The Financial Market Earthquakes – The Property Imperative Weekly 24 March 2018

Today we examine the recent Financial Market Earthquakes and ask, are these indicators of more trouble ahead?

Welcome to the Property Imperative Weekly to 24th March 2018. Watch the video or read the transcript.

In this week’s review of property and finance news we start with the recent market movements and consider the impact locally.

The Dow 30 has come back, slumping more than 1,100 points between Thursday and Friday, and ending the week in correction territory – meaning down more than 10% from its recent high.

The volatility index – the VIX which shows the perceived risks in the financial markets also rose, up 6.5% just yesterday to 24.8, not yet at the giddy heights it hit in February, but way higher than we have seen for a long time – so perceived risks are higher.

And the Aussie Dollar slipped against the US$ to below 77 cents from above 80, and it is likely to drift lower ahead, which may help our export trade, but will likely lead to higher costs for imports, which in turn will put pressure on inflation and the RBA to lift the cash rate. The local stock market was also down, significantly. Here is a plot of the S&P ASX 100 for the past year or so. We are back to levels last seen in October 2017. Expect more uncertainty ahead.

So, let’s look at the factors driving these market gyrations. First of course U.S. President Donald Trump’s signed an executive memorandum, imposing tariffs on up to $50 billion in Chinese imports and in response the Dow slumped more than 700 points on Thursday. There was a swift response from Beijing, who released a dossier of potential retaliation targets on 128 U.S. products. Targets include wine, fresh fruit, dried fruit and nuts, steel pipes, modified ethanol, and ginseng, all of which could see a 15% duty, while a 25% tariff could be imposed on U.S. pork and recycled aluminium goods. We also heard Australia’s exemptions from tariffs may only be temporary.

Some other factors also weighed on the market. Crude oil prices rose more than 5.5% this week as following an unexpected draw in U.S. crude supplies and rising geopolitical tensions in the middle east. Crude settled 2.5% higher on Friday after the Saudi Energy Minister said OPEC and non-OPEC members could extend production cuts into 2019 to reduce global oil inventories. Here is the plot of Brent Oil futures which tells the story.

Bitcoins promising rally faded again.  Earlier Bitcoin rallied from a low of $7,240 to a high of $9175.20 thanks to easing fears that the G20 meeting Monday would encourage a crackdown on cryptocurrencies. Finance ministers and central bankers from the world’s 20 largest economies only called on regulators to “continue their monitoring of crypto-assets” and stopped short of any specific action to regulate cryptocurrencies. So Bitcoin rose 2% over the past seven days, Ripple XRP fell 8.93%and Ethereum fell 14.20%. Crypto currencies remain highly speculative. I am still working on my more detailed post, as the ground keeps shifting.

Gold prices enjoyed one of their best weeks in more than a month buoyed by a flight-to-safety as investors opted for a safe-haven thanks to the events we have discussed. However, the futures data shows many traders continued to slash their bullish bets on gold. So it may not go much higher. So there may be no relief here.

Then there was the Federal Reserve statement, which despite hiking rates by 0.25%, failed to add a fourth rate hike to its monetary policy projections and also scaled back its labour market expectations. Some argued that the Fed’s decision to raise its growth rate but keep its outlook on inflation relatively unchanged was dovish. Growth is expected to run at 3%, but core inflation is forecast for 2019 and 2020 at 2.10%.  They did, however, signal a faster pace of monetary policy tightening, upping its outlook on rates for both 2019 and 2020. You can watch our separate video blog on this. The “dots” chart also shows more to come, up to 8 lifts over two years, which would take the Fed rate to above 3%.  The supporting data shows the economy is running “hot” and inflation is expected to rise further. This will have global impact.  The era of low interest rates in ending. The QE experiment is also over, but the debt legacy will last a generation.

All this will have a significant impact on rates in the financial markets, putting more pressure on borrowing companies in the US, and the costs of Government debt. US mortgage interest rates rose again, a precursor to higher rates down the track.

Moodys’ said this week, that the U.S.’ still relatively low personal savings rate questions how easily consumers will absorb recent and any forthcoming price hikes. Moreover, the recent slide by Moody’s industrial metals price index amid dollar exchange rate weakness hints of a levelling off of global business activity.

The flow on effect of rate rises is already hitting the local banks in Australia.  To underscore that here is a plot of the A$ Bill/OIS Swap rate, a critical benchmark for bank funding. In fact, looking over the past month, the difference, or spread has grown by around 20 basis points, and is independent from any expectation of an RBA rate change.  The BBSW is the reference point used to set interest rates on most business loans, and also flows through to personal lending rates and mortgages.

As a result, there is increasing margin pressure on the banks. In the round, you can assume a 10 basis point rise in the spread will translate to a one basis point loss of margin, unless banks reduce yields on deposit accounts, or lift mortgage rates. Individual banks ae placed differently, with ANZ most insulated, thanks to their recent capital initiatives, and Suncorp the most exposed.

In fact, Suncorp already announced that Variable Owner Occupier Principal and Interest rates will rise by 5 basis points. Variable Investor Principal and Interest rates will increase by 8 basis points, and Variable Interest Only rates increase go up by 12 basis points. In addition, their variable Small Business rates will increase by 15 basis points and their business Line of Credit rates will increase by 25 basis points. Expect more ahead from other lenders.  The key takeaway is that funding costs in Australia are going up at a time when the RBA is stuck in neutral. It highlights how what happens with rates and in money markets overseas, and particularly in the US, can have repercussions here – repercussions that many are possibly unprepared for.

Locally, the latest Australian Bureau of Statistics showed that home prices to December 2017 fell in Sydney over the past quarter, along with Darwin. Other centres saw a rise, but the rotation is in hand. Overall, the price index for residential properties for the weighted average of the eight capital cities rose 1.0% in the December quarter 2017. The index rose 5.0% through the year to the December quarter 2017.

The capital city residential property price indexes rose in Melbourne (+2.6%), Perth (+1.1%), Brisbane (+0.9%), Hobart (+3.9%), Canberra (+1.7%) and Adelaide (+0.6%) and fell in Sydney (-0.1%) and Darwin (-1.5%). You can watch our separate video on this, where we also covered in more detail the January 2018 mortgage default data from Standard & Poor’s. It increased to 1.30% from 1.07% in December. No area was exempt from the increase with loans in arrears by more than 30 days increasing in January in every state and territory. Western Australia remains the home of the nation’s highest arrears, where loans in arrears more than 30 days rose to 2.44% in January from 2.08% in December, reaching a new record high. Conversely, New South Wales continues to have the lowest arrears among the more populous states at 0.98% in January. Moody’s is now expecting a 10% correction in some home prices this year.

According to latest figures released by the Australian Bureau of Statistics (ABS), the seasonally adjusted unemployment rate increased to 5.6 per cent and the labour force participation rate increased by less than 0.1 percentage points to 65.7 per cent.  The number of persons employed increased by 18,000 in February 2018. So no hints of any wage rises soon, as it is generally held that 5% unemployment would lead to higher wages – though even then, I am less convinced.

The latest final auction clearance results from CoreLogic, published last Thursday showed the final auction clearance rate across the combined capital cities rose to 66 per cent across a total of 3,136 auctions last week; making it the second busiest week for auctions this year, compared with 63.3 per cent the previous week, and still well down from 74.1 per cent a year ago. Although Melbourne recorded its busiest week for auctions so far this year with a total of 1,653 homes taken to auction, the final auction clearance rate across the city fell to 68.7 per cent, down from the 70.8 per cent over the week prior.  In Sydney, the final auction clearance rate increased to 64.8 per cent last week, from 62.2 per cent the week prior. Across the smaller auction markets, clearance rates improved in Brisbane, Perth and Tasmania, while Adelaide and Canberra both returned a lower success rate over the week. They say Geelong was the best performing non-capital city region last week, with 86.1 per cent of the 56 auctions successful. However, the Gold Coast region was host to the highest number of auctions (60). This week they are expecting a high 3,689 planned auctions today, so we will see where the numbers end up. I am still digging into the clearance rate question, and should be able to post on this soon. But remember that number, 3,689, because the baseline seems to shift when the results arrive.

As interest rates rise, in a flat income environment, we expect the problems in the property and mortgage sector to show, which is why our forward default projections are higher ahead. We will update that data again at the end of the month. Household Financial Confidence also drifted lower again as we reported. It fell to 94.6 in February, down from 95.1 the previous month. This is in stark contrast to improved levels of business confidence as some have reported. Our latest video blog covered the results.

Finally, The Royal Commission of course took a lot of air time this week, and I did a separate piece on the outcomes yesterday, so I won’t repeat myself. But suffice it to say, we think the volume of unsuitable mortgage loans out there is clearly higher than the lenders want to admit. Mortgage Broking will also get a shake out as we discussed on the ABC this week.  And that’s before they touch on the wealth management sector!

We think there are a broader range of challenges for bankers, and their customers, as I discussed at the Customer Owned Banking Association conference this week.  There is a separate video available, in which you can hear about what the future of banking will look like and the importance of customer centricity. In short, more disruption ahead, but also significant opportunity, if you know where to look. I also make the point that ever more regulation is a poor substitute for the right cultural values.  At the end of the day, a CEO’s overriding responsibility is to define the right cultural values for the organisation, and the major banks have been found wanting. A quest for profit at any cost will ultimately destroy a business if in the process it harms customers, and encourages fraud and deceit. You simply cannot assume banks will do the right thing, unless the underlying corporate values are set right.  Remember Greenspans testimony after the GFC, when he said “I made a mistake in presuming that the self-interests of organisations, specifically banks and others, were such that they were best capable of protecting their own shareholders and their equity in the firms.”

The Unknown Unknowns From The Royal Commission

The first round of hearings at the Royal Commission into Financial Services Misconduct closed out after two weeks of frankly amazing evidence. Their live streaming of the hearings was well worth watching.  Of the 2,386 submissions received so far 69% related to banking alone!

The case study approach looked at issues across residential mortgages, car finance, credit cards, add-on insurance products, credit offers and account administration. We discuss the findings so far. Watch the video or read the transcript.

The litany of potential breaches of both the law, company policy and regulatory guides were pretty relentless, with evidence from various bank customers as well as representatives from ANZ, CBA, NAB and Westpac, plus others. It looks to me as if many of these breaches will possibly force the banks to pay sizeable remediation costs and penalties. Weirdly, NAB who was first up, probably came out the least damaged, despite the focus on their Introducer program. Their own whistleblower programme brought the issues of fraud inside the bank and beyond to light.

Some of the other players were clearly caught out trying to avoid scrutiny, and seeking to bend the rules systematically to maximise profitability, despite the severe impact on customers. They also tried to blame systems, or brokers, or executional issues. It was pretty damming. We should expect extra remediation costs and even fines together with a heightened risk of further individual or group actions. It is not over yet.

A number of industry practices will be changed, centred on responsible lending, including a further tightening of lending standards and so credit will be harder to get – this will continue to drive credit growth, especially for housing, lower still.

In the final session, in addition to legal breaches, there was also discussion of what conduct below community standards and expectations might mean. The case study approach brought the issues to the fore.

Specific areas included mortgage broking where we think it is likely remuneration models will change, with a focus on fees rather than commissions, and this will shake up the industry. Insiders are already saying this could reduce competition, but we do not agree. Also take note that the banks tended to blame the brokers and aggregators, but they ALL have responsible lending obligations, and they cannot outsource them.

If there is a move towards meeting customer best interest as opposed to not unsuitable, this could lead to a consolidation of brokers and financial planners, something which makes sense, in that a mortgage, or wealth building is part of the same continuum, and credit is not somehow other – the two regimes are an accident of history because the credit laws evolved separately from individual state laws. They should be merged, in the best interests of customers.

But now to those unknown unknowns. I do not think the poor behaviour resides only in the large players which were examined. Arguably, it is endemic across smaller banks and non-banks too. In fact, many smaller players are very active broker users. This means that the proportion of loans held by customers which are unsuitable is considerable. We must not let this become a big bank, or broker bashing exercise. We need structural and comprehensive reform across the board.

Next we need to remember that half of all loans are originated in the banks themselves, and the same underwriting weaknesses are sure to reside there too – the banks will try to deflect attention beyond their boundaries, but they need to look inside too (and evidence suggests they prefer to look away!). Have no doubt, liar loans are found in loans written by bankers themselves. But the case studies in this sector are harder to find, for obvious reasons.

The same drivers are also apparent in the growing non-bank sector, where regulation is weaker. We need to look there too – including the car loans, and pay day loans, plus the strong growth in interest only mortgages by some players. APRA only now has new powers of oversight, but they are still pretty weak.

At its heart we need to rebalance the cultural norms in finance from profit at all costs, to serving the customer at all costs. The fact is, do that, put the customer first, and profitability follows. We discussed this in our recent Customer Owned Banking post.

Now, recalling the terms of reference of the Royal Commission, they will need to look beyond bank practice to think about completion, access to banking services and even the broader impact on the economy.

As we have argued, credit growth has been the engine of GDP growth, – the RBA has used this growth in credit to drive household consumption to replace mining investment. As lending practices are progressively tightened this has the potential to slow growth significantly at a time when rates are rising. We expect the rate of slowing to speed up ahead. I also think the confused roles of the regulators – ACCC, APRA, ASIC, RBA and The Council of Financial Regulators, where they all sit round the table (minus the ACCC) with The Treasury – are partly to blame. As the recent Productivity Commission review called out there needs to be change here too. But that is probably beyond the Commissions ambit, for now.

The bottom line is this, the economic outfall of the Royal Commission, even based on just round one will be significant. Credit growth may well slow. Bank share valuations will be hit (they have already fallen) and as the size of the costs of remediation emerge, this could get worse. But lending practices will not get fixed anytime soon. There is a long reform journey ahead.

And in three weeks, we are back, this time looking at financial planning and wealth management, the $2 trillion plus sector.


Trail commissions may lead to “poor customer outcomes,” – CBA

A senior manager of the Commonwealth Bank (CBA) has admitted that upfront and trailing commissions for mortgage brokers can lead to poor customer outcomes, as reported in the Australian Broker.

During his 15 March testimony before the Royal Commission, executive general manager of home buying Daniel Huggins said the commission structure is linked to the size of the loan. The longer loan takes to pay off, the larger the trailing commission will be. “[T]hat can lead to a conflict – well, there is a conflict between – between the customer, you know, and – and the broker,” he added.

Huggins confirmed to Senior Counsel Assisting Rowena Orr that brokers can maximise their income by getting the largest possible loan approved to extend over the longest period of time for the customer to repay.

The bank knew about this as early as February 2017, according to a confidential letter by outgoing CBA CEO Ian Narev to Stephen Sedgwick, who was the independent reviewer for the Retail Banking Remuneration Review back then. Orr presented the confidential letter during the hearing.

“We agree with the reviewer’s observations that while brokers provide a service that many potential mortgagees value, the use of loan size linked with upfront and trailing commissions for third parties can potentially lead to poor customer outcomes,” said Narev in the letter.

“We would support elevated controls and measures on incentives relates to mortgages that are consistent with their importance and the nature of the guidance that is provided,” Narev added. These initiatives include delinking of incentives from the value of the loan across the industry, and the potential extension of regulations such as future and financial advice to mortgages in retail banking.

Another CBA submission attached to Narev’s letter said that broker loans are reliably associated with higher leverage compared to those applied through proprietary channels. “[E]ven for customers with an identical estimate of ex ante risk, loans through the broker channel have higher leverage… [and] loans written through the broker channel have a higher incidents of interest only repayments,” it added.

Huggins agreed with Orr that CBA’s submission lends some support to the case for discontinuing the practice of volume-based commissions for third parties. But he said there are a range of considerations that the bank would have to make.

“There is a first mover problem, in that the person who moved first would likely lose a lot of volume. The second problem is you create a conflict if one person, or half of the people move, and the other half don’t,” Huggins said.

According to Huggins, CBA has not stopped paying volume based commissions to brokers. He also confirmed the lender has not taken any steps towards ceasing its practice.

Fees for service would only benefit major banks: AFG

AFG, a major Mortgage Broker Aggregator says that introducing fees for service would cause a “major disruption” in the finance industry, be a “clear disincentive” for borrowers to use brokers and “further entrench the oligopoly powers of the major banks”, in a response to the Productivity Commission, as reported by The Adviser.

In its response to the Productivity Commission’s (PC) draft report into competition in the Australian financial system, the Australian Finance Group (AFG) responded to the call for more information on the effect of replacing broker commissions with a fee-for-service model.

The group pulled no punches in warning that the introduction of such a model would “provide a clear disincentive for consumers to use brokers and would inevitably cause a major disruption in the finance industry”.

“The four major banks would be the only beneficiaries of a change of this kind as they would gain an additional competitive advantage over competing lenders that do not have extensive direct distribution channels,” the broking group said.

“This would further entrench the oligopoly powers of the major banks, which, coupled with the commission’s observations concerning the regulatory advantage of D-SIBs, ha[s] a negative impact on competition in the finance sector and [will] lead to a loss of the pricing benefits that resulted from the development of the mortgage broking industry.”

AFG also predicted that should such a change occur, it would not necessarily mean that any savings would be passed on (i.e. that loans would be repriced or that consumers would save money), as banks would have to distribute their products and would have additional costs (including increased staffing) “to deal with direct applications that have not been professionally compiled and pre-assessed by a broker to meet the lender’s requirements”.

“It is AFG’s contention that the presence of the mortgage broking channel is one of the few drivers of competitive tension in the Australian lending market,” the response reads.

“A consumer dealing directly with a lender has limited negotiating power or knowledge of the interest rates and lending criteria offered by competitors. A mortgage broker with access to a panel of lenders drives competition between lenders to the benefit of all consumers, not just their own clients.”

Touching on trail, AFG said that it “strongly supports” the removal of trail that increases over time, but that it does not agree that the standard trail commission operate as a disincentive to switching.

It said: “When a broker assists a consumer to refinance, trail commissions that cease with respect to the repaid loan will be replaced with the trail commissions payable on the new loan. As a result, it is AFG’s view that, in the absence of increasing trail commission rates over time, trail commissions per se are not likely to have a negative impact on broker behaviour.”

It concluded: “It is important that any changes should not result in an economic drift away from the broker to the lender, as devaluing the service provided by brokers would have significant and long-term detrimental effects for consumers by lessening the competitive tensions that currently exist in the credit industry.

“It is essential that anticompetitive conduct is not permitted to proliferate under the guise of regulatory reform.”

Best interests duty

In regard to the PC’s suggestion that a duty of care be implemented on lender-owned aggregators to act in the consumer’s best interests, AFG said that it was “very concerned” about introducing a test that would be applied to only one section of the industry “as it is likely to result in market distortions and unintended consequences”.

For example, it suggested that lender-owned aggregators could suggest that consumers are at risk if they use a broker that is not subject to the same test (and assert that the safest course for consumers is to only use brokers that are subject to the additional “best interests duty”).

Noting that the Combined Industry Forum has been working on a reform package, AFG added that “before considering additional law reform proposals, sufficient time must be allowed for those proposals to be implemented and embedded into the processes, procedures and culture of individual broker businesses”.

“Once that has occurred, it will be an appropriate time to again review the extent to which community expectations are met and good consumer outcomes are achieved,” the group said.

Lack of data on costs “disingenuous”

Noting that the commission found it difficult to ascertain from lenders the costs and benefits of using brokers rather than branches to source home loans, AFG said that the lack of information from lenders “should be considered to be disingenuous”.

“It is difficult to accept that entities that are sophisticated enough to develop and manage banking products and meet complex legal and regulatory obligations do not have information about product costs that would be needed to price those products,” the group said.

“However, absent a willingness to publicise that information, AFG submits that the willingness of lenders to embrace broker distribution should be considered reasonably reliable evidence that brokers provide an efficient and cost-effective means of distributing lending products.”

It added: “Brokers provide a variable cost base for lenders, with payment only required when a loan is settled and while it remains undischarged and not in default. This means that the risk of non-completion by a prospective borrower is substantially borne by the broker. As a result, lenders using broker distribution (as opposed to fixed-cost branch networks) can more easily price loans in a way to ensure that they are profitable.”

AFG also outlines that it believes ASIC should be responsible for advancing competition in the financial system, that consumers would receive “an inferior standard of service” should financial advisers also offer credit advice, and that ASIC could produce a best practice guide on disclosure requirements.

‘No evidence’ that brokers limit switching: NAB

NAB, the owner of three of the larger mortgage aggregators, says Broker-originated loans are refinanced at “more than double” the rate of direct-channel loans in its new submission to the Productivity Commission; reports The Adviser.

In its second submission to the Productivity Commission (PC), released on Wednesday (21 March), the National Australia Bank (NAB) stated that it has found “no evidence” which suggests that the payment of trail commission has limited “switching” for broker-originated loans.

The big four bank responded to draft finding 13.1 of the PC’s draft report, which alleged: “The payment of trail commissions creates perverse incentives for brokers by rewarding them for keeping customers in their existing loan. Broker loyalty appears skewed towards the institution, not the customer, and thus likely discourages refinancing.”

In its submission, NAB noted that in the 2017 financial year (FY17), switching was more prevalent among borrowers with broker-originated loans.

“NAB has no evidence that incidence of switching is lower for mortgage broker-originated borrowers compared to those originated via direct channels,” the submission reads.

“In fact, refinance out rates for NAB’s mortgage broker-originated loans was more than double the rate of direct channels in FY17.”

The submission echoed the views put forward by NAB COO Anthony Cahill in his address to the PC on 5 March, stating that brokers are, in fact, rewarded for refinancing a client’s loan.

“[If] a broker were to assist a customer to move the loan to another lender, they would cease receiving a trail commission from the incumbent, but earn upfront and trail commission from the new lender.”

Further, the bank reiterated its view that trail commissions are paid as an incentive for brokers to “service customers on an ongoing basis” (which PC chair Peter Harris has questioned recently).

NAB highlighted the work the Combined Industry Forum was doing to improve commission structures and raise standards.

NAB concerned over “best interests duty”

The PC has also suggested that the Australian Securities and Investments Commission (ASIC) could impose a legal duty of care obligation on brokers and called for increased broker disclosure requirements.

In its submission, NAB said that a best interests duty “may be difficult to achieve practically” as “both mortgage products and customers themselves are not homogeneous and price is not the sole determinate of a good customer outcome”.

NAB added that it was “concerned” that applying a legal best interests duty only to brokers operating under lender-owned aggregators would create an “uneven playing field”.

The bank reiterated that bringing in a fee for service would be “detrimental to competition in the mortgage market” as it would see brokers “become unaffordable for customers”.

NAB also pointed out that proposals have already been put forward by the Combined Industry Forum (CIF) to improve broker and aggregator transparency.

The major bank also said that it does not believe the publication of median interest rates would benefit consumers, as it would “create unreasonable expectations, whereby all consumers anticipate receiving an interest rate at or below the median”.

“There are legitimate, risk-based reasons for customers to receive a price that is above a median rate; for example, high-risk loans require significantly more capital compared with low-risk loans, necessitating a different price strategy,” the major bank said.

Is this the beginning of the end of the mortgage broking industry?

ABC Radio National Breakfast did a segment on Mortgage Brokers, in the light of the Royal Commission, including DFA commentary.

A prominent finance industry expert has warned we’re witnessing the beginning of the end of the mortgage broking industry as new technology makes it easier for consumers to apply for a loan on their own.

But it’s not the only pressure facing these middlemen between lender and borrower.

The mortgage broking industry has faced intense questioning about its practices during the first round of the Banking Royal Commission, with evidence of conflicts of interest and outright fraud being brought to light.

But the sector’s hit back saying critics are seeking to disparage an entire industry made up of predominantly honest small business owners.


COBA and the Future Of Banking

I had the opportunity to participate in the Customer Owned Banking Association conference yesterday.  I hold the view the these smaller, but more customer aligned financial services organisation are Australia’s best kept secret.  In fact, often they offer better rates, and a distinctive set of cultural values. But they need to drive a different path to the majors, when the economics of their businesses are stressed.

The current environment with the more than 20 inquiries including the Royal Commission and the higher funding costs as represented by the 20 basis point spread growth in the A$ Bill/OIS raises a whole set of questions. Plus the FED is predicting a further 8 rate hikes in the USA over the next couple of years, taking the US rate well above 3%! That will impact here.

I made a video blog of my visit to Sydney, and included extracts from a live radio interview I did for 6PR on interest rates, and my comments from a panel discussion regarding the future of banking.




Why don’t we read the fine print? Because banks know the pressure points to push

From The Conversation.

The Financial Services Royal Commission has exposed the pressure selling tactics used by the banks. They draw on simple psychological rules to target vulnerabilities among some of their most loyal customers.

One example is the high-pressure selling of add-on insurance for customers when they sign up to a credit card. The Commonwealth Bank of Australia (CBA) acknowledged that upwards of A$13 million of refunds are likely to be paid to consumers who had been pressured into buying these add-on products.

Another witness at the commission, Irene Savidis, relayed what happened when she tried to cancel this insurance:

they just kind of kept pushing it on me saying, you know, “It’s good for you, it will help you.” I just felt pressured or kind of like, you know, no matter what I said, it was the opposite. So I couldn’t – I felt like I couldn’t cancel it.

These techniques are well established in psychological research as ways to manipulate behaviour. In this single example, we can see how the representative of the CBA used trust, repetition (the more something is repeated, the more we are likely to believe that it is true), authority (the salesperson is perceived to be an expert), and scarcity (act now, or you will miss out). All of these factors are part of the marketers’ bag of tricks.

As much as trust can be useful under certain circumstances, at times it can be dangerous. When we are faced with choices or decisions where we don’t feel confident, we have a tendency to give over our decision making to somebody who we believe has those skills and authority and trust them to do the right thing by us.

How we make decisions under situations of stress

As we can see in the examples from the commission, many of these financial decisions are being made by consumers under already significant financial and psychological stress. We also know that under these conditions none of us make the best decisions.

In psychology, we know that people don’t always think through their decision making in a rational and linear way when placed under situations of stress. This becomes more pronounced when – counter intuitively – people are provided with lots of information related to a topic that they don’t have the ability to fully understand, either because it is complex and confusing, or even simply because it is in an area that they don’t have any experience in.

It’s in these situations that they rely on peripheral information to make their choices – things like colours, previous experience with similar situations, even the aesthetic layout of the information, or the way the person giving them the information is dressed.

When we feel we have less resources, we perform worse on tasks requiring high-level cognitive control, like important decision making. Logical reasoning, the kind that should occur when signing up to a loan, extending our credit, or committing to any major financial agreement, is relatively inefficient in these situations.

Responding to pressure selling techniques

So, how do we respond to the types of techniques that we have seen and any others that might be exposed by the commission over the next 12 months?

We need to accept that our decision making is flawed and not judge ourselves, or others, harshly, when they seem to make irrational decisions, or behave in a way that is counter-intuitive. We need to accept that people are complicated, and will make a decision that conforms to their emotional state of mind, at that point in time.

That said, there are some things people can do to avoid some of these manipulative tactics. One thing is to do your best to slow down when it comes to decision-making. If you do want to buy something, that’s fine, but do it outside the heat of the sales process.

Speak to someone you trust about your plans. Recognise that your emotional brain may already have convinced your rational brain that you are making a good decision, so you need to check in with someone who isn’t emotionally engaged in the decision.

And if the person offering something like add-on insurance creates a sense of scarcity, then identify the feeling, and assume you can walk away. A classic technique of traditional sales is to say something along the lines of, “I can only offer you this now”, but the best response is always to take your time. If they are offering you this today, they are more than likely to offer it to you tomorrow.

One thing that has emerged from the royal commission is the somewhat obvious fact that banks are businesses. Indeed, people should not be fooled into thinking that banks are anything other than profit-driven organisations. Banks know exactly what they are doing when it comes to the use of manipulative techniques to get customers to buy their products.

The hope is that this royal commission will be able uncover and act upon some of the practices verging on illegal, while highlighting some of the more unpleasant and unethical practices that have been occurring.

Author: Paul Harrison, Director, Centre for Employee and Consumer Wellbeing; Senior Lecturer, Deakin Business School, Deakin University; Chiara Piancatelli, PhD Candidate

Consumers need critical thinking to fend off banks’ bad behaviour

From The Conversation.

The irresponsible (if not predatory) lending and the selling of “junk” financial products highlighted by the Financial Services Royal Commission should raise concerns for regulators, educators and parents interested in financial literacy.

Research shows a strong correlation between financial literacy and literacy and numeracy skills. Literacy and numeracy are critical for, among other things, making sense of product disclosure statements and understanding the impact of loan terms and interest rates on the total amount to be repaid.

But teaching financial literacy requires going beyond these skills, by cultivating a healthy scepticism of financial institutions and the capabilities and confidence to make informed financial decisions.

There is a strong relationship between a low socioeconomic background and low financial literacy in both adolescents and adults.

It’s not just disadvantaged and vulnerable groups that struggle with financial decision-making. People who are highly educated in finance also make poor decisions – for instance, by focusing too much on growing their assets and ignoring risks.

But studies show that when regulation is effective and the financial system can be trusted, even consumers with limited financial knowledge and information-processing capabilities have the potential to deal with complex financial decisions.

For example, when considering mortgage protection insurance, applicants stand to benefit from knowing the actual risk of events like serious illness or injury that can affect their ability to meet monthly loan repayments.

Building financial capability

One way to develop better financial literacy is through simulating real-world risks, rewards and decisions in safe and supportive environments. For instance, families can play games like Monopoly and The Game of Life.

Secondary school students also have access to more sophisticated online simulations, such as the ESSI Money Game and the ASX Sharemarket Game.

Hypothetical scenarios like these provide opportunities for role play, where students can practise drawing on evidence and using it to think and reason about situations.

A recent survey of teachers of Year 7-10 commerce students revealed that more could also be done to teach students how to compare and choose between banks and financial products and services, what to do in the case of a financial scam, and how to escalate an unresolved complaint.

But we also need to take a look at the role banks play in financial education. Programs like the Commonwealth Bank’s Dollarmites Club and Westpac’s Solve to Save teach children about money on the banks’ terms.

A key call to action in these programs is often to open a bank account and activate a savings plan. In the Solve to Save program, parents pay a $10 weekly subscription, which is “automatically refunded” to their child’s nominated Westpac account every week they complete three mathematics exercises.

Late last year, in response to criticism by the consumer advocacy group Choice, the Commonwealth Bank stopped kickback payments to schools related to its longstanding Dollarmites scheme.

While the banks may be proud of their investment in these education programs, they serve to position the banks as experts in money matters while cultivating trust and brand loyalty.

What does it really mean to be smart with money?

Misguided trust has exposed vulnerable individuals to the moral hazard of the banks – and underscores the importance of improved financial regulation and education moving forward.

Given that borrowing decisions are complex, multidimensional and often emotional, it’s important to consider any lender’s motives, or “What’s in it for them?” Banks are profit-driven. This means an important question to ask oneself is: “Where can I get information and support that is independent, comprehensive and easy to understand?”

In the current climate, teaching capabilities for a healthy scepticism and personal agency is the way forward.

We also need to change the public perception of what it means to be financially literate. The conventional focus on individual responsibility and wealth accumulation is flawed.

Arguably, this focus has contributed to the need for a Financial Services Royal Commission. Whether you are a bank, a mortgage broker or a consumer, the impact of your decisions on others must be carefully considered.

While education can contribute to preparing all Australians for informed financial participation, the task is challenging.

Authors: Carly Sawatzki, Assistant Professor, University of Canberra; Levon Ellen Blue, Lecturer, Queensland University of Technology

System Alert – Does Not Comply With Responsible Lending!

The Royal Commission looking at Financial Services Misconduct heard today that the Commonwealth Bank’s automated system for approving overdrafts failed and so for four years from 2011 it gave some customers a line of credit they shouldn’t have received.

As a result, the volume of overdrafts rose significantly from 228,000 in 2012 (up 80% from the previous year) to 550,000 in 2014. The bank said its automated system “spat out” wrong approvals and was “doomed to fail” because of bad design.  We discuss this in our latest video blog.

In fact, questions were raised by consumer advocacy groups before the bank released there was an issue. The implementation of serviceability assessments was not made correctly. As a result of changes made to the system, the bank failed its responsible lending obligations.

It was also slow to interact with the regulator on this issue.  Once again, cultural and behavioural issues were in the spotlight.

The object lesson here is that automated credit decision systems can lead you up the garden path.  This is important given the current rush to digital channels and more automation.