Flat White

Ignore Hayne and deregulate the banking sector

14 February 2019

7:31 AM

14 February 2019

7:31 AM

It may seem paradoxical – even insane in polite society. But with a surge of new technologies emerging, which could provide competition for traditional banking, the government would do well to consider responding to the Hayne Royal Commission by deregulating the banking sector.

The news of the month has been the Hayne Royal Commission into financial services, which contained damning reports of dastardly misdeeds by big bad bankers, who presumably smoked cigars lit with $20 bills while they charged fees for no service and committed other iniquities. As the dust settles and work begins on implementing the response, we might do well to consider one, very simple, alternative response to Hayne’s findings.

Instead of relying on politicians to pass new laws to fix the problem we should pressure the government to deregulate the banking sector, and at least take some responsibility for engaging with alternatives thereto ourselves.

It might seem totally paradoxical, and completely against the tide of calls for greater regulation of the banking sector based on the Commissioner’s recommendations, but economic theory suggests we would do well to consider this alternative. At present, we are observing a surge of new technologies which could provide serious competition for traditional banking. If the government is really serious about reforming the banking sector, it ought to really consider deregulating the sector to the extent necessary to allow these alternatives to enter it.

Competition limits exploitation

The economic theory behind this idea comes from a famous liberal (in the American sense) economist: Albert Hirschman. His famous book Exit, Voice and Loyalty, argued that loyalty was reflected in the degree to which people would choose “voice” over “exit” as a response to the decline in organisations of all kinds. Traditionally, we tend to under-emphasise the power of “voice” in market theory, and under-emphasise the power of “exit” in political theory.

“Voice” consists of continuing to interact with an organisation (such as a bank) with which one is dissatisfied, but using feedback channels to “voice” dissatisfaction in the hope the organisation changes its ways. “Exit” consists of simply ceasing to interact with an organisation with which one is dissatisfied and seeking better organisations. “Voice” allows feedback within the organisation, “exit” limits the extent to which decline, such as the practices Hayne found, can even arise in the first place.

For the largest part, the Hayne Commission’s findings and the public debate emphasise what we might roughly call “voice” – using our elected representatives to pass new laws to regulate the sector through our unelected regulatory bodies. We all know how successful that has been in Australia in the past – my colleague and former doctoral classmate Cameron Murray wrote a whole book about it.


Our response to the Commissioner’s findings would be all the better if we seriously investigated how we might make “exit” a more feasible option in the essentially monopolised banking sector, further limiting the extent to which exploitation of the sort the Commissioner has discovered can arise in the first place. Thankfully, new technologies are making that option more feasible in principle, but the government would do very well to make them more feasible in practice by allowing organisations using them to enter the banking sector proper.

The internet and blockchain are beginning to offer alternatives

Most directly, we have got word in the past month that the first of the “neo-banks”, Volt, has obtained an unrestricted banking license from APRA, with two more (Xinja and 86,400), awaiting approval before they can offer unrestricted competition in the banking sector. These banks make use of e-commerce technology implemented over the internet to provide banking services, avoiding the costs associated with extensive networks of physical branches. Imagine if you were building an internet-based bank from the ground up instead of tacking it on to an existing banking institution, and you have a neo-bank.

We have also observed the emergence of peer-to-peer lending platforms such as Society One, ThinCats Australia and Bigstone. These online platforms attempt to compete with traditional banking by eliminating the financial intermediary and matching borrowers directly with lenders. While interesting, these will necessarily be limited in the degree to which they can compete with the banking sector because we know (Financial Economics 101) that the ability to pool funds and dilute risk are critical for a functioning financial sector.

We have also seen more radical alternatives to traditional banking beginning to emerge in cryptocurrency.

For those who do not greatly value the (in any case small) interest they accrue on their bank accounts, stablecoins offer an alternative to store the value of their earnings. Stablecoins such as Tether and the soon-to-be-launched Novatti are exchangeable at a fixed rate for national currencies, and are stored in highly secure and decentralised blockchains. Imagine a highly secure version of putting your savings under the mattress in the cryptocurrency age, and you have stablecoins as an alternative to traditional bank deposits.

But we have also observed an embryonic cryptobanking sector emerge. New banks such as SEBA, World Bit Bank and Cryptobank are pioneering institutional banks which deal in cryptocurrency assets. These are still in their embryonic stages of development, but if you imagine a bank which operates with cryptocurrencies rather than national currencies, you’re not far from the mark.

As blockchain, the technology underlying cryptocurrencies, continues to develop and evolve, we are likely to observe the emergence of Decentralised Autonomous Organisations – automated structures of interlocking smart contracts on blockchains which create an Internet of Things. Where they are built in order to intermediate between lenders and borrowers, we will observe an entirely new form of financial intermediary (we might call it the Decentralised Autonomous Bank).

In some ways the Holy Grail of FinTech, such an institution would constitute the most radical competitive challenge to traditional banking since its creation. It would be radically transparent (all the smart contracts which comprise it would be publicly stored on the blockchain), secure (blockchains are notoriously secure the larger they get), it would be automated (and thus seriously limit the potential for human corruption), and therefore be highly efficient. All things we could imagine Commissioner Hayne at least wishes were true of traditional banks.

The challenge any organisation adopting such technologies faces in Australia is that the financial system in Australia – at the heart of which the banking sector sits – is heavily regulated. Any new financial institution, let alone one which directly challenges banks, must meet a range of requirements before it can operate, let alone becoming integrated, within the Australian economy.

Deregulation will help foster competition

APRA, much to their credit, has begun the process of lowering barriers to entry for the banking sector with their Restricted ADI framework, which essentially allows for potential entrants to become comparatively easily registered in a “restricted” way before being able to enter the market with a full ADI license. This is what allowed Volt bank to get into the Australian market (relatively) quickly.

Nevertheless, as my colleagues Chris Berg and Darcy Allen at the RMIT Blockchain Innovation Hub have written, the cost of regulation in Australia remains significant. And in the financial sector, it exists by design, ostensibly to protect consumers from just the sort of practices the Hayne Commission has uncovered. We have a long way to go before our banking sector is going to be exposed properly to competition which restricts its ability to exploit customers.

The technologies exist, and they are being developed, which will provide genuine competition in the banking sector which limits the exploitation the Hayne Royal Commission has discovered. The extent to which they can improve the quality of service in that sector is limited only by our willingness to pressure the government to allow their emergence through de-regulation of the banking sector, and to engage with them ourselves.

Brendan Markey-Towler is an institutional cryptoeconomist affiliated with the RMIT Blockchain Innovation Hub.

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