 It is not of me to address you and also to thank Diego, do you want to stand up Diego, who was my trusty assistant and put up with many, many hours, thank you. The bad news was that at 10 o'clock last night this paper was 24,000 words, the good news is that by midnight it was 15,000 words, but if it's a bit long and you'd rather go and have a nice dinner I fully understand, so I'll see what I can do. Look, I've had a long career in the financial service industry globally and most of my professional life has been devoted to fixing foul banks. I've worked on bailouts in the United States, Australia, Europe and Asia and despite these regional differences there's remarkable commonality to the cause and effect of their failure, restructuring and resolution. And when financial crises do occur, as they seem to do with remarkable regularity, we see very important people looking very serious, making very sage announcements that everything will be okay, but we nevertheless we sort of figure out what is actually going on and we're none the wisest to why this has occurred. Because for most people the notion of safe as a bank is dearly held. From the time we are young, putting our few coins into a piggy bank, to our first school banking account, ensuring our first car, nervously meeting with a bank manager, about a housing loan and now using ATMs and internet banking, financial institutions are the very bedrock of our own financial stability. And a hundred years ago people would go to Martin Place and look at the magnificence the banking chamber had been cocooned in its safety, security and stability. That was the impression. So what a financial crisis does actually occur, there's a huge amount of confusion and a sense of disbelief. As safe as a bank, a global financial crisis sit very frankly uncomfortably with each other, as a sort of perplexing financial oxymoron. And if you look at historical photographs of banking runs, you'll see a dazed and frightened public lining up to withdraw their deposits with no idea what they'll do to their money. And it's because the financial sector is so central to a functioning economy that when things go wrong, the impact is so widespread and devastating. And so this lecture what I'm going to do is start with the basics of banking, then explain the inherent conflict of interest between depositors and bank regulators and bank shareholders and look at how regulators arbitrate this, look at the cause and effects of financial failures and the regulatory response to this and finally having looked at the broader aspects of the financial sector in Australia and internationally, particularly around what's called the too big to falconundrum, I will give my recommendations for reforming the Australia's banking section G20 world. It's a very broad canvas and I hope to do justice to it, particularly my alma mater. So I'm going to use a bit of technology here which I'm not very good at. I'm going to use a slide, there we go. So look, here's the financial services sector. What you can see pretty well if you look at it is that the deposit taking institutions are absolutely massive in terms of $3.3 trillion of assets. Life insurance companies and superannuation is obviously $1.8 billion, but the rest of the sector is actually rather small. If we then look at the market sector participants by market capitalization, it becomes fairly obvious what the sector looks like. And if you think about that NAB, which is the smallest of the four trading banks, has four times the market capitalization of the next largest institution, either Macquarie or Suncorp, and that CBA is six times that, you can see that a sector that is absolutely dominated from a financial perspective by the four trading banks. If we then look at the banks by market capitalization, remembering that Australia is 2% of the world's GDP, out of the 25 top banks by market capitalization around the world, we have all four of our trading banks in there. So four out of the 25 largest institutions by market capitalization are in Australia. Now that we have a snapshot of the financial sector as a whole, let's begin with the fundamentals of banking, and in particular the banking sector, which is the most important component of a financial sector. Now we know the expression lies, dam lies and statistics, but very few people realize the expression as safe as a bank is a myth. Banking by its very, and activity is a fundamentally unsafe undertaking. It's an unsafe undertaking, which also involves monumentally huge numbers, huge numbers of customers, huge numbers of capital, and vastly huge amounts of deposits, borrowings, loans and assets. Let me demonstrate this by comparing the balance sheets of Coal Milk Bank and Westpac with those of BHP and Rio. So that we have the two largest banks and two largest mining companies headquartered. Now the thing that I want you to focus on is a line that says equity ratio and financial leverage. So we have an institution such as ComBank, which has about $800 billion in assets, where shell is equity of only 50 million. It has an equity ratio of 6.2% compare that with BHP and Rio, which are 50%. If we look at the leverage involved, which is over 16, and you look at the leverage of BHP and Rio, they're entirely different. But then interestingly enough, the banks are higher rated. So you go, how is an institution that's only got 6% equity leverage ratio had a AA rating, whereas BHP, which has obviously got a lot more equity in it, has a lower rating. Now there's a trick to this because it would have seemed to be a logical. Now the important point to make is if the banks had the same ratio, in other words, they were levied at 16 to 1, they would be regarded as junk by the rating agencies. So they have a leverage ratio, which in the non-financial world is a junk rating. But in the financial world, they have a AA rating. And if you think that ComBank and West Bank are highly levied, the global investment banks, including Goldman Sachs and Morgan Stanley, were levied at 30 to 1 and even 40 to 1 prior to the GFC. So by and large, banks globally have similar leverage structures. They borrow a lot of money on a slim capital base. And as of today, the major Australian trading banks have got 3 trillion of assets to border by a capital base of only 170 billion. So once this has understood this concept of leverage, it's not difficult to understand that bank failures are not incomprehensible aberrations, but inherent to the very enterprise itself. And indeed, if the true risk embodied in financial institutions reflected their published balance sheets, they would not be financially viable at all. And they will be unable to attract investors to invest in them. So the trick to banking and the process of credit intermediation as a whole is that the economic leverage in a bank is far less than the accounting leverage disclosed in its balance sheet. In other words, the economic leverage of ComBank and West Bank is far less than the 16.1 accounting leverage of accurate assets that you see and it supports their ratings. So where does this enhanced economic leverage come from? Will the shelves of the bank create and contribute to a balance sheet? But in addition to this, everyone who has a mortgage or a bank loan also contributes capital. This contributed capital is the amount of collateral that every individual or business contributes by way of down payment of their mortgage or corporate loan. Without this contributed capital, the entire financial system could not actually function because it will be far more risky than it is. Therefore, the economic risk inherent in banking is a function of its balance sheet capital plus its contributed capital compared with the riskiness of its loans and assets on its balance sheet. And some of these assets are corporate loans and government bonds. To demonstrate the importance of contributed capital, let's look at the simple illustration of a standard 25-year housing loan. For the purpose of analysis, we are going to assume the loan is paid off in equal annual installments over 25 years, although in practice housing loans turn over less than five years in average. So the price of the house in question is half a million dollars with a loan to value ratio and LVR of 90%. So the first thing we see, and you'll see this in a minute, is the borrow has initially contributed 50,000 to the home price. The bank has provided 450,000 as a loan and this loan from the bank's perspective as an asset in its balance sheet. So when the loans first entered into, the borrow has provided 50,000 of contributed capital to the transaction. In simple terms, if the value of the home falls during an economic cycle of more than 10%, this decline in the price of the home is referred to as negative equity by the banks. Now the really interesting observation is that as the mortgage is paid off over time, the amount of contributed capital made by the homeowner to the transaction increases from 10% in year one to 96% in year, whoops, no, they've missed that, yep, in in year 24. So what we've got here is a chart. You can see from the slide that in year 13, the value of the same house would have to fall more than 50% before the bank's shells were at risk in terms of their balance sheet capital. In year one, if the price of the house fell by more than 10%, it would imperil the bank's shareholders. But by year 13, because of the loan pay downs and the contributed capital increasing, then the bank has got a more secure position. So the price of the house would have to fall by more than 50% before its own balance sheet capital was impacted. So when you see the true economic risk in a mortgage structure, you can see why banks are very keen to provide this product. There are a lot of advantages to mortgage loans in terms of regulatory capital, which I'll deal with later on. That's important to note that the contributed capital provided by customers in the transaction does not belong to the bank. It belongs to the customer. And as such, its only role is to protect the bank's balance sheet from the economic risk in a transaction, and a bank can't draw upon it in a financial crisis. It could only use its own balance sheet capital. Contributed capital cannot be amalgamated or summed to protect a bank's capital. So for example, you may have a surplus of contributed capital in total in a bank's portfolio of mortgage loans, but a deficit in commercial or property loans, which is sufficient to imperil the bank's balance sheet as a credit failure. Now this sounds a bit complicated, so I'm going to give you a very simple example. So what we have here is three loans, a housing loan, an SME loan and a commercial loan. Now as of today, we have that on the top chart, you'll see that the bank has balance sheet capital of $125,000 against total assets of $1.5 million. Now let's assume there's a financial crisis, or the bank has overled to the commercial loan and it declines by 70%. Note that the housing loan and the SME loan have not changed in value at all. There is no difference to their contributed capital. But the problem with the bank faces is that the commercial loan has now declined from $500,000 to $150,000, which in itself is enough to wipe out the contributed capital into the deficit, which then affects its balance sheet capital. This is really important because as we look to financial crisis, people say, well look, all the mortgages in housing went alright, but a few bad apples brought down the whole system. It's because the contributed capital does not belong to the bank, it's only individuals and if there's poor loans in the portfolio, that in itself is enough to create a crisis. Now just in case you're wondering, what we've actually done just now is to create a bank stress test. You've read about this. This is what's being applied to the major financial institution in Europe. What we have done is to hypothetically reduce asset values in a simulated banking crisis to observe, is there a call on balance sheet capital arising from the reduction in contributed capital across asset classes. As I said, our housing and SME loan were perfectly fine, but the commercial loan created a major solvency from the problem. So what is the purpose of contributed capital and balance sheet capital anyway? It's only got one role, which is protect depositors money. When an individual or company makes a deposit, I think this, I'll come back to that, when individual or company makes a deposit with a bank, is an absolute given that its money can be withdrawn at a moment's notice. That is, it's at call. This withdrawal may be at a bank branch, it may be through an ATM overseas, it may be paying electricity bill, but the deposit belongs to the customer and is held on trust by the bank as custodian. Without this absolute given, the entire economy would come to a standstill. Can you imagine every time you went to pay a bill, you were not sure that the bank had enough money to pay it to affect your transaction. Now when people do feel this way, depositors start lining up and it's what it's called a bank run and it's happened on numerous occasions around the world and most recently in Australia in the 1980s Winston George was a building society, it had a run on it. Well then you say okay well let's think about an ideal world. Wouldn't depositors then say well we'd like to have a bank with a balance sheet like BHP Billiton rather than Westpac or ComBank. Well of course not, every deposit Australia or any other country of the matter has absolutely no idea about banks and their balance sheets. They just assume that when they want their money it will be there. They don't think about they don't think about balance sheet capital, contributed capital, registered capital aid just want their money and they assume the system will be there. Well therefore, well who does think about these things? Well historically bank was a highly entrepreneurial activity. Citizens, sometimes worthy, sometimes not, would put up some money as capital and commence the enterprise of borrowing lending money and over time and with good reason after the depositors lost their money in numerous bank failures governments and regulators began to protect honest honest ordinary folks. They had new regulations, govern these institutions which either held a sort of banking license and imposed increasingly sophisticated licensing requirements on them including how much capital shareholders need to provide. Further, with the development of larger financial institutions operating in multiple jurisdictions the regulatory framework has actually morphed from the national sphere to the international sphere. But nationally or super-nationally regulators still need to balance the interest of depositors with those of bank shareholders. Shareholders have to get an economic return in their investment. So let's superimpose what happened in Westpac did look like BHP. I think that's correct, yep. Now if we look at this slide what we've now done is we said okay let's make we've superimposed the Shell's equity relationship that BHP has on Westpac. One problem look at the return on equity. Westpac's return on equity goes from 18% to less than 2% and any bank that is offering its investors a 2% return on equity won't be in business for very long. So the problem that the regulators have is between this whole concept of leverage and return to shareholders. So financial regulators are the business either explicitly or implicitly of arbitrating the conflict of interest between depositors and shareholders. A stronger capital position assists depositors but it can't be the expense of diminishing Shell to returns to an unaccompanied level. Further there are competitive aspects in terms of driving out marginal players and which impact customer choice. So even in bank bailouts remember new capital can only be formed for the surviving entity if the providers of capital believe they can get a satisfactory return taken for the risk of their investment. And so as I'll discuss later financial regulators have a very significant role in determining the economics of banking that most people don't realize. So that's turned to the ordinary honest depositor. Outside a very small elite nobody has any idea about the arcane world of bank capital and balance sheets and I'm surprised you probably when you saw that demonstration thing I didn't really think about that. People just assume the function of the system will function. But what happens when we do her bank failure? Who ends up actually guaranteeing the safety and security depositors money and the banking system as a whole? Well governments do. It's only governments that have the financial resources to protect depositors because as we've seen when a crisis results in the diminution of asset values as to overwhelm contributed capital and look at only look at balance sheet capital on a proportional basis and not very much balance sheet capital support the system. So time and time again it's governments and taxpayers that have ended up ensuring depositing their money back and the banking system actually functions as it should. And this is a unique benefit provided to banks and in some times an insurance company which no other private sector company could dream of. As recently as the last financial crisis the government of Ireland guaranteed its entire banking system only to find that the guarantee bankrupted the entire country which then had to go to the IMF. You can see what happens here. So now we've looked at the structure of a balance sheet from the perspective of capital and assets and discuss protection of depositors. Now if this wasn't complex enough we need to look at another unique feature of financial systems globally and Australia in particular which is the timing mismatch between a bank's obligation to repay its depositors money at call and a borrower's obligation to repay a bank loan which may stretch over years or decades. This is referred to as duration risk or in the vernacular borrowing short lending long and the greater the duration event the more likely a bank can and will suffer a liquidity event in a banking crisis. Let me go back to simplify this by looking at our half a million dollar house purchase. At the closing the purchaser provides a bank check of $50,000 from their contributed capital to the vendor and the bank provides a 25 year amortising loan and delivers a bank check for 450,000 to the vendor. The vendor's now got the half a million dollars. The bank takes possession of the title lease for the property. It keeps pending the full repayment of the mortgage after 25 years or a layer of salt. Well that's pretty straightforward isn't it? Well not really from an economic perspective because what the bank has just entered into is a 25 year mortgage contract that is assuming the borrower doesn't go into default it will get its money back gradually over 25 years and there are really defaults. So then therefore we have to say well wait a minute well how did the bank then finance this 450,000 dollar loan which is not going to get back for 25 years and what are its obligations to it the people who finance the bank? What I can tell you would all know from looking around is there is no such thing as a 25 year deposit. In an ideal world there'd be 25 year deposits which will be on off of the banks and people would go along and say I'm going to have for 25 years they would loan 25 year money and would have no duration risk. There'd be no problem but of course that doesn't occur and it can't even occur overseas. Banks don't go overseas and say I'm lending Mr and Mrs Bruce Hall $450,000 what I need to do is borrow half a million dollars of 25 year, 450,000 of 25 year money. What it actually does in reality is it finances its $450,000 with a combination of at-call deposits, overnight borrowings, 30, 60 and 90 day medium term notes in the Euro and US markets. Occasionally banks borrow longer term 5 to 10 years but it's a very, very small portion of liability structure. So the existential problem that all banks face in liquidity crisis is that depositors small and large can demand immediately withdraw their money to be able to take it back but a bank cannot turn around and demand that a mortgage holder or a borrower repay that money immediately to pay back the depositor. That's the problem that is created in the liquidity crisis and the greater duration mismatch and the now the financing of a bank if it's in different countries has got a broad financing base the more likely it is to fail because it runs out of money. Now you may have a home that's worth half a million dollars but if you've got nothing in your bank account you can't pay your mortgage back the bank will take your home away even though you may have equity in it. So it's very important liquidity is very important to the system just as is for individuals. Now the financing of the Australian banks during the GFC became a major systemic problem for the entire economy which is still is today and I'm going to turn this later on and it's exacerbated by a tax regime which penalised Australian deposits creating disincentive to save for this mechanism and therefore our financial system is overaligned on offshore borrowings and this problem of offshore borrowings was particularly acute for the non-trading banks including Macquarie, St George and Sun Corp of the GFC. So therefore what we need to do is to we need to look at what the major banks are doing and they are amongst the very largest borrowers in the global debt markets of all institutions despite the relative modest size of Australia's GDP relative to the global GDP, global GDP about $74.5 trillion, we're about $1.6 trillion and yet our banks are some of the biggest borrowers. Now liquidity is one of a large number of banks sorry risks that banks have to manage. There's concentration risk, geographic risk, counterparty risk, credit risk, duration risk, reputational risk, default risk, interest rates and others. That will come as a surprise to many people that within the financial sector globally most employees within the financial sector have little or no idea about how the institution manages these risks. Tomorrow go to your local branch manager and ask her how do you manage liquidity risk or duration risk? You will get nothing but a look of bafflement. What are you talking about? So the complex task of managing these risks and the balance sheet as a whole is visit a very high sliver bank in what is called an asset liability committee, ALCO. It is only here amongst a select few that all the information about bank risk and the bank balance sheet is pulled together and managed. Governments however have found themselves in the business of having to understand these risks, regulate them and in certain cases even prescribe limits on certain types of loans and other assets in order to protect deposit money and the safety and security of the financial system as a whole. Now in Australia the financial sector is overseen by a number of bodies under the umbrella of the Council of Financial Regulators, CFR. The chairman of the CFR is Glenn Stevens, the Governor Reserve Bank. Other representatives include Australian Treasury, the Australian Prudential Regulatory Authority, APRA and the Australian Securities and Investments Commission. The RBA provides a secretariat and I'll give you this later but a notable non-member is the Competition Authority of the ACCC. Now financial sector supervision is more from a national regulators to supernational regulators. The most important one is the BIS in Switzerland, the Bank of International Settlements which was established in 1930 after the Wall Street crash. The BIS of which Australia is a member is the Global Regulator of the International Banking System and additionally provides very useful commentary about the state of the global economy and financial markets in particular. The BIS is most well known for establishing and revising global capital rules related to the treatment of bank risk and capital known as the BIS regime for capital adequacy. And since 1988 there's been three durations of the BIS rules, namely BIS 1, BIS 2 and now BIS 3, sort of very creative names. This has been currently implemented by banks and being overseen by domestic regulators. Held by banks and insurance companies have different risks. What the BIS, which we've seen in the previous chart, what the BIS regime does is to ensure that globally banks treat the same assets the same way and they are risk-weighted in identical manner with identical capital applied against those to ensure that depositors have access to identical capital within the sort of risk they're taking. So the whole idea is to have a minimum capital standards to protect depositors. Remember I said that banking is an under safe undertaking involving monumentally huge numbers. So in order to become grits as the BIS setting, it's important to note that there are two variables, the risk-weighting of assets, the numerator and the capital acquired as a percentage of those risk-weighted asset denominator. I'm going to explain this a bit more. The trick here is that national regular such as APRA can play with both the numerator and the denominator and the net result is the absolute level of capital held by an institution and within the country itself. So I'm going to demonstrate this. A bank may have a higher level of capital adequacy but a lower absolute level of a bank with an identical portfolio depending on how the regular looks at risk-weighting the asset treatment. Now recall the expression I had lies, damn lies and statistics. Now Australia has the proponents of housing loans compared with corporate loans financed by the banking sector. Indeed we have the highest proportion of housing loans of any major economy in the world. We are quite an outlier as you can see from that. So the calculation of how these loans are treated by APRA has a major impact on the absolute level of capital in the banking system. Now in its wisdom APRA treats a housing loan originated by a major trading bank entirely differently from the same loan originated by a regional bank, originated by a regional bank. So if we look at the risk weightings for unbalanced sheets, like the unbalanced assets what I want you to look at is forget some of the other weightings I'll get to two things. Look at look at the the ratings on AA and AA minus securities which have a zero capital allocation required. But look at the mortgages now look at the zero to 80 which is 35, 90 to 80 to 90 LVR and 90 to 100. What's it actually showing is APRA is incorporated as concept of contributed capital in the way it looks in the capital ratios because they're saying the more contributed capital by people you're transacting with, in other words the home loan, the more the more favourable capital treatment you'll get. So you can observe this. Now what APRA permits the Australian trading banks to do is to determine the risk weightings for a home loan under an advanced modelling technique. This means that the major banks, unlike the regional banks, do not use this approach. They determine how much capital they need and in and actually it's a lot less than what the regional banks are required to do. So think about it. A loan originated by a regional bank has a lot higher capital requirement than the same loan originally about a major bank. This is anti competitive and it's a distortion to the market. And it also means in terms of international comparisons about which banks of which capital it's undermining one of the key features of the BIS regime, which is consistency of credit risk applications across global jurisdictions. I'm going to give an example of this. So the Australian collective bank, the banks collectively, the majors have actually less than a 20 percent risk weight and applied to their total home portfolio, which makes a huge difference that capital are required to hold by APRA, particularly as I said, given the importance of housing stock in the market. Now, what I'm going to do here is is to say there are two banks in the economy where we have a three trillion dollar book. There's two banks, major bank and regional bank. Major bank, forget all the numbers, major bank is able to risk weight its housing portfolio, which is 70 percent of its of its book at 18 percent capital, but it uses a 10 percent capital ratio. So that's the first line. The regional bank has to apply a 30 percent risk weighting, but only has an 8 percent capital buffer. Now, that sounds a bit confusing, but let me go into a bit more detail. The major bank has sixty three point nine billion of absolute capital with an equity assets ratio of four point two six percent, but shows a BIS capital ratio of 10 percent. The regional bank, because it's being more penalized on the way the risk weighted assets are done for housing loans, actually ends up with more absolute capital, sixty four and a half billion has a better leverage ratio, but looks worse on a BIS capital ratio. Now, if you're the management of regional bank, you might be pretty annoyed about this and you might complain about the Murray inquiry. You might even be more annoyed when the head of the central bank who is coincidentally the chairman of the council of financial regulators makes a submission of the same Murray inquiry that is unlevel playing field should be maintained in case it leads to an asset bubble in Australia's housing stock. The key point about this is if our domestic regulators such as APRA can apply such latitude in the numerator, the risk weighting under a bank's modeling techniques, questions had to be asked about the result, the numerator and you've seen how regional bank has more capital that shows a weaker capital base in its published accounts. And that's why there's so much difficulty figuring out what's going on about BIS capital globally. Now, the cause and effects of banks and financial crisis have been the subject of much academic and regulatory discussion. And what I'd like to do now is to go through. Now, you sort of understand this, I hope you do, is to sort of give you a bit of what's happened to me in terms of practice and theory. Most people in this audience some of them would be too young to have experienced it, but most of the last century until the 1980s, Australia had a highly regulated banking system in which interest rates on loans and deposits were regulated by the federal government. This was known by bankers as a rule of three, six, three. By all three, lend it six, be on the golf course by three p.m. It was a very good rule. Bankers were unable to lend outside prescribed interest rates and there was actually credit rationing. For example, this happened to me before being eligible for a housing loan. Customers would normally have to make a deposit sizeable with a bank between 18 months and two years before being inconsidered by the bank manager for a loan. Now, all this ended the financial sector deregulation in the mid 1980s from the Campbell inquiry and a similar deregulation of financial markets in the United Kingdom, the same times referred to as the Big Bang. And in not only five, the Treasurer of Australia, Paul Keating, announced that 16 banks have been approved for new banking licenses, which resulted in new credit being available to the economy. The new market entrance quickly made their presence felt with the grinding of substantial corporate loans, particularly the entrepreneurial sector and for large scale property development. Overnight, these entrepreneurs, including Alan Bond, Christopher Space, Bruce Judge and a whole lot of financial engineers now had access to vast amounts of money on very liberal terms, allowing them to buy assets all over the world at ever-inflating prices. Now, after Wall Street crashed in 1987, which severely revised down the valuations of these companies globally, particularly those leveraged, these go-go entrepreneurs who had borrowed from the new liberated banking sector suddenly found their market value of the acquisitions was substantial as to what they had the banks. So the music stopped in 1988 with a resulting financial crisis in Australia and New Zealand that led to the failure, then restructuring and sale of the entire state banking system, the sale of the state-owned bank of New Zealand to NAB and the exiting of most of the new bank entrance. Further, at the time, there was a shadow banking industry in Australia in the form of finance companies. Now, shadow bank is nothing more than a financial service company which provides credit to consumers and businesses, normally at substantially higher interest rates, but is not entitled to fund itself with a deposit or have access to central banking facilities. So shadow banks have to issue debentures or to borrow money in the private markets or institutional markets to fund themselves which they then on lend. Now, in Australia, the large finance companies, shadow banks, such as ANZ Asander, were wholly owned subsidiaries and capitalised directly by the large trading banks. Customers who proposed transactions which were deemed too risky for these trading banks because a customer would provide enough security, i.e. contributed capital, were referred by their bank managers to the very same finance companies owned by the bank. Now, theoretically, this practice bifurcated risk between the banking sector and the shadow banking sector thereby protecting bank depositors. There was a number of practical issues here. The poor lending practice of the Australian finance companies led to such asset quality problems, particularly with commercial property and construction loans, that the finance companies themselves actually failed and had to be supported by the shareholders of the large banks and taxpayers in the case of state banks. It also had finance companies. Consequently, the banks and the regulators came to the realisation there was no artificial bifurcation of risk. These financial companies were absorbed into banks and, effectively, the financial regulars of this country have got rid of shadow banks. So today, Asander is a business division of A&Z, but not a set of subsidiary with its own separate funding sources. Now, the acquisition of assets, as we've seen in the 1980s and in other times, of at ever-increasing prices is referred to an asset bubble. Now, central bankers and bank regulators devote a great deal of time trying to create long-term economic growth without allowing the economy to create asset bubbles or deflation in which the value of assets such as housing and commercial properties actually decline. Now, while deflation is pretty identifiable, there's a great deal of debate within academic circles and within central bankers what actually constitute an asset bubble and also whether it's a role of central bankers to take action to deburse these before they occur. A lot of debate still goes on about what is the role of monetary policy in this. But historically, there have been asset bubbles in tulips, securities, housing, internet companies, minerals in which the financial value of these assets departs significantly from their underlying economic value. Further, these overvalued assets need to become a large enough component of the investment arena and be subfunded by sufficient debt as to when this valuation balance is corrected. There is destruction of both contributed capital and balance sheet capital. In other words, you need a combination of artificially high asset prices and enough concentration in those assets to bring the system down when prices come down. The asset bubbles are normally burst either by their own volition or by central bankers recognized by potentially inflationary aspects and raising interest rates or applying liquidity restrictions through the banking system to prevent these asset classes being financed. Now, when asset bubbles occur it's critically important to look at and when they burst it's very important as having the GFC to look at what is essentially a liquidity crisis or in layman's terms, a crisis of confidence with that of a fundamental deterioration of a bank's asset quality, which is sufficiently severe to degrade its balance sheet capital. Other counterparty banks are normally the first to recognize this problem and don't want to be holding the baby. So as a banking crisis unfolds, the first thing that happens, this is what you see in the papers, the first thing that happens is banks stop lending to other banks in the interbank market. That's the first thing that happens. And the reason why they do this is they, of all people, recognize just how levied the other banks are because they are levied themselves. Also, they as an institution are scrambling as asset prices decline to figure out how much contributed capital have an institution and how much of a threat to this is their balance sheet capital. So what happens is, banks stop lending to banks in overnight markets, the liquidity starts drying up. And the borrowing short, lending long problem of global banking starts to assert itself and it stresses the institutions. So another unique privilege extended to accompany the banking license is the ability to turn to the central bank for funding illiquidity crisis, which is referred to as the lender of last resort. So with panic and disorder as a result of banks lot into other banks in the interbank market, the central banks, in Australia's case a reserve bank, steps in to provide liquidity. Non-banks, including investment banks, do not have access to this. Registered banks do with deposits. So during the GFC, the last of the independent investment banks, Goldman Sachs and Morgan Stanley, were transformed into commercial banks over a single weekend. So they could get access to liquidity from the Federal Reserve. In a non-crisis, I work for Goldman Sachs, in a non-crisis period, the conversion to a commercial bank from an investment bank would have taken years and years and years and thousands of lawyers. This was done overnight, recognising that they had to become commercial banks to access money. Now during the GFC, no Australian bank reported an accounting loss and even one quarter, let alone any capital loss. Nevertheless, the entire banking system faced an acute liquidity crisis. Access to offshore funding, which is a structural component, was becoming more and more restricted and it was going to impact the economy. So on October the 12th, Wayne Swann, the Treasurer, announced that all the offshore borrowings of Australian banks would receive the sovereign triple A rating. In effect, he guaranteed over $1 trillion of bank borrowings with taxpayers' money. Now, the Irish government did the same thing. The difference was, firstly, that the Australian financial system had a crisis and a liquidity problem. It didn't have a fundamental problem with its asset quality. So it had a liquidity crisis. It didn't have an asset quality crisis. And they're very, very different. What's called a solvency crisis. Secondly, and most importantly, his predecessor, the Peter Costello, had eliminated all federal government debt and therefore the international markets looked at Australia and said, they're good for the money. That triple A guarantee, yeah, we'll bank that. So money came back into the Australian system. When we look at this going forward, the impact of our federal debt on this problem is going to be something I address. Now, I'm going to address, turn now to the issue of bank failures. The good, the bad, the truly ugly, which then sets the too big to falcon under them, which is confronting global regulators in Australia and globally. As we know, there's been numerous financial crisis. I've talked about the Wall Street crisis and the GFC. There's also been regional crisis in South America, Asia and Central Europe, which have impacted these important economies throughout throughout the last, throughout the last century. And there's been a great deal of research about what caused it. Ben Bernanke, of course, famously studied the Wall Street crash as part of his PhD in an MIT. Now, in the normal course of an industrial company that fails, liquid is appointed by the creditors or a court. The business either sold or broke it up. An asset sold over a period of time. The process can take many years. Creditors stand in line and hope that they're going to get some money back for their investment. That's what happens in the corporate world. This cannot happen with a bank because the creditors are its depositors and transactors through the payment system. In short, as banks have become bigger, a bank failure is simply too big an event and the consequences of the economy as a whole too profound to be subject to a traditional liquidation process. So failed banks do not go through bankruptcy. They go through a process of resolution until they become resolved. And by resolved, we mean ownership is transformed either by a recapitalization or a sale, often forced by the regulator, to a larger bank. Banks have to be resolved so that the deposit and transactional activities can go on even when a bank's capital has been exhausted. In the 1980s, during the US banking crisis, Congress established the Resolution Trust Company to acquire, recapitalize and then sell failed banks across the country, which is why it worked in Texas. And resolution has an important psychological terminology because for deposit borrowers, a banking crisis by definition is being resolved. It's a resolution. It's not a failure. However, in multiple situations I've worked on, the taxpayer is first called upon to underwrite the resolution process with some returning capital in later years as banks are transferred to private sector ownership either through the salve institution or to another bank or sell through the public markets, which has been currently being undertaken in the United Kingdom with two of its four high street banks. So the issue that governments, central bankers and financial regulars can fund is we're looking at two different risks. A financial system that does not finance innovators, entrepreneurs, exporters in the MSc sector as a whole will dampen economic growth and constrain national productivity. But a system which finances asset bubbles will inevitably result in distortions then economic dislocation, including taxpayer-funded bailouts for exceptional employment. The Federal Reserve Chairman, Alan Greenspan, famously described the role of the central bank and scrapped a Goldilocks economy. Not too hot, not too cold, just about right. Now, in Australia's case, we actually may have the worst of both worlds. That is a financial sector which is limiting our national productivity by not sufficiently supporting our innovators, entrepreneurs and the MSc sector as a whole while facilitating a potential asset bubble in domestic housing, which no surprises creates huge returns to bank shareholders through the favourable capital treatment of mortgages I referred to earlier. Indeed, David Murray has warned of potential correction of strained asset prices in both residential properties and the share market as has RBA Governor Glenn Stevens. Now, by and large, with a small institution, effectively if it fails, it's sold to a larger institution. But what about really huge, complex institutions that are critically important in either a single country or in fact to the entire global economy? Welcome to the two big to foul conundrum. The new paradigm in financial services in which regulators have overturned the sensible advice given about bankers as far back as the New Testament. And Jesus into the temple and drive out all of those who sold and bought in the temple. And he overtold the tables of the money changes and the seats of those who sold pigeons, Gospel of Matthew. Now, in 1984, Continental Illinois, which was then the seventh largest bank by deposit in the United States, experienced a run by large depositors into bank lending, following news that it incurred significant loss in its loan portfolio. Concerns that a failure of Continental would have significant adverse effects on the US bank's system led the US Federal Reserve, the Federal Deposit Insurance Corporation and the control of the currency to take the unprecedented action of assuring all of Continental's depositors large and small that their money was fully protected. More importantly, during congressional hearings after Continental's resolution, the control of the currency indicated the 11th, so the 11 largest banks in the United States were too big to fail and would not be allowed to fail. So the emergence of two big to foul institutions in the 1980s intersected with moves to deregulate the financial sector, permitting greater competition between institutions and therefore risk-taking. And a series of financial crisis, culminating with the GFC in 2008, has exposed taxpayers to the massive costs of a deregulated financial markets operating side by side with a too big to fail regulatory regime. Indeed, since Continental Illinois, the size, the scope and the global reach and complexity of too big to bank fails about banks has increased significantly over the past three decades. This has made the mild hazard faced by regulators even more problematic. Now, following what I want to show now is the Continental Illinois resolution cost 7.3 billion, which in 1984 was a pretty eye-watering number. What we have now after the GFC was an IMF report called the Fiscal Implication of the Global Economic and Financial Crisis, which looked at Fourier support, capital injection, asset purchases, central banking support and guarantees for the financial sector, liabilities. In all, the IMF estimated the total support for the financial sector was over 50% of GDP for advanced G20 countries. With the United States at 81%, the United Kingdom at 82% of GDP and Australia at only 9.5% of GDP. And currently, there are 29 too big to fail banks, which according to the Financial Stability Board, pose a threat to the entire global economy if they were to fail, not all of them individually. And these banks, these 29, are not only too big to fail, but require additional capital. That was just released in November last year. Now, the four major Australian banks are not too big to fail in a global context, but they are in the context of Australia and New Zealand. And what's evident from this slide is that Europe, which accounts for a quarter of global GDP, accounts for half of the world's too big to fail banks. Now, since the GFC, there has been a significant body of work undertaken by regulators internationally about how to eliminate this moral hazard of taxpayers being forced to provide hundreds of billions and even trillions of dollars to the financial sector in the event of another, i.e., the next financial crisis. So, topics under discussion include credit rationing, deposit insurance, too big to fail capital, stress test capital, bail-in bonds, guarantee fees, structural separation, and non-operating holding companies. I was going to write about all of these, but then I realized that you'd probably want to go home for dinner because each of these requires a substantive discussion in their own right, but I will look at some of these in terms of my recommendations on the Murray Report. So, in the Murray Report, reference is made to a potential failure or bail-out of one of the domestic trading banks, one of them. But what happens if two or three of these banks actually failed? What will be the consequence of the economy, the provision of finance, and public sector debt in this event? To this end, the financial crisis, which engulfed the United Kingdom in 2008, is highly instructed to what could happen in the event that was a major systemic asset-based event in our country, and a graphic illustration of the impacts on the economy when two big banks fail, actually fail. Let's just go back to the UK briefly because I wanted to talk about my recommendations, and I'll try to get people out for a reasonable time for dinner. As I said, I'll make available the 24,000-word version in the next few days. So, if we look at the UK, which I'll get into, the percentage of banking assets to GDP in the UK is more than double that of Australia. But its culture, political system, and legal framework is very similar. Now, we think about London as a major global financial hub, and we think with so many people there, there'd be a palethora of banks offering mortgages to the household sector and SME loans and to business loans. This is not actually the case. The UK has four high-street banks, namely Barclays, HSBC after the acquisition of Midland, Lloyd's TSB, and Royal Bank of Scotland. So, a high-street bank is a large retail bank found on the high street of any commercial town, sort of like Main Street in America. And these high-street banks are as important to the UK economy as the four major trading banks are to the Australian economy. And during 2008, during the GFC, RBC and Lloyd's are the subject of a government-sponsored bailout, and at one point, Barclays is very close to requiring government assistance. Now, in truth, because I was advising NAB on the acquisition of NABI National, and when we looked at NABI National's true capital ratios, we were stunned that they were about a quarter of NABs, if less, of the same rating. So, the balance sheet strength was considerably less than the Australian counterparts, and their asset composition far riskier. So, these banks did not suffer a liquidity event, but a fundamental diminution of asset quality, such that RBS and Lloyd's became insolvented at the bailout by the taxpayers. And as we've seen the cost of the taxpayer in the United Kingdom in terms of the GFC is absolutely enormous in terms of GDP cost and public sector finances. But in reality, the only difference between the UK and Australia is they're too big to fail banks, failed, and ours haven't. They have the unenjoyable experience of dealing with this after it happened, where we can deal with it before it happens, which is really what I'm talking about with my submission to the Murray Inquiry. Now, there's a fantastic book you should read. I think every bank director should read it called Shredded, Inside RBS, the bank that broke Britain by Ian Fraser. And I'll quickly go through it. There's one lesson we learned from the financial crisis that giant, world-straddling, universal banks like RBS and a good friend would make little or no way can make sense. Rather than helping the broader economy that tend to exploit implicit government subsidies, sound familiar, in order to rent-seek with their own resonant debt being to enrich their own management, not only are they too big to fail, they are too big to manage, too big to regulate, and too big to prosecute. The only short-term solution for such financial behemoths is to break them up into more manageable chunks. That way, they are more likely to focus on serving the needs of the real economy in geographies in which they focus and less likely to prioritize negative behavior like rent-seeking and empire building. Smaller banks find it difficult to hold a gun to the government's head and the re-regulation of the banking sector, which is certainly occurring in the UK, in order to hold the government to ransom into difficulties. So in the United Kingdom, we have seen regulators imposing credit rationing, ring-fencing so-called risky activities, taking them away from the deposit side, deposit-taking institutions that are funded separately, look at the competitive landscape, and even determining who will be on the boards and management of these institutions in what is known as a fit and proper test. Before you go on to a UK bank or insurance board, you are interviewed by the regulator who will then determine if you are fit and proper to go on that board. So John Vickers undertook a comprehensive review of the UK banking system and made some recommendations about structural separation of risky activities. And further, just in July this year, the Competition and Markets Authority announced it was launching in-depth investigation into competition in the UK banking market with a possible break-up of the high-street banks. So they are actively looking at this. All the things that could be on the agenda for the Murray Inquiry are actually being done in the UK as we speak. So let's get to the reason you're here, which is talking about the Australian financial sector's reforms recommended. So what we've observed is that almost any, unlike any other business, the risks undertaken and the returns to shareholders in the financial sector and the banking sector in particular are greatly influenced, if not determined, by regulators in each country and increasing globally. By virtue of attaining a license to operate in the financial sector, companies within it, public or private, submit themselves to regulatory architecture, which is as comprehensive as it is overarching. It's regulators, not shareholders, nor boards that determine how much capital each institution requires, how assets will be risk-weighted and even how much risk institutions can assume on their balance sheets by promulgating rules on counterparty risk, geographic risk, concentration risk, liquidity risk, and the like. That's what regulators do. It's also not commonly understood, but in the financial sector, there's an inherent conflict of interest between the council of financial regulators and the competition regulator, the ACCCC. Because the CFR is focused on the stability of the financial system and the economy as a whole, whereas the ACCCC is simply focused on competition. Put simply a freewheeling, highly competitive banking system in which loans are freely available to finance asset bubbles and any other corporate activity would not be a problem for the ACCCC as long as competitive. It'd be a very big problem for the CFR. But through its legislative remit, regular authority and sheer political power, the council of financial regulators is far more influential in shaping the structure, the administration, and everything else that goes on in the financial sector, and the ACCCC is a marginal player at best. Indeed, in the context of the Murray Inquiry, the Treasury, the RBA, and Apropos Submissions, does it not strike wonders more than curious that the ACCCC, the competition regulator, has not made any submissions at all? In other words, the ACCCC has absolutely nothing to say about the current environment in our financial system or how competition could be enhanced. Indeed, the RBA has been quite explicit in pointing out the risk of additional competition and where the borrowing changes, quote, might accelerate household borrowing and the associated implications for systemic risk and the available funding for Australian business. However, I do not think it's good public policy where an inquiry invested in the most important sector of the economy is simply the rest of the views of the agency charged with competition that sector. The most important symbol of competition in the financial sector, of course, was first propagated in 1990 by the Honourable Paul Keating as a six-pillars policy, which was the four banks plus the two insurance companies, A&P and AXA. And then reaffirmed by Peter Costello and every treasurer since as the four-pillars policy and under this policy, the four major trading banks not permitted to merge with each other. However, this is not an ACCCC guideline. It's a statement of political philosophy with a power to maintain it or modifying it resting with the treasurer. The Wallace's inquiry of 1997 assumed there would be such contestability in the financial sector, including new entrants. It actually recommended elimination of four-pillars policy, which fortunately wasn't adopted. Indeed, since Wallace, the Australian financial service sector has been transformed by a rolling series of acquisitions by the four major trading banks and the exiting of most of the new market entrants from the 1980s. In the banking sector, Westpac acquired St George and Combeck acquired Bank West in the same year. Within the St George and Bank West's independent entities, the opportunity of creating a fifth real competitor to the major trading banks was lost. In my view, the acquisition of St George by Westpac in particular should never have been allowed by the ACCCC and should not have been allowed by the treasurer, the Honourable Wayne Swann. I know that it would have never been permitted by Petticastello or Allen Fells because when they were announced, I actually discussed with them and they were appalled. The St George transaction in particular is anti-competitive and, worse, exacerbates the too big to fail problem facing Australian financial regulars today. So let's look at what's happened to the Australian banking sector since the St George acquisition. This is a graph that looks at the combined profits of the Australian banks since that time and plots these against increased Australia's GDP. The GDP is on the bottom line. What you'll see is a banking sector that in five years has gone from a profit of $10 billion to a profit of $30 billion and this year the equity analysts are forecasting even higher profits. Here is a chart that compares return and equity of Australia's four major trading banks and the current market capitalisation to book value, what's called price to book, compared with other large global banks. Now before, we had the Australian banks at the lower end of size comparisons but when it comes to their valuation, they are at the very top of global banks anywhere in the world. Our banking system is producing banks that have the highest returns in equity and the highest price to book values of any banks in the world. When we look at the ratings of the major global banks, I want to say two things. First of all, look at the ratings of the Australian banks and the Canadian banks because if we go back to this chart, have a look at the other people with the highest ROEs and the highest price to books, the Canadian banks. So you've got concentrated banking systems, you've got high ratings and you've got high ROEs and high price to books. And there's a reason for this and that is they're not taking enough risk which I'll get into later on. But I'd also like to point out that in Germany, the banking system seems to operate very well with single-aid banks as does the United States, as does the UK banking system and indeed all the global investment banks are running single-aid. Indeed, in the global system, Australia and Canada are total outliers. The rest of the world operates with single-aid banks very nicely. What I've done here is to look at the combined provision for loan losses of the four major Australian banks over the last decade. It may seem counterintuitive, but a banking system which is both highly profitable and has negligible loan losses is not competitive and it's risk averse. And that is a transfer of wealth from the users of banks to the owners of banks which is absolutely clear in this chart. Now, I'm not advocating going back to the 1980s, the go-go years that was a bit of fun with Alan Bond and all the others, but it is very clear from just these charts that the pendulum has swung way too far the other way. So now Australia has a significant structural and systemic problem with its financial sector which put simply is dominated by four very profitable banks that benefit from unusually high credit ratings creating an unlevel playing field with the few small remaining banks in the economy and the ratings of the majors incorporate the implicit support of the Australian government. The four major trading banks are all too big to fail and have created a regulatory conundrum in which APRA is forced to favor bank shareholders compared with borrowers in order to bank depositors. In other words, because they can't have the banks failing. And as the GFC demonstrated, when push comes to shove, the Australian government has been forced to guarantee the liabilities of these institutions or to protect the financial system. It is axiomatic that the greater the proportion of banking assets to GDP, banking assets to GDP, the great proportion, the more reliant an economy is on its banking sector and the more it risks an economy becomes with the failure of this sector. So what we have here is a demonstration of banking assets that presented to GDP. Now Australia is not an outlier compared with Europe and the problem for Europe is its banking crisis continues to wash back on the economy but look at the United States. So the reliance on banks to intermediate credit is clearly evident in Europe and Australia but what's also evident is that the US, despite representing a quarter of the world's GDP, has a financial system in which banks play a far less role in the provision of credits and the bond markets are deep, broad and diverse and far more important the economy. So on a proportionate basis, there are far fewer too-big-to-fail banks in the United States than in Europe or Australia. Yes, they have a few but not role to the size of the economy. Our entire financial system is for too-big-to-fail banks. So that allows the Americans, their entrepreneurs, SMEs and larger corporates significantly more flantial flexibility and access to credit. Well, now that we have the financial system we do, what are we going to do about it? If anything, as David Murray himself said, the essence of this inquiry is about funding the economy and the financial crisis toll is not straightforward. Now there are basically three broad approaches. There's been thousands of submissions but there's three broad approaches being taken by people putting in submissions. In the first instance, the BCA, Business Council Australia, which incorporates the large Australian companies, domestic and international financial institutions and multinational corporations wants the status quo to prevail. The concern of the BCA is that any additional costs such as additional capital might be required by the regulators to try to prevent the banks being too-big-to-fail will be borne by business customers rather than bank shareholders. It's interesting, so from an economic perspective, one could reasonably infer that the BCA believes that our banks have sufficient market power to transfer costs back to customers reflecting an oligopoly. That's the BCA's submission. Because as we know, in highly contestable and competitive sectors of the economy, pricing power of this magnitude is limited at best. The second approach taken is what I would call status quo with a twist of line. This would be the position of our financial regulators that would say, look, our banking sector has demonstrated its stability and resilience since the world's worst financial crisis of the Great Depression. So yes, the sovereign rating was required to support the financial system in the depths of crisis, but only for a limited period of time. They're also concerned about the too-big-to-fail problem and would like to have some additional capital. And they'd probably like to have a deposit protection system to build up a capital buffer, et cetera. And they would say, look, thanks to 1990 Christ that we went through the rest of the world didn't, and thanks to the problems of the HIIH in early 2000, which really got apparent, which really took apparent by surprise and reformed apparent after that, then we were ahead of the curve. And therefore, we don't need to have the same regulations that the rest of the world is looking at because they had a proper financial system and we didn't. So they're saying, let's do a bit of tinkering, a bit of extra capital, a bit of this, a bit of that. It's what I call with a twist of line. The final approach taken, by a guy called John Darlson, who is a former Long Center Director of the ANZ, was the Chairman of the Audit Committee. He's a former chairman of Woolworths and a founder of Southern Cross Boardcasting, is the Australian financial system is not sufficiently competitive and contestable. Financial regulators and conservative bank boards have skewed lending away from risk-taking activities, illiterate SMEs and small corporates and increasingly focused on housing loans to the detriment of the economy as a whole. One of the most important roles of the financial system is to intermediate credit across a wide spectrum of risks and provide as appropriate pricing for risk, this allows for a more productive and innovative economy. Increasing regulation and the virtual elimination of the regional banking sector has driven out competition. Darlson states in his submission to the Murray Inquiry, the interim report has been prepared by bankers on behalf of bankers, for bankers. The challenge of re-establishing a balanced system without compromising one of the best supervised systems in the world is not easy. Growing bank concentration and profitability will only serve to increase public anger over the lack of competitiveness and inferior service. Now, we do know that the ACCC did not make a submission to the Murray Inquiry, but we also know that John Darlson, who wrote a 200 page submission, has not been invited by the Murray Inquiry to ventilate his views. So it's imperative for Australia in the context of Murray and most generally that we have a hard look at the way we are gonna become a more innovative and technologically advanced society, particularly given the problems of the demographic challenges that face in the years and decades ahead. In a recent report, Moody's noted that in six years, the world will have 13 super aged nations. So by 2020, there'll be 34 by 2030. A super aged country is one in which more than one person in five in the population is over 65. So we've got three now, we will have 13 in six years, we'll have 34 in 2013, 20, 20, 30, 30. Moody's estimates are by 2030, 19.2% of Australians and 20.1% of New Zealanders will fall into this category. Now, as youthful as I am, I will unfortunately contribute to this problem myself. And indeed, the OECD predicted that aging will slow global growth down from an average of 3.6% this decade to 2.4% between 2050 and 2060. So innovation cannot exist without the funding to sustain it, nor without a society that's embracing of it. Unfortunately, older people tend to be more risk-inverse and empirically contribute less to innovation, I'm exceptional as of course, which is clear from such things as university research papers, new patent applications, Nobel Prizes. So we have to work out of ways we age to get the settings right to fund our younger innovators. So we actually need a broader societal change in respect of innovation, entrepreneurship and risk-taking that we as a country need to address if we are to become another US or even an Israel, a country with a population of 8 million that is producing incredible innovation. So people in the United States and say, wow, yes, the US, well, Israel is leading the world with 8 million people. So this has not got to do with the financial markets per se, it's how we address business failure. In Silicon Valley, business failure is not regarded as a stigma the way it is in Australia. It's regarded as a lesson learned that will make an entrepreneur better in another venture. Angel Investors and venture capital funds look at their investments as a portfolio with many enterprises failing, but those that succeed more than compensating the investors for the risks they've taken. It's quite common in the US and in Israel for entrepreneurs to fail the number of businesses but still attract new funding on the basis of that's a good business plan. Henry Ford had a number of failed businesses himself before he founded Ford Motor Company, but in Australia, we treat business failure as an irrecoverable character flaw and our bankruptcy laws in the context of promoting innovation entrepreneurship need drastic changes to eliminate their Dickensian nature. For example, an individual who's declared bankrupt cannot travel overseas without the permission of their trustee during five years. These are not teenagers, these are adults. In other respects, people who are bankrupt are treated worse than individuals with minor criminal convictions in the justice system. Further, if as an individual, you have a workout, you work out an accommodation with your financier that you don't go to bankruptcy, there is a permanent record of this on a database which anybody in the public can access. So you don't even have to become bankrupt to have the stigma of financial failure. We demonize this even through financial arrangements with creditors. It may be of some comfort to the financial sector but it has major societal implications and it's extraordinary in my view that privacy laws do not extend to those who are bankrupt and frankly from a GDP perspective or even lost the financial system, these individuals who lose everything are absolutely a rounding error. Our financial system is too risk averse to creating a culture of innovation failure included. Though the Treasury is rightly concerned about Australia's productivity challenge and how we can sustain growth over past the next five years and it sounds a bit counterintuitive but I sort of think our mining boom created a culture of complacency which we can ill afford, give them demographic tax ahead of this country because the mining boom left way once in a generation, maybe once in three generations, improving our terms of trade into Australian dollar. And this dollar problem is exacerbated by a reversal of budget surpluses into budget deficits for a sustained period forced the reserve bank to maintain far higher interest rates than the rest of the world and facilitating a carry trade which oversees investors purchase Australian bonds and other securities. People don't realize that the deficit funding which didn't need to happen actually had interest rate consequences which we are now unwinding now. Now, around the world, central banks and other market participants are saying there's an asset bubble occurring which is resulting from long periods of liquidity and low interest rates. We're now seeing regulators in the US and Europe applying greater interest rates and we've seen a sharp decline of the Australian dollar even recently but even with these more competitive, if we become more competitive as a result of a better exchange rate, this in itself does not lead to a higher standard of living. You actually need to have real economic growth to maintain real wage growth. And for this to occur, because it's a largest employer in the country, it's got to be better connected to the global economy. There's an institution called Epic which is actually at assist to support to support the SME sector. It's 100% owned by the federal government and there's a lot of efficacy around the world. 80% of Epic loans are made to the SMEs and these loans are made to assist exporters and they're made on commercial terms. Epic's got a loan book of two billion and provides a dividend to its shareholder. It's commercially viable. But Epic's $2 billion SME export loan book is a drop in the ocean with the $3 trillion of assets in the banking system particularly focused on housing. But the problem is worse for the SME sector because if you are not an SME that is looking for export credit, there is no other facility apart from the banks that you can turn to. There is no equivalent in Australia for an Epic if you just want to expand. So then the question in the context that Murray inquiries, well, why does Epic need to play this role if it's making money providing export facilitation for SMEs? That is an example of market failure. And also from a national productivity perspective housing loans have increased from three billion per annum in 1990 to 23 billion in 2014. We have had a seven fold increase in housing loans in 14 years. Let's go back to the thought about asset bubbles and how they're financed and think about that. And yet 23 billion of housing credit, of new housing credit, there's only a $2 billion book for SMEs exporting. So we have a bit of a bind in our financial system because we need to actually think about what system we need to have. We have foreign banks very profitable, too big to fail. Regulator can't let them fail. And even if they wanted to extend more broader lending the regulators too concerned about them doing that because in case they lose money and the system threatened. We also have then had through regulatory arbitrage money being directed to domestic housing and we now have the highest proportion of domestic housing anywhere in the world, a complete outlier. Now, given the future shocks will be inevitable. That is, there will be future shocks into the system. So unless something's done, there could come a day of reckoning in our financial markets which has happened in the United Kingdom. You know, the United Kingdom is not some sort of third world economy. It's very, very simple. Yet it lost two out of its four banks and almost a third. And a banking crisis did in golf this country 25 years ago and I worked at the very epicenter. I worked on virtually all the state bank recapitalizations that I referred to and I worked on all the demutalizations and when Westpac needed the $1 billion to actually sustain it, I managed to get my firm which was in First Boston to put its entire capital up to save Westpac as a 36 year old. It wouldn't happen today because the regulators wouldn't allow the United States but we did that. This could happen again. And why could it happen again? Well, Australia's got a number of headwinds. First of all, public sector debt has blown out and even with a horror budget, taxation receipts as proportion to GDP are still below revenue increases. And which means we have a continued generation in our net debt of the foreseeable future. So things have not actually improved there. Secondly, global economies, particularly in the US and Europe have not even rebounded their PGST levels and with China slowing, there is more than a statistical risk of another global banking crisis and we are seeing regulators talking about that right now. Thirdly, with a less rosy outlook for mining exports, there are greater uncertainties about the long-term growth. And fourthly, unemployment's been on the uptick for several quarters with concern about oversupply of white collar workers and university graduates. So Australia has not had a recession in nearly 25 years again, a complete outlier and our financial system has therefore never had to go through the economic stress of the rest of the OECD only several years ago. So we haven't had to do this yet. Everybody else has done it. So what is the ultimate stress test? It's a real recession. As I mentioned before, thanks to the elimination of the government dead under Peter Costello, Australian banks were able to fund themselves in the worst of this. But because our financial sector was a lot more sad, our finances, well, because we had no debt, it wasn't easy to say. We may not be so well positioned for the next crisis because our public sector finances have deteriorated markedly and we're also a major importer of credit and capital which is needed to sustain our economic growth now and in the future. So our public sector position has got a lot worse, unemployment is ticking up and we need foreign capital, both equity and debt to grow. So there has to be mature discussion about the potential impact of weakened and weakening public sector finances on the sovereign credit rating, our relative attractiveness of providers of offshore debt and whether in the next crisis we can sustain that blink moment when these creditors decide will they or will they not extend liquidity to the Australian system? Because effectively that's the moment they say yes or no. So there's been little public policy discussion about what is required to maintain Australia's triple A sovereign rating and the confidence of offshore investors generally. So what do we do? Do we live with the current financial system and hope that she'll be right mate? Do we put some incremental changes in and hope that she'll be right mate? Or do we actually say we need to actually do something else? Now, the she'll be right mate approach to the BCA and the trading banks is actually a lost cause not only respect the Murray inquiry but because Australian international regulators are actually moving to increase capital and to put in things like bail-in bonds. And those domestically who think that the efforts internationally to eliminate the too big to falconundrum will rather obligingly just ignore the financial Australian financial system are deluding themselves. So there are lots of things our financial regulators can do in the context of tinkering at the edges. One of them is I'm gonna go this quickly because of time but one of them is to put in an offshore tax on borrowings offshore. Another is deposit insurance and the idea of putting a tax offshore would be to sort of say what is the arbitrage? What is the arbitrage gained by the big banks by virtue of this double A rating? All you could do is bail-in bonds was another alternative which is what we've seen in Canada. Now interestingly enough, Canada is actually looking at this and the credit rating agents have said ah, with bail-in bonds, bail-in bonds are where in a financial crisis the bondholders have to bail-in capital into the bank. So they're kind of a hybrid instrument. They're a composition of, let's say you lend a hundred billion dollars to an Australian bank, you're not a billion back but 10 stays with the system ahead of time. So that's where bail-in bonds work. The Canadian banks have now all been, they're on negative credit outlook. So when the Canadians have said we're gonna transfer some of the risk from the taxpayer to bondholders, lower beholder credit agents and said, well actually that's bad for the bondholders which it is, but it's good for the taxpayers. So the Canadian banks are now on negative credit watch. We've got to reduce our offshore, reliance on offshore funds and we've got to fix this tax bias against, so we have a bias, four bank dividends, we have a bias against domestic deposit. Now, if you lend money to Australia, you only pay 10% with holding tax on Australian deposits. If in Australian you may pay 50% which is pretty crazy. So I think that what we should do is to adjust the tax system. If you have a deposit for more than two years that'll attract a 10% rate and more than five years zero tax, that will actually get people to put more money in the banking system. I believe that the current approach by APRA to the difference between regional banks having a hard risk-waded assets on domestic housing and the major trading banks effectively having the advanced model that leads to be scrapped, these trading banks that are gonna 35%, that will increase their capital quite significantly but it'll put them on a competitive level playing field and will add capital to the system. So look, that's basically what I wanted to talk about in terms of as is. But what we need to now look at is what should a system look like? And what I'd like to do here is to sort of pose a question to you all. Would Australia be better off with eight to 10 single-a banks all competing vigorously with a single-a rating which is exactly like the rest of the OECD and relying on domestic deposit to further activities and specialise the other areas or do we wanna continue in for an item with four big banks that are the economy? And which use the Australian government rating to access low cost offshore funding? So I think this is the fundamental question that has to be asked in the context of the Murray Inquiry. What system do we actually need to support the Australian economy? So what should a good system have? Well, it's about a wide range of competitive offerings to individuals and businesses, customers should have access to different products and services at prices which do not reflect a non-liberalistic situation. They reflect a competitive market situation. The knowledge-based economy entrepreneurs, innovators and new businesses need to have access to capital across a wide range of spectrums. Bankruptcy laws should reflect a political philosophy that business failure is not a stigma and that pricing for risk models undertaken by the banks and other institutions actually incorporate losses into them. That's what pricing for risk is. If you pride for risk and you have no losses, well, people have paid for that risk but the shells have actually got the benefit. We need to actually reverse that and let entrepreneurs actually get more money. So we need a much more flexible bankruptcy rules. Again, we need to look at pricing for risk. We need to make sure that shells do get rewarded for the risk they're taking. That is absolutely essential. They need to be well-capitalized and attract new money but they should be free of implicit tax subsidies and they should be in a competitive setting. We need to make sure that if banks are borrowing offshore and increasing rates to fund domestic housing that we have the mechanisms in place to actually limit that because we cannot have asset bubbles because they impact our deposit protection and new technologies should be encouraged subject to stringent anti-fraud. We need to have a superannuation system. The superannuation system is quite interesting because it was part of an accord and suddenly it suddenly become a massive number and we actually don't know, it's sort of, we don't have a national policy around it so we need to do that. We also need one that's less trustee driven. The trustee effectively goes to one or two asset allocators. They say, do this and do that. We have a one size fits all. So you get the same advice from your 20s and your 60. We need to actually change that and we also need to adjust provincial supervision. So how do we actually do this? Well, this is gonna require breaking a few eggs and taking on powerful vested interests. We're gonna, if we actually want a competitive banking system with eight to 10 players, we're gonna have to break up the existing players to achieve that, which is what they're looking at the UK. So who's got the power and authority to actually do that? Well, the council of financial regulators and the treasurer. Bond has the treasurer announced an eight pillars policy and saying, we want eight banks in the system. Well, how would you do that? They have absolute, our treasurer regulators have enormous powers at disposal to achieve this. And they can say this in the guise of resilience against the next financial shocks. They can actually already have the power to break the oligopoly by increasing capital, by simply saying over the next few years, we intend to increase the capital allocation against two big to bank fail, two bank to fail banks, until they become smaller, it allows the bank boards to say, this capital bill will be too great, we should become smaller. Now in the corporate sector, you will see demerges happening all the time. People say our business units don't work with each other, et cetera. There is absolutely no reason why this can't be done in the financial sector. What it requires is enormous political will and it requires the regulators to actually sit back and discuss and live with people and say, here's a kind of system we need to allow entrepreneurs to develop, to allow a company for economic growth. Finally, it needs a charter that says competition is equally as important as provincial supervision. We need to have competition and we need to balance that off with the supervisory processes, but we can't eliminate competition or dumb it down. So I'm looking to have this council supervised by, not supervised, informed by a board of business people, of people who are interested in competition policy and people onto the entrepreneurial sector, the innovation sector, to actually have a counterweight to the natural balance of financial regulation, which to be conservative. So the other thing it needs to do, and this is going to be, again, controversial in political terms, is to allow this council to have a discussion about the direction of public sector finances because after all, they are something we rely upon, not just to the forward estimates, but beyond that. The information's there. They just want to comment on it. So we need to have a group that actually says if the trajectory of our public sector finance is going this way, we could very well have a liquidity problem in the future. So look, by its nature, as you've seen, banking and financial services are complex and difficult to fathom, but I believe it's incumbent on financial rigour to talk about what they want, what system is good for Australia, and then to articulate that position and then go and do it. We need to have objectives of sustainable growth, sound public finances and full employment, and then implement the policies. So you can have motherhood statements that say we'd like to have a bond market and then actually go and do it. Finally, because I know you want to leave and go and have some dinner, we have a financial sector inquiry that is the whim of the government. We've had only three in 35 years. Now, if we think about, if we go back to the Campbell Inquiry of 1981, no reference to derivatives, and yet, five, 10 years later, derivatives were an integral part of the entire banking system, and in fact, they ended up with a glass deagle. Wallace Inquiry, 997. No mention of internet banking wasn't invented. One of the most important things we do now is internet banking. So what will be the next innovations that are beyond the scope of anything considered by the Murray Inquiry that may be here in 10 years time that completely changed the way we interact? So basically, we did have a council that is constantly reviewing recalibration of the financial system according to what economic needs and not have an inquiry once every 15 years. And lastly, I'd like to see forgiveness of my parents. My father, Thomas Walton, has an academic degree from the London School of Economics. And without wishing to be cruel, he has benefited enormously as a shareholder from the structure of the current financial system. His bank shares have been a wonderful investment, particularly since St George was acquired by Westpac. He has made a lot of money and he does not at all like my observations and recommendations I showed to him. So I seek my parents' forgiveness for this heretical lecture because selfishly, I'm more concerned about the Australia of my children than I am of my parents' generation. Thank you very much. Thank you.