Question

The traditional business of banking comprised lending, deposit-taking and the provision of transaction services. Through the first half of the twentieth century, banking was a regulated, local, low risk business based on a customer’s credit worthiness and yielded returns based on interest.

Much has changed, but the mid-century model persists in the popular consciousness. Bank advertising draws heavily on this historical image. During the 1950s, banking had little to do with funds management, where an entity pools and invests money on behalf of customers.

The funds management sector was composed largely of superannuation and life insurance. For reasons discussed below, the reach of this sector was limited until regulatory and financial conditions changed.

In the 1970s, Australia began to deregulate its financial markets. Restrictions on bank interest rates and liability structures were removed; foreign banking was made easier to access; the Australian dollar was floated. The financial sector expanded. At the same time, growth in the size and liquidity of securities markets allowed more diverse financial products to develop.

The next critical steps were the expansion of superannuation, which shifted the responsibility for and control of provision for retirement from employers into the hands of individuals. From 1983, successive changes to the tax treatment of superannuation increased the complexity of superannuation but also established it as a vehicle for compulsory saving. These developments included the incorporation of superannuation into employment awards in 1986 and legislation in 1991 imposing tax penalties where employer contributions were not made.

With greater amounts of savings invested in superannuation funds, Australians now have a far higher exposure to capital markets and since the 1980s Australians have increasingly seen a need for financial advice.

In 2000, CBA acquired Colonial Mutual Life Assurance Ltd, which conducted life and other insurance business, and a funds management business

In 2000, NAB acquired the financial services businesses of Lend Lease, including its MLC Holdings Ltd. advice, platform and superannuation and asset management businesses.

In 2002, ANZ entered joint venture arrangements with ING Group in respect of wealth management and life insurance businesses in Australia and New Zealand, and later acquired the full business.

In 1999, Westpac founded Magnitude Group Pty Ltd. In 2008, as part of its merger with St George Bank Ltd, Westpac acquired St George’s financial advice business, which included employed advisers as well as Securitor Financial Group Ltd. In 2002, Westpac acquired all of BT Financial Group’s asset accumulation businesses.

Scandals dating back to the GFC began to shed light on the conflicts and culture in the financial advice industry.

In their submissions to the Commission, financial services entities acknowledged conduct that amounted to misconduct or conduct falling below community standards and expectations in connection with the provision of financial advice.

Clients of financial advisers or financial advice licensees being charged fees for services not provided to them is now rightly recognised to have been a large and endemic problem in the industry.

Charging for doing what you do not do is dishonest. No-one needs legal advice to tell them that.

https://financialservices.royalcommission.gov.au/Documents/interim-report/interim-report-volume-1.pdf (Links to an external site.)Links to an external site.

1. What are the core traditional functions of commercial banks? (1 mark)
2. How did banks generate profits prior to the 1980s, and what was their attitude to risk? (1 mark)
3. Identify two major changes which happened in the funds management sector of the Australian financial system between the 1970s and the 1990s. (1 mark)
4. How did Australia’s big-4 banks respond to these changes? (1 mark)
5. What is the main problem which arises as a result of providing financial advice and selling investment products in the same organisation? (1 mark)
6. Identify evidence of undesirable cultural change in the banking and financial services sector of the economy in the above extract. (1 mark)
7. Identify and distinguish between the roles played in the Australian banking system by APRA and ASIC. Which of these two institutions appears to have been more heavily criticised by the Royal Commission, and what is the main reason for this criticism?
8. What does it mean to say that the big-4 banks are ‘too big to fail’? Explain your answer clearly and concisely. (1 mark)
9. In what sense do the big-4 banks face a problem of moral hazard? (1 mark)

Answer 1

1. The core traditional functions of commercial banks included taking deposits, lending and offering transaction services.

2. Before 1980, banks generated profits based on interest rates of lending and deposits and had little exposure to funds management. Banking was a low-risk taking business model based on customer's credit worthiness for lending.

3. The deregulation of Australia's financial markets in 1970s provided access to wider foreign markets and diverse financial products. The two major changes in the funds management industry were thus:

a. Access to diverse financial products for funds management as a result of deepening of the securities markets

b. Transfer of responsibility for superannuation and retirement provisioning from employers to individuals which led to the increase in demand for financial advisory and funds management services for individuals.

4. Australia's Big 4 Banks: CBA, NAB, ANZ and West Pac, responded to these changes by venturing into asset/wealth management and financial advisory services by acquiring, merging with or entering into joint ventures with institutions that had substantial presence in these markets.

5. Providing financial advice and selling investment products in the same organisation gives rise to a conflict of interest as the adviser is inclined to promote investment in products offered by the organisation which may not be best suited to the customer's needs.

6. As per the extract, this evidence dates back to the global financial crisis: "In their submissions to the Commission, financial services entities acknowledged conduct that amounted to misconduct or conduct falling below community standards and expectations in connection with the provision of financial advice".

7. Requires detailed study of the report.

8. Banks are termed "too big to fail" when their insolvency can have a significant adverse impact on the financial markets and consequently the economy. This impact may include loss of customers deposits and taxpayers money apart from destabilizing the financial markets resulting in illiquidity and huge losses to investors and market players.

9.Requires detailed study of the report.