Published by Australian Financial Review on Sunday 30 September 2018
The Interim Report of the banking royal commission is clear, firm and direct. A wide variety of financial institutions has been able to pursue its own private interests virtually unchecked. Neither the law, nor its enforcement, has been effective.
Some of the issues seem conceptually quite straightforward. Compliance with responsible lending law and regulation has been patchy, with the commission finding many cases of inappropriate lending. While the stories have been individually harrowing, banks will know how to fix these problems. Better internal processes, agreements about what are appropriate treatments of customers in difficulty, and remediation will all have to be redesigned, but these are practical rule-driven fixes which are “normal” problems that banks deal with every day.
How to give advice poses a more difficult problem. Advice is normally given face-to-face and as with any human interaction is subject to vagaries of personality, to ambiguities, and to misunderstandings. For most households, decisions about how to invest, which home loan to take out, and which insurer to use are infrequent decisions but potentially of great significance. The seller inevitably knows more than the buyer and the buyer is looking for guidance, often from the seller.
The 1996 Wallis report shifted the responsibility on to the buyer. Sellers were required to produce product disclosure statements which described the product characteristics in some detail. This failed because buyers did not read them or could not understand them.
A decade later the Future of Financial Advice (FOFA) rules were tried. These shifted the responsibility onto the seller to make sure the product purchased was suitable for the buyer. So far these have not worked very well either. Organisations large and small have struggled with trying to ensure the advice their staff, and the principals in some cases, offered is appropriate. There are two sorts of problems: how to determine what is appropriate for any particular individual (which is both difficult and expensive), and how to run a business providing advice where often the best – expensive – advice is to do nothing.
The Productivity Commission proposed that the prices paid for some standard products – like basic mortgages – should be monitored publicly and published. The Thwaites report into electricity pricing in Victoria proposed something similar in that there should be a simple standard product available to consumers that they could use as a reference in negotiations. The underlying idea in both is that such approaches could give individuals a timely reference point to help offset the informational advantage of the seller.
However the most difficult conundrum posed by Hayne refers to regulators, and most particularly to the Australian Securities and Investments Commission. It seems very clear that the regulator has failed. Despite the long history of ASIC, under its previous management in particular, complaining that it did not have the resources to do its job, the royal commission has refuted that argument.
As Minister Frydenberg put it, “the failure to enforce the law undermines the authority of the regulator whose fundamental responsibility is to do just that”.
The standard explanation for the failure of a regulator to enforce the law is that it has been captured by the industry. Just looking back to the global financial crisis provides lessons from many other countries, of regulators who were too close to the industry they supervised and failed to ask the hard questions. This seems the most likely explanation for the failure of ASIC to enforce the law against financial institutions over the last decade.
The question Frydenberg needs to ask is how to ensure that ASIC acts in future with appropriate independence. The commission has pointed out that ASIC has plenty of powers, it just hesitates to use them, so ceding ASIC more powers is not the answer.
A short-term step has been to change senior management and to encourage management to take a more litigious approach. But this is a short-term solution and does not confront the underlying concern: how to stop financial sector regulators from being captured by the sectors they regulate?
The longer-term and more thorough reform requires important changes. There seem to be three steps the minister should take.
Simplifying the law is the first. The commissioner has suggested that the law is very complex and that this complexity makes it hard to comply with and to administer. We have plenty of laws.
The second step is to require the regulators to provide more information about their activities so that politicians, journalists and academics are able to review the regulators’ behaviour and ask difficult questions. The minutes of meetings of the Council of Financial Regulators should be made public. The regulators should provide informative regulatory impact statements, and informative annual reports.
The third step is to make it harder for staff to be captured. This will involve limiting how long any staff member can remain at a financial sector regulator, rotating staff to other sectors, and prohibiting staff at regulators from moving to an industry position for two years after they finish at the regulator.
These changes are overdue.