Australia

The Report of the Financial System Inquiry led by David Murray was published on 7 December 2014. This is my comment, focused on regulatory reform, the topic of my paper earlier this year for the Australian Centre for Financial Studies.

“David Murray and his committee have put their energies into the urgent, the de-risking of Australia’s banks and the avoidance of the more obvious risks mounting in superannuation, but seem to have had no energy left to take on the important, the longer-term need to reform the regulators.

As far as the regulatory architecture goes, the Financial System Inquiry makes almost no significant recommendations. So virtually all the predictable weaknesses will be sustained into the next crisis. The Murray Inquiry has fallen into the same trap as the rather more revolutionary Campbell Inquiry, which failed to recommend a regulatory architecture that would limited the likelihood or extent of the next crisis. The Wallis regulatory architecture got Australia through the GFC, but only with a Wallis-free-market-philosophy-busting taxpayer guarantee of the banks. Luckily the bill was never crystalised.

The informality and clubbish weaknesses of the Council of Financial Regulators (CFR, an in-house committee of ex-officio heads of the regulatory agencies) are to be maintained, so the potential for stronger regulatory oversight has been lost. The recommendation for a new Financial Regulator Assessment Board, with ex-post review responsibilities (a revitalisation of the almost unknown Financial Sector Advisory Council, bolstered by a secretariat in Treasury) surely is only a bandaid. While the RBA and APRA have been goaded into talking more positively about macroprudential policies through the course of the FSI, the absence of any recommended change to the CFR (no independent chair and no explicit responsibility for macroprudential policy) means the likelihood of actual implementation of any macroprudential policies is now much lower again.

The FSI proposes more tinkering with powers for ASIC, very much the usual mission creep favoured by past inquiries. Defensively, Murray claims he is not recommending extra responsibilities for ASIC, only extra funding and beefed up powers, but undermines that purity by arguing that ASIC’s mandate should take competition explicitly into consideration. ASIC’s decision-making will appear yet slower and more confused and its scope will remain too widely drawn: structurally it remains set up to fail.

About the only ‘improvement’ in the regulatory architecture is another recommended non-change: the Financial Claims Scheme (FCS, a generous ex-post-funded deposit insurance scheme) is recommended to be maintained even in the face of a heightened pretence pre-crisis (for that is surely all that it ever is) that banks will be allowed to fail and taxpayers will not be exposed. Together with continued depositor preference, the maintained FCS will help protect consumers careful enough to use banks, and thereby protect the banks and the banking system (and therefore the essential structure and operations of the Australian financial system) from shadow or non-banks.

The regulators and the Government will be relying on the good sense of the Australian public to keep using the banks through thick and thin. Strangely, Murray make no recommendation to publicise the FCS, so consumers are to be left in the dark, or at least poorly informed, until after the next crisis.”

(25/09/2014) Thank goodness that is over. The high turnout reflected both the very large number of Scots voting with their heart (blame the Corries!) and their more numerous fellow-countrymen, urgently fighting back to contain the threat posed to Scottish welfare and opportunities if the independence push had got up. I wrote this as an Australian-oriented briefing as the results came in:

“So the YES vote in the Scottish referendum did not get up. But we should all pause and think through why Scotland nearly left the UK and the implications for Australia if it had.

Cutting out Scotland, close to 9 percent of the UK in population and GDP, would have diminished the UK in the world order and make it much less likely to continue to actively lead Western nations in the difficult challenges that Nato, the UN and the EU now face. Australia is strongly aligned, often at the forefront in supplying troops and equipment, but cannot itself lead. A bullet dodged.

A YES vote would have been genuinely shocking, unravelling the fabric of the world we wake up to each day. That something as apparently solid can change overnight, igniting what the Economist Intelligence Unit sees as ‘seismic’ economic, political, legal and constitutional repercussions, would have created uncertainty that would raise costs and slow growth (albeit marginally). The uncertainties would have been undoubtedly greatest for those in Scotland and the rest of the UK but, like a stone thrown into a still pond, the waves would reach the furthest shores.

Though the UK has been diminishing in importance for Australia in trade, overtaken by the US, continental Europe and Asia, in 2013 two-way trade between Australia and the UK was a still-consequential $20 billion. More significantly, the UK was Australia’s second largest source of and destination for foreign investment, behind the USA, with total bilateral cross-border investments valued at over $800 billion. The extra costs and uncertainties provoked by Scottish independence would create headwinds: a continuation of the post-GFC outflow of UK investment from Australia, mainly from debt securities, is likely.

Scottish independence would also impose some monetary costs on Australia, mainly renegotiation of the hundreds of treaties and agreements between Australia and the UK. The burden would probably have been contained: most of the new treaties could have been be simple duplicates, one with the rest of the UK and another with Scotland. Even Australia’s flag might have survived, as a remembrance (ever more anachronistic, nonetheless) of its British colonial origins.

But it is non-monetary costs that would be more potent. A vote for independence in Scotland would seem an extreme example of the decline in the legitimacy of democratically elected governments and a catalyst for ever-smaller nations, even verging on gated communities, so like-minded people can get the representation they seek. Secession movements would be encouraged again, as would the ease of jurisdiction-shopping.

On a wider view the lesson from this near-run referendum for the rest of the world is the danger of complacency and its ally, underestimation of risk. The potential for change through the ballot box is now vivid, and everyone must be alive to the risk of underestimating emerging political leaders, especially the successful politician that is not part of the conventional party structures. Some outsiders do win. The Scottish Government’s First Minister Alex Salmond was widely ignored by the leaders of other parties when they gathered in London, in denial about his popular appeal in Scotland because it did not fit their conventional mythology.

The substantial, if not majority, support for Scottish independence results from a dramatic failure of modern Britain to deliver democracy’s core promise of effective governance, as extolled by Francis Fukuyama in his new book Political Order and Political Decay: From the French Revolution to the Present.

Fukuyama presciently warns that no one living in an established liberal democracy should be complacent about the inevitability of its survival. “Democracies exist and survive only because people want and are willing to fight for them; leadership, organisational ability, and oftentimes sheer good luck are needed for them to prevail.”

Whether breaking up the UK could ever be seen as progress is moot, given the blow that Scottish independence would have dealt to the stability and order of the UK that led to civilisation as we know it: a broadening group of nations adhering to common law, democratic process and economic liberalism. The lesson from the vote in Scotland is that nothing is certain and what is valuable has to be fought for.”