Self Managed is the Key

Posted on April 20, 2011
Filed Under ACFS Commentary, Funds Management & Superannuation, Policy, Publications | Leave a Comment

Professor Kevin Davis, Research Director of the Australian Centre for Financial Studies ponders about the ramifications of the Government’s decision to exclude SMSF investors from the compensation arrangements for losses due to the Trio/Astarra failure .

There has been an immediate clamor for a protection scheme to be created for self managed super funds (SMSFs) following the Government’s exclusion of SMSF investors from the compensation arrangements for losses due to the failure of Trio/Astarra. That decision is a good one, but does raise a number of issues worthy of consideration.

The Government decision was based on the provisions of part 23 of the SIS Act (1993) which provides discretion to compensate members of prudentially regulated funds for losses due to fraud, and levy other funds to finance such payments. In the review of Financial System Guarantees in 2004, the issue of protection of superannuation was considered, but viewed as being of a different nature to protection of bank depositors etc.

The reason was that (except for defined benefit funds) the fund does not make a promise of a defined amount reliant upon the balance sheet strength of the agent operating the fund, such that failure of that agent would mean that the promise was broken. Super fund members are collectively the owners of the assets of the fund and bear the market risk (both upside and downside) associated with the value of the assets.

The risk members face which does warrant prudential concern is that of possible fraud, including non-arms length investments by the fund trustees, which diminish the value of fund assets. Ideally, APRA oversight of regulated funds limits the likelihood of these outcomes, and the Treasurer’s discretion to compensate for losses due to fraud etc. provides an adequate level of protection.

But SMSF come in all shapes and sizes, ranging from “really” self managed, where the member-trustee does virtually everything (although self-audit is not permitted), to virtual complete outsourcing. Stockbrokers and financial advisers provide platforms which provide accounting, advising, transactions, taxation, custody services and arrangements, such that the member-trustee’s role is effectively that of a signatory acknowledging ultimate responsibility.

This variety of arrangements does produce potential risks, but a one sized approach to regulatory protection won’t fit all. For the “really” self managed, the benefits of independent control and decision making come with (and should come with) the risk that those decisions might turn out to be pretty bad. There is no case for government compensation for investment losses, such as arising from fraud associated with issuers of securities or managed funds in which the SMSF has invested.

Where such investors suffer losses, they are in the same position as other investors in those assets, and the appropriate policy is that of supervision and enforcement by ASIC to reduce the prevalence of such losses.

A prevalence of such losses among SMSFs may suggest that there may be an argument that those with inadequate financial expertise should not be allowed to self-manage retirement balances which receive substantial tax-concessions from government. But that is a proposition which would raise many hackles.

At the other end of the spectrum, there is the possibility that outsourcing of SMSF functions to a “full service” provider creates risks. These could include the risk that commission payments by manufacturers of financial products induce advisers to promote inappropriate products. Ideally reforms under the Future of Financial Advice legislation will reduce that risk.

But if such risks are viewed as substantial, the solution is not to develop a scheme applying to all SMSFs. It is a problem arising from the possibility that some providers of SMSF platforms may fail in a way which creates losses to their clients. Thus if a protection scheme is thought to be warranted, it would be some form of insurance scheme involving those providers, rather than SMSF’s directly.

Ultimately, those insurance costs would be passed on to members of SMSF’s using such services. The dilemma is that this relative pricing effect could induce some individuals to go the “really self managed” route, with its attendant risks.

Maybe there is some case for limiting the scope for individuals to go the “really self managed” route unless they can demonstrate the requisite expertise!

This Commentary is written by Professor Kevin Davis, Research Director of the Australian Centre for Financial Studies. Kevin is also a Professor of Finance at the University of Melbourne.

info@australiancentre.com.au

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ACFS Banking Panel: Is this the dawn of a new era in Banking?

Posted on April 15, 2011
Filed Under Banking, Financial Institutions and Markets, Event News, Policy | Leave a Comment

Yesterday, ACFS held a Banking Panel with a number of industry heavyweights , in conjunction with the Economic Society of Australia and sponsored by PricewaterhouseCoopers.

The event was sparked by debate arising fom the long-running Senate Economics Committee Inquiry into Competition within the Australian Banking Sector. Over a hundred submissions were received by the Committee from a wide range of organisations and individuals. There were many questions that needed to be addressed.

Prof Kevin Davis, Research Director ACFS, led a panel discussion to shed some light on the debate. Invited panellists were key players of the industry with their own points of view:

• Michael Ullmer, Deputy Chief Executive Officer, National Australia Bank;
• Ian Harper, Director, Deloitte Access Economics;
• Steven Münchenberg, Chief Executive Officer, Australian Bankers’ Association; and
• Graeme Samuel AC, Chairman, Australian Competition and Consumer Commission.

The panel attracted a 150-strong audience from all strata of the industry.

In summary:

Outgoing ACCC Chairman Graeme Samuel was passionate in expressing his thoughts on current commentary about the Commission’s recent decisions. He defended the proposed reforms for price signalling to remove any loopholes and technicalities in illegal cartel behaviours; and cited rigorous due diligence in granting permission for the takeovers of BankWest by CBA and St. George by Westpac during the GFC.

CEO of the Australian Bankers Association Steve Munchenberg was candid about the negative perceptions of banks and its impact on politics and regulation. He recognised as foremost importance that banks must step up to do things that would convince the public that banks are concerned about customer interests. He referred to recent heat on banks raising rates beyond the Reserve Bank adjustments to the cash rate.

Outgoing NAB Group Deputy CEO Michael Ullmer noted that his bank’s strong growth in new accounts indicated that competition between banks was alive and well. He challenged advocates of account portability to look at the cost-benefit trade-off of the implementation.

Prof Ian Harper of Deloitte Access Economics renewed his call for a new “root and branch inquiry into the Australian financial system”.  This should be prerequisite to any major reforms to the banking industry. He also cautioned that effects of the GFC are still to be felt across the industry. This was agreed by Ullmer,  referring to banks continuing at relatively high level of liquidity reserves compared to pre-GFC.

View event info

View ACFS submission to the Inquiry

Contact details:
Australian Centre for Financial Studies
T: +61 3 9666 1050
info@australiancentre.com.au

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The Future of Australian Bank Funding Report released by the Australian Centre for Financial Studies (ACFS) and KPMG identifies many issues for banks and government in relation to bank funding and questions the sustainability of current funding models of the major banks

Posted on April 6, 2011
Filed Under Banking, Financial Institutions and Markets, Contracted Research and Consulting, Funds Management & Superannuation, Media Release, Policy, Publications, Research Review | Leave a Comment

Bank funding models are unlikely to substantially change and regulatory intervention will make little difference, according to the Report.

The ACFS/KPMG Report examines the difference in funding patterns between major and second tier banks and the heavy reliance of the major Australian banks, in particular on wholesale funding, much of it from overseas.

Future options for bank funding structure are limited by two main factors: the ongoing national balance of payments position, with the banks being a main conduit for financing the current account deficit, and the significant ongoing flow of household savings into superannuation funds.

Currently the major banks effectively fund Australia’s large and longstanding balance of payments current account deficit by borrowing offshore, and, then lending on-balance sheet to Australian companies.

Detailed analysis of the true cost of funding Australian mortgages is difficult given the geographical and operational diversity of the major banks, but the Australian banking system is exposed to several features that influence perceptions of risk. These relate to the heavy reliance of banks on wholesale funding, the domination of the four majors with similar funding patterns and a relatively high reliance on residential property as an asset class.

The ACFS/KPMG Report draws attention to the relative tax disadvantage of deposits compared to superannuation as a further factor affecting bank funding. Professor Deborah Ralston, Director of ACFS, notes that

“as the Henry Review identified, there is a considerable discrepancy in the tax incentives accorded to different forms of saving.  As a consequence, this leads to some distortion in personal savings patterns and makes it more difficult for banks to increase the proportion of retail funding sources.”

The report acknowledges that the management of funding risk is now a fundamental part of planning and risk management for banks, and finding new ways to diversify funding sources is a key focus.

The report also suggests that given the need for banks to meet new net stable funding (NSF) ratio requirements, use of covered bonds as a stable funding source is an attractive proposition, which may help recycle household savings via superannuation funds back to the banking sector.

ACFS Research Director, Professor Kevin Davis added

“While Australian banks weathered the recent Global Financial Crisis with distinction the international liquidity drain during the GFC highlighted the reliance of our banks on offshore funding. Given that the taxpayer was required to support our banks at that time it is important that lessons from that time are well learnt.”

About the ACFS-KPMG Monograph The Future of Bank Funding
The Australian Centre for Financial Studies (ACFS) and KPMG are pleased to publish the ACFS-KPMG Monograph The Future of Bank Funding and see this type of research as central to the mission of both firms. The monograph is the first outcome from a research partnership between ACFS and KPMG.

ACFS and KPMG gratefully acknowledge the industry participants who so obligingly contributed their time and thoughts to this monograph.

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Download full report

Media contact details:
Professor Deborah Ralston
Director, Australian Centre for Financial Studies
(03) 9666 1050
info@australiancentre.com.au

Professor Kevin Davis
Research Director, Australian Centre for Financial Studies
(03) 9666 1050
info@australiancentre.com.au

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