How the Productivity Commission wants to shake up competition in the financial system
With all the news about the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, we should not overlook an inquiry by another commission into the financial system, also announced last year, which has already proposed big changes.
Background
On 8 May 2017, the Treasurer asked the Productivity Commission to review competition in Australia's financial system. The Commission was given a wide-ranging brief. It was asked to:
consider the level of contestability and concentration in key segments of the financial system (including vertical and horizontal integration, and the related business models of major firms), and the implications for competition and consumer outcomes;
examine the degree and nature of competition in the provision of personal deposit accounts and mortgages for households and of credit and financial services for small and medium sized enterprises;
examine barriers to and enablers of innovation and competition in the system, including policy and regulation; and
prioritise any potential policy changes with reference to existing pro-competition policies to which the Government was already committed or considering in light of other inquiries.
The Commission commenced the inquiry on 1 July 2017 and published a draft report in January 2018. Comments closed on 20 March, and there were 53 submissions received following the draft report. The final report is due to be delivered by 1 July 2018.While the Royal Commission is concerned with ‘misconduct’, the Productivity Commission is looking at the financial system from the angle of competition. The draft report provides a good indication of where it is heading. It contains a number of recommendations which could have significant operational impact for the financial services industry, whether or not they lead to the competition benefits that the Productivity Commission has in mind.
Key points
The Commission found that the benefits of competition for consumers “are being reduced in the quest for stability”. It seems that the Commission regards competition and stability as trade-offs, and the current balance is not optimal.
It also found that while customer satisfaction levels are generally high, customer loyalty is often unrewarded, with existing customers being kept on high margin products. The Commission believes that for this to continue, channels for providing information and advice such as mortgage brokers “must be failing”.
General comments
In retail banking, the Commission does not consider that market concentration is necessarily a problem, as long as new and innovative business models can thrive. It says that price competition for loan products is constrained by external factors including price setting by the Reserve Bank, expectations of rating agencies that large banks are too big to fail, and some prudential regulation that favours large institutions over smaller ones. The Commission believes that competition for the quality of services is not constrained in this way. Quality of services covers matters such as the effective use of technology to better price risk, responding to shifts in demand, and simpler and cheaper processes. However, the Commission thinks that rather than competition of this kind, we instead have marketing and brand activity designed to “promote a blizzard of barely differentiated products and white labels”.
In particular, the Commission believes that the growth in mortgage brokers and other advisors does not appear to have increased price competition. The Commission considers that there is not enough transparency in fees and trailing commissions, and that there are conflicts of interest created by ownership.
It describes the general insurance market as highly concentrated and says that this concentration is not immediately apparent because there are numerous retail brands.
The Commission says that new entrants to the market cannot be counted on as the main source of competitive pressure, and that therefore “reforms to the regulatory framework under which incumbents operate” are also essential to improve competition. It recommends more nuance in the design of prudential regulation by APRA for risk weightings and directions to authorised deposit-taking institutions (ADIs), to address issues of market power and imbalances in lending between businesses and housing.
Recommendations in the draft report
Summarised below are the main recommendations in the draft report by subject area.
Banking regulation
APRA should implement its phased approach for licensing ADIs.
Revised ownership rules including a higher threshold on ownership under the Financial Sector (Shareholdings) Act 1998 (Cth) to improve access to capital for new entrants and existing banks.
Share ownership limits should be reviewed for existing ADIs without the presumption of the ‘Four Pillars’ policy.
Mortgage broking
ASIC should impose a clear legal duty on mortgage aggregators owned by lenders to act in the consumer's best interests.
ASIC should require that before a mortgage broker recommends a loan to a consumer, the broker must have a discussion with the consumer about:
the types of products offered by different lenders, including white label loans, and which lender provides the funding for them, and associated loan features;
the role of mortgage brokers in matching borrowers with home loan providers, including how brokers are limited in their ability to help consumers apply for loans from all lenders because not all lenders are on the aggregator’s panel, or the broker is not accredited with a particular lender;
how mortgage brokers are paid, including specific information about their payment arrangements; and
any ownership relationships between lenders and the aggregator, and the requirement for brokers to act in the consumer's interest when an ownership relationship exists (as per the recommended best interests duty above).
Brokers would also be required to provide plain English documents on these matters.
Mortgage lending
APRA should collect monthly data from mortgage lenders on median interest rates for different categories of new residential home loans. ASIC should use this data to develop an online tool which would allow consumers to select different combinations of loan and borrower characteristics and which would report on median interest rates for loans in the previous month, by lender. APRA should also publish the data in a way that is accessible to users such as web application developers, to develop comparative websites, if there is a commercial benefit in doing so.
Lenders should be required to offer home loan customers refunds for the cost of lenders mortgage insurance when customers choose to refinance or pay out their loan.
Prudential
APRA should provide a broader schedule of risk weightings in Prudential Standard APS 112 rather than a single risk weight to all small and medium business lending not secured by residences.
Implementation of the revised Prudential Standard APS 120 that came into effect on 1 January 2018 should be revised and limited to warehouse funds provided to ADIs.
APRA should commence and complete a review of the standardised risk weights for residential mortgages in Prudential Standard APS 112.
Payments
A tiered prudential regime should be developed for purchased payment facilities to reduce barriers to growth. Purchased payment facilities with total stored value below $50 million and individual holdings of no more than $500 would not face prudential regulation.
ASIC should amend the ePayments Code to make it mandatory for any entity that intends to send or receive electronic payments.
The Payments System Board should introduce a ban on card payment interchange fees by mid-2019. Any remaining fees should be directly related to system operating costs and be made transparent and published.
Merchants should be given the ability to choose the default network to route contactless transactions for dual network cards.
The New Payments Platform should be subject to an access regime imposed by the Payments System Board.
General insurance
Renewal notices for general insurance products should include the previous year's premium and the percentage change.
Insurance websites should include a list of other brands underwritten by the same insurer, and insurers would be required to provide an up-to-date list of the brands they underwrite to ASIC, which would be published on the ASIC website.
State and Territory taxes and levies on general insurance should be phased out.
ASIC should proceed as soon as possible with its proposal to mandate a deferred sales model for all sales of add-on insurance by car dealerships. After this, the Federal Government should establish a working group to extend the deferred sales model to all add-on insurance products in a practical timeframe.
Financial product advice
“General advice” as defined in the Corporations Act 2001 (Cth) is misleading and should be renamed. Consumer testing should be conducted on alternative terminology. The term “advice” should be limited to personal advice.
Regulators
An existing financial system regulator should be given a mandate to take the lead on matters related to competition in the financial system.
The Council of Financial Regulators should implement a process of review before members put in place regulatory interventions that may have a material impact on competition in a product market.
APRA should conduct and publish annually quantitative post-implementation evaluations of its macro prudential policies. This would include the costs and benefits to market participants and the effects on competition.
Statements of Expectations and Statements of Intent by regulators should be urgently implemented.
Mergers and acquisitions
Mergers and acquisitions within the financial system should be notified in advance to ASIC and the ACCC. This information would be maintained in a publicly accessible database.
Open Banking
Open Banking should be implemented.
Other possible recommendations
In its draft report the Productivity Commission has also sought information and comment on some other possible changes being considered. These possible further changes include:
Extending the fintech licensing exemption offered under the ASIC regulatory sandbox to prudentially regulated fintechs that want to take retail deposits and issue other eligible financial products.
Consumers should pay mortgage brokers directly through fees for service, rather than brokers receiving commissions from lenders.
Regulation of mortgage broker trail commissions and commission clawbacks.
ASIC-licensed financial advisers being allowed to provide advice on some credit products, in particular home loans, personal loans and credit cards.
Redefining the activities that are currently regulated under general advice and providing a more customised regime for some activities, and removing licensing and regulatory obligations currently associated with some or all forms of general advice.
Kathleen Harris and Patrick Dwyer
Legal Directors