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

CHAIR —Welcome. Would you like to make an opening statement?

Mr Liddy —I would firstly like to thank the committee for the opportunity to appear tonight. Competition in banking is a topic that is very close to my heart and something that is particularly pertinent to any non-major bank in Australia in the aftermath of the GFC. Our commitment to greater competition in the marketplace is matched only by our commitment to our customers in delivering them a differentiated banking experience. BOQ’s model is quite unique in the retail banking sector of this country and in fact worldwide as we allow our managers to take direct ownership of their branches. We promote this model of owner managed branches as we believe the most efficient interface in a community is still small business and local market management.

For the benefit of senators who are not familiar with BOQ, we have: 269 branches nationally, almost 200 of which are owner managed branches; 10 business banking centres nationally; a national finance division which offers equipment finance and vendor finance; and recently purchased a consumer credit insurance business called St Andrews. What we do not have in comparison with the major banks is a wealth management arm. However, we are trying very hard to be a genuine alternative for consumers to the major banks in Australia.

Later this week, I will have been in banking 43 years—33 years of which were with a major bank and the last 10 with BOQ. There is no doubt that the GFC was the toughest period that I have ever seen or experienced in the industry. Probably one of the most significant outcomes of the GFC has been the negative impact to competition in our industry.

Whilst there is more to competition in banking than purely price, such as service or access to capital, I am sure the committee appreciates that pricing is fundamental to enabling genuine competition. An important caveat here is that it needs to be non-predatory pricing competition—that is, players do not engage in unsustainable pricing designed to squeeze out competitors in the short term in order to enjoy higher profits in the long run. Without the ability to provide sustainable pricing competition, it is difficult for a participant in the Australian banking sector to provide meaningful competition to the dominant players—that is, the major banks.

Prior to the GFC, non-major banks, the mutual sector and the nonbanks were able to price competitively with the major banks and in fact assisted in driving interest rates down despite being a fraction of their size and having lower credit ratings. This is because there was access to a funding source which acted as a leveller—securitisation. Access to the securitisation market was the fuel that allowed non-major banks to grow and compete as it allowed an equal cost for funds for lending.

Post GFC, it has been well documented that the securitisation market has been crippled. Despite the government’s $16 billion-plus investment in the RMBS market in an attempt to revitalise it, the cost of securitisation today remains high. If the government is genuine in its intention to reinvigorate competition in the banking sector, BOQ believes the most effective and sustainable way to do so is to focus on reducing funding costs and to focus on re-establishing a competitive playing field in terms of funding.

The government released its competitive and sustainable banking system reforms after BOQ had submitted its submission to this committee. We believe that some of the reforms canvassed are useful. However, part of the risk in responding to the specific initiatives put forward is that we do not believe they canvassed all the sustainable competitive issues facing Australian banking. For genuine competition in banking, we believe a more realistic framework is needed. I will try to succinctly explain what I mean.

Banking is a unique sector in our economy. It plays a fundamental role in intermediating and reducing the costs of connecting savers with borrowers. It provides capital, interest and access certainty to savers who deposit funds with banks and it manages the risk of different interest rate requirements and term maturity requirements of the savers versus the borrowers using its equity, liquidity, credit and balance sheet management skills and in the process pooling thousands of transactions into a portfolio and thereby diversifying and reducing the overall risk.

For banks to deliver the operational capabilities necessary to achieve these three things, equity capital is needed. It is equally important when considering expansion in competition that emerging players authorised to collect deposits from retail or wholesale investors possess the required operational and capital strength to maintain investor confidence in the Australian financial system. Regional banks with established capabilities are essential in this equation.

A robust, healthy banking system must support a sustainable return on equity in order to maintain the attractiveness of the sector for the providers of capital—both investors to provide new capital and also to allow for greater retention of existing profits. Increases in equity capital in banking increases a buffer on impairment risk on banking assets eating into liabilities owed by all depositors. In this context, government policy should allow banks to operate at acceptable returns on equity, ROE, and this should be encouraged rather than shied away from.

We believe objectives for genuine competition policy need to address three key factors. The first factor is the ease with which a new entrant or an existing player can enter or grow in the banking sector to reach the ROE enjoyed by the industry leaders. This will determine the number of real alternatives available to consumers as new and existing players jostle on improving their value proposition to win over customers.

The second factor is to ensure the differing needs of banking customers are met adequately by the system, be they consumers borrowing for housing or personal needs of businesses borrowing to invest in the productive capacity of our economy. They must all have access and terms of debt, including pricing, which are reasonable and fair in terms of the risk-reward equation for the banking shareholders. In this context, one segment of customers subsidising another needs careful consideration. It can be a useful strategy for competition but, if sustained for long periods of time, it will impact on resource allocation in the different customer bases and therefore asset allocations in our economy.

The third factor is accessibility of banking transaction infrastructure. Whilst most credit unions and building societies can offer competitive home loans and deposit rates, they are not all equal in terms of accessibility of funds through national branch footprints, internet banking, Treasury operations et cetera. In this context, a direct charging type approach to other transaction infrastructure services may overcome the disadvantages that are faced by smaller subscale players. These three factors need to be kept in mind when crafting genuine competition policy.

In our submission BOQ outlined five ways we thought the government could assist in enhancing competition. These initiatives are practical ways the government could act; however, upon reflection, after reviewing the December banking competition reforms, I am not sure our proposed initiatives go far enough in establishing true sustainable reform. So, to the list of five initiatives we proposed to the committee, I would like to add another one. At the risk of raising yet another inquiry, I think we need a far more fact based view on the sources of competitive advantage in banking. I think the merits of maintaining the current biases towards major bank regulations needs independent analysis.

The four major banks are unique not just in terms of their size in the banking market; they are also now the biggest players in the insurance, wealth management and financial advisory markets. It could be argued that they already have an implied guarantee from the government, as they are systemically important and too big to fail. This is worth $1.3 trillion, or 100 per cent of GDP. So, if we want to ensure there is genuine competition to this oligopoly, then we really need to get into the detail and understand what the current competitive advantages are and have independent experts provide advice on the way forward. When I say ‘independent experts’, this should be in addition to the current regulators, as it is important to recognise the narrow mandates that the RBA and APRA have and to understand that it precludes them from a broader view on some issues. For example, the RBA’s focus is rightly on stability and this does not always fit the lens that is needed for a broader issue, such as competition. Any genuine competition debate should address concentration issues and potential contagion risk. It is obviously important to balance promoting competition with minimising systemic risk. An independent inquiry—like the independent commission on banking in the UK—could be charged with this task.

I will not go into detail on the five initiatives included in our submission, as you have already covered many of them in your hearings today. We believe they are important to implement in the short term, so the advantages built up by the major banks over this period is not allowed to be consolidated and entrenched. In this regard, dealing with the return on equity discrepancy between the majors and all other participants, including new entrants which are needed for genuine competition, is critical.

The four major banks enjoy ROEs of around 15 to 18 per cent; while regional banks are between seven and 10 per cent. The quickest way to enhance competition and to enhance the ROEs available to nonmajors and new entrants—that is, to create the level playing field that will entrench competition in the banking sector—is to lower the funding costs available to them. As I have stated, pricing is a key variant of competition, and lower funding costs allow more competitive pricing with the market leaders.

The initiatives in our submission address ways to achieve this—for example, expanding the RMBS program to levels where there is a meaningful impact on competition. The extra $4 billion investment in RMBS is a welcome addition. However, adding this to the existing $16 billion does not add any incremental funding, given the amortisation of the original $16 billion will be around $4 billion in a year, as a rule of thumb. A good statistic to keep in mind is that housing loans in Australia are $1 trillion. So even a below average growth rate of, say, seven per cent will require $70 billion in funding. So doubling the RMBS investment by another $16 billion would be meaningful to competition.

Introducing a Canadian style RMBS mortgage structure or introducing a government guarantee of lenders mortgage insurance would certainly assist in reducing the cost of funds and providing a sustainable basis for re-establishing a level playing field between all providers in the mortgage market over the long term.

We have called for reducing the capital ratio required on mortgages held by the nonmajors under the standard importation of Basel II framework to the levels enjoyed by the majors under the advanced approach to Basel II. A feature of the global application of the advanced Basel II framework has been the relative advantage gained by the Australian majors in the level of capital required to support their mortgage products. This outcome has created a significant competitive disadvantage for the nonmajors, who apply a standard capital release which could be addressed in conjunction with APRA.

And, of course, there is the old chestnut: flattening the fee for all remaining payments as part of the government guarantee on wholesale funding. I should note that this very committee concluded, in your inquiry into the bank funding guarantees in 2009, that this fee had had an unintended impact and should be reviewed. If the government guarantee on wholesale funding were flattened to the fee that the major banks pay for all remaining payments, BOQ would be able to immediately reduce our variable mortgage rate by 20 basis points.

I will end now as I began. We are unique in the banking sector of this country and we are proud to deliver to people a banking experience that, I believe, they cannot find anywhere else. BOQ is firmly committed to this mantra and to enhancing and fostering genuine competition in the Australian banking sector. I am of course happy to take any questions that you may have.

CHAIR —Thank you. You finished up on wholesale funding. You mentioned that, if that were flattened and the price differential were removed for the funds that you have under that guarantee, you could reduce your price by 20 basis points. What impact would that have on your competitive position? Do you think that that would enable you to increase market share?

Mr Liddy —We would be the cheapest variable rate mortgage provider in Australia today.

Senator XENOPHON —By how much?

Mr Liddy —By one basis point. There is quite a variance, as you probably realise, in all the rates charged by all the banks, but that would certainly bring us back below all the other banks—and all the other providers, for that matter.

CHAIR —We have gone through this before, as you mentioned, in a previous inquiry, and in this inquiry as well, but ultimately the government has made a decision to price on the basis of rating, which they say reflects risk. Do you think that the ratings as they have been allocated to financial institutions in Australia accurately represent the risk to government from the guarantees?

Mr Liddy —I do not believe so. APRA are a tremendous regulator and do their job exceptionally well. When the guarantee first came in, a AA bank was charged 70 basis points to access the guarantee, an A rated bank was charged 100 basis points and a BBB bank—or any non-rated bank, for that matter—was charged 150 basis points. So the difference between, say, a BOQ and a Westpac was 80 basis points. When you go into the markets and borrow funds under the government guarantee, as my colleague from Suncorp mentioned in his address before, investors take account of not just the sovereign status of the AAA rated guarantee of the Australian government; they look in between, to the actual rating of the issuer. So it is a double dip. You are paying 80 basis points more for the guarantee, and then you are paying the difference in your credit rating to the investors. I think that was an unintended consequence, but I think it is easy to fix.

CHAIR —I think Treasury acknowledged, at the hearing when we looked into it, that they had not anticipated that happening. Nonetheless it has and it means that you are paying twice, effectively, compared to the major banks. Ultimately the Treasury evidence at that hearing was that they have a responsibility to protect the taxpayers’ funds and so they have priced it according to the risk. The easiest way to do that was with the ratings. So the question is whether that is an accurate way of assessing the risk to the taxpayers or not.

Mr Liddy —I do not believe so. We are regulated by APRA, we have minimum capital holdings that we have to have, we have minimum liquidity holdings and we are supervised very closely, believe me.

CHAIR —Very good. You mentioned the government’s competition in banking package. When that was released, I think you were in the media as saying that this was not a silver bullet and was not even a copper bullet, or words along those lines. Today you have been fairly measured in your comments about it. I think all the evidence we have had suggests that it is a move in the right direction to some extent. To what extent do you think that that package actually delivers on enabling institutions such as yours and other non-major banks to compete in the market?

Mr Liddy —I think time will eventually tell. I think some of the initiatives are very good. One of the biggest issues that was made as a result of that was the introduction of a potential for covered bonds in this marketplace. Covered bonds will form a new form of funding in the Australian market, and liquidity, but a bank like ours, a BBB rated bank, will not be able to issue AAA rated securities. The investors will look for AAA rated securities. Whilst it will improve liquidity in the Australian market, I think the majority of that benefit will go to the major banks because they will be able to issue AAA rated securities.

CHAIR —So it will improve liquidity but not necessarily enhance competition.

Mr Liddy —No.

CHAIR —Are you saying that, even if you joined with other institutions, you would not be able to issue AAA-rated covered bonds? We have had some evidence to suggest that that may be possible.

Mr Liddy —There have been suggestions of pooling. If we joined with our colleagues in Melbourne—Bendigo Bank, a BBB rated bank; Suncorp are an A rated bank—I am not sure whether we would still get to the AAA rated status. The issue is that there will be a limit placed on how much of your assets can be issued under covered bonds. It is either going to be five or perhaps 10 per cent. The main part of that will be issued by the major banks. The names associated with that will benefit the major banks. That is my personal feeling.

CHAIR —What percentage of your funds would have been raised through securitisation before the GST?

Mr Liddy —About 28 per cent.

CHAIR —What is it now?

Mr Liddy —About 14 per cent.

CHAIR —How have you made up the difference, or have you contracted in terms of your lending?

Mr Liddy —Retail funding has obviously been a key focus of all the Australian banks and we have certainly improved our position in retail funding, albeit it is expensive. We have been able to change the mix of short-term and long-term wholesale funding. So we are a pretty balanced bank today in terms of that. The AOFM has certainly assisted us. We have raised about $3½ billion through securitisation since 2009. The AOFM have taken about $1¼  billion of that onto their own books, with investors taking the rest.

CHAIR —We discussed the flattening of the guarantee term. Item 5 in your submission related to superannuation. We had John Brogden from the Financial Services Council appear before us earlier. We discussed the idea of getting some more superannuation money into the banks. He was obviously strongly opposed to compulsion in that regard. In terms of changing the regulatory structure so that we could assist in making it more attractive, he had a concern that even if we did do that the trustees would make investment decisions that sent that money to the big banks anyway and it would not necessarily enhance competition. Do you think that is the case or do you think that a bank like yours could adequately compete for those funds and attain them at a price that would enable you to then compete?

Mr Liddy —The whole idea of the importance for superannuation from a covered bond perspective was that in Australia we are heavy on equities and low on fixed interest investments. My view or our view was that if we could encourage the superannuation funds to invest in covered bonds, it moves towards more of fixed interest investments and improves liquidity in the Australian banking market. Whether the superannuation funds would choose a Bank of Queensland bond over a Westpac bond, for instance, is questionable, but I am sure is it is a step in the right direction.

CHAIR —You also advocated the doubling of the RMBS by a further $16 billion, saying basically that an investment of that size is what is needed to make a difference. What cost would that come to for the government?

Mr Liddy —In terms of the existing RMBS process, obviously the government is investing in bank paper and it is receiving a return on those investments. So, from a cost perspective, it has got a liability to Australian banks as issuers, but apart from that I do not think the cost is significant at all.

CHAIR —That is my understanding as well. We will be asking at estimates to see what sort of money they are making on it at the moment as well. Given the time, I will hand over to Senator Hurley.

Senator HURLEY —I want to continue to explore that very point. You were talking about a couple of measures—doubling the RMBS investment and also levelling out the wholesale funding guarantee. It does beg the question: how important is it to the government to direct money into reducing interest rates by something like 20 basis points? Why, in your view, is it so important that the government pour so much money into maintaining your organisation and other similar organisations?

Mr Liddy —Firstly, this is a government inquiry into competition, so the government is interested in competition and perceived that there is a lack of competition. Otherwise, I am sure we would not be having this inquiry. Pre-GFC, there was a great equaliser in terms of funding that enabled smaller players to compete head-to-head with similar pricing and in many cases much lower pricing—that is, when Aussie Home Loans came into the market 10 years ago. They brought down the cost of mortgage lending significantly. The reason they could do that was that they were able to securitise their loans. So that was the big equaliser, and it was exactly the same for us. All I am saying is that the government has already indicated its willingness to support competition through the RMBS issuance, given that the international markets are virtually closed. The word ‘mortgage’ or ‘home mortgage’ worldwide, apart from Australia, is a dirty word. We have never had the experience of defaults in this country in our home mortgage market, so it is a safe investment. The government gets adequate return on its RMBS portfolio and it enables the smaller players to compete, as I said, on a much more level playing field.

Senator HURLEY —I think you are comparing this with the nineties, when, as you quite rightly said, there were many players in the market using securitisation as a funding vehicle. But there is an argument that we have heard in this committee that those were very unusual times. So you are asking the government to try and bring back those days when, globally, securitisation was forming a big pool of funding. You are asking the government to artificially bring it up to a similar level by government intervention. I am querying whether that is such a good idea.

Mr Liddy —As I said, the mortgage market was tainted as a result of exposures in the US—North America, mainly, but I guess in Europe as well. So a lot of people who were investing in those mortgages will not invest in mortgages today, because a mortgage is a mortgage is a mortgage, regardless of where it originates. In our country, we do not have anywhere near the default rates of other countries in terms of our mortgage portfolio. So I believe it is a safe investment for the government. If the government wants to assist in competition and in reducing the cost of funding to enable more relevant competition, then that is a key mechanism for it to do that.

Senator HURLEY —You do not accept the argument that we have come out of a highly unusual period in the securitisation market?

Mr Liddy —No. I believe the GFC was a very unusual situation, perhaps a once-in-a-lifetime situation, in financial services. That is what caused the unusual nature. I am sure, if we did not have a GFC, Australian mortgages would be very readily accepted overseas. Today Australian personal loans—cars, equipment finance—securitised as leases, are sold in the international markets, yet a mortgage cannot be. Why? Because mortgages have been tainted.

Senator HURLEY —So your view is that the government should actively step into the market?

Mr Liddy —As I said, if we have growth of seven per cent in mortgage lending in Australia, that requires $70 billion worth of new funding. We want a competitive and dynamic environment. I am not asking the government to go to $70 billion, but the government proved that it could bring competition back into the market through the $16-odd billion that it already put into the market. If we doubled that, it would enable a much more competitive environment.

Senator WILLIAMS —That is seven per cent over what period of time—a year?

Mr Liddy —Yes, if we had seven per cent growth in mortgage lending.

Senator WILLIAMS —Is that normal—seven per cent growth in mortgage lending a year?

Mr Liddy —It is low.

Senator WILLIAMS —You normally grow your mortgage lending more than that?

Mr Liddy —Much more.

Senator XENOPHON —In terms of volume, which could be a reflection of house prices.

—Yes. The mortgage market is subdued this year. It is probably less than seven per cent at the moment, but in previous years it has been 11 per cent, 14 per cent, 16 per cent. Over that period BOQ has, in system growth terms, more than doubled system growth. The only reason we could do that was to be competitive. As a small player we are a net receiver of disgruntled customers from major banks, and hopefully we do not lose too many that come over. But price is very, very important to consumers. If you are not competitive on your pricing then it takes a big leap of faith to say that BOQ is the better proposition than one of the majors.

Senator HURLEY —So the wholesale funding guarantee that the government brought in as a result of the GFC was clearly of benefit to you?

Mr Liddy —It was the saviour for the Australian financial services market, but it had to follow the worldwide trend. Ireland led with it. Once one government moved many governments did move. But we moved very quickly and we did it both on the lending side and also on the deposit side. It was very, very timely and certainly needed.

Senator HURLEY —I think it is a very important point that you raised about predatory pricing in your introduction. You said it as though—and I could be wrong on this—that there was predatory pricing being undertaken at the moment.

Mr Liddy —No, I do not think so. All I am saying is that if you have got the strength and the power, you can move the market which ever way you want. The major banks have a massive ability to cross-subsidise one area for another. For instance, in the retail deposit market in Australia, if you chose to put a 7½ per cent term deposit out there today when the market is six per cent, you could do it as a major bank, because you cross-subsidise any loss you had on that portfolio with a gain somewhere else. That is the facts. All I am saying is that that is not good for competition.

Senator HURLEY —Are you saying that the way to stop that is by maintaining competition or are you saying that there should be some regulation to prevent that?

Mr Liddy —I think it needs to be looked at in the whole competition theory issue that we are discussing today. I am certainly not saying that there is predatory pricing happening. But there is the potential for it to happen. Senator Williams raised the issue of retailers. We all know what has happened with major retailers in terms of pricing. Now it has all come back to a more level playing field, if you like. But the ability is there to price what you want.

Senator HURLEY —Yes, I think that clearly encapsulates why the government is concerned about maintaining competition in the banking sector. Thank you, Chair.

Senator XENOPHON —Thank you for your submission and being here today. Further to Senator Hurley’s line of questioning on predatory pricing, do you think the ACCC should have additional powers to deal with the issue of predatory pricing?

Mr Liddy —I definitely think it needs to be a consideration in the overall competition theory, yes.

Senator XENOPHON —Do you think our current predatory pricing laws are inadequate, either in terms of what is on the statute book or enforcement? I am not asking you to give a legal opinion on this, but is it your impression that it is either not actively enforced or not strong enough?

Mr Liddy —I do not think I have seen examples of predatory pricing. All I am saying is that I think the ability is there if a competitor chose to do that.

Senator XENOPHON —But the fact that the ability is there, does that affect behaviour in the marketplace, do you think?

Mr Liddy —Well, it could, certainly.

Senator XENOPHON —So you do not actually have to engage in it without it causing detriment to consumers?

Mr Liddy —In some cases it would be a plus for consumers. If one of the banks decided to go out with a terribly aggressive deposit rate, they will get customers, believe me. Customers move on rate; that is a fact—certainly on the deposit market. The average term of liabilities in banks these days is much, much shorter than it used to be. That is because customers will change.

Senator XENOPHON —Can I ask you about switching. You would have heard Suncorp’s evidence. What is the Bank of Queensland’s view on switching? In particular, Choice was quite praiseworthy of the Netherlands model, where there is an onus on the institution that you wish to switch from to provide the paperwork, to do the relevant things so that it is much more seamless and easy for a consumer to be able to switch. Would you have a problem with that sort of model?

Mr Liddy —No, not really. As I said, we are net receivers of people who do not want bank with a big bank, so I encourage any mechanisms that allow it to be easier to move between organisations. The only question I have got, if it becomes a very expensive technology issue, then the smaller players are going to find it hard.

Senator XENOPHON —I am not talking about the expensive technology approach, I am talking about the Netherlands, which seems to be more than an onus and a paper trail in a sense.

Mr Liddy —I am not totally familiar with the Netherlands model but I would support any mechanisms that make it seamless for a customer to switch banks without undue burden.

Senator XENOPHON —When Choice did a survey of Queensland businesses it found that those banking with the Bank of Queensland were more satisfied than those banking with the majors, which is good from your point of view. What prevents that good customer survey translating into increased market share for you? The big banks are still the big banks and they have got the lion’s share of the marketplace. You seem to have happier customers—

Mr Liddy —It is a great question. Post GFC the majors control roughly 90 per cent of the mortgage market, for instance. That is probably around the mark. BOQ has a national market share of around about 2.5 per cent. If we could double that to five per cent that would obviously make a major impact. We have to remain competitive to gain customers and we do. Our owner managed branch model is unique. It is run by small business people whose small business happens to be a bank. Believe me, they know their customers much better, I believe. If they do not look after their customers they basically do not feed themselves. So the level of service has to be good. We gain a lot of business from word of mouth. We are probably underspent by eight to one by most of the other banks in terms of advertising on television or radio, but we gain customers through word of mouth.

Senator XENOPHON —You made reference to Aussie Home Loans and the impact they had on the marketplace. I agree with you in terms of their impact and competition. Aussie Home Loans cannot access the AOFM because it seems that there is a view by government that it is a subsidiary of the Commonwealth Bank. The Commonwealth Bank has a 33 per cent share but John Symond controls four of the six board seats. Do you consider Aussie Home Loans to be a subsidiary of the Commonwealth Bank?

Mr Liddy —My understanding is that it is owned about 30 per cent by the Commonwealth Bank.

Senator XENOPHON —It is 33 per cent.

Mr Liddy —My understanding—and I have seen what John has said—is that the Commonwealth Bank do not have any direction in terms of the running of Aussie Home Loans. Knowing John Symond I would probably think that is correct.

Senator XENOPHON —But it is not a subsidiary in any corporate sense.

Mr Liddy —Not in a legal sense. It just happens to have a big elephant sitting on top of it.

Senator XENOPHON —Is that the case though?

Mr Liddy —I do not know. I am not involved in the Commonwealth Bank or Aussie Home Loans. I think it was a pretty tough deal to have that securitisation pulled.

Senator XENOPHON —Pulled from Aussie Home Loans?

Mr Liddy —They were due to go to the securitisation markets through the AOFM and it was stopped.

Senator XENOPHON —So you regard it as pretty tough on Aussie Home Loans?

Mr Liddy —I thought it was tough.

Senator XENOPHON —This line of questioning comes under the ‘what the hell were you thinking’ category and that relates to the fact that you have offered a deposit account where the return is effectively a lottery. I think you know what my views are on that. Is that product—if you want to call it that—still being offered?

Mr Liddy —Yes, and it is not a lottery. Under a lottery, or gambling, a depositor or a consumer puts their capital at risk. With our Save to Win account the capital is guaranteed.

Senator XENOPHON —But the interest is at risk.

Mr Liddy —The interest is one per cent, but there is a chance that you can get a prize going forward. We have just had the first draw of that.

Senator XENOPHON —Is that being a bit disingenuous? Whilst the capital is not at risk, if you put your money into an account where you have an interest rate of X per cent, you are actually saying, ‘Punt on the interest you will get,’ in terms of your savings remaining static. If you lose you do not get any interest. If you win—you have a 20,000 or 50,000 chance—you will get a bonus. You are putting your customers interest at risk in that sense.

Mr Liddy —No, I think we are encouraging savings. Firstly, as I said, I am here to talk about competition, by the way, but I am happy to talk about this for a second.

Senator XENOPHON —I will draw it back to competition in a minute. But go ahead.

Mr Liddy —To us it is an innovation—it is an innovation to provide competition to the major banks in getting new customers. It pays a nominal interest rate of one per cent—

Ms McMullen —Guaranteed.

Mr Liddy —guaranteed—and the capital is guaranteed. We do not expect customers to put all their savings into these accounts, but we are seeing customers put some of their savings in. They may bank with a major bank; they may bank with a credit union. And they are putting some of their savings in with Bank of Queensland. It offers choice—

Senator WILLIAMS —Is there a minimum amount required?

Mr Liddy —Yes: $250.

Senator XENOPHON —Mr Liddy, you say it is innovation. Others say it is an abomination, including consumer groups such as Choice. But the reason I have asked is that this is an inquiry about competition in the banking sector. Does this account that you offer, this so-called product, suggest that the pressure of competing with the major banks can push smaller banks such as yours into offering what many would consider to be an irresponsible product?

Mr Liddy —Firstly, we do not think it is an irresponsible product. It is a registered product. It is overseen by ASIC. It is a tier 1 product in terms of selling, so there are certain requirements that our staff have to go through in terms of selling that product. And, as I said, it is a unique offering in this market. It already exists in New Zealand. It already exists in the UK. And of course we have to innovate, to be different.

Senator XENOPHON —One per cent is below the market rate—way below the market rate.

Mr Liddy —A $20,000 prize every month is way above the market rate.

Senator WILLIAMS —It depends on how many customers you have got. If you had only 10,000 customers it would be. But if you had 10 million it would be below the rate.

Mr Liddy —I wish I had 10 million customers—I would not worry about it!

Ms McMullen —It should be noted: the account has been set up not as a savings account; it has been designed to attract people who have some spare cash, basically, to put away. That is why the minimum amount is $250 to get an entry into the draw. It is capped at $20,000. So, for anyone who puts in: if they have $250, $500, $1,000 or up to $20,000, the interest rate they would get on a term deposit at six per cent at the moment compared to what you would get on an interest rate of one per cent per month is, in actual dollars, not that different. So it is an incentive for a culture of savings for people who perhaps would not normally save.

Mr Liddy —And people will make a choice.

Senator XENOPHON —I cannot see how you are encouraging a culture of savings when you are giving way below the market rate, on a punt. But how do you advise customers to treat these accounts when compiling their tax returns?

Mr Liddy —It is taxable. Any interest is taxable in this game.

Senator XENOPHON —And the winnings, if they happen to win the jackpot?

Mr Liddy —Taxable.

Senator XENOPHON —I will be asking ASIC some questions about it, so please do not think I am only picking on you. I think Senator Williams had some further questions, but I will leave it up to the chair.

CHAIR —Senator Williams.

Senator WILLIAMS —Mr Liddy, I am very interested in predatory pricing. That concerns me. My colleague Barnaby Joyce made amendments to the Trade Practices Act—the Birdsville amendments—to see that the big end of town cannot just go out there and undersell at a price to squash the little competitor away. I do not think those movements have gone far enough in the Trade Practices Act. Have you seen any sign of predatory pricing, whether on investment rates or lending rates?

Mr Liddy —No.

Senator WILLIAMS —Good.

Mr Liddy —As I said, competition is hot in the Australian market at the moment, particularly in deposits. If you are going to compete, you have to be competitive in terms of pricing. But certainly I have seen no instance of predatory pricing.

Senator WILLIAMS —The committee is well aware of the competition. Prior to the GFC there was competition in lending money; now there is competition in getting money in.

Mr Liddy —That is right.

Senator WILLIAMS —You are seeing exactly that?

Mr Liddy —That its purely because of the cost of wholesale funding. There is about a 90 basis points difference between pre GFC and post GFC for us.

Senator WILLIAMS —If I made you dictator of Australia, hypothetically, tomorrow for one week, what would you change at a government or regulation level to give more competition in the banking industry?

Mr Liddy —I think I have covered that in the submission, but just to recap—

Senator WILLIAMS —Do you mean the five points?

Mr Liddy —Yes, the five points I have raised. I think levelling the playing field in terms of access to funding is probably the most important one, because it does enable the smaller players to compete head to head. If you look at what has happened in our marketplace, we have had the three main non-bank lenders disappear. We have had the two major regional banks disappear. You can call that consolidation or whatever you want to.

Senator WILLIAMS —A takeover, abolishing competition—whatever you want to call it.

Mr Liddy —We still have competition in the marketplace. I am not saying we do not have competition. I am saying we can make it a much more even competition by addressing some of the issues we have raised in our submission.

Senator WILLIAMS —Thanks, Chair.

CHAIR —I have a couple more questions before we finish. You referred to the Canadian model of RMBS funding. How would that translate to Australia? How do you see that could work here?

Mr Liddy —Sorry, Senator?

CHAIR —The Canadian model of essentially supporting the RMBS market.

Mr Liddy —The Canadian model involved a whole series of initiatives, but essentially they took the risk through an RMBS type scheme guaranteeing the banks’ paper—and providing significant liquidity in the Canadian market, for that matter. So it helped both on pricing and certainly in terms of the liquidity of paper in the Canadian market. There have been a lot of objections to it on the basis that such a scheme potentially creates a contingent liability for the government. But at the end of the day, as I said, if you look at the size of the big banks in this country—and I believe that they are systemically important—that is a liability for the government anyway.

CHAIR —So you are saying that there is an implicit liability anyway, in the same way that formalising the deposit guarantee side of things—

Mr Liddy —I cannot see the Australian government allowing one of our major banks to fail.

CHAIR —No. So the implicit guarantee that exists in terms of the banks themselves is really no different, in effect, to providing an explicit guarantee here for the RMBS in the same way that the Canadian model does?

Mr Liddy —No. I believe so.

CHAIR —Okay. So there is no real difference in risk, whether it be implicit or explicit.

Mr Liddy —No.  And there would be a significant benefit to the Australian government. The Canadian government get around $1 billion in fees through their RMBS scheme.

CHAIR —You would think that, at this point in the cycle, that would probably be quite attractive to the government, $1 billion in fees.

Mr Liddy —I think it would be too!

CHAIR —Yes. Is that annually?

Mr Liddy —I think that is over the period of the issue. I cannot be sure about that.

CHAIR —We might check that. Another thing that you mentioned in your submission was the change to the risk-weighting of mortgages for non-major banks, which obviously comes out of Basel II. Do the announcements that were made by APRA just prior to Christmas have any impact on your submission and what you were recommending at that point?

Mr Liddy —No, not really. My point there was that we accept APRA’s status in terms of Basel II. APRA have also made amendments to Basel III, which I think is probably in the interests of the major banks more than anyone else’s because it involves capital. If you were defined as systemically important, you had to put in one to 2½ per cent of additional capital. Now, that is not going to apply to the Australian banks. Under Basel II, there were many issues that came from that. One was that the major banks were granted advanced status in terms of Basel II, which gave them risk-weighting on their mortgage portfolio of circa 20 per cent.

CHAIR —But you could apply for advanced status, couldn’t you, if you were prepared to—

Mr Liddy —No.

CHAIR —No?

Mr Liddy —We could apply for it, but it would take years.

CHAIR —You would need to change your systems and do things like that, yes.

Mr Liddy —Exactly. But we were instructed—I use that word, but it is probably a bit strong—that there would be four advanced statuses issued (there were three initially and then one of the majors came in later) and the rest would be on a standardised approach. My point is that the cost of capital to us on a standardised approach is, say, 40 basis points, as opposed to 20 basis points. Our origination systems, our mortgages, our insurance et cetera are identical. So I do not want advanced status across the board, but I think in terms of mortgages it is appropriate, because the risks, to me, are identical.

CHAIR —And that difference in cost comes about because of the administration side of it—how much capital you have to hold because you do not have advanced status?

Mr Liddy —Yes. Because we work on a standardised approach, we have to hold double the capital, basically, for that mortgage portfolio.

CHAIR —That is based on Basel II, which is negotiated internationally. Is the Australian government bound to apply that to you or is there any flexibility

Mr Liddy —My understanding is that that is at the regulator’s discretion. Regulators, as you have seen recently, have already made concessions in terms of Basel III.

CHAIR —They had to be negotiated. I was asking regulators at every estimates over about two years how they were going with Basel III, and they kept on telling me that they would tell me in the end. Quite rightly, they did not want to expose what they were negotiating because they did not want to undermine the potential for them to deliver an outcome that would advantage—

Mr Liddy —The operational risk aspects of a smaller bank compared to a major bank are different. We could not get to advanced status in a short period of time. It would probably take us a minimum of three years.

CHAIR —If this committee were minded to try to address that issue, what would we have to recommend and what is within the realm of government that they could actually change to assist in delivering that outcome?

Mr Liddy —I believe that if the government instructed APRA to apply a part of Basel II in relation to the mortgage portfolio in Australia to give it the same risk weighting across the board that would be—

CHAIR —It could do that without breaching internationally agreed rules?

Mr Liddy —I believe so. That is my understanding.

Senator XENOPHON —What has happened to Basel III? Has that been finalised at this stage?

Mr Liddy —No.

Senator XENOPHON —That is what I thought. So it is still in negotiations.

Mr Liddy —It is indicated that Australian banks will not be classified has systemically important under the definition of Basel III, which means that Australian banks will not have to put additional capital in place as a result of that.

Senator XENOPHON —Some of the witnesses have said that we will see increased pressure on funding costs. That together with European governments having to refinance their sovereign debt means things could be tighter by the end of this year in terms of finance and the cost of money. Do you think there is a risk of that?

Mr Liddy —I think there is a definite possibility. There is going to be a huge demand for funds over the next 12 months as the rollovers happen and the major banks are certainly more involved in that than the smaller banks in terms of the volume.

Senator XENOPHON —With Basel III, could that be a factor in the sense that could we be caught up to some degree in the fact that there will be stricter prudential requirements on banks globally even though the Australian banking sector has been very strong and robust in terms of its regulatory framework?

Mr Liddy —Definitely. A lot of it has not been finalised, so the change to liquidity is still years away. But the capital issues are there now. But we still do not know all the details, so it is a bit hard to guess what the impact may be. The search for funding is a big issue globally and there are a lot of countries requiring funding and our banks will be involved in that. There is only so much to go around.

Senator XENOPHON —And Basel III does not say anything about lottery type accounts?

Mr Liddy —It does not say anything about accounts with save to win, no.

Senator XENOPHON —I call them lottery accounts. Maybe it should.

CHAIR —Thank you Mr Liddy and Ms McMullen for assisting us tonight.

Committee adjourned at 7.59 pm