Australia's long-standing policy to prevent mergers of the big four banks is "redundant" and the sector needs a new champion to promote competition, the Productivity Commission says.
The commission released a wide-ranging draft report into financial sector competition, following a request by Treasurer Scott Morrison, on Wednesday.
It found no government agency was specifically tasked with overseeing and promoting such competition and questioned the roles of the Reserve Bank of Australia, Australian Prudential Regulation Authority and the Australian Securities and Investments Commission.
"Under current regulatory architecture, promoting competition requires a serious rethink about how the RBA, APRA and ASIC consider competition and whether the Australian Competition & Consumer Commission is well placed to do more than it currently can for competition in the financial system," the report said.
The commission also found the four pillars policy, first articulated in the 1990s as a way to maintain the separation of the big four banks to ensure competition, was no longer effective and may have done more harm than good.
"The Four Pillars policy is a redundant convention," the report said.
"It is also not clear that the Four Pillars policy has met its stated objective of preserving competition, or whether instead it has eroded competition by embedding a fixed market structure."
Meanwhile, the commission said a regulatory clamp-down last year on the interest-only home loan applications for investors may have actually benefited the banks.
It argues the action by APRA resulted in higher interest rates on both new and existing investment loans.
"Up to half of the increase in lenders' profit was in effect paid for by taxpayers, as interest on investment loans is tax deductible," the report said.
It estimated the cost borne by taxpayers at up to $500 million a year.
Federal Labor says the report's humiliating for the government.
"They have trumpeted the measures they say were introduced to bring the banks to heel," Senator Jenny McAllister told reporters in Canberra.
"What the PC report shows is that these measures have only provided further opportunities for banks to gain more profit at the expense of consumers."
The draft report comes ahead of the start next week of a royal commission into the financial sector.
A final report will be handed to the government in July.
