Executive summary

This report responds to the objective in the Inquiry’s Terms of Reference to best position Australia’s financial system to meet Australia’s evolving needs and support economic growth. It offers a blueprint for an efficient and resilient financial system over the next 10 to 20 years, characterised by the fair treatment of users.

The Inquiry has made 44 recommendations relating to the Australian financial system. These recommendations reflect the Inquiry’s judgement and are based on evidence received by the Inquiry. The Inquiry’s test has been one of public interest: the interests of individuals, businesses, the economy, taxpayers and Government.

Australia’s financial system has performed well since the Wallis Inquiry and has many strong characteristics. It also has a number of weaknesses: taxation and regulatory settings distort the flow of funding to the real economy; it remains susceptible to financial shocks; superannuation is not delivering retirement incomes efficiently; unfair consumer outcomes remain prevalent; and policy settings do not focus on the benefits of competition and innovation. As a result, the system is prone to calls for more regulation.

To put these issues in context, the Overview first deals with the characteristics of Australia’s economy. It then describes the characteristics of and prerequisites for a well-functioning financial system and the Inquiry’s philosophy of financial regulation.

The Inquiry focuses on seven themes in this report (summarised in Guide to the Financial System Inquiry Final Report). The Overview deals with the general themes of funding the Australian economy and competition.

The Inquiry has also made recommendations on five specific themes, which comprise the next chapters of this report:

Strengthen the economy by making the financial system more resilient.
Lift the value of the superannuation system and retirement incomes.
Drive economic growth and productivity through settings that promote innovation.
Enhance confidence and trust by creating an environment in which financial firms treat customers fairly.
Enhance regulator independence and accountability, and minimise the need for future regulation.

These recommendations seek to improve efficiency, resilience and fair treatment in the Australian financial system, allowing it to achieve its potential in supporting economic growth and enhancing standards of living for current and future generations.

Guide to the Financial System Inquiry Final Report

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Overview and general themes

The Inquiry has taken into account important features of Australia’s economy. Australia has an open, market-based economy and is a net importer of capital. The Australian economy faces a considerable productivity challenge, and the Australian population, like many around the world, is ageing. Finally, Australia is in the midst of one of the most ubiquitous, generally applicable technology changes the world has ever seen.

Characteristics of an effective financial system

The financial sector plays a vital role in supporting a vibrant, growing economy that improves the standard of living for all Australians. The system’s ultimate purpose is to facilitate sustainable growth in the economy by meeting the financial needs of its users. The Inquiry believes the financial system will achieve this goal if it operates in a manner that is:

Efficient: An efficient system allocates Australia’s scarce financial and other resources for the greatest possible benefit to our economy, supporting growth, productivity and prosperity.
Resilient: The financial system should adjust to changing circumstances while continuing to provide its core economic functions, even during severe shocks. Institutions in distress should be resolvable with minimal costs to depositors, policy holders, taxpayers and the real economy.
Fair: Fair treatment occurs where participants act with integrity, honesty, transparency and non-discrimination. A market economy operates more effectively where participants enter into transactions with confidence they will be treated fairly.

Confidence and trust in the system are essential ingredients in building an efficient, resilient and fair financial system that facilitates economic growth and meets the financial needs of Australians. The Inquiry considers that all financial system participants have roles and responsibilities in engendering that confidence and trust.

The Inquiry’s approach to financial system regulation

Central to the Inquiry’s philosophy is the principle that the financial system should be subject and responsive to market forces, including competition.

However, competitive markets need to operate within a strong and effective legal and policy framework provided by Government. This includes predictable rule of law with strong property rights; a freely convertible floating currency and free flow of trade, investment and capital across borders; a strong fiscal position; a sound and independent monetary policy framework; and an effective, accountable and transparent government.

The Inquiry’s approach to policy intervention is guided by the public interest. Given the inevitable trade-offs involved, deciding how and when policy makers should intervene in the financial system requires considerable judgement. Intervention should seek to balance efficiency, resilience and fairness in a way that builds participants’ confidence and trust. Intervention should only occur where its benefits to the economy as a whole outweigh its costs, and should always seek to be proportionate and cost sensitive.

General themes

The Inquiry identified two general themes where there is significant scope to improve the functioning of the financial system:

Funding the Australian economy.
Competition.

Funding the Australian economy

The core function of the Australian financial system is to facilitate the funding of sustainable economic growth and enhance productivity in the Australian economy. The Inquiry believes Government’s role in funding markets should generally be neutral regarding the channel, direction, source and size of the flow of funds.

The Inquiry identified a number of distortions that impede the efficient market allocation of financial resources, including taxation, information imbalances and unnecessary regulation. Reducing the distortionary effects of taxation should lead the system to allocate savings (including foreign savings) more efficiently and price risk more accurately. The Inquiry has referred the identified tax issues for consideration in the Tax White Paper.

A number of the Inquiry’s recommendations aim to assist small and medium-sized enterprises in obtaining better access to funding. To strengthen Australia’s ability to continue to access funding, both domestically and from offshore sources, recommendations have been made to improve the resilience of the Australian financial system. More broadly, given that Australia’s growing superannuation system will have an increasing influence on future funding flows, the Inquiry believes that the recommendations it has made to improve the efficiency of the superannuation system would also enhance financial system funding efficiency.

Competition

Competition and competitive markets are at the heart of the Inquiry’s philosophy for the financial system. The Inquiry sees them as the primary means of supporting the system’s efficiency. Although the Inquiry considers competition is generally adequate, the high concentration and increasing vertical integration in some parts of the Australian financial system has the potential to limit the benefits of competition in the future and should be proactively monitored over time.

The Inquiry’s approach to encouraging competition is to seek to remove impediments to its development. The Inquiry has made recommendations to amend the regulatory system, including: narrowing the differences in risk weights in mortgage lending; considering a competitive mechanism to allocate members to more efficient superannuation funds; and ensuring regulators are more sensitive to the effects of their decisions on competition, international competitiveness and the free flow of capital. In particular, the state of competition in the financial system should be reviewed every three years, including assessing changes in barriers to international competition.

Recommendations relating to funding and competition are listed in Table 1.

Table 1: Funding the Australian economy and competition recommendations
Funding the Australian economy
Number	Description
–	Tax observations
18	Crowdfunding
19	Data access and use
20	Comprehensive credit reporting
33	Retail corporate bond market
Competition
Number	Description
2	Narrow mortgage risk weight differences
10	Improving efficiency during accumulation
14	Collaboration to enable innovation
15	Digital identity
16	Clearer graduated payments regulation
18	Crowdfunding
19	Data access and use
20	Comprehensive credit reporting
27	Regulator accountability
30	Strengthening the focus on competition in the financial system
39	Technology neutrality
42	Managed investment scheme regulation

Chapter 1: Resilience

Historically, Australia has maintained a strong and stable financial system supported by effective stability settings. However, the Australian financial system has characteristics that give rise to particular risks, including its high interconnectivity domestically and with the rest of the world, and its dependence on importing capital. More can be done to strengthen the resilience of Australia’s financial system to avoid or limit the costs of future financial crises, which can deeply damage an economy and have lasting effects on people’s lives.

As the banking sector is at the core of the Australian financial system, its safety is of paramount importance. Australia should aim to have financial institutions with the strength to not only withstand plausible shocks but to continue to provide critical economic functions, such as credit and payment services, in the face of these shocks. Adhering to international regulatory norms will help ensure Australian financial institutions and markets are not disadvantaged in raising funds in international financial markets.

The Inquiry’s recommendations to improve resilience aim to:

Strengthen policy settings that lower the probability of failure, including setting Australian bank capital ratios such that they are unquestionably strong by being in the top quartile of internationally active banks.
Reduce the costs of failure, including by ensuring authorised deposit-taking institutions maintain sufficient loss absorbing and recapitalisation capacity to allow effective resolution with limited risk to taxpayer funds — in line with international practice.

These recommendations seek to ensure that Australia’s financial system remains resilient into the future, and that it continues to provide its core economic functions, even in times of financial stress. These recommendations should also produce efficiency benefits, including through reducing implicit guarantees and volatility in the economy and promoting confidence and trust.

Chapter 2: Superannuation and retirement incomes

Australia’s superannuation system is large by international standards and has grown rapidly since the Wallis Inquiry, primarily as a result of Government policy settings.

An efficient superannuation system is critical to help Australia meet the economic and fiscal challenges of an ageing population. The system has considerable strengths. It plays an important role in providing long-term funding for economic activity in Australia both directly and indirectly through funding financial institutions, and it contributed to the stability of the financial system and the economy during the global financial crisis.

However, the superannuation system is not operationally efficient due to a lack of strong price-based competition. Superannuation assets are not being efficiently converted into retirement incomes due to a lack of risk pooling and over-reliance on individual account-based pensions.

The Inquiry’s recommendations to strengthen the superannuation system aim to:

Set a clear objective for the superannuation system to provide income in retirement.
Improve long-term net returns for members by introducing a formal competitive process to allocate new workforce entrants to high-performing superannuation funds, unless the Stronger Super reforms prove effective.
Meet the needs of retirees better by requiring superannuation trustees to pre-select a comprehensive income product in retirement for members to receive their benefits, unless members choose to take their benefits in another way.

These recommendations seek to improve the outcomes for superannuation fund members and help Australia to manage the challenges of an ageing population.

Chapter 3: Innovation

Technology-driven innovation is transforming the financial system, as evidenced by the emergence of new business models and products, and substantial investment in areas such as mobile banking, cloud computing and payment services.

Although innovation has the potential to deliver significant efficiency benefits and improve system outcomes, it also brings risks. Consumers, businesses and government can be adversely affected by new developments, which may also challenge regulatory frameworks and regulators’ ability to respond.

The Inquiry believes the innovative potential of Australia’s financial system and broader economy can be supported by taking action to ensure policy settings facilitate future innovation that benefits consumers, businesses and government.

The Inquiry’s recommendations to facilitate innovation aim to:

Encourage industry and government to work together to identify innovation opportunities and emerging network benefits where government may need to facilitate industry coordination and action.
Strengthen Australia’s digital identity framework through the development of a national strategy for a federated-style model of trusted digital identities.
Remove unnecessary regulatory impediments to innovation, particularly in the payments system and in fundraising for small businesses.
Enable the development of data-driven business models through holding a Productivity Commission Inquiry into the costs and benefits of increasing access to and improving the use of private and public sector data.

These recommendations will contribute to developing a dynamic, competitive, growth-oriented and forward-looking financial system for Australia.

Chapter 4: Consumer outcomes

Fundamental to fair treatment is the concept that financial products and services should perform in the way that consumers expect or are led to believe.

The current framework is not sufficient to deliver fair treatment to consumers. The most significant problems relate to shortcomings in disclosure and financial advice, which means some consumers are sold financial products that are not suited to their needs and circumstances. Although the regime should not be expected to prevent all consumer losses, self-regulatory and regulatory changes are needed to strengthen financial firms’ accountability.

The Inquiry’s recommendations to improve consumer outcomes aim to:

Improve the design and distribution of financial products through strengthening product issuer and distributor accountability, and through implementing a new temporary product intervention power for the Australian Securities and Investments Commission (ASIC).
Further align the interests of firms and consumers, and improve standards of financial advice, by lifting competency and increasing transparency regarding financial advice.
Empower consumers by encouraging industry to harness technology and develop more innovative and useful forms of disclosure.

These recommendations seek to strengthen the current framework to promote consumer trust in the system and fair treatment of consumers.

Chapter 5: Regulatory system

Australia needs strong, independent and accountable regulators to help maintain confidence and trust in the financial system, thereby attracting investment and supporting growth. This requires proactive regulators with the right skills, culture, powers and funding.

Australia’s regulatory architecture does not need major change; however, the Inquiry has made recommendations to improve the current arrangements. Government currently lacks a regular process that allows it to assess the overall performance of financial regulators. Regulators’ funding arrangements and enforcement tools have some significant weaknesses, particularly in the case of ASIC. In addition, it is not clear whether adequate consideration is currently given to competition and efficiency in designing and applying regulation.

The Inquiry’s recommendations to refine Australia’s regulatory system and keep it fit for purpose aim to:

Improve the accountability framework governing Australia’s financial sector regulators by establishing a new Financial Regulator Assessment Board to review their performance annually.
Ensure Australia’s regulators have the funding, skills and regulatory tools to deliver their mandates effectively.
Rebalance the regulatory focus towards competition by including an explicit requirement to consider competition in ASIC’s mandate and conduct three-yearly external reviews of the state of competition.
Improve the process for implementing new financial regulations.

These recommendations seek to make Australia’s financial regulators more effective, adaptable and accountable.

Appendix 1: Significant matters

In addition to the recommendations in the above areas, the Inquiry has made 13 recommendations relating to other significant matters. These are contained in Appendix 1: Significant matters.

Appendix 2: Tax summary

A number of tax observations are included in Appendix 2: Tax summary for consideration by the Tax White Paper.

Recommendations

The Inquiry has made 44 recommendations relating to the Australian financial system. The nature of some recommendations warrants more in-depth discussion. These recommendations are shaded darker in the Summary of recommendations by chapter tables on the following pages. The Inquiry considers that the remaining recommendations in the body of the report can be made without providing the reader with the same depth of explanation. Recommendations contained in Appendix 1: Significant matters are only explained briefly.

Summary of recommendations by chapter

*Chapter 1: Resilience* (pages 33–88)
Number	Description
1	Capital levels Set capital standards such that Australian authorised deposit-taking institution capital ratios are unquestionably strong.
2	Narrow mortgage risk weight differences Raise the average internal ratings-based (IRB) mortgage risk weight to narrow the difference between average mortgage risk weights for authorised deposit-taking institutions using IRB risk-weight models and those using standardised risk weights.
3	Loss absorbing and recapitalisation capacity Implement a framework for minimum loss absorbing and recapitalisation capacity in line with emerging international practice, sufficient to facilitate the orderly resolution of Australian authorised deposit-taking institutions and minimise taxpayer support.
4	Transparent reporting Develop a reporting template for Australian authorised deposit-taking institution capital ratios that is transparent against the minimum Basel capital framework.
5	Crisis management toolkit Complete the existing processes for strengthening crisis management powers that have been on hold pending the outcome of the Inquiry.
6	Financial Claims Scheme Maintain the ex post funding structure of the Financial Claims Scheme for authorised deposit-taking institutions.
7	Leverage ratio Introduce a leverage ratio that acts as a backstop to authorised deposit-taking institutions’ risk-weighted capital positions.
8	Direct borrowing by superannuation funds Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds.

*Chapter 2: Superannuation and retirement incomes* (pages 89–142)
Number	Description
9	Objectives of the superannuation system Seek broad political agreement for, and enshrine in legislation, the objectives of the superannuation system and report publicly on how policy proposals are consistent with achieving these objectives over the long term.
10	Improving efficiency during accumulation Introduce a formal competitive process to allocate new default fund members to MySuper products, unless a review by 2020 concludes that the Stronger Super reforms have been effective in significantly improving competition and efficiency in the superannuation system.
11	The retirement phase of superannuation Require superannuation trustees to pre-select a comprehensive income product for members’ retirement. The product would commence on the member’s instruction, or the member may choose to take their benefits in another way. Impediments to product development should be removed.
12	Choice of fund Provide all employees with the ability to choose the fund into which their Superannuation Guarantee contributions are paid.
13	Governance of superannuation funds Mandate a majority of independent directors on the board of corporate trustees of public offer superannuation funds, including an independent chair; align the director penalty regime with managed investment schemes; and strengthen the conflict of interest requirements.

*Chapter 3: Innovation* (pages 143–192)
Number	Description
14	Collaboration to enable innovation Establish a permanent public–private sector collaborative committee, the ‘Innovation Collaboration’, to facilitate financial system innovation and enable timely and coordinated policy and regulatory responses.
15	Digital identity Develop a national strategy for a federated-style model of trusted digital identities.
16	Clearer graduated payments regulation Enhance graduation of retail payments regulation by clarifying thresholds for regulation by the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority. Strengthen consumer protection by mandating the ePayments Code. Introduce a separate prudential regime with two tiers for purchased payment facilities.
17	Interchange fees and customer surcharging Improve interchange fee regulation by clarifying thresholds for when they apply, broadening the range of fees and payments they apply to, and lowering interchange fees. Improve surcharging regulation by expanding its application and ensuring customers using lower-cost payment methods cannot be over-surcharged by allowing more prescriptive limits on surcharging.
18	Crowdfunding Graduate fundraising regulation to facilitate crowdfunding for both debt and equity and, over time, other forms of financing.
19	Data access and use Review the costs and benefits of increasing access to and improving the use of data, taking into account community concerns about appropriate privacy protections.
20	Comprehensive credit reporting Support industry efforts to expand credit data sharing under the new voluntary comprehensive credit reporting regime. If, over time, participation is inadequate, Government should consider legislating mandatory participation.

*Chapter 4: Consumer outcomes* (pages 193–232)
Number	Description
21	Strengthen product issuer and distributor accountability Introduce a targeted and principles-based product design and distribution obligation.
22	Introduce product intervention power Introduce a proactive product intervention power that would enhance the regulatory toolkit available where there is risk of significant consumer detriment.
23	Facilitate innovative disclosure Remove regulatory impediments to innovative product disclosure and communication with consumers, and improve the way risk and fees are communicated to consumers.
24	Align the interests of financial firms and consumers Better align the interests of financial firms with those of consumers by raising industry standards, enhancing the power to ban individuals from management and ensuring remuneration structures in life insurance and stockbroking do not affect the quality of financial advice.
25	Raise the competency of advisers Raise the competency of financial advice providers and introduce an enhanced register of advisers.
26	Improve guidance and disclosure in general insurance Improve guidance (including tools and calculators) and disclosure for general insurance, especially in relation to home insurance.

*Chapter 5: Regulatory system* (pages 233–260)
Number	Description
27	Regulator accountability Create a new Financial Regulator Assessment Board to advise Government annually on how financial regulators have implemented their mandates. Provide clearer guidance to regulators in Statements of Expectation and increase the use of performance indicators for regulator performance.
28	Execution of mandate Provide regulators with more stable funding by adopting a three-year funding model based on periodic funding reviews, increase their capacity to pay competitive remuneration, boost flexibility in respect of staffing and funding, and require them to undertake periodic capability reviews.
29	Strengthening the Australian Securities and Investments Commission’s funding and powers Introduce an industry funding model for the Australian Securities and Investments Commission (ASIC) and provide ASIC with stronger regulatory tools.
30	Strengthening the focus on competition in the financial system Review the state of competition in the sector every three years, improve reporting of how regulators balance competition against their core objectives, identify barriers to cross-border provision of financial services and include consideration of competition in the Australian Securities and Investments Commission’s mandate.
31	Compliance costs and policy processes Increase the time available for industry to implement complex regulatory change. Conduct post-implementation reviews of major regulatory changes more frequently.

*Appendix 1: Significant matters* (pages 261–276)
Number	Description
32	Impact investment Explore ways to facilitate development of the impact investment market and encourage innovation in funding social service delivery. Provide guidance to superannuation trustees on the appropriateness of impact investment. Support law reform to classify a private ancillary fund as a ‘sophisticated’ or ‘professional’ investor, where the founder of the fund meets those definitions.
33	Retail corporate bond market Reduce disclosure requirements for large listed corporates issuing ‘simple’ bonds and encourage industry to develop standard terms for ‘simple’ bonds.
34	Unfair contract term provisions Support Government’s process to extend unfair contract term protections to small businesses. Encourage industry to develop standards on the use of non-monetary default covenants.
35	Finance companies Clearly differentiate the investment products that finance companies and similar entities offer retail consumers from authorised deposit-taking institution deposits.
36	Corporate administration and bankruptcy Consult on possible amendments to the external administration regime to provide additional flexibility for businesses in financial difficulty.
37	Superannuation member engagement Publish retirement income projections on member statements from defined contribution superannuation schemes using Australian Securities and Investments Commission (ASIC) regulatory guidance. Facilitate access to consolidated superannuation information from the Australian Taxation Office to use with ASIC’s and superannuation funds’ retirement income projection calculators.
38	Cyber security Update the 2009 Cyber Security Strategy to reflect changes in the threat environment, improve cohesion in policy implementation, and progress public–private sector and cross-industry collaboration. Establish a formal framework for cyber security information sharing and response to cyber threats.
39	Technology neutrality Identify, in consultation with the financial sector, and amend priority areas of regulation to be technology neutral. Embed consideration of the principle of technology neutrality into development processes for future regulation. Ensure regulation allows individuals to select alternative methods to access services to maintain fair treatment for all consumer segments.
40	Provision of financial advice and mortgage broking Rename ‘general advice’ and require advisers and mortgage brokers to disclose ownership structures.
41	Unclaimed monies Define bank accounts and life insurance policies as unclaimed monies only if they are inactive for seven years.
42	Managed investment scheme regulation Support Government’s review of the Corporations and Markets Advisory Committee’s recommendations on managed investment schemes, giving priority to matters relating to: Consumer detriment, including illiquid schemes and freezing of funds. Regulatory architecture impeding cross-border transactions and mutual recognition arrangements.
43	Legacy products Introduce a mechanism to facilitate the rationalisation of legacy products in the life insurance and managed investments sectors.
44	Corporations Act 2001 ownership restrictions Remove market ownership restrictions from the Corporations Act 2001 once the current reforms to cross-border regulation of financial market infrastructure are complete.