The chairman of the Australian Financial System I nquiry has given the clearest indication yet about the direction that the landmark review is likely to take, including addressing complex questions such as whether Australia should align its future more closely with Asian markets. David Murray, chair of the Financial System Inquiry, told an industry forum that Australia needed to develop a regulatory model that would facilitate its future growth in the region. He said this may include putting in place a regulatory system that enables the Australian financial sector to tap into the growth engines of Asia, while decoupling from its traditional ties to the United States and Europe.

In an address at the Australian Centre for Financial Studies, Murray said one of the goals of the inquiry would be to determine whether Australia could put in place a regulatory framework that avoids the stagnant growth seen in many mature northern hemisphere markets. The former Commonwealth Bank chief executive said the U.S. and Europe, in particular, were likely to experience an extended period of low growth or economic contraction. He said Australia may instead want to take advantage of its political stability and geographic location to tap into the growth engines of China, South-East Asia and India.

Murray said the inquiry would look beyond the technical aspects of regulation to the broader economic goals of Australia in a changing financial and geopolitical landscape. He said this would inevitably involve questioning whether Australia's economic future lay with the traditional centres in Europe and the U.S., or with closer ties to Asia.

"In Australia so much of our trade is with Asia. We talk about the 'Asian century' and the 'Asian miracle' and all of these things. But the driver of Asia is basically the process of admitting into the global economy an under-utilised workforce and driving higher productivity of the global economy. The natural tendency in that process, as that workforce gets used, is that the growth rates of their economies will be higher," Murray said.

"My own view is that the size of the fiscal problem in Europe and the United States is such that, having brought forward growth with loose fiscal policy, they've got to 'pay back growth' before they can start growing more strongly. That means that they are locked into low rates of growth," he added. 

Murray said Australia had been content with growth rates of around 3 percent for "a long time". He said one of the conceptual questions underpinning the inquiry would be whether Australia should strive to achieve higher rates of growth by expanding its financial sector to harness technology and tap new markets.

He said a key question for the inquiry would be whether the Australian financial system could manage a higher rate of growth because of its connections with Asia. Given the relatively small labour force, this could require a move away from the traditional reliance on labour-intensive sectors such as tourism, mining and manufacturing. 

"With a small workforce, as soon as we have a capacity utilisation problem the government pulls the handbrake on because we've got a higher inflation risk, which is mirrored in our high real interest rates," Murray said. "The policy issue here is could we get much higher productivity in our economy and maybe try to lift that trend growth rate up a bit, which will only help to feed on itself and make us even more productive?"

Murray said the inquiry's terms of reference would allow it to take this broader perspective and address these deeper questions.

"If you look at the financial system as an industry in its own right, are we getting everything out of it that we should? Are we getting the employment levels, the learning levels, the engagement and the dynamic development of knowledge in that system as part of Asia? There are three very interesting financial centres in Asia: Hong Kong, Singapore and Australia," he said.

"We talk about tourism and mining and all these other things but finance never gets a look in on that list. So if we raise our sights and investigate where the roadblocks are and look at issues about Australia as a financial centre, we may be able to do even better. I don't see why we should have a low target, put it that way," Murray added.

Technological solutions 

Murray said technology would inevitably feature significantly in the inquiry's discussions. He said technological development was fundamental to economic growth and this was especially important in a country with a relatively small labour pool. He said some examples included using new technology to conduct credit assessments for banks, and the implications of biotechnology on the calculation of life insurance risks. Other issues for discussion would include developments in payments technology and how this would affect traditional banking and finance business models.

"The array of business models that are available to people are endless with this technology — across all industries," Murray noted. "You just can't predict what business models people will adopt."

These questions regarding technology would naturally flow on to a discussion about the larger structural issues — such as how to build a deeper corporate bond market to tap superannuation savings.

"Another way of looking at it is, if we are quite a sophisticated financial system, why don't we have a more dynamic venture capital market? Why don't we have a much more highly developed corporate bond market? You would think that within the superannuation system there are some beneficiaries who naturally need bonds," Murray said.

He said the inquiry would need to explore the reasons for these characteristics of the Australian financial sector. It could then determine whether changes are appropriate — or indeed possible — to achieve by regulatory reforms or policy settings.

Super structure 

Murray said looking into the superannuation sector would be critical for the inquiry. With $1.6 trillion in savings, the Australian superannuation pool is "significant" in international terms and extremely large in the context of the Australian economy. The inquiry would need to explore why that pool of funds is being invested in the way it is and whether this is desirable from an economic, social and political viewpoint. This would involve considering the trustee decision-making process, tax issues and regulatory issues, among other things. 

"This system is large. It's large in international terms and it's large in our economy — $1.6 trillion now is large relative to GDP. If [superannuation] is going to continue to grow at a differential rate to the banking system ... we could look at the way credit is allocated in the banking system and extrapolate that and find that, in 20 years' time, the system is going to look amazingly different," he said.

Murray noted, however, that the inquiry's goal would not be to dictate how superannuation funds should be invested.

"If that pool of [superannuation] funds is there, it is difficult to see how a government should dictate how it is managed. We don't want an open market economy and the Soviet financial system," he said.

Structural reforms 

In terms of the overall approach of the Financial System Inquiry, Murray said the approach would differ "quite significantly" the previous Campbell Inquiry and Wallis Inquiry. He said the focus of the Campbell Inquiry was how Australia could transition from a system that is fully regulated to a financial system in a more open economy.

"Because of the way that work was done it became a bit of blueprint for people at the time. It was like getting rid of the 'L plates' on how a financial system actually can work," Murray said.

"The value of the Campbell Inquiry was how to get efficiency out of the financial system in an economy that was turning from closed to open. The Wallis inquiry was more about how we effectively regulate the system. It had narrower terms of reference than we have," he added.

Murray said the FSI would be more akin to the Campbell Inquiry, with a focus on the major structural questions about where Australia sees its economy heading. He said this broad approach would cover issues ranging from tax and accounting through to some more detailed questions about regulation.

"We are in a system that's had 20-plus years of continuous growth. And we're sitting alongside other systems that have had severe disruptions or have had higher rates of growth," Murray said.

"We will have to deal with the dilemma that we deal with Asia — and we want to deal with Asia — but we rely on the capital intermediation processes of Europe and the United States. So where do we sit in terms of our regulation and the way we conduct our financial system? Do we want to be more like Europe and the United States with some dependency issues driving this, or do we want to align ourselves more with Asia and the people that we are going to be growing with, quite considerably?"

Murray said these broad questions would inevitably require the committee to take a macroeconomic — and more long-term — view of the challenges facing Australia.

"In doing that I don't think we shouldn't take a short time horizon. We should look at some natural horizons that are out there — the growth of Asia and the demographics is an obvious one, with the ageing of the population. They can give us a fix on a longer term view that I think the inquiry can take," Murray noted.

Beyond the crisis 

The chairman of the inquiry also stressed that the 2008 financial crisis would form a backdrop to the discussions that take place. He said the financial system was still grappling with the challenges and lessons that the crisis had presented.

"The possibility that the systemic failure externally can knock us off our perch is critical, as are the moral hazard consequences of that ... I guess they're the most important things," Murray said. "The problem with the crisis is that the political framework has to respond by laying the blame somewhere. That's politics. But absent a crisis [the question is], is that framework working well?"

In answering these questions, Murray said there would be no magic bullet in terms of copying the regulatory model from any other single jurisdiction. He said the key would be to cherry pick the best parts of each model and decide on what is the most appropriate framework for Australia, given its geographical, political and economic drivers.

"There are people who have written about the difference between Canada and the United States and said that Canada has not had the degree of failure that the United States has. But they attributed that to a completely different political system," Murray said. 

"I think we should look at them all and figure out as best we can what drives these different outcomes. But deciding that one is appropriate for our model ... diverts us from studying what's different about the Australian economy itself," he said.