The Financial System Inquiry: How it will affect you

The 320 page final report from the Murray Inquiry, otherwise known as Australia’s Financial System Inquiry, was released yesterday, and there were no big surprises.

The report makes 44 major recommendations, designed to make the financial system stronger and more resilient, lift the value of the superannuation system, drive economic growth, enhance confidence and regulator independence and accountability.

If the government does act on the report, some of the recommendations will have adverse consequences for some sectors of the economy, particularly the banks.

Here are some of the major recommendations and their impacts…

1. Banks need to have higher capital ratios

Australia’s big four banks, Australia and New Zealand Banking Group (ASX: ANZ), Commonwealth Bank of Australia (ASX: CBA), National Australia Bank Ltd. (ASX: NAB) and Westpac Banking Corp (ASX: WBC), will be required to hold more equity and change the way they assess risk on home loans, to make the banks safer.

The increased costs will likely be passed onto customers in some shape or form. That could result in reduced interest rates on deposits, higher rates for borrowers or lower dividends for shareholders. But if these rules are implemented, it definitely makes it harder for the banks to grow profits.

2. Self-managed super funds banned from borrowing

SMSFs can borrow to invest in property. This looks likely to be banned, as the inquiry says it could get out of hand in future. SMSFs with existing borrowing arrangements will be allowed to keep those, but no future borrowings will be allowed.

3. Negative gearing and capital gains tax

Capital gains tax concessions for assets held longer than a year may be reduced or eliminated. The Inquiry also suggests that negative gearing tends to encourage leveraged and speculative investment in Australia’s property sector. And the inquiry notes that housing is a potential source of risk to the financial system and banks in particular. That could see bank loan growth come to a screeching halt, particularly to investors.

4. Lower the cost of providing superannuation products

The inquiry noted that costs associated with the default MySuper product are still too high, and wants to introduce a formal competitive process. That could see fund managers tender for running the MySuper product – which should lower the fees members pay.

5. Franking credits and interest on bank deposits and fixed income securities

Dividend imputation, or franking credits, may be creating a bias for our local superannuation funds to invest domestically (such as in the big four banks), and provides little benefit to non-residents. The Inquiry also notes that interest on deposits and fixed income securities are taxed at a relatively higher rate (no franking credits for interest). This is an obvious negative for all domestic equity investors, but could be offset by lower company tax rates, which should result in higher profits and dividends.

These are obviously just some of the changes discussed in the final report. The big unknown is how far the government and regulatory authorities will go in adopting the recommendations.

Let’s hope it doesn’t end up like the 2008 Australia’s Future Tax System Review, which basically ended up in the bin, thanks to its valid and logical, but likely, extremely unpopular recommendations.

You'd better take a look at this... especially if you own bank shares!

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Motley Fool writer/analyst Mike King doesn't own shares in any companies mentioned. You can follow Mike on Twitter @TMFKinga

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