Is the Australian financial sector too big?

Australia’s financial sector has doubled the size of its contribution to the economy in the last three decades and now represents 10 per cent of total value added, one dollar in every 10 of value. Relative to other countries, this is a lot. The question is whether it is too much. Is the sector too big?

While finance provides many valuable services we simply don’t know what the right size for the sector is. As an economist, my answer to the question of whether something is “too big” is to ask if there is some regulatory or other distortion which is responsible for the size. And which might be better removed.

Figure 1: Financial sector as % of the total value added in the economy

Click image to zoom Tap image to zoom

Source: BIS

In Australia, financial system growth has had three main drivers: a substantial increase in household borrowing since financial liberalisation in the 1980s; the growth in the superannuation savings pool; and the very rapid growth in financial markets (Figure 2). 

Figure 2: Indicators of increased demand for financial services relative to GDP

Click image to zoom Tap image to zoom

Sources: GDP from ABS, financial assets from RBA, ASX turnover from Annual Reports (with some changes in classification). All based at 1989 = 100 except the market turnover based at 2005=100


Household dwelling assets have grown much faster than GDP. Most of this is the result of price rises: average house prices went from two to four times household disposable income between 1980 and 2010.

This was a global trend and as such it was probably driven by common global forces rather than local events - not say negative gearing and not Aussie Home Loans. The two most commonly cited global forces are the fall in inflation the removal of financial market distortions which had restricted the supply of credit to many households.

Household borrowing was constrained during the post-war period so the removal of those constraints, combined with an ability to service larger loans, induced the large increase in global house prices.

Financial institution behavior played a secondary role but the fall in lending margins (cheaper credit) and the launch of new products would have helped boost volumes. 


Compulsory superannuation is a very large distortion in the economy and by shifting funds from consumption into savings it shifts economic value from other sectors into the financial sector. While the wedge between total financial assets and total housing assets in Figure 2 is not as big as the uplift in housing assets, the wedge is mainly driven by superannuation and is clearly growing quickly.

The superannuation pool is now about $1.7 trillion, a bit bigger than GDP, and the average margin paid is around 1.3 per cent of funds being managed. So superannuation has added close to 2 per cent of GDP to the measured size of the financial sector.

However, comparisons with other countries where retirement savings are often managed within corporations are difficult. We do not know to what extent retirement savings in other countries are being measured within their corporate sector (manufacturing, agriculture etc) rather than in the financial sector. It is also clear that in a number of countries corporate schemes are unfunded, so the liabilities are being passed to the future.


The astounding growth in markets based activity since 2005 is clear from Figure 2.

Government action has driven equity market growth. Businesses which were previously government owned constitute some 20 per cent of the market’s capitalisation. Tax changes – franking and the removal of transactions taxes – also played a role.

In other markets, volumes have increased by even more than in equity markets. This appears to have been driven purely by individual preferences without significant market distortions. The floating of the currency shifted risks onto individuals and created the need for the insurance provided by hedging through markets. 

Costs, margins and wages

Since the GDP-contribution of any sector is measured effectively by the sum of the wages it pays plus the profit it makes, the next issue in trying to address whether the sector is too big is to ask whether margins and wages are excessive.

Normally when the demand curve for a service increases, we see supplier margins rise. Surprisingly, bank margins have fallen quite consistently with net interest margins roughly halving since the 1990s and bank fees per asset funded also falling.

The superannuation sector has also seen a (gradual) reduction in fees - of about 2 basis points per year across all fund types. Again this is somewhat surprising given the growth in demand. With forecast restructuring and scale in the sector, experts have argued fees could come down further.

Fees in markets have also fallen. The declines in the trading fees for equities and currencies have been even more notable than bank or superannuation fees with retail equities margins for example falling from over 2 per cent per trade in the 1980s to flat fees of about $20 on a typical transaction. Similar reductions in fees for on-market trades have occurred across a wide range of products.

Moving away from the consideration of the profit margins of institutions, the other main component of sector value added is wages. The Figure below comes from a major bank annual report. It shows how much more than wages pre-tax profits have grown. 

Figure 3: Major bank: profits, wage bill and unit wage growth

Click image to zoom Tap image to zoom

Source: Westpac Annual Reports

So is the system too big?

As befits an economist, my answer is probably. Despite the rapid growth in demand for financial services, margins have contracted – a sign of oversupply – but only slowly. Demand is now slowing and - outside superannuation – that suggests competition will force margins down more quickly which in turn will shrink the relative size of the system. In superannuation, where the market is distorted, margin compression will be slower and moreover will be driven by people escaping the system into SMSFs and perhaps into MySuper. So whether the system is currently too big or not, I expect its share to fall.

Professor Rodney Maddock is adjunct professor in Economics at Monash University. He was formerly a senior executive at the Commonwealth Bank, chief economist for the Business Council of Australia and head of Economic Policy in the Victorian Cabinet Office. He wrote “The Future Demand and Supply of Finance” paper for the Australian Centre for Financial Studies Funding Australia’s Future project. He is currently working on a book on the Australian economy.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

editor's picks