When a financial services inquiry was first proposed by Joe Hockey — borrowing from an eclectic group of economists — in 2010, the banking environment was somewhat different. The banking cartel had been lifting interest rates above the RBA’s rises for a year, although few people understood that that merely meant the RBA would be slower to lift official rates and the eventual difference would be minimal. There was considerable focus on the dearth of competition in the banking system in the wake of the financial crisis, which had allowed the big banks to consume some of their nearest smaller rivals.

And there was a lot of talk of “too big to fail” — the problem on institutions that are so large, everyone knows a government won’t let them collapse during a financial crisis, giving it an implicit guarantee that enables it to access funding at a lower cost than smaller competitors and encourages riskier behaviour. In a speech back then, Hockey correctly observed:

“… we have the major banks claiming that they need to expand offshore to pursue higher growth opportunities than those they can find domestically, or move into non-core areas of business, like funds management. But it was precisely the absence of these overseas exposures that the RBA regularly opined was the chief saviour of Australia’s banking system during the Financial Crisis.

“With massive taxpayer risk in play we as policymakers need to decide if we want the major banks to be unrestrained growth stocks, like resources or technology companies. Or do we want the industry to be more akin to bullet-proof utilities that are focused on delivering stable returns to shareholders? One possible solution here is to quarantine the risks that taxpayers will insure, and accordingly quarantine the coverage of our moral hazard.”

So strident was Hockey on the performance of the banks that an exasperated Mike Smith, CEO of the bank most prone to behaving like an unrestrained growth stock, ANZ, compared him to Hugo Chavez. Hockey talked tough in response: “Bank CEOs can shoot me, they can decry me, they can have a go at me. I don’t mind, because we are standing up for consumers, we’re standing up for small business, we’re standing up for the people that are missing out on more competition in banking.”

Well, maybe. After becoming Treasurer, that focus on too big to fail was watered down by Hockey in the terms of reference for the Murray financial services inquiry, reflecting the much more bank-friendly nature of the inquiry that Hockey finally delivered.

Still, too big to fail occupies some space in the interim report. The report concludes that it “is difficult to estimate the size of any possible funding cost advantage that the perception of being too-big-to-fail provides large banks. This is in large part due to different creditors having different perceptions around risk.” But it knows it’s there, because in the stability section, the report devotes a lot of space to how to address it, asking for comment on measures like:

  • “imposing losses on particular classes of creditors during a crisis” — albeit acknowledging this could actually worsen a crisis given how banks lend to each other;
  • giving financial sector regulators greater “resolution” powers to use during a crisis (a regulatory process that’s already underway);
  • more pre-planning and “pre-positioning” for crises by regulators and banks, so everyone is clearer about how a “resolution” process would work;
  • further increases to capital requirements to reduce the likelihood of failure and need for bail-out;
  • imposing a charge for the government’s retail deposit guarantee; and
  • ring-fence certain banking activities, Volcker Rule-style, to minimise the risk of contagion from riskier activities.

None of these ideas are likely to win favour from the big banks, but then again the report is a million miles from Hockey’s original talk about regulating them like utilities. However, the inquiry has picked up and run with an issue raised by the Reserve Bank that provides a different context for too big to fail: homegrown contagion from property.

The way our tax system “tends to encourage leveraged and speculative investment in housing” is a problem, the inquiry suggests:

“Since the Wallis Inquiry, the increase in households’ mortgage indebtedness has been accompanied by banks allocating a greater proportion of their loan book to mortgages; the share of loans for housing has increased from 47 per cent in 1997 to its current share of 66 per cent. A large enough disruption to the housing market could have significant implications for household balance sheets, financial stability, economic growth, and the speed of recovery in household spending and broader economic activity following a shock … It is difficult to quantify the likelihood of such a scenario occurring in Australia. Official stress test results in recent years have found Australian banks are likely to be relatively resilient to most shocks. Historically, banks have mainly realised losses on their commercial property loan portfolios. However, the exposure of the financial system to the housing market has clearly increased over time and, in the opinion of the Inquiry, the systemic risk associated with this trend should be further considered.”

While the report doesn’t explore it, a key feature of this change is, as the Reserve Bank has noted, the growth of self-managed super funds and the way successive policy changes by the Howard government encouraged SMSFs to invest in property. As the Murray inquiry report explains, SMSFs have been growing rapidly partly because of the costs of super funds management in Australia are now so high.

The result: our tax system encourages greater investment in housing by households and banks, our super system encourages greater investment in housing by SMSFs, and our financial planning regulation encourages people into SMSFs — all of which is increasing the systemic risk to our financial sector from a housing market disruption. It’s homegrown contagion.

And here’s a tip: what will be the result that wretched FOFA deal the government has done with Clive Palmer? More gouging by the big banks on super, more conflicted financial advice, and more Australians deciding they’ll chance their own with a SMSF rather than risk it with the big banks. This contagion will grow and grow.