Submission to the Financial System Inquiry Foreword

The Reserve Bank of Australia has prepared this Submission for the Australian Government's Financial System Inquiry of 2014. The Terms of Reference are broad, covering aspects such as: the consequences of developments in the Australian financial system since the 1997 Wallis Inquiry and the global financial crisis; the philosophy, principles and objectives underpinning the development of a well-functioning financial system; and the emerging opportunities and challenges that are likely to drive further change in the global and domestic financial systems.

This Submission outlines developments in the Australian financial system in the 17 year period since the Wallis Inquiry, exploring in more detail those that the Reserve Bank considers have had the largest influence in shaping the system. In keeping with the Reserve Bank's responsibilities, a system-wide perspective is adopted in the Submission. Areas where the Reserve Bank was given an explicit mandate following the Wallis Inquiry, particularly the oversight of payment and settlement issues, are examined in some detail.

The scope of the financial sector addressed in this Submission includes all institutions that provide financial services in Australia, including both entities that are prudentially regulated (such as authorised deposit-taking institutions, insurers and financial market infrastructures) and those that are not, such as registered finance companies and investment funds. However, the treatment of issues throughout is largely on thematic lines, because many of the key forces and developments are not entity or market specific.

A good starting point for evaluating the Australian financial system is to consider the desired role of finance in our society. Chapter 1 provides an introductory discussion of the core functions of the sector and the characteristics that set it apart from other sectors of the economy.

The evolution of the Australian financial system since the Wallis Inquiry is covered in broad terms in Chapter 2. The global financial crisis emerged during this period, hence many of the trends are examined from the perspective of the decade or so leading up to the peak of the crisis in 2008 and then the period since. Given the significant international regulatory reform agenda that the crisis generated, a chapter is dedicated to describing these reforms, including Australia's responses (Chapter 3). Systemic risk is also explored in some detail, given the renewed focus on it as a result of the crisis (Chapter 4).

Apart from stability issues, a number of other factors have contributed to the evolution of the financial system since the Wallis Inquiry, and are likely to continue to do so in coming years. At the broadest level, changes in how the different sectors in the Australian economy fund themselves are interlinked with innovations in the financial sector which serves the economy; longer-term sectoral trends in funding are discussed in Chapter 5. Competitive forces since the Wallis Inquiry have been shaped to a significant extent by financial market conditions, with changes in risk appetite among market participants being at least as important as regulatory reform or other structural change; Chapter 6 considers these issues.

Since 1997, superannuation assets as a per cent to GDP have more than doubled to be over 100 per cent. Changes in superannuation shaped the financial system and economy in a number of important ways – including the role in household and national saving, the transfer of retirement income risk to households and the relationship with the banking sector – which are explored in Chapter 7.

The government's response to the Wallis Inquiry resulted in the Reserve Bank being assigned a number of powers and responsibilities in respect of payment and settlement systems. Many of these cover retail payments issues, where Australia has played a leading role internationally in its approach to reform; these are examined in Chapter 8 along with a discussion of innovation in the payments system. In addition, the global financial crisis also brought renewed focus on the role of financial market infrastructures (FMIs) in the financial system, resulting in a significant reform agenda and implications for the Reserve Bank's responsibilities for oversight of FMIs.

The preparation of the Submission was overseen by a small team within the Financial Stability Department, with significant contributions from many staff in that Department as well as a number of other areas of the Reserve Bank, particularly the Domestic Markets, Information and Payments Policy Departments.