A pillar of economic reform is competitive neutrality. We strip government utilities of tax and regulatory advantages over private competitors because we want the best to win, not the most favoured. But banking is a different country. They do things differently there.
Our regulatory arrangements pathologically favour the large over the small and legacy business models over newer ones. This weakens competition, fattens margins and salaries, and paves the way for future crises.
Where banks attract deposits to fund loans, a more recent business model involves ''securitisation'': pooling loans into securities and selling them to wholesale investors. Securitisation enabled non-banks, such as Aussie Home Loans, to break into the banks' market and force a near halving of margins.
Competing on a level playing field, securitisation might well dominate home lending. It avoids the banks' extreme asset-liability mismatches - with banks' short-term borrowing supporting long-term lending. Because they've been crafted for the external scrutiny of investors, mortgage-backed bonds (MBS) are more comprehensible to outsiders, whereas complex banking institutions with revolving managers getting bonuses for short-term performance are difficult - arguably impossible - to regulate effectively.
But it's not a fair fight. When banking markets get skittish they can seize up without a risk taker of last resort. Three centuries of banking evolution, three centuries of crises have given us central banks that go lender of last resort, delivering liquidity to distressed banks' balance sheets when others are heading for the exits.
As we've seen, securitisation markets seize up too and making them liquid would require similar action, though in this case the risk taker of last resort would be buying MBS.
Large banks also enjoy an implicit guarantee of their solvency because, being too big to fail, they'll be bailed out in a crisis. Because smaller banks and non-banks aren't too big to fail, they pay wholesale funders much more.
Our two banking regulators, the Australian Prudential Regulation Authority and the Reserve Bank of Australia, focus on "financial system stability" within the ''official family'' of banks. Competitive neutrality with ''shadow banking'' from securitisation gets short shrift.
As Professor John Kay puts it: "The principal objective of regulation appears to be to stabilise the existing structure of financial institutions, this goal is in fact a guarantee of further, and potentially more damaging, crises.''
Sure enough, when the crisis came, the big banks got huge public support.
Taxpayers guaranteed their retail deposits for free and guaranteed their wholesale loans at fees reflective of credit ratings, which incorporated the too-big-to-fail distortion, further disadvantaging the small fry.
While no investor in AAA-rated Australian MBS ever lost principal during or after the crisis, liquidity in this market nevertheless collapsed. Securitisers needed a buyer of last resort. The Australian Office of Financial Management gingerly provided life-support, but still allowed the securitisers' market share of home lending to fall by around three quarters while the major banks snapped up RAMS, Aussie, Wizard and Challenger's lending arm.