Australia’s ‘Four Pillars’ banking policy is redundant, there is not enough competition in the insurance industry, and the banks are using their market power to gouge their customers.

That’s what the Productivity Commission thinks. The independent government agency has released its Draft Report on Competition in the Australian Financial System. It does not paint a pretty picture.

The report comes just five days before the first public hearings of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, the inquiry the Federal Government was forced to call in November last year after strongly resisting calls to do so for over a year.

The Government is unlikely to be happy with the timing of the Productivity Commission report, nor with its findings. The report paints a damning picture of a Government asleep at the wheel. It criticises virtually every aspect of the regulation of financial services in Australia, in what for a report of this nature is very strong language.

The Productivity Commission has become something of a thorn in the Government’s side in recent years, its forthright analysis often a little too close to the bone.

The first comments in the press have come out within hours of the draft report being released. The Fairfax press calls it ‘scathing’ and ‘withering’. The usually Government-friendly Murdoch press calls it ‘damning’ and ‘at odds with the Government’s claims’.

So what does it say? The detailed analysis takes hundreds of pages, but some brief extracts will give you the flavour.

Four pillars policy

“Australia’s four-pillars policy … is an ad hoc policy that, at best, is now redundant, as it simply duplicates competition and governance protections in other laws. At worst, in this consolidation era it protects some institutions from takeover, the most direct form of market discipline for inefficiency and management failure. Raising the cap on ownership would offer a greater threat of market discipline, without green-lighting mergers.”

General insurance

“Market concentration is high and camouflaged, with a proliferation of brands but far fewer actual providers. Consumer confusion on product differences is attributable to the poor quality of information required to be provided to consumers and, to a lesser degree, the incentives faced by advisers.”

Industry oversight

“The institutional responsibility in the financial system for supporting competition is loosely shared across APRA, the RBA, ASIC and the ACCC. In a system where all are somewhat responsible, it is inevitable that (at important times) none are.”

Switching banks

“Barriers to switching can make loyal customers ripe for exploitation. The RBA reports that the variable interest rates of existing home loan customers average around 0.3 to 0.4 percent points higher than rates on new home loans. These higher rates are paid by around 15 percent of existing customers and equate to an extra $66 to $87 per month on the average home loan balance.”

(Across the economy, this translates to a windfall to the banks of more than $1 billion a year).

Lack of competition

“Compared to banks overseas, Australia’s banks offer products that have comparatively low fees but give the banks moderately high interest margins. While industry participants point to lower fees and falls in some loan interest rates as indicative of price competition, lower input costs (the RBA’s target cash rate has fallen from 7.25 percent to 1.5 percent over the past decade) are substantially responsible.

“The fall in the cash rate does not appear to have been fully passed on in lower prices across the board. Instead, the spread between home loans and the cash rate, for example, has largely increased in recent years. The RBA reports similar increases in interest rate spreads for business lending. In credit card markets, interest rates were estimated by CHOICE to be around 3 percentage points higher than they would be had the reduction in the cash rate in recent years been reflected in credit card interest rates.”

There’s a lot more in the same vein. The report dissects the regulatory landscape so thoroughly that it is hard to see how the Government can defend it.

The Government called the Royal Commission because it could no longer resist the pressure to do something. It tried to muddy the waters by increasing its scope to superannuation, where it likes to criticise union involvement in industry funds (which actually perform better than those run by the big banks).

It also hobbled the Royal Commission by giving it an impossibly short deadline – just 12 months – to complete its work. The Productivity Commission report shows that the real problem is with the whole structure of Australia’s financial system, which needs a root and branch overhaul.

This is, it should be noted, a draft report. The Productivity Commission is seeking further submissions, and intends to send its final report to the Government on 1 July.

The draft report can be found here.