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ECONOMICS REFERENCES COMMITTEE
09/02/2011
Competition within the Australian banking sector

CHAIR (Senator Bushby) —Good evening. I declare open the sixth hearing of the Senate Economics References Committee’s inquiry into competition in the Australian banking sector. The committee had originally planned to hear from Queensland witnesses in Brisbane on 24 January, but, recognising the difficulties the terrible flooding would cause for witnesses, the committee decided to postpone that hearing until March. I am pleased that the CEOs of the two Queensland bank who could not attend on the day of the rescheduled Brisbane hearing are able to be with us this evening.

These are public proceedings, although the committee may determine or agree to a request to have evidence heard in camera. I remind all witnesses that in giving evidence to the committee they are protected by parliamentary privilege. It is unlawful for anyone to threaten or disadvantage a witness on account of evidence given to a committee and such action may be treated by the Senate as a contempt. It is also a contempt to give false or misleading evidence to a committee. If a witness objects to answering a question, the witness should state the ground upon which the objection is taken and the committee will determine whether it will insist on an answer, having regard to the ground which is claimed. If the committee determines to insist on an answer, a witness may request that the answer be given in camera. Such a request may of course also be made at any other time. I welcome our witnesses. Would you like to make an opening statement?

Mr Foster —Yes, thanks very much, and thanks for the opportunity to appear before the committee. We will be happy to take some questions, but first I would like to make a few comments about matters relevant to this inquiry. The events of recent years have fundamentally changed the dynamics of competition in banking. The terms of reference for this inquiry are particularly pertinent for our bank, due to the unique size and nature of our business in the Australian banking sector. As the largest of the second-tier banks, Suncorp Bank is the natural proponent to facilitate competition and is best placed to contribute to this debate and support solutions. We are in a stronger position than any of our non-major peers, but the last couple of years have been enormously challenging for all non-major banks.

As the only remaining A-rated retail bank, we know all too well the effect that the GFC has had on competition. This really was driven by funding. Pre-GFC, our cost of funds was only 10 or 15 basis points greater than the major banks. It is now up to 80 basis points more than what the major banks pay. The other regional banks pay an even wider differential on their funding. One of the key impacts of the funding issue was consolidation. Bankwest and St George have become parts of major banks, leaving Suncorp Bank as the largest regional, occupying a unique space between the majors, with their AA ratings, and other regional banks, which have BBB ratings.

Among the non-bank financial institutions we have also seen consolidation, with the major banks taking ownership of mortgage originators. Aussie is now a third owned by CBA. Wizard and the GE mortgage book are owned by NAB and RAMS is with Westpac. There are seemingly a number of participants in the market right now, many of them owned by major banks, due to consolidation in recent years. For the independent providers remaining, at question is their ability to offer a sustainable, competitive proposition going forward. The ability of the second-tier sector to offer long-term, sustainable, competitive consumer propositions is bound by a constrained and expensive funding market. That is a real risk to the competitive landscape going forward.

For Suncorp Bank, we have had to adapt. We have a larger balance sheet and a higher credit rating than other regionals but a lower rating than the majors. We believe that we have responded appropriately to the changing funding markets and competitive dynamics and as a result we have driven significant change in the shape of our bank over the last couple of years. The bank we operate today is far different to the organisation that it was in 2008, and this is as a result of changing funding dynamics, highlighting the criticality of funding in competition. The global financial crisis led to a series of events which served to strengthen the position of the market and the power of the major banks, at the expense of regional banks and non-bank financial services institutions. The gap between the cost of funds for major banks and that of all other financial services institutions has been greater in the past few years than for decades prior to the GFC. It does threaten to drive further consolidation and a further reduction in competition.

Current domestic and global industry dynamics are a further threat to competition. The competitive reform package announced in December by the government is a step in the right direction, but the key to competition is funding. In RMBS, continued support for this will be essential for a sustainable, competitive system. There are various measures that provide some support for this, but the full impact will need to be monitored over time. Likewise, the proposed introduction of covered bonds may provide additional sources of funding for Australian banks. But what impact it will have on enhancing competition is not known, given that the major banks will be able to source funding at a cheaper rate than the smaller regional players.

The Basel III package has also recently been released, and it was pleasing to see the efforts of government and regulators to put in place measures that reflect the differences of the Australian financial system versus other global markets. It is important to note that such industry reform, national and international, does carry an administrative and regulatory compliance burden which inevitably adds cost to the system and then, likely, consumers.

Whilst, as I said, we believe most of the initiatives announced are a step in the right direction, there are two areas I would make comment on. The proposed removal of exit fees is not a measure we believe will enhance competition. It is the smaller, non-bank lenders that will be hurt most by this. For the majority of banks, the deferred establishment fee was put in place as a competitive response to reduce the upfront albeit legitimate costs of taking on a new mortgage. In addition, the proposed legislation against price collusion stops the industry commentating and commenting on interest rate and market movements, preventing education of the community about interest rates and the factors that go into product pricing and exacerbating a one-sided debate.

We believe that the key objectives of enhancing competition and advancing any reforms should be to deliver enhanced funding diversity and system stability, the creation of securities that meet eligible liquid asset rules under the new Basel framework and cost-effective funding for the economy. We believe there is a significant opportunity to reduce the cost of funding for the industry and for consumers by leveraging the significantly untapped value of the residential mortgage collateral. There are solutions that exist and there are models for funding that could be adapted to the Australian environment. These could achieve a lower cost industry funding model while balancing the inherent public sector risk in ensuring the orderly functioning of the banking industry.

One option, similar to that in the Canadian system, would be to enable banks to access government guarantee for RMBS issuance for a fee, effectively creating a new class of security which would be seen by investors as an Aussie government guaranteed mortgage bond. This would supplement Australia’s low bond issuance volumes and provide significant liquidity to the important RMBS market. It would lower industry funding costs and provide the public purse with a revenue stream for any exposure it had to ensure a functioning banking system in a crisis scenario.

We think there are also some other opportunities to support competition through taxation reform to increase or eliminate the cap on concessional taxation treatment for bank deposits—where, currently, above the cap, depositors pay tax on the inflation component of their return—via further superannuation reform to encourage a greater proportion of fixed interest investments by superannuation funds, via removal of the fee differential on government guaranteed wholesale funds that still exists, via broadening government account holdings and investment mandates to include non-major banks, and via improving the ability to switch banks. Research certainly shows that consumers would prefer to bank with a regional, but the impediments to switch are significant. It is important to be mindful of the costs that would be associated with any switching.

Clearly, any changes need to be well thought through to avoid unintended consequences, such as further impacts on competition or additional cost to consumers. The government wholesale guarantee, while a necessary move at the time, had the unintended consequence of creating a greater funding gap between the majors and all other banks, further consolidating the position and market power of major banks at the time.

Another matter requiring careful consideration in relation to its impact on competition is the transition to the financial claims scheme and the expiry of the current government guarantee on retail deposits later this year. We still see significant volatility in financial markets. This transition must be handled well and the interests of smaller organisations protected. If not, this too could have a significant and adverse impact on competition given the reliance particularly of non-major banks on retail deposits to enable them to fund new lending. But we have the opportunity to put measures in place to ensure that there are increased competitive landscapes and alternatives for the Australian consumer. Well-constructed measures will ensure and avoid unintended consequences.

I am strongly of the view that competition initiatives should support multiple smaller banks and non-bank financial service institutions rather than simply replicating another big corporation or a fifth pillar. It is in the best interests of consumers and our economy for a robust, multitiered banking system to exist. Access to a variety of liquid funding markets will support this.

We certainly welcome the opportunity to continue the dialogue to support a more competitive banking system for the benefit of consumers. We would be very happy to take any questions the committee has.

CHAIR —Thank you, Mr Foster, for your opening statement. You have raised a lot of issues and, in particular, made a lot of suggestions as to how we could move forward, most of which probably were not addressed in your written submission. I was going to ask whether it is possible to have a copy of your opening statement now so that senators can look at it and ask questions if there is a need to do so.

Mr Foster —We can certainly provide that.

CHAIR —Thank you. As I said, you did raise a lot of issues, so we will try to deal with those in the time that we have got. You mentioned that, prior to the GFC the difference between you and the majors in terms of your funding cost was about 10 to 15 basis points and it is now about 80 or 90, but with the other banks it is wider than that. I presume that you had a funding advantage because of your A status prior to the GFC, and you still maintain that. Does that give you an ability to compete better compared to the second tier? Obviously the big banks have had an opportunity to consolidate their market share and improve it significantly as a result of events over the last two or three years. Because of your relative advantage over other, smaller players, have you had the ability to do the same thing within your space?

Mr Foster —There are probably two issues. For clarity, pre the GFC, given the broader market pricing, there was very little differential based on credit rating between organisations, so there was not too much difference—as I said, 10 to 15 basis points, and the BBB banks were a little bit wider than that but reasonably narrow. As it exists now, we do have some advantages over our BBB counterparts based on our A-plus credit rating, which I guess provides us greater access and depth to a number of funding markets that are not accessible to the BBB, not to the same extent as the major banks with a AA rating. I mentioned covered bonds in the commentary. There is an opportunity there, we believe, but yet to be tested, that we may be able to access covered bonds to supplement our funding position.

CHAIR —Would you be able to do that on your own?

Mr Foster —We believe so.

CHAIR —Evidence we have had suggests that the issue of covered bonds needs to be in the order of $350 to $400 million to actually go ahead. That is something of a size that Suncorp could manage on its own.

Mr Foster —I think that is possible for us to do on our own. A couple of things to consider is that, which relates to the size of the organisation and rating. The other is, based on ratings, there is likely to be a phased ability for players to access that market. Anthony has been involved in the industry working group on funding alternatives, so I might see if he has anything to add.

Mr Rose —No, not at the moment; I think you have covered it.

CHAIR —In talking about consolidation, you also mentioned that there are a lot of players in the market but that a lot of them are owned by the majors. We have had evidence that there are an awful lot of people out there in the market offering mortgages—there was a suggestion that there were over 100, from memory. How many of those are genuine, in terms of being genuine competitors to each other? What proportion of them are less likely to be aggressive in competition? Does that number of 100 show that we have real competition in the mortgage market?

Mr Foster —I think the point to make is that certainly there are a lot more people in the market that are associated with or owned by the same institutions, which perhaps was different to what existed previously. The other factor is that the ability, particularly of smaller institutions such as a number of the regional banks, to compete has been constrained. And it is a little bit different by different markets. If you look at the deposit market, the regional banks have probably led the market in terms of competitive pricing on deposit offerings because that is a source of funding that the regional banks have been able to access readily in a constrained funding market more broadly, so that certainly has been a very competitive market, led essentially by the smaller banks and smaller players.

If you look at the lending side, that is an area in which the various things that have occurred during the past two years have enabled a number of the major banks to really strengthen and consolidate their position, through pricing and availability of funding, to aggressively grow those books. Whilst a number of players have stayed in the market over that period, their ability to compete aggressively during that period and uncertainty around both pricing and access to funding have constrained their ability to do that. I think that is the residual question that remains, particularly for smaller, lower rated organisations. They are in the market presently, but what is their ability to compete over the medium term if there is not certainty and efficiency in the market in terms of provision of funding?

CHAIR —You mentioned that Suncorp has had to change and adapt over the last couple of years. Does that mean that you have moved away from securitisation and looked at other sources of funding? What has Suncorp actually done to be able to do that, and how has that affected your share of the market?

Mr Foster —Some of the key pressures that we saw through the GFC were the cost and availability of funds, and that drove a couple of things. In terms of our ability to compete in particular markets, particularly the corporate banking market and the like, we made some decisions very early on. We did not believe we would be able to compete on a funding differential that existed at the time. We therefore made the decision to exit and run down those portfolios. The other catalyst, I guess, is that at the time we had a lower proportion of retail deposits funding our loan book. We had a higher proportion of short-term wholesale money, with offshore money and term debt supplementing that funding position. Just based on the change in dynamics of funding markets and so forth, we have essentially split our lending book in two to a piece that we do not think we can be competitive in on a go-forward basis. We essentially used the wholesale funding guarantee to fund that book and run it down. For our business that we are managing going forward, which is a significant part of the business, we currently fund roughly 70 per cent through our deposit base, which we have grown aggressively, as I mentioned before. The balance of that is funded with a combination of short-term and long-term funding, including securitisation. Certainly securitisation is a market where, as I mentioned in the commentary, we think there is enormous opportunity for Australian business in RMBS, but it has been impacted—probably unfairly—by the noise coming out of the US and Europe on securitisation.

CHAIR —On securitisation, the market is back to about $30 billion a year, roughly, from what we have heard in the past. It was up close to $50 billion prior to the GFC. The Reserve Bank told us when they appeared before us that they thought the $30 billion that it is approaching now roughly represents where it will end up, given that $20-odd billion of that $50 billion that did exist came from unsustainable investment vehicles that probably will not re-enter the market. Do you think that we are approaching a natural limit in terms of the securitisation market getting back on its feet without those vehicles, or do you think there is opportunity for us to grow it further with the right regulatory settings?

Mr Foster —I might let Anthony touch on that.

Mr Rose —There are a couple of answers to that. Firstly, I do not think that the securitisation market has returned to normalcy. Without the support by the AOFM, many participants in that market would not have the access to those transactions that they have completed, where the AOFM has cornerstoned a number of the transactions and has provided liquidity and the impetus for those transactions to actually occur. As for RMBS as an instrument today, part of the issue globally is that it fits into what international investors call structured product. Unfortunately, it has been tainted with a brush that fits in the same bucket as subprime lending and those subprime CDOs and COOs that have caused a lot of the grief. As a consequence of that, it is very difficult to get credit committees and investment committees to actually see Australian RMBS as a different instrument and then enable the limits and the volume to come into that market that it probably justly deserves given the credit risk that underlines those securities.

There are plenty of investors in that market who do see the value in that, but there are large components of the global pool of money that we just have not been able to penetrate. Some of the suggestions that we have talked about here are about how we break that nexus and how we can turn that into an instrument that enables us to use the collateral of the mortgages to really bring down funding costs and provide liquidity to the whole system, not just—

CHAIR —And your primary suggestion there is that the government guarantee the RMBS?

Mr Rose —Yes.

CHAIR —I am conscious of the time. We have other senators who need to ask questions, so I will just move on to some other issues. You mentioned exit fees. Obviously the government, as part of its package, is going to ban exit fees from 1 July this year. Prior to that the government had tasked ASIC with looking at the issue, and ASIC had come out with some guidelines on how it thought that exit fees should operate. Basically, it thought that they should cover the costs and no more and that would be reasonable. Do you think that that approach to addressing any real problems with exit fees had had an opportunity to work? Had ASIC been given a chance to get out there, do that and see if that actually solved the issues?

Mr Foster —I think there are a couple of issues. As I mentioned in the commentary, the main people that are going to be affected by this are the smaller non-bank lenders, who do have reasonably significant exit fees, and that is part of their operating model that they have operated. In the case of the majority of banks it is essentially, as I mentioned, a competitive mechanism. Rather than charging an up-front establishment fee for the set-up work and costs, including external valuations that are obtained for properties, in the interests of stimulating competition and encouraging customers to switch lenders that was then moved—at the option of the customer in many cases—to what we called a deferred establishment fee so that, in the event that the customer wished to leave within a short period of time, some of that cost was recovered—

CHAIR —Essentially they paid the costs of setting up the loan.

Mr Foster —So, from that perspective, we think that is legitimate and does provide a competitive incentive for customers to move.

CHAIR —And that is essentially what ASIC was going to do: it was going to ensure that exit fees only reflected real costs of entry and exit.

Mr Foster —I guess there is a little devil in the detail, so we need to see how that plays out in practice.

CHAIR —We really had not had a chance to see how that played out in practice, and we are about to get to the point where we are going to abandon it altogether.

Mr Foster —That is right.

CHAIR —Do you think that the approach that ASIC had been asked to take and what they had come up with—just requiring fees to be limited to those genuine costs—would have impacted in any material way on those non-bank lenders you were talking about, who do have higher fees? Would that have undermined their ability to operate? Some of them did charge ridiculously large fees.

Mr Foster —Yes.

CHAIR —If they were told that they had to limit it to reasonable costs that they could demonstrate, do you think that that would have undermined their business models?

Mr Foster —Probably not close to the financial dynamics of their business model. But certainly, as I said, our belief was that those would be the people most impacted by the implementation of that approach.

CHAIR —And even more so if they cannot even cover the actual costs.

Mr Foster —Yes.

CHAIR —You also mentioned super reform to try and encourage more of the super money into funding of financial institutions. We had John Brogden from the Financial Services Council appear before us. He obviously was not keen on the idea of mandating super money into it, but the concept of providing incentives to make it more attractive for trustees to make decisions to invest in banks as opposed to other options was raised with him. He did, though, say in that context that the second-tier and below institutions would even then be at a disadvantage because, even if the incentive was there to make it more attractive, they would tend to go to the big banks. Do you think that is right? Do you think you could sell your wares to superannuation trustees so that, if we as lawmakers changed the laws and made it more attractive to park money with you or with banks generally, they would not just park it with the big four anyway?

Mr Rose —I think the answer to that is that it is proportional to the size of your balance sheet. So, if you have a smaller balance sheet, your funding requirement on the market is smaller. If you are a BBB-rated bank, given the domestic market that we are talking about here, the BBB-rated banks are well-understood organisations. The investor base understands those institutions and would be able to understand the credit and allocate accordingly an appropriate pool commensurate with the size of their balance sheet, and likewise for A-rated banks. AA-rated banks would get a higher proportion, but they are bigger banks.

CHAIR —And probably the lower cost ones again too. Their offerings would be taken up at a lower rate that you have to pay to get it, which would inherently build in a problem again, wouldn’t it? It would be a disadvantage for smaller banks?

Mr Rose —We would like to think that, with greater supply, removing that supply-demand imbalance and reducing the reliance on offshore funding, you end up in a position where the whole industry benefits—

CHAIR —It would be in fact closer to 10 to 15 rather than 80 to 90? It would be somewhere in between?

Mr Rose —It would improve from where it is.

Mr Foster —The alternate securities vehicle could play a part in making it more attractive for super funds to invest in as well, which is the mortgage bond that we talked about earlier.

CHAIR —What needs to change to make it more attractive? Ignoring the idea of compulsion, what could be done to make it more attractive for super funds to invest in your industry?

Mr Rose —In the old world in superannuation we used to have increased contribution benefit limits for those that went into guaranteed annuity style product. You are talking about the same types of carrots I would think. The industry has seen it before. We would expect it would be able to work again. So lifting the limit on superannuation contributions as long as a higher proportion is going into fixed interest guaranteed product—

CHAIR —That would come at a cost to government revenue though, wouldn’t it?

Mr Rose —It depends upon that equation around what proportion of the population you are covering in support payments in their retirement.

CHAIR —I am not saying that that is a bad thing, but in the current climate that might be a challenge. I want to ask about the impact of the floods on your business and your ability to compete. You are essentially Queensland based, although no doubt you extend further. Have the floods undermined your ability to compete against the big four banks in particular that operate across Australia? Have they caused you any challenges in your ability to compete essentially?

Mr Foster —The impacts of the floods and other events are still playing out in Queensland. Queensland does represent about 60 per cent of our business. Our immediate priority has been our staff and making sure that the operational components of the business are up and running, and that has worked quite well. We obviously continue to monitor in the different markets that we operate, particularly around our personal customers, SMEs and agricustomers, as to what the impact of the various weather events, including floods, cyclones et cetera, are on their business. You would expect that there will be certainly a short-term impact on the economy more broadly in Queensland and then probably in six months or so there will be a stimulus effect to the economy.

There is no doubt that for all businesses operating within the state, regardless of the proportions of their business, there will be some impact. As you pointed out, we do have a national business from a bank point of view and we are growing strongly in New South Wales and WA in particular. We have certainly still got growth opportunities there and we are part of a broader financial services group that has a diverse business.

CHAIR —You mentioned in your opening statement that you believe that the way forward is a strong second tier with I presume a number of players offering competitive products rather than consolidating the second tier into one fifth pillar or mergers between you and the Bank of Queensland, Bendigo Bank or whomever it might be to try to create a larger alternative to the big four. Why is that? Is that because you think that that would actually lead to a better and more competitive environment and that a fifth pillar would just become one of the big five and be lost? Why do you think that would be a preferable outcome?

Mr Foster —Our belief is that a strong multi-tiered banking system is the right model for the country. It provides a good competitive dynamic, good choice for consumers and business customers and good options for investors in terms of choice of different institutions. So, across a whole number of bands, we believe that a multi-tiered structure provides the best balanced outcome across the board. By supporting a fifth pillar alone, whilst there would be some benefits for that organisation in the near term, recreating the competitive environment that existed prior to the GFC, a multi-tiered structure would achieve that.

Senator HURLEY —I want to explore the exit fees issue a bit more. Is it set so that after five years people do not pay them, which is a common model with other banks? Or is a period not set for Suncorp?

Mr Foster —There is a period set. Of the top of my head I think it is four years. That arrangement is established upfront with the customer when the product is taken out. As I said, it merely reflects a deferral of what normally would be charged as an upfront establishment fee in the normal course.

Senator HURLEY —Different banks and mortgage originators and others charge different fees in different ways. I think an issue for consumers is being able to find out what the effective interest rate is. Let us set aside the exit fees, because you may or may not incur them. Do you have any thoughts, not necessarily on taking away all fees but providing a total at the end that enables consumers to compare effective interest rates easily?

Mr Foster —There is a mechanism that exists today, via the various regulations and presentation of product pricing and material, which does provide an effective interest rate which incorporates the interest rate being charged as well as the ongoing fees that apply to the product. In addition to that, it is quite transparent in the documentation and in our discussions with customers around what the fees relating to the particular product are. We participate in a number of the industry comparator products, such as CANNEX and the like, to make sure that our products are clearly disclosed and understood. Particularly from a mortgage perspective, the broking industry itself makes a living by being able to explain the differences in pricing to customers. We see about 40/45 per cent of the industry mortgages originated through brokers. So I think there are a number of mechanisms already in place, through existing documentation requirements driven by legislation and the like together with a number of the competitive mechanisms to disclose that information.

Senator HURLEY —The criticism has been that, if you do not deal with a broker, for example, or you are not savvy enough to look up CANNEX or whoever, you are quite a long way down the path of obtaining a loan before you get to the stage where the bank explains to you the effective interest rate.

Mr Foster —I think all that information is a core part of our discussions with customers upfront. It is available online and in our various promotional materials and so forth. I come back to the point that I made around the suggested change in terms of banks’ ability to comment on interest rates and so forth. One piece that collectively the industry does need to do better is help educate customers about pricing mechanisms, how funding works and how that flows through to the end price that they pay. I think it is an important acknowledgement that we know we can do a lot better on that. But I think there is adequate information upfront on the actual product pricing itself, and it is an important part of the discussion we have with customers early on.

Senator HURLEY —I will go back to exit fees. We are talking about trying to let customers take advantage of lower interests, lower prices, lower fees and be able to switch accounts more easily. If we took away the ban on exit fees that is in a way contradictory, because people who have a large exit fee—Senator Williams might address this later—

Senator WILLIAMS —I probably will.

Senator HURLEY —might feel a bit constrained in switching accounts. It is no use being able to have account portability if you have this thumping great exit fee sitting there deterring you. So the argument will be that it is better to have it as an up-front fee even though, as you say, a lot of customers do not like it. But in terms of improving competition and people being able to switch between competitors an exit fee is not a good idea at all.

Mr Foster —For context from our perspective there is not a significant number of customers that have an issue with us, and it is not a huge financial issue from our perspective. But going back to the point around the reason for the change in structure in the last few years, it was to try to encourage competition. So I acknowledge your point that once you are somewhere it does put something in the road to move elsewhere, but, from a cost equation point of view, if the structure is reversed and an up-front fee is put in place the same challenge exits. Obviously the removal may lead to different pricing structures to cater for those legitimate origination costs that are incurred. That would need to be worked through if that in fact played out. But at the end of the day there are legitimate up-front costs that are both internal costs to financial institutions, plus services paid away to providers such as valuers and the like to originate loans.

Senator HURLEY —Can you tell me what percentage of your customers would incur an exit fee?

Mr Foster —It would be very low single digits.

Senator HURLEY —You mentioned price collusion and speaking out about price signalling. Has Suncorp generally moved their interest rates in line with the RBA in recent times or have they moved with the other banks—the majors?

Mr Foster —On an ongoing basis we monitor our pricing according to the competitive dynamic that exists at the time, as well as our own funding costs. As I mentioned earlier the inherent funding costs of the regional banks and smaller players tends to be higher than that of the majors. So we obviously need to maintain a competitive dynamic both in terms of our return to shareholders but also our place in the marketplace. Our movements over time have tended to vary our position in terms of where we sat against the major banks. As it stands today our mortgage rate is pretty well middle of the pack. However, on the small-business rate, which was a conscious decision, we only moved that rate by 25 basis points and we are the lowest in the market by some way. So it does depend on product and the various initiatives that are underway.

Senator HURLEY —So you are trying to build up your small-business loan portfolio.

Mr Foster —That is an area that we are looking to grow. We think that is an area that has been underserviced for a long period of time and we think that is a good opportunity for us to provide a good service.

Senator HURLEY —In regard to securitisation and how you fund that, you have talked about the importance of underpinning securitisation. Do you think that the government assistance that has been put in through AOFM needs to be increased in amount or do you think it is about right?

Mr Rose —It is keeping the market going for the time being. I suppose the question the industry is asking is: you would expect that there is a sunset for that type of support at a particular point in time and what is going to be left at the end of the sunset? Our submission goes to one of the things that we think can drive a replacement of that sunset and actually turn it into something that is more powerful for the sector.

Senator HURLEY —I would like to go into that but I suspect I am out of time, so I will go to another question. We heard from Professor Davis about an OECD proposal to encourage banks to change to a non-operating holding company structure where one part does the standard banking—taking deposits and making simple loans—and the other subsidiary part does the investment banking. Is that the kind of thing you have done with the split that you talked about?

Mr Foster —The Suncorp Group does operate with a non-operating holding company as at, I think, 7 January this year, so that the bank is one of the divisions within that non-operating holding company. The split I referred to earlier is not a legal, structural split. It is still part of our core banking operations, but in terms of operational delineation we have split the management and funding of it, the financial business around it, so it is quite clear, and we report on that basis to the market.

Senator HURLEY —Right.

Mr Rose —But we do not run an investment banking operation. We have a banking operation, and the other entities underneath the non-operating holding company are insurance businesses, both life and general insurance businesses.

Senator HURLEY —Okay. Do you see any advantage in other banks adopting the structure that Professor Davis has described?

Mr Rose —I think the reasons why we have adopted that are probably unique to our organisation. For us, it was about transparency and simplicity to be able to explain the operations of each of our businesses more clearly.

Senator HURLEY —We had some evidence from Tyro about the way that they are trying to forge a business in the area (and I will probably get some of the terminology wrong) of providing services to merchants who use credit cards—providing that intermediate service. Does Suncorp have any involvement as a bank in funding that service?

Mr Foster —I am not sure of the exact technicalities or whom you are talking about, but certainly we provide comprehensive merchant facilities in various forms, including credit card facilities, to our business customers.

Senator HURLEY —Okay. Do you know what percentage of the market you have in that area?

Mr Foster —Probably, given that it is a developing business, on a national basis it would be less than two per cent.

Senator HURLEY —And would you say that the major banks have a stranglehold on that at the moment?

Mr Foster —I think with most of the payment businesses—and ATMs are included in those—you are seeing some divergence in the provision of services. All the major banks participate strongly, but you also do see a number of independent organisations providing various payment services as part of the value chain, including ATMs.

Senator HURLEY —You say you provide that service to your business customers. Does that mean you provide it only to your customers and not to merchants who use other banks’ services—in other words, who do not bank with you?

Mr Foster —We certainly have customers who only utilise merchant facilities within our base. But, obviously, a key objective of ours is to deepen the relationships that we have with our customers and therefore provide broader services.

Senator HURLEY —Okay. Thank you.

CHAIR —Senator Xenophon.

Senator XENOPHON —Mr Foster, thank you for your submission. In relation to exit fees, you are saying that if a bank cannot charge them they will find some other way of recouping the costs?

Mr Foster —No. I think the point that I was making was that there are legitimate costs incurred in originating a loan and that the change from an upfront fee to a deferred fee was put in place at the time to try to encourage a different competitive dynamic. So, depending on how the regulation played out—and different institutions would have to look at how they deal with that separately—there could be a broad spectrum of outcomes from working out whether it becomes an upfront fee again or whether they absorb the fees.

Senator XENOPHON —So the broad spectrum of outcomes could include other ways for banks to recoup their costs?

Mr Foster —I could not comment on what other banks will do.

Senator XENOPHON —No, I mean what you would do.

Mr Foster —We will wait and see how the legislation unfolds.

Senator XENOPHON —Sure. Do you consider that there is a real issue with mortgage insurance, where you take out mortgage insurance and then switch banks? If you pay for mortgage insurance, there is a cost involved in that for the term of the loan. There is no transferability in respect of mortgage insurance at the moment, is there?

Mr Foster —No. That is exactly right. It is a good area to look at as part of the switching considerations. A significant number of borrowers utilise mortgage insurance for a number of reasons, and certainly there are a variety of providers. They include external providers, and a number of banks write that in-house as well. So exploring the portability of mortgage insurance would be an advantage to consumers. But it does not come without complications.

Senator XENOPHON —Sure. I think Bernie Fraser is going to look at the issue of portability and the technological aspects of that. But there is a simpler system in place that could still be effective, and that is in the Netherlands, where the onus is on the institution you wish to switch from to make it as seamless as possible. Do you have a view on the Netherlands model, if you are familiar with it? I think it is something that Choice prefers or says should be considered. And do you think increased portability will help the non four big banks in relation to this?

Mr Foster —Simply put, increasing the ability of consumers to switch banks is a positive from our perspective. We certainly support any initiatives to put in place to enable customers to switch more easily. In terms of what shape that solution takes, I think it is certainly worth exploring the technology solution, but that certainly is likely to be complex. I do agree that there are a number of pragmatic steps that could be taken, whether it be the model in the Netherlands or just some protocols around how things are done today to make that a better process.

Senator XENOPHON —Would you be able to provide the committee, on notice, with some details of what you think would be workable protocols for practical measures that would not be unduly onerous but could be helpful?

Mr Foster —Sure.

Senator XENOPHON —I put this question to Westpac, to Gail Kelly and her fellow executives, recently. It is on the issue of requiring insurance for damage to a property if you have a mortgage. I understand that in the UK and France it is mandated: if you take out a mortgage, you also need to have insurance for the property. Suncorp obviously has a huge exposure in the Queensland market but seems to offer a better product than many others. Do you require insurance to be taken out on home and contents, but on the home particularly, if you are providing a mortgage for a home?

Mr Foster —Yes, we do.

Mr Rose —Yes, it is a contractual obligation of the borrower.

Senator XENOPHON —Are you unique in that?

Mr Rose —No.

Senator XENOPHON —How many others do that?

Mr Rose —I would be surprised if it was not in every single loan.

Senator XENOPHON —I am talking about mortgage insurance, to ensure your home.

Mr Foster —General insurance, the home insurance? It is a pretty standard inclusion in most loan covenants in terms of terms and conditions.

Senator XENOPHON —I am talking about home insurance.

Mr Foster —Yes.

Senator XENOPHON —But not all banks require that contractually, do they?

Mr Foster —I do not have intimate knowledge of all others but my understanding is that it is a standard condition.

Senator XENOPHON —We might check that because I thought—and I might be wrong—that Westpac said it was not a requirement.

CHAIR —I bank with Westpac and they have always made me have a certificate of insurance.

Senator WILLIAMS —You need a certificate of insurance when you borrow money for a motor vehicle. It is compulsory, basically, if you owe money on a motor vehicle to have comprehensive insurance.

Mr Foster —That is right. Just on a couple of points were mentioned at an earlier meeting, it certainly protects a high proportion of the market. About 30-odd per cent of people actually have a mortgage and therefore it certainly helps protect those customers to a degree, but not the broader population necessarily. Certainly in our case about 71 per cent on our mortgage customers have Suncorp flood cover as part of their insurance.

Senator XENOPHON —You said there is an 80 basis points difference in the cost of funding since the GFC compared with pre-GFC. Is that correct?

Mr Foster —I said up to 80 basis points, and it does depend on whether it is domestic, offshore, and what the term of that funding is. Certainly the funding difference was far more significant during the last two years, but that is the current state of play as it stands today.

Senator XENOPHON —Has that been exacerbated by the bank guarantee, the Commonwealth guarantee, in the sense that it puts you at a relative disadvantage to the big four?

Mr Foster —The point we have made around the government guarantee is that, firstly, it was absolutely necessary for the whole industry at the time, so we certainly agree with that. The unintended consequence around that is essentially that the assumption was that everyone would be priced off the sovereign curve for the pricing; however, the market looked through that and essentially priced against the credit ratings of the various institutions, and on top of that was a fee differential.

Senator XENOPHON —So how do we fix that?

Mr Foster —The wholesale government guarantee has come to an end in terms of new issuance against that. That was earlier last year. However, on the residual balances of wholesale funding, there is still a significant cost to us each year by paying that fee differential on outstanding balances.

Senator XENOPHON —But being given access to the AOFM, which helps—do you have access to the AOFM?

Mr Rose —Yes.

Senator XENOPHON —Do you have a view as to whether Aussie Home Loans should have access to the AOFM?

Mr Foster —No, probably not.

Senator XENOPHON —That is all right. If you do not have a view, that is fine. Thank you.

Senator WILLIAMS —Mr Foster, you said in your opening statement that small institutions such as Aussie, Rams et cetera have virtually been taken up by the big majors due to consolidation. Is that correct?

Mr Foster —Correct.

Senator WILLIAMS —How do you define ‘consolidation’?

Mr Foster —Essentially, in the case of Aussie, they are now a third owned by CBA. In the case of the others I mentioned, they are now completely owned by major banks.

Senator WILLIAMS —Are you saying that the bigger ones are consolidating and getting stronger?

Mr Foster —And buying the small—

Senator WILLIAMS —Is that how you define consolidation—those bigger banks just taking out competitors, perhaps, and getting more market share?

Mr Foster —Correct.

Senator WILLIAMS —I find it very concerning not only in the banking industry but right around Australia. In the grocery industry we have Coles and Woolworths with 80 per cent. We now have the big four with 90 per cent of the home loan market. It seems to me that we are getting this whole thing in Australia where big is powerful and if you are small you get squashed out. Do you see that in the banking industry? Do you have concerns that the small player is going to find it more and more difficult to survive in the future?

Mr Foster —As I mentioned earlier, our strong belief is that having a multitiered banking system is the right structure for the industry here, which means that you do have big players, medium players and smaller players. The big question mark really for all the industry in that regard is the long-term outcomes around the pricing and sustainability of funding. That is where certainly a number of the measures revealed as part of the competitive package, the steps taken in Basel III, as we acknowledge, are all steps in the right direction to help support that but will take time to have effect. And I guess there are still question marks around the degree to which they will have any impact. So that is essentially the residual question that remains. To ensure that there is a prosperous, multitiered banking system, we need to ensure that there is cost-effective funding for all players within that structure. Certainly we think that the measures taken are a step in the right direction. We think there are some other measures that are available either immediately or in the fullness of time when these other measures can be tested out to extend that function—but, again, that is a little bit unknown at this stage.

Senator WILLIAMS —During the GFC when the government had the wholesale guarantee, you paid a premium to the government and the government guaranteed those wholesale markets if you would repay the money to them—okay? Your premium was higher than the big banks’; is that correct?

Mr Foster —Correct.

Senator WILLIAMS —I will put that in relation to exit fees. You say you support exit fees. When I left a credit union I did not pay an exit fee. They were a second-tier bank, not a big operation, but there was no exit fee. Surely you would not need exit fees because, if you were competitive in the price of your product, why would someone want to exit?

Mr Foster —As I said, from our own perspective—

Senator WILLIAMS —Let me put it a different way. If I were banking with you and I wanted to leave you—unless there was a personality clash, which is very rare because the people in the banks at the coalface are always very friendly, very professional et cetera—it would probably be for a better deal. But if you could compete with a good deal, as good as anyone down the road including the big ones, I would never want to leave you, would I?

Mr Foster —It does depend a little bit, as you said, on the reasons why customers want to leave, but as I said before it is certainly not a significant issue for us in terms of the numbers of customers or from a financial point of view. But, as I made the point, the dynamic is around what is best from a competitive offering point of view and then, I guess, the way that the industry and different players will deal with that differently in terms of the actual costs that are incurred as part of that.

Senator WILLIAMS —Your bank is Suncorp. Used you to be Suncorp as well as QIDC and Metway, was it—and the three of you combined?

Mr Foster —Yes, the origins of the bank within Suncorp date back to 1902 with the Agricultural Bank, which—

Senator WILLIAMS —I know QIDC was a very popular—

Mr Foster —Correct.

Senator WILLIAMS —rural bank basically in Queensland, based at Goondiwindi and places like that, very good with farm and rural finance.

Mr Foster —That is right. About 12 years ago or so, there was a merger of Metway Bank, which was previously a building society, the Suncorp building society and QIDC, which brought that together.

Senator WILLIAMS —Good luck in the world of tough competition!

Senator PRATT —I have a question regarding small business credit. You have outlined how it is part of your agenda to continue to grow that space. Indeed, I think you said you have a lower interest rate than most of your competitors. In the themes that have come up in this inquiry, there has been some commentary about the difficulty for small business in gaining credit and the concern of many small businesses that they do not believe that their risk is judged fairly. I want to ask Suncorp how you approach that issue, particularly in relation to the relationship that many small businesses have with the equity in their personal house as opposed to the equity in their small business.

Mr Foster —It does depend a little bit on the size of the business that you are talking about. Certainly it is an area that we are very focused on trying to grow. I think, if you look at the market over the last year or two, there have been as many demand issues as there are supply issues in the provision of credit in the market. Certainly on the demand side of the equation many businesses have elected to deleverage—not invest—and therefore the underlying demand for credit has diminished anyway. And then, on the supply side—and that has probably evolved over the course of the last couple of years—certainly both pricing of risk and also inherent funding costs have increased, and there is a very different risk profile for business customers from that of a mortgage customer generally. That has been built into pricing, which for a variety of reasons had diminished over preceding years.

There is certainly a lot of dialogue and a lot of discussion around this particular issue with industry groups and with customers directly, and we are very active in doing that, but there will always be a mismatch, particularly from a risk point of view, in terms of what perhaps an unsecured need of a small business is versus a credit appetite of a financial institution. What you have seen is that a number of the providers that existed pre the GFC and filled that niche in the market of higher risk, more cash flow based lending to small business either essentially withdrew or contracted and therefore left a hole in the market for some small businesses.

Senator PRATT —Does your lower interest rate mean that you are judging risk more conservatively? It is interesting that you are targeting it as an area to grow, and yet it seems that, as you have indicated, a lot of the growth in that market historically comes from lenders who are prepared to take on more risk. I am really trying to come to terms with the competitive dynamics in this.

Mr Foster —I think there are two parts to that. One is in terms of the sort of facility that I am talking about. It would typically be a customer that utilises either their commercial premises or their residential premises to support their borrowing requirements. That market, just like the other part you mentioned, historically has grown solidly as businesses have evolved. But certainly we have seen that contract in recent times.

The separate issue to that is a part of the market that existed previously in terms of a requirement of businesses to source, I guess, higher risk, unsecured type credit. There were providers in the market that provided that, but they are the ones that perhaps have—

Senator PRATT —So you would accept the argument of small business that they are not being treated completely fairly by the banks, in that that risk is largely mitigated by the equity of the home that is secured against the loan, and perhaps banks are not adequately taking that into account in their risk assessments?

Mr Foster —No, I do not think banks are generically treating small business customers unfairly. I think there are two separate issues at hand. One is that there is a part of the market that banks did not participate in and still do not participate in. But those who did participate in that market, for a variety of reasons, have either wound back or exited. That is where a lot of the noise is being created. In terms of inherent risks, there are very different statistics and requirements from a regulatory point of view around capital weighting, default scores and real experiences in defaults and so forth in small business versus mortgages. There are some very fundamental differences.

Senator PRATT —Irrespective of the equity in your house or any default costs, yes.

Senator XENOPHON —The question put to Westpac was: do they require mandatory flood insurance for homes? They do not. What is the position with Suncorp? Is flood insurance an optional extra for someone who takes out a mortgage with Suncorp?

Mr Foster —No. The point I made before was that 71 per cent of our mortgage customers have Suncorp insurance that includes automatic flood cover. The Suncorp product, which is the product that we distribute and sell through the bank, has flood cover as an automatic inclusion.

Senator XENOPHON —So Suncorp is ahead of the pack compared to other institutions?

Mr Foster —Correct.

Senator XENOPHON —That is good.

Mr Rose —To clarify, a customer can come in and chose to go with another provider of comprehensive insurance that does not include flood cover. We would have customers in that category in our portfolio.

CHAIR —I have a final question. In terms of the wholesale funding guarantee, if the government were to remove the differential in fees on your ongoing funds, what difference would that make to your ability to compete, particularly with the big banks?

Mr Foster —It will certainly be a significant, ongoing cost to our organisation for the coming years, so that would certainly feed into our overall funding costs and dynamic and into our pricing decisions as a result.

CHAIR —Thank you very much. Thank you for assisting us.

[7.08 pm]