Banks and their capital needs occupied the headline and reports on the Murray Committee’s investigation into the financial system, but there was a lot more in the report than that.
There were in fact a total of 44 recommendations issued, covering banking at all levels, superannuation, regulation, efficiency and minimising the cost to taxpayers of this regulation.
And there were non-recommendations, but comments critical of quite a few well known tax lurks – negative gearing, dividend imputation and capital gains exemptions for example – which will excite some commentators, politicians and lobby groups.
But don’t worry this government and the ALP won’t have the political courage to move against them.
That’s despite thew way they discriminate against some financial products, with a cost to national performance::
“To the extent that tax distortions direct savings to less productive investment opportunities, a more neutral tax treatment would likely increase productivity," Mr Murray wrote.
“The relatively unfavourable tax treatment of deposits and fixed-income securities makes them less attractive as forms of saving and increases the cost of this type of funding."
But the basic thrust of the inquiry’s final report was wider than just tax lurks. That was summed up in this paragraph:
"The Inquiry’s recommendations are designed to enhance the resilience of the Australian financial system, which underpins the strength and efficiency of the economy. The recommendations seek to make institutions less susceptible to shocks and the system less prone to crises, reducing the costs of crises when they do happen, and supporting trust and confidence in the system. They aim to minimise the use of taxpayer funds, protect the broader economy from risks in the financial sector and minimise perceptions of an implicit guarantee and the associated market distortions.”
Bank shares today will no doubt come under pressure, but what we should remember the plans to boost capital and change the weightings for mortgages in the big banks’ capital allocations, will take time. If the latter works the likes of Bank of Queensland, Bank of Bendigo and Adelaide and the credit unions and other lenders will benefit because their capital needs for home lending will fall relative to those of the big banks.
The big banks will moan and groan about the extra capital and mortgage weightings, but those will fall on deaf ears with the key regulators, the Reserve Bank and the the Australian Prudential Regulation Authority (APRA).
But it is possible that interest rates on lending products (not just home loans) could edge up, it is also possible that the banks will not be able to lift dividends for a couple of years, and it is possible that profits will remain under pressure.
It is also possible that increased competition will force the banks to put a lid on rate rises, to cut costs to make up for the higher capital imposts, and will payout more and more of their dividends in shares through dividend reinvestment programs.
In superannuation the committee has recommended that the ability of super funds to borrow (introduced in 2007) be ended because of the risks entailed in the idea.
"Direct borrowing by superannuation funds could pose risks to the financial system if it is allowed to grow at high rates. It is also inconsistent with the objectives of superannuation to be a savings vehicle for retirement income. Restoring the original prohibition on direct borrowing by superannuation funds would preserve the strengths and benefits the superannuation system has delivered to individuals, the financial system and the economy, and limit the risks to taxpayers,” the Committee said in its report.
For this reason, the Murray report recommends that “Government should restore the general prohibition on direct borrowing by superannuation funds by removing Section 67A of the Superannuation Industry (Supervision) Act 1993 (SIS Act) on a prospective basis. This section allows superannuation funds to borrow directly using limited recourse borrowing arrangements (LRBAs). The exception of temporary borrowing by superannuation funds for short-term liquidity management purposes (contained in Section 67 of the SIS Act) should remain. Direct borrowing in this context refers to any arrangement that funds enter into where the borrowing is used to purchase assets directly for the fund.”
The committee says this should be done to “(To) prevent the unnecessary build-up of risk in the superannuation system and the financial system more broadly (and) Fulfil the objective for superannuation to be a savings vehicle for retirement income, rather than a broader wealth management vehicle.” In recommending this the Committee has accepted strong calls to do so in submissions from the two key regulators, the Reserve Bank and APRA (The Australian Prudential Regulation Authority).
The report points out that this lurk has seen a rapid build up of debt and leverage in super funds since 2007, with the amount of funds borrowed using these Limited Borrowing Arrangements (LRBAs) soaring, from $497 million in June 2009 to $8.7 billion in June this year, This has had the effect of introducing leverage into the super system where no existed before. It also has lowered returns by increasing costs for borrowers, and allows some high net worth individuals to circumvent caps on contributions “over time” and build up asset holdings larger than they would have been allowed without this leverage.
"The GFC highlighted the benefits of Australia’s largely unleveraged superannuation system. The absence of leverage in superannuation funds meant that rapid falls in asset prices and losses in funds were neither amplified nor forced to be realised. The absence of borrowing benefited superannuation fund members and enabled the superannuation system to have a stabilising influence on the broader financial system and the economy during the GFC.
“Although the level of borrowing is currently relatively small, if direct borrowing by funds continues to grow at high rates, it could, over time, pose a risk to the financial system,” the report added.
Of interest as to the committee’s wider think were comments on tax contained in an appendix to the report.
Many of these are explosive – such as capital gains, negative gearing and dividend imputation – and will be considered in the White Paper on tax the Abbott Government is preparing and could release later this month.
If Inquiry head, David Murray, had his way, tax breaks for housing, shares and superannuation could all be scrapped, and GST could apply more broadly to financial services, for example.
The report suggests a range of tax breaks distort borrowing including negative gearing, capital gains tax concessions and dividend imputation.
Mr Murray takes particular aim at tax breaks for housing, saying negative gearing and capital gains tax exemptions on the family home "tends to encourage leveraged and speculative investment" and "is a potential source of systemic risk for the financial system and the economy."
Mr Murray pointed out how capital gains concessions were was a tax subsidy for the wealthy and reducing it “would lead to a more efficient allocation of funding in the economy".
"All else being equal, the increase in the after-tax return is larger for individuals on higher marginal tax rates," he said.
The report does not outrightly suggest scrapping them(that’s a decision for government), but points out that they are concessions that distort behaviour and create risk.
On dividend imputation Mr Murray reiterated his view that "the case for retaining dividend imputation is less clear than in the past" and suggested this could instead be replaced with a lower company tax rate.
He said dividend imputation had removed the "bias towards debt funding" but then pushed Australians and superannuation funds to invest in domestic shares.
“The benefits of dividend imputation, particularly in lowering the cost of capital, may have declined as Australia’s economy has become more open and connected to global capital markets," he said.
“Imputation provides little benefit to non-residents that invest in Australian corporates," he said.
"Mutuals cannot distribute franking credits, unlike institutions with more traditional company structures. This may adversely affect mutuals’ cost of capital, with implications for competition in banking."
Anf then there’s the loss to government revenue. "For investors, including superannuation funds, subject to low tax rates, the value of imputation credits received may exceed tax payable," he said. “Unused credits are fully refundable to these investors, with negative consequences for government revenue,” he said.
Some analysts have estimated imputation costs the government more than $20 billion in lost revenue and other costs.
Mr Murray also called for the end of generous concessions on superannuation, saying they had not been “well targeted to achieve provision of retirement incomes" but instead were being used to reduce tax.
And he also suggested GST could be levied on financial services to level the playing field and reduce inefficiencies in pricing of products and services.
Currently financial service providers that do not charge GST, still must pay GST on inputs, but cannot claim input tax credits.
“Providers pass this cost on to consumers in the form of higher prices,” Mr Murray said.
“As a result, households could be over-consuming financial services compared to what they would consume if GST was applied to these services.” And since businesses also cannot claim input tax credits, “this could result in businesses consuming fewer financial services than otherwise would be the case”, Mr Murray wrote.
