RSM Australia

Financial Services Inquiry - what does it all mean?

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Following the release of the Financial Services Inquiry report on 20 October 2015, a number of key recommendations were announced as what is viewed as the largest overhaul of the financial system in nearly 20 years. But what does it mean and how will impact you? Brad Eppingstall (Partner) and Evan Tsipas (Principal) look at the key recommendations from the report.

Banking

In 2015 all of the major banks have announced some form of capital raising in an effort to bolster capital ratios in response to APRA increasing risk weights on mortgage loans. The aim is to boost the bank’s financial strength. While this may reduce solvency risk, there is a price.

Evan Tsipas, principal, RSM, said, “The cost of making the financial system resilient is borne by shareholders. Credit growth (lending growth) may be more subdued in the future as the Australian household sector is both highly leveraged and ageing. When banks raise capital by issuing additional shares because their hand is forced by APRA, future profits are divided into an increasing number of shares. If profits are not growing at a faster rate than shares are being issued, earnings per share may fall, putting downward pressure on the share prices of the banks.  

“Unfortunately for bank shareholders, we may see some further capital raisings in 2016, especially if we see a slowdown in the economy, which could see a rise in loan provisions.

Superannuation

The government will be looking to legislate efficiency and transparency in the superannuation system.

Evan Tsipas said, “It is not entirely clear what this will involve and it sounds a little contradictory. Why? Typically additional legislation and regulation can impose new costs on superannuation funds and ultimately the public. If implemented well, increasing transparency may drive more competitive behaviour amongst superannuation providers and improve member choice and lower fees. Over the longer term, this may have ramifications for the profitability of retail and industry superannuation fund providers, and more consolidation may be the outcome.”

“Measures to increase member engagement may be counterproductive but we should keep an open mind that some good initiatives are being developed. Projecting retirement income for members seems to be one suggested measure. One suspects a push to increase the use of annuity products is underway and is hinted at in the report.”

Greater investment product choice is usually of net benefit to consumers who are trying to “manage longevity risk and other risks” to quote the report. That said, mandating members to invest in one product such as a fixed income annuity over another product would be a mistake.

Evan Tsipas said, “Hopefully the government continues to allow members to control their own destiny when it comes to investment choice. The use of annuities should be more available to Australians who are typically overexposed to shares, but members  should always have the last say on their money. Annuity providers may be excited by these reforms.”

The government has not agreed with the inquiry's recommendation to prohibit limited recourse borrowing arrangements (LRBAs) by superannuation funds.  

Brad Eppingstall, Partner, said, “The government has said it is interested in gathering further data and has asked the Council on Financial Regulators and the ATO to report back in three years.

“The confirmation by the government that LRBA’s will not be prohibited provides certainty for at least the next three years that superannuation funds can borrow for asset purchases.  Borrowing for asset purchases, particularly property, lets SMSFs acquire assets that were otherwise out of reach and potentially lets SMEs own their business premises in their SMSF and lease back to the business.”  

Innovation

The report shows the government is committed to reducing excessive card fees, encourage crowd funding and new finance business models. The report is also suggesting a move to make it easier for companies to issue ‘simple’ corporate bonds.

Evan Tsipas said, “RSM supports this initiative as the Australian corporate bond market could be expanded. Investors should welcome this move to boost choice in the fixed income area. Mum-and-dad retirees looking for income securities, especially self-managed super fund investors, have historically relied on term deposits, floating rate notes and high (fully franked) dividend paying shares. A gap certainly exists in fixed coupon corporate bonds.”

Other matters

The report outlines a number of other reforms in areas the government is in agreement with the Financial System Enquiry, including aligning financial advice with consumer’s needs, especially in the personal insurance area, giving power to ASIC to intervene and modify financial products and a range of other measures.super, and perhaps over time, we may see lower financial product fees, especially in superannuation.”

Evan Tsipas said, “As always the intentions for reform are good but proper implementation is key. For investors, banks are still in APRA’s sights, new bond and annuity products may be on their way, you can still borrow in super, and perhaps over time, we may see lower financial product fees, especially in superannuation.”