Submission to the Financial System Inquiry 7. Funding Bank Supervision

Introduction

206. Banks in Australia do not pay a licence fee for authorisation or a levy for the cost of RBA supervision. Supervision costs form part of the general expenditure of the RBA. Banks are, however, required to lodge with the RBA Non-Callable Deposits (NCDs) equivalent to 1 per cent of their liabilities (excluding capital) in Australia. They attract an interest rate set 5 percentage points below the average yield at tender in the previous month on 13-week Treasury Notes. By this route, banks contributed some $185 million in 1995/96 to RBA profits and thereby to Commonwealth budget revenue.
207. NCDs do not serve any monetary policy or prudential purpose. Although the revenue derived has been described as a kind of payment for the ‘benefits’ which come with bank authorisation and supervision, the re-introduction of a discounted interest rate in mid 1995 was essentially a revenue-raising measure.

Is there a case for a bank licence fee?

208. The case for a licence fee depends on there being identifiable net commercial benefits from banking status. If such benefits exist, the ‘user pays’ principle suggests those institutions enjoying them should make a payment in return, otherwise they enjoy a public subsidy.
209. Market perceptions of the safety and soundness of authorised banks are undoubtedly enhanced as a result of official screening, ongoing prudential supervision and access to any lender of last resort facilities that may be extended to them. Banks are also permitted to accept deposits without the need to issue prospectuses. While the depositor protection provision in the Banking Act does not provide a guarantee of bank deposits, bank depositors have historically enjoyed a high level of security. As a result, banks may be able to fund themselves at a lower cost, or to attract business which would not otherwise be available.
210. The commercial (as opposed to community) benefits flowing from supervision can, however, be overstated. Banks do not always enjoy cheaper funding than non-banks, especially in wholesale markets where local banks face significant competition from foreign banks operating as (unsupervised) merchant banks in Australia, or from offshore funding. More generally, an increasing range of financial institutions can provide particular banking-type services without being authorised as banks, lessening the economic value of a banking authority vis-a-vis other forms of operation. Any benefits to banks associated with direct access to the payments system has also been reduced as the system has been opened (indirectly) to building societies and credit unions in recent years. Furthermore, banks do not have a right of access to RBA emergency support facilities during times of liquidity crises. Liquidity support is purely at the discretion of the RBA and will not be provided to ensure the continued operation of an insolvent institution.
211. Bank authorisation also entails costs to banks. They are required to meet ongoing supervisory requirements; provide data and other information; and pay for external auditor reporting to the RBA. The RBA does not consider these costs to be unduly burdensome. However, insofar as they exceed the standards which would otherwise be imposed by financial markets, banks will be competitively disadvantaged at the margin vis-a-vis unsupervised institutions.
212. Many non-bank institutions in Australia (such as life offices, building societies and credit unions) are also subject to official screening on entry, and are either directly or indirectly supervised and regulated. These entities enjoy some enhanced status as a result, and none is subject to a licence fee.
213. There would be various disadvantages in imposing a licence fee. It could compromise the pursuit of systemic stability by discouraging large non-bank financial institutions, such as foreign bank-owned merchant banks, from converting to authorised bank status. It could discourage other applications for banking authorities (and possibly cause some authorised institutions to contemplate surrender of their authorities). At the margin, a fee could also act as a barrier to entry into the banking sector, which would be at odds with the thrust of policy to reduce entry barriers and encourage greater competition in Australia.
214. A licence fee would also risk producing distortions within the financial system of the type seen under old Statutory Reserve Deposit arrangements. The extent to which this occurred would depend, of course, on how the fee was structured. More importantly, however, application of a licensing fee based on the notion of access to favoured treatment may reinforce expectations of official support for a bank encountering difficulties, so heightening the problems of ‘moral hazard’ associated with authorising and supervising banks.
215. In summary, while the benefits and costs of banking status are not readily quantifiable, it is not at all clear that there are substantial net commercial benefits. There would be considerable difficulty in putting a value on a banking authority and setting any licence fee would be arbitrary and subject to much debate. A fee which exceeded any net benefits gained by banks would have an adverse impact on the banking industry. There would appear to be no major gains to be made from imposing a general licence fee on banks.

A charge for the costs of supervision?

216. Arguments for and against levying a charge on banks to meet the specific costs of RBA supervision are similar to those outlined in the previous section. The main argument in favour is competitive neutrality, since most other financial institutions pay the costs of their supervision. It can also be argued that supervisors provide a service for depositors, notably small depositors, in monitoring the condition of banks on their behalf. A payment for this service could be made by these beneficiaries, through their banks.
217. Against this is the argument that the RBA supervises the banking system primarily for the general benefit of the community. Banks stand at the core of the Australian financial system – they continue to be the main depositories of community savings and play a central role in the operation of the payments system. Supervision of banks provides benefits which spread across the whole economy, and do not accrue just to banks (and their depositors and shareholders). On this view, bank supervision is a ‘public good’, contributing importantly to maintaining financial system and economic stability, as well as to protecting individual depositors. The annual costs of RBA supervision, which are in the order of $10 million, are low overall, particularly so when compared to the implicit tax imposed by NCDs.
218. There are some other reasons not to pursue a levy:
     • as argued above, payment by banks for their supervision may be perceived by the community as a de facto payment for ‘guaranteed’ RBA support, either to individual banks or to their depositors. Any encouragement of the perception that banks are guaranteed by the RBA would be highly undesirable; and
     • if required to pay for their supervision, banks may seek to place pressure on the RBA and Government to reduce the costs by curtailing supervision. This could tend to impair the independence, and compromise the integrity, of supervisors. Other countries have experienced such pressures (eg the supervision of savings and loan associations in the US during the 1980s). While such pressures can be resisted, considerable time and effort might be diverted to debating supervision charges, rather than to supervision itself.

Overseas practice

219. Practice in overseas countries in levying fees and charging for supervision is mixed. Most countries do not levy licence fees. Where they do, the amounts are relatively small and do not appear to attempt to recoup any net advantages accruing from the authorisation of banks. Licence fees, more often than not, are viewed predominantly as fees for supervision.
220. As a general rule, central banks do not charge for supervising banks. They regard supervision of banks as a public good which forms part of their general operations and the costs as part of their overall operating expenses. Where specialist supervisors are responsible for supervising banks, they generally do charge for supervision. This is largely out of necessity given the absence of alternative funding sources available to them. The charge for supervision ranges from partial to full cost recovery. Supervisors who undertake extensive examinations of banks (and other institutions) often charge to help cover the substantial costs of this process. The structure of supervisory charges levied on banks can, in some instances, be complex and unwieldy from an administrative viewpoint.