The Wallis Report

1. Introduction

The final report of the Financial System Inquiry (the Wallis Report) was release in April of this year. Although the report is wide ranging, its most important recommendations fall into three categories: the establishment of new regulators, consideration of mergers and acquisitions and recommendations concerning electronic commerce.

One of the most interesting aspects of the report is the central position accorded to the payment system. The Inquiry noted that there was evidence linking the efficiency of the payments system and the total cost of the financial system (estimated to be on the order of $40 billion per year). Changes in the payments system are in turn driven by new technology, customer needs and the regulatory framework.

The Inquiry acknowledged that its principal aim was to achieve a more competitive and efficient financial system. Its view was that the best way to achieve this was to identify regulatory structures, both institutional and substantive, that would promote the principal goal.

2. New Regulatory Structure

The Inquiry proposed the establishment of several new regulatory structures. Prudential regulation should be undertaken by a new body, the Australian Prudential Regulation Commission (APRC). Another new body, the Corporations and Financial Services Commission (CFSC) would be responsible for market integrity and consumer protection. The Reserve Bank of Australia (RBA) remains responsible for systemic stability, monetary policy and payments systems regulation.

The role of the APRC would be to combine the present prudential regulations functions of the RBA, the Financial Institutions Scheme and the Insurance and Superannuation Commission. All deposit taking institutions would be treated approximately equally, differences being allowed where different classes of institutions clearly have different characteristics.

In line with the view that the payments system is central to orderly function of the financial sector, the Inquiry further recommended the establishment of a Payments System Board (PSB). The PSB would be "subsidiary" board within the RBA. The PSB would have some membership in common with the RBA board, but would make decisions independently, concentrating on payments system regulation.

A more uniform treatment of deposit taking institutions is probably desirable. In spite of protests from some of the major banks, there seems little reason why building societies and credit unions should necessarily be barred from the cheque system. Prudential regulation of these organisations should be based upon stability requirements, not upon the particular name or class of institution.

It is less obvious that prudential supervision should be removed from the RBA. It is an open secret that the RBA and most major banks are lobbying aggressively to prevent the partitioning of the RBA functions. The Inquiry identified three main reasons for moving responsibility from the RBA.

- The RBA could not be expected to fulfil the function since its primary relationships are with banks;

- Removing prudential supervision from the RBA will emphasise that there is no guarantee of deposits; and

- Separation permits the RBA and the APRC to focus clearly on their primary objectives.

The first two of these are hardly convincing, and the third could really be an argument for having all of the functions in one body. After all, the functions are not separate, and if the separate institutions are to fulfil their function there must be a great deal of cooperation. The history of inter-agency co-operation is not overly encouraging.

3. Mergers and acquisitions

The Inquiry's views on mergers and acquisitions made front page news when the report was released, but in fact the approach is rather conservative. The Inquiry did recommend the abandonment of the "Six pillars" policy, but the Government quickly made it clear that mergers among the big four will not be seen soon.

On related matters, the Inquiry recommended that limitations on shareholding remain (at a 15% limit). This is based on the view that spread of ownership is itself a form of prudential regulation. The limitation would cover both deposit taking institutions and insurance companies (including holding companies). The limit would not apply where the shareholder is itself a licensed institution and the APRC gives its approval.

The Inquiry also approved restrictions on foreign ownership, but acknowledged that there would be no particular disadvantage in some increase in the percentage of foreign ownership of the Australian financial system.

The Inquiry also advocated that financial mergers and acquisitions be governed by the same test as other areas, namely, whether the movement would substantially lessen competition.

4. Electronic commerce

The Inquiry made it clear that technological change, and in particular, electronic commerce, is one of the most important changes occurring in the Australian financial system. It noted that significant legislative changes are required to facilitate electronic commerce, and that the resulting law should apply equally to all delivery systems.

Perhaps the most important and urgent matter is to legislate to allow and to facilitate the use of digital signatures. Digital signatures, and cryptography generally, are fundamental to any serious expansion of electronic commerce.

In order to conduct commerce in an orderly fashion, our means of communication must meet some basic requirements:

- Message integrity: it must be difficult to alter a message without the alteration being detected;

- Authentication: it must be possible to determine who sent the message;

- Non-repudiation: if X sends the message, he or she may not later deny it. Non-repudiation is obviously related to message integrity and authentication

The physical nature of paper and ink gives ordinary paper based communications these necessary qualities. In an electronic environment, only public key cryptography seems able to deliver.

Developments in this area are being hampered by a somewhat confused government attitude toward cryptography. In particular, the refusal to release the Walsh report evidences some internal governmental conflict that can seriously hamper efforts to establish a reasonable cryptographic policy. Without such a policy, all the high-sounding press releases will do nothing to establish serious electronic commerce.

5. Miscellaneous matters

The Inquiry noted that privacy concerns must be addressed. It recommended that legislation be reviewed and that codes be developed so that there is some uniformity in application.

The Inquiry recommended that information sharing among group entities be permitted unless the customer has taken some action to indicate that they refuse consent. This is contrary to the existing law for entities governed by the Tournier case. [Tournier v National Provincial and Union Bank of England [1924] 1 KB 461; see Bank of Tokyo Ltd v Karoon [1987] AC 45; Bhogal v Punjab National Bank; Basna v Punjab National Bank [1988] 2 All ER 296 ] Although Building societies seem to believe that they are no governed by Tournier's case, it is not a view that is universally shared. [See Tyree, Alan L, "Does Tournier apply to building societies?," Journal of Banking and Finance Law and Practice, 6, pp. 206-208 (1995). ]