Why financial regulators are ineffective

The heads of the banking and corporate regulators face tough questions at the financial services royal commission.

ASIC chairman Greg Medcraft. Picture: Stuart McEvoy

The heads of the banking and corporate regulators, reportedly due to appear at the royal commission into financial services later this month, will inevitably have to bat away questions from QCs that cast them as lazy or timid.

They haven’t had the best year. The interim report of the commission was scathing about ASIC in particular, noting that over the decade to June this year, it sent infringement notices to the major banks totalling less than $1.3 million — a piddling sum for a gargantuan industry.

It banned fewer than 130 ­financial advisers out of 25,000 in business.

Certainly, it seems they didn’t act forcefully enough to stop a barrage of misconduct that has stopped the nation.

But blame lies with government at least as much as with ASIC.

Government sets the penalties, it sets the funding and the wider legal framework in which both regulators operated. It fell short on all three measures, so poorly that a cynic might wonder whether the finance sector had undue influence in Canberra.

For a start, former treasurer Joe Hockey’s first budget slashed ASIC’s budget by 20 per cent, which came on top of a series of “efficiency dividends” carried over from Labor’s Wayne Swan in his time as treasurer.

More than 200 staff were laid off over three years.

The cut was reversed after Labor started pushing for a royal commission in 2016, which the government ultimately set up through gritted teeth late last year.

It’s remarkable that a body charged with regulating financial services should shrink as that sector’s share of the economy crept up towards a record — at about 9 per cent — more than any other sector. For an industry that’s meant to be an intermediary, that’s impressive.

As for penalties, in early 2014 ASIC publicly called to toughen them, noting they were a fraction of those overseas.

The Murray inquiry of the same year agreed with ASIC, but only this year has the Coalition moved to stiffen white-collar penalties.

Other recommendations including to give ASIC a competition mandate, and power to quash dodgy financial products, were not taken up either.

Indeed, whistleblowing protections are risible by global standards, making it risky and potentially very costly for white-collar professionals to dob in their colleagues for malfeasance.

The biggest problem has been intellectual. The fundamental law governing financial regulation, the 2001 Financial Reform Act, assumed the honesty and integrity among finance sector workers.

For instance, it requires financial service licencees to notify ASIC of “any significant breach of their obligations under the law as soon as practicable, and within 10 days of becoming aware of a breach”. What would people think of a clause in criminal law requiring thieves to self-report?

Far from being timely, in Senate testimony in June, it emerged that it’s taken four years on average for breaches to be identified internally, based on evidence from 12 banks.

Then it took another two months to report to the regulator, followed by another seven months for any recompense to reach customers. Of course, this relates only to those breaches that were actually identified and reported.

ASIC had lobbied the government to reform the system of awarding financial licences, to make them a privilege, as in other countries, rather than a right. Here, even those with criminal records can get one.

The legal system hasn’t helped either, and economic incentives have made ASIC reluctant to take action.

For a start, cases are heard in state courts, without juries.

“Often there is a culture problem with judges, where they do not perceive white-collar crime at the same level as blue-collar and sentencing is often much lighter, particular in state courts,” said a well-placed source.

“One innovation might be to allow civil cases to be heard by jury rather than a judge as is currently the case — something banks and judiciary would hate, but decisions would be more likely to reflect the community’s view of financial services’ social licence.”

And then, because legal costs are imposed on the losing party in civil cases, taking a case against major banks has been highly risky. They have deeper pockets and can outspend on legal services.

The recent shift to an industry funding model, where the finance sector in effect funds ASIC, has neutralised this — legal costs are counted as part of the levy.

Nevertheless, ASIC under Greg Medcraft, who was chairman from 2012 to 2017, won a case against Westpac for attempting to manipulate wholesale interest rates. It was the first time a major bank had been convicted of rate rigging in the developed world. The other major banks settled out of court.

Ultimately, the spate of misconduct in the sector stems from a lack of competition, which allows businesses to get away with overcharging and arrogance.

To be sure, it arises in part because consumers are not well placed to understand financial products, or how they are priced.

And yet the assumption underpinning financial services regulation remains that customers are highly rational and equipped to sift through products to find what’s best for them,

That’s looking increasingly misguided, not just here, but globally where large financial institutions have similarly been found to have erred on the side of systematic gouging and misconduct.

Governments, of either political persuasion, don’t appear to want tough regulators. It’s still far from clear they do. The vast revenues of large financial institutions, which underpin exorbitant bonuses and ridiculous corporate excess, are built mainly on charging significantly more than is necessary.

At the same time, governments have permitted the growth of ever larger and more powerful financial institutions, blessing mergers and takeovers, and increased the sector’s market power further.

Perhaps digital technology will put more power back in consumer hands. Waiting for governments to create effective regulators appears unlikely, and will always be an inferior outcome to genuine competition in any case.