Big dividends if Murray inquiry can solve the micro not macro issues

David Murray, in calling for submissions to the financial system inquiry he is chairing, exhorted interested parties not to push a narrow self interest. Of course, most submitters ignored him.

But this is not a bad thing: the Murray committee is charged with not just reviewing an existing system but giving it the flexibility for a largely unknown future. The commercial instincts of existing and prospective players provide the realpolitik against what easily can become a clash of ideologies or theoretical utopias.

To use a policy metaphor that seems popular at the moment, this plane is already in flight, the key is to choose the right destination and not damage its flight worthiness.

The submissions break down into roughly three categories and amount to Flight Financial System Australia being sound and heading in the right direction – a view held by the Reserve Bank among others; the direction is fine but the course plotted could be better; or we’re heading the wrong way or at least into turbulent weather.

Looking back at the Wallis Inquiry of 1997, which I’m old enough to have covered (and indeed the Martin Inquiry too - although not Campbell, I was at least still at university then), what is notable is how well its recommendations have endured.

Not because Wallis picked the future – after all there are famously only a couple of pages on superannuation – nor that markets have indeed replaced bank balance sheets – a point Wallis committee member Ian Harper has noted they misread.

The enduring strength of Wallis was it focussed on markets and consumers, not institutions. Wallis didn’t say the payments system, for example, should only be open to banks or that regulation favoured certain players. It identified the essential s of a sound payments system – what capital participants needed, counter party risk issues, the essentials for an efficient system.

If a radically new player or an established one satisfied those tests, then it was up to the market to decide.

One of the Wallis themes which is often forgotten, given the review’s big ticket reforms like the creation of the Australian Prudential Regulation Authority and the Australian Securities and Investments Commission, was its concern with economic efficiency.

Wallis identified massive productivity improvements in the financial system, especially in payments but also in the operation of markets. In some cases inefficiencies were due to poorly constructed or out of date architecture. But in others it was rules or processes which simply created friction for no good reason.

Looking at the Murray submissions, there is an underlying theme of efficiency which is potentially more significant than the major antagonisms such as whether the big banks pay enough for an implicit government guarantee (the too big to fail conundrum) or whether capital weightings or risk measures are accurate or the role of super.

Policy efficiency is difficult to measure but there are clearly large potential frictions when monetary, prudential and growth policies are pulling different ways. A clear example is the debate over funding for small business: it is riskier, so capital weightings are higher. Yet a financial system which encourages the provision of finance to business is necessary to sustain an economic recovery.

Asking whether superannuation should play a particularly role is wrong headed. Super should fund the retirements of members but the real question is  whether systemic issues create incentives for super funds to invest in ways that are not the most productive for the broader economy.

In the case of the bank I work for, ANZ’s focus on Asia in its submission may be self interest, given the bank’s super regional strategy, but it is enlightened self interest. The evidence is irrefutable this will be an Asian century, Australian can play a major role and hence its institutions need to be capable.

Yet as other observers, including Murray himself, have noted there are policy and regulatory issues – in ANZ’s case particularly the capital penalties applying to investments in Asian financial companies – which degrade this capability.

Now that may be desired by regulators for defensible reasons but that must actually be the case. It would be a poor outcome if Australia’s role in the region was diminished by arbitrary regulatory disadvantages rather than intended ones.

The RBA itself has acknowledged there needs to be a pause in the post-financial crisis regulatory effort to see where everything is settled. That’s an efficiency perspective. It also implicitly recognises a key element which indeed demands deeper scrutiny, the need for some kind of cost benefit analysis of the impact of regulation and policy.

Banking itself is all about this. Banks price risk, the intention is not – or shouldn’t be – to avoid failure at all cost but to offset losses with wins, preserving profits. So too regulation, we can never avoid failure, nor in a capitalist system should we, but we should price it properly.

The Murray Inquiry may end up making some seismic changes, like Campbell, Martin and Wallis, but if it doesn’t a more enduring legacy would be microeconomic reform, improving the efficiency of the financial system.

The submission from Industry Super Australia researched by The Boston Consulting Group makes the alarming claim the cost of capital formation in Australia, crudely the efficiency of the system, has blown out by 40 per cent in recent decades. It’s an argument which needs to be tested but the thrust rings true.

Both the RBA the Federal Treasury have drawn attention to apparent inefficiencies in the superannuation system which contribute to a system with excessive costs – which in turn detract from member returns. This is not just because of fees but poor administrative productivity.

Improving the efficiency of the Australian financial system as a whole would deliver better dividends than trying to rebuild a plane in flight.