR: I have just checked it. I do not know about the fiscal surplus in terms of any one year, but as at the beginning of—

Senator CAMERON: If you do not know that, you should not be in the chair.

CHAIR: In 2007, the debt that was a percentage of the GDP was 37 per cent.

Senator CAMERON: But they were running a fiscal surplus.

CHAIR: But they were heavily in debt, and I think you were right—

Senator CAMERON: I know you like defending the banks.

CHAIR: No. If you were maligning a witness—

Senator CAMERON: I know the coalition love defending the banks, but you should just butt out. I do not interrupt you.

CHAIR: No, I let it go initially, but when you were haranguing a witness—

Senator CAMERON: If you want to take it down another path then that is okay.

Senator WILLIAMS: Point of order, Chair. Senator Cameron remarked to you that it was the coalition that defended the banks, but it was the Labor Party that voted against this inquiry in the Senate.

Senator CAMERON: I exclude the Nationals from that. You will have to—

Senator WILLIAMS: Hang on, we are part of the coalition. You voted against the inquiry, Senator Cameron; now you are here rolling it.

CHAIR: That is not a point of order. Senator Cameron, I am happy for you to raise the point, but just get the facts right.

Senator CAMERON: You chair the meeting and I will get on with asking my questions.

CHAIR: Please proceed.

Senator CAMERON: Experts like Stiglitz broadly argue that you have to curb excessive risk-taking in the too big to fail and the too interconnected to fail financial institutions. Are you saying the too big to fail proposition does not apply in Australia?

Mr Munchenberg : I think you are drawing a rather long bow there. I am not suggesting that at all. I have not had a chance in the last five minutes to suggest anything—

Senator CAMERON: I am asking; I am not suggesting.

Mr Munchenberg : Obviously, we have a situation in Australia where the collapse of one of our larger banks would be catastrophic and that is why we have such close and tight regulation and such close and tight supervision, and why APRA imposes additional capital on those banks. This issue of domestically significant financial institutions is being looked at internationally. APRA is waiting to see what the international conclusions are before looking at the extent to which they are relevant to Australia and APRA will form a view about what needs to be done.

Senator CAMERON: He also goes on to say that there should be restrictions on leverage and liquidity.

Mr Munchenberg : We have new liquidity requirements coming in through the Basel III exercise. We have leverage requirements that are tied to that. We have a lot of regulation dealing with a lot of these points already.

Senator CAMERON: He says that we should make banks more transparent, especially in the treatment of over-the-counter derivatives.

Mr Munchenberg : Over-the-counter derivatives are going to have to be essentially cleared so that regulators are able to track who holds those derivatives.

Senator CAMERON: He says to make the banks and credit card companies more competitive to ensure that they act competitively. I suppose some of the rates on credit cards are very high in Australia.

Mr Munchenberg : There is quite a range of rates on credit cards. Fortunately with the internet it is very easy to find the cheaper ones if that suits your purposes.

Senator CAMERON: What are the cheaper ones? What is that per annum?

Mr Munchenberg : The range broadly is between 10 and 20 per cent.

Senator CAMERON: So it is not towards the bottom of the market.

Mr Munchenberg : Given that a mortgage secured by a property is around seven per cent, 10 per cent on an unsecured debt is not a bad deal.

Senator CAMERON: What about fees? Mr Stiglitz says that there should be legislation to make sure that banks cannot impose large fees on transactions.

Mr Munchenberg : Banks do charge fees—that is partly how we charge for our services—but we have reduced fees for Australian households by over a billion dollars over the last couple of years.

Senator CAMERON: He says we should make it more difficult for banks to engage in predatory lending.

Mr Munchenberg : I am not aware that the banks in Australia engage in predatory lending. I am certainly not aware of any regulatory concerns.

Senator WILLIAMS: Point of order, Chair. To clarify, did you say you have reduced bank fees by a million or a billion dollars?

Mr Munchenberg : A billion.

Senator CAMERON: I think both Senator Williams and I have examples that we would want to raise of what people consider to be predatory lending and unfair practices—banking practices that could be called into question.

Mr Munchenberg : I will not be in a position to answer any particular cases because I will not be familiar with those cases. If there are concerns then those concerns need to have some light shone on them and they need to be examined. We are aware that things were done that should not have been done—for example, in the case of the Storm Financial situation.

Senator CAMERON: Not just them.

Mr Munchenberg : Yes. We are not pure, but also I do not think we have a systemic problem with predatory lending. It is not actually in the banks' interest to lend money to people who cannot repay it.

Senator CAMERON: So he goes on to say there are four issues in relation to risk that banks are engaged in. One is organisational incentives in banks that push much of the risk on to government—because you are too big to fail.

Mr Munchenberg : The government did have to wear some risk, in theory at least, when they guaranteed wholesale funding through the GFC—a risk for which they have earned probably some $3½ billion by now for the government's coffers.

Senator CAMERON: We should have been paid for the risk that we took.

Mr Munchenberg : Absolutely. We do not dispute that. My smaller members dispute the amount that they were charged, and I think with some reason, but we do not dispute the fact that that was a risk that the government was taking and that they should therefore be rewarded for that risk. Banks actually understand the concepts of risk and reward, although overseas evidence would suggest not always as well as they should.

Senator CAMERON: The other issue that is raised is individual incentives—what is described as agency problems—those inside the bank having incentives that encourage risk-taking. I suppose one of the areas that government would have to be concerned about is some of the massive incentives paid to executives in banks to grab short-term profitability. What analysis has been done on that by your organisation? What changes are going to take place, if any?

Mr Munchenberg : I dispute your premise that executives have massive incentives to make short-term measures. Why would boards want to incentivise people to make short-term gains at longer-term cost? Your own government has been looking very carefully at all of these sorts of issues and has taken measures against commissions, for example, and the Future of Financial Advice is continuing to look at a whole range of these sorts of issues. I would say that that is a matter that is currently being looked at by the government.

Senator CAMERON: So, taking a decision on commissions as an appropriate decision to make sure that there are not improper individual incentives?

Mr Munchenberg : We did not object to the changes around commissions, in terms of the principle that a person who is acting on behalf of a client should have that client's interests at heart, not their own.

Senator CAMERON: Are you saying that there are no individuals in the banking system in Australia with incentives to increase risk-taking?

Mr Munchenberg : I do not think any of the people in the banks are incentivised to take risks. They may be incentivised to sell products as part of their remuneration, and we need to be very careful about that, obviously. They may be incentivised to grow their businesses, as most businesses are indeed set up to do. They are also carefully managed internally by their boards which look very carefully at the risks, particularly in the current climate in which the banks are running, and we have in APRA a very capable world-standard regulator that is constantly monitoring the risks being taken by banks. If they have any concerns about those, they are not at all shy about raising those concerns, and indeed have the power to penalise banks they think are taking undue risks by increasing their capital charges to counter any incentives that there may be.

Senator CAMERON: So there is no problem with risk-taking in the banking industry?

Mr Munchenberg : I think the experience of the last five years has shown that, overall, our banking system has got the right balance between risk and reward.

Senator CAMERON: That is the last five years. We are still paying the price—

Mr Munchenberg : Over the last 10 years, over the last 20 years. You are starting to stretch my memory beyond that.

Senator CAMERON: The other argument is that there is a bit of self-selection going on in the banking sector. That is, the people who like risk-taking move to the banking industry because it is an area of risk-taking. Have you seen any of that?

Mr Munchenberg : Banking is an area of risk. Every time we give a customer a home loan, a credit card or a business loan, we are taking a risk. That is why we are rewarded for intermediating those funds. I also do not see risk-taking per se as a problem. Entrepreneurs take risks all the time. Small businesses that put their houses on the line to get money to build a business are risk-takers as well.

Senator CAMERON: I suppose a lot of people would disagree with you in terms of the benefits of risk-taking, given the global financial crisis.

Mr Munchenberg : That is where risk-taking has not been done well. My point is that risk-taking per se is not a negative thing. People getting it wrong, people having the wrong incentives, regulators not supervising risk as well as it is supervised in Australia—those are the things that are problems, not risk-taking per se.

Senator CAMERON: The association and your members, I suppose, discuss risk and the issues of risk quite a lot?

Mr Munchenberg : No.

Senator CAMERON: You do not?

Mr Munchenberg : Our members discussed very few of those sorts of things between them, because they are areas of competition as well as areas of how you manage your bank and manage your risks. If, for example, APRA is proposing some measure across the industry, we would certainly discuss that with the banks and APRA.

Senator CAMERON: Have you heard of 'pervasive irrationality'?

Mr Munchenberg : I have not.

Senator CAMERON: It is defined as those in the financial sector systematically underestimating risk and their investors not understanding the risk of leverage and underestimating its consequences. Is that something that applies in Australia?

Mr Munchenberg : If that were something that applied in Australia, we would have absolutely found out in the last few years. Our banking system in Australia and banking systems worldwide have been through the most robust and thorough stress testing over the last few years you could possibly imagine. Many of those systems and many of those banks have fallen short. Ours has not. That is not to say that we should not be looking at the lessons for Australia from the experience of those overseas or, indeed, our own experience here. If I can characterise what I think I hear you saying: your attempts to introduce into Australia the problems that are at the core of the global financial crisis overseas I think flies in the face of the fact that it was not through accident that our banking system did as well as it did; it was through careful management of risk in Australia and very good regulation and supervision—all of which was in place before the GFC. Should we look at improving on that? Absolutely, and we have been over the last couple of years. The government has introduced a whole range of measures and a whole range of measures are coming from offshore.

Senator CAMERON: So we were ahead of, say, the US in regulation?

Mr Munchenberg : In terms of our management of the risks, clearly.

Senator CAMERON: So it is a good thing to be ahead of the field in regulation?

Mr Munchenberg : It can be a good thing, but all regulation comes at a price and what we have to do is strike a balance. We can have an incredibly stable banking system by not allowing them to take any risks at all. That would mean not allowing them to lend. The costs of that would obviously far outweigh the advantages of stability. So there is always a balance between stability and risk-taking and between stability and competition.

Senator CAMERON: So you accept the need for regulation. You would not argue that the market in the banking industry is self-correcting, would you?

Mr Munchenberg : I do not think it is an either/or proposition. We are one of the most closely regulated industries in Australia. Just because regulation has helped to keep us safe does not mean that all regulation is therefore good, and just because markets deliver benefits does not mean that all markets are good either. There is always a balance between these things. Through the GFC we have broadly got the balance right. That is one of the reasons we did so well relative to others. Our argument would be: let's not lose that balance by trying to deal with problems that we do not have but they do have overseas. We need to strike that balance. I think the government has done a very good job at doing that.

Senator CAMERON: The banking system is an international banking system. There are international links and connections all over the place. You guys play in the international scene. You borrow internationally; you lend internationally; you operate—

Mr Munchenberg : We are regulated internationally.

Senator CAMERON: There is a lack of regulation internationally that caused the global financial crisis. I suppose it is a bit like: you reap what you sow. You are part of the international banking system, and because we have done it a little bit better here does not mean that we should not take into account the issues that Basel III are putting in place and the analysis that is taking place.

Mr Munchenberg : We are putting Basel III in place and we are largely willingly putting in Basel III in place. We have had some technical issues and we have a disagreement with APRA, which is fine, because APRA gets the final say, about the pace at which some of those changes have been made. As I have said several times, we absolutely need to learn from the lessons of overseas, but just because banks and bankers and regulators failed in some other jurisdictions and therefore need major overhaul to their regulatory systems does not mean that that is the appropriate situation for Australia. Thank you for your questions.

Senator WILLIAMS: Gentlemen, thank you for being here today. Mr Munchenberg, how many banks do you represent with the ABA?

Mr Munchenberg : Twenty-four.

Senator WILLIAMS: Big and small?

Mr Munchenberg : Yes.

Senator WILLIAMS: Your smaller banks obviously find it hard to compete because of their cost for funds. If they could have wholesale funds from overseas and be rated like the big four, they have to pay more for overseas money—is that correct?

Mr Munchenberg : They tend to be less reliant on overseas money, but there is no doubt that over the last few years the smaller banks have felt the funding pressures more severely.

Senator WILLIAMS: I want to take you to a few things, because time is limited. Are low doc and no doc loans still being issued by some of the banks?

Mr Munchenberg : If by that you mean—

Senator WILLIAMS: I mean, if someone has a house worth $1 million, they go to the bank, they get a $400,000 loan, a few questions are asked, it is approved, the bank takes security of the title of the house—just low doc or no doc. Are they still out there in the system?

Mr Munchenberg : I am not aware of them in the terms that you have just described. Low doc loans were very much aimed at those people who do not have a regular income, who are self-employed or a contractor, and therefore did not meet the traditional banking approach of identifying your income and everything. I do not think that the scenario you have given me would be able to exist, simply because we have responsible lending obligations. We have legal obligations to make sure that you are in a position to manage the loan that we are giving you.

Senator WILLIAMS: Is it mainly the smaller banks that sell off their loans in securitisation, not so much the bigger banks—is that correct?

Mr Munchenberg : Not entirely. It depends on how you look at it—not in terms of the percentage of the securitisation market, where the major banks are still very active players, but in terms of the importance of securitisation as a way of continuing to fund your bank. It is certainly a more important source of renewing your funding for smaller banks than it is for majors.

Senator WILLIAMS: My concern is that, when some of the banks sold off their loans to AOFM—and some of them may have been low doc loans or no doc loans and not very good loans, if I can put it that way—was there any way of drafting up the quality of loans that were sold to the Australian Office of Financial Management? How do they do it? Do they just say, 'This section is going off to bring more money in for us to lend,' or do they segregate them or classify them? My concern is that the taxpayer is being dumped a bundle of bad loans.

Mr Munchenberg : I have not had that put to me by anyone else.

Senator WILLIAMS: We can put it to AOFM when we have them in front of us.

Mr Munchenberg : The way these things normally would work is that you bundle up a whole pile of loans so that you can get the money for the loans and continue to lend to new people. In that bundle of loans there will be loans of mixed character, if you like, but ultimately that bundle of loans has to reach a certain standard. There is going to be an assessment of the risk of some of those loans going bad. That is the basis of the whole system. I am not aware that there has been any suggestion that any of the loans that AOFM has taken out have got—

Senator WILLIAMS: We will go through it with them. Just looking ahead, do the banks in Australia have enough money to meet demand under the current situation, with the crash of securitisation increasing cost of wholesale funds? Sure, domestic deposits have increased to 60 per cent, I think, to some of the banking institutions. What I am asking is: is there any shortage of money to meet the market in Australia?

Mr Munchenberg : No.

Senator WILLIAMS: Good.

Mr Munchenberg : Money is obviously a lot more difficult to get and is more expensive at the moment, and that is one of the reasons we are seeing banks so hungry for deposits and paying so much for deposits. But at the moment demand for both business credit and household credit is also subdued, and the growth in demand for credit at the moment is being funded out of the growth in deposits. So in terms of growth we are actually saving at a greater rate than we are demanding credit at the moment.

That is the situation at the moment. Going forward we do not know what is going to happen with demand for credit and savings behaviours in Australia. In the longer term there is a question about the extent to which the Australian economy relies on overseas money—

Senator WILLIAMS: You say there are concerns about that?

Mr Munchenberg : I think it is an area where we would be foolish not to be—not because it is a current problem and not because it is an imminent problem but, looking at the growth and putting aside the current unusual set of circumstances, if you go back to pre-GFC demand for credit and pre-GFC savings rates, which we may never go back to, that growth, and the amount of money that the banks had to raise overseas, was very strong. There are legitimate questions about whether that is a growing exposure to overseas situations and what it is that we might need to do. It goes back to Senator Bushby's earlier question about whether government policies have been put in place to moderate that growth. I think that is the discussion we need to continue.

Senator WILLIAMS: Is that where we might need a tax incentive from the government to encourage super funds to invest more money with their domestic banking systems?

Mr Munchenberg : Those are the sorts of things that we were talking about before.

Senator WILLIAMS: In other words, borrow our own money from the super funds instead of borrowing from overseas?

Mr Munchenberg : Provided banks are able to offer appropriate investment opportunities to our super funds, absolutely—

Senator WILLIAMS: Exactly.

Mr Munchenberg : not just directing the money from one to the other.

Senator WILLIAMS: Lastly, I rang you several months ago about sending receivers into family farms.

Mr Munchenberg : You did.

Senator WILLIAMS: It was a catastrophe that was going on where a receiver went into a family farm, the farmer being removed from the land, and the receiver had no idea how to look after livestock. Sheep were dying. Sheep were sent to market in disgraceful conditions. I asked you to send that message out to the banks that you represent. It is all right in the corporate world where the management remains in place, but when you kick the family farmer off the farm the receiver does not know how to look after sheep, worms, flies, and all the problems with weed control in the paddocks et cetera. What was the response from the banks when you forwarded my request for not sending those receivers into family farms?

Mr Munchenberg : I certainly passed that message on; I am sure they are diligently watching now and they have just heard that message again. The message was noted but I have not had a response back from any of the banks.

Senator WILLIAMS: If the RSPCA had seen what happened in this case I have referred to then someone would have been in real trouble.

Mr Munchenberg : That is very understandable. I understand the issues very well; we have, as you say, discussed them on a number of occasions at length, and I am absolutely convinced that the banks are very much aware of them. As to what they are doing about that or whether they share your concerns or your views I do not know. That is a matter you will have the opportunity to raise with each of the major banks when they appear before you.

Senator EGGLESTON: I am interested in Bankwest and some of the issues around it. Prior to the GFC as part of its east coast expansion Bankwest was seemingly trying to attract small-business and property development borrowers that other banks would not touch. A number of submitters noted that Bankwest was the only bank that would consider their applications. How does the ABA view Bankwest's lending practices prior to its takeover by the Commonwealth Bank?

Mr Munchenberg : I am sorry, I am not in a position to express any opinion because I do not have that information. We do not look at individual banks' commercial operations or their risk appetites; our concern is the industry as a whole.

Senator EGGLESTON: If that is the case then it probably precludes you from answering the other questions I have relating to Bankwest. Would you agree?

Mr Munchenberg : I can only talk in general terms. I am happy to attempt to answer your questions, but in terms of the extent to which they are specific to one bank I am not really going to be in a position to provide you with any responses.

Senator EGGLESTON: I have some other questions which are not to do with Bankwest specifically, although they might, in fact, have related to it. Nevertheless, what is the justification for charging penalty interest to small-business borrowers of up to 18 per cent? What sort of circumstances would justify that?

Mr Munchenberg : We were discussing risk pricing earlier, and that would be a case of where the bank perceives there has been a fundamental shift in the risk of the loan, for whatever reasons, and they reprice accordingly.

Senator EGGLESTON: By terminating loans to small-business customers when they are in trouble, can banks, in fact, generate more income through tax write-offs and insurance claims than they would if they were to allow the borrower to restructure and find a way to repay their debt?

Mr Munchenberg : I very much doubt it. Despite public opinion at times, the last thing banks want is for a loan to go bad and to have to call it in. The last thing they want is to have to deal with their assets. As Senator Williams has indicated in his view, they do not do that very well at times. We do not want people's farms, businesses or houses; we want them repaying their loans—it is how we operate.

Senator EGGLESTON: I have some questions about Basel III. In his submission, Professor Moosa from RMIT argues that Basel III ignores the lessons of the GFC because it is still capital based regulation. It still allows banks to calculate regulatory capital by using internal models because the rating agencies are still involved. What is your view of that criticism of Basel III?

Mr Munchenberg : Basel III is very much about making sure that banking systems in individual banks have resilience if things go wrong through either capital and liquidity—capital being the money you need to absorb losses and liquidity being the money you need if there is, effectively, a run on the bank or some issue similar to that. Basel III is not intended to de-risk banks but, certainly in the way APRA approaches these things, the riskier you are perceived to be the fair judgment is that the more of a buffer you need if things go wrong. APRA will look very carefully at bank risk profiles, and if they have concerns they will obviously express those to bank management. Ultimately, APRA has the ability to acquire additional capital. Holding capital is expensive for banks, so there is a financial penalty for banks becoming more risky than APRA is satisfied with.

The biggest lesson for Australia out of the GFC was how important supervision by regulators is—not just the rules but also having the rules properly supervised and having a quality regulator who can do that. We have that, some would say, in part because of the HIH problems 10 years before. This is a reward, if you like, for Australia dealing well with those concerns back then. Increasingly, it has been accepted internationally that it was not a regulatory failure so much as a supervision failure that allowed the GFC to occur.

Senator EGGLESTON: I think that is the generally accepted view. Where, then, does Basel III come into effect? Australia came through the GFC very well essentially because of the way our banks were regulated, supervised and so on. Is Basel III really going to provide a more secure banking system worldwide?

Mr Munchenberg : It will provide a more secure banking system worldwide, yes—no doubt. Will it prevent future financial problems? I do not know that anything can prevent future financial problems. We are dealing with an industry which is dealing with risk, and everything prudent and appropriate and farsighted that we can do to ensure that we never have another experience like the GFC needs to be done, recognising that all of that comes at a cost and that we need to balance that.

One of the issues in Europe at the moment, for example—and which I do know something about, Senator Cameron—is the dilemma the European banks have where they need to increase their capital to make them stronger.

Senator CAMERON: I hope you are sure about that.

Mr Munchenberg : I am reasonably sure, but I will check on Wikipedia afterwards. The European banks need to increase their capital at a time when they are also under pressure to continue lending because the economy in Europe is struggling as well. We keep getting back to making sure we have the right balance, and our fundamental point is that in Australia we have a good balance; that does not mean we cannot finesse or continue to improve it, but, equally, we do not want to lose the positives we already have.

CHAIR: Thank you to the Australian Bankers Association.