Category: Banking Culture

Fund managers not keen on ‘good customer outcomes’

The “dilemma” of pleasing both customers and institutional shareholders as a listed bank have been explored by the royal commission this week, via InvestorDaily.

On Thursday (29 November), Bendigo and Adelaide Bank chairman Robert Johanson spent a short amount of time in Hayne’s witness box where he was mostly used as an example of how banks should be remunerating their staff.

Unlike the big four, Bendigo bankers are paid a higher proportion of their remuneration in a base salary, with a smaller proportion linked to short-term incentives. Part of the long-term incentives are linked to the bank’s Net Promoter Score (NPS) and other customer centric measures.

Mr Johanson told the commission that shareholders have generally supported the bank’s remuneration model, which he admitted was different to its peers.

However, counsel assisting Rowena Orr submitted into evidence a report by proxy advisers ISS Governance relating to Bendigo’s 2018 AGM, which advised shareholders to vote against a resolution approving performance rights and a deferment of shares to the bank’s managing director, Marnie Baker.

The report noted that one reason for the recommendation was the increased weighting given to the “customer hurdle” in Ms Baker’s long-term incentives. The proxy advisers believed this “had no direct link to shareholder wealth outcomes”, and that “customer-centric measures should be “considered and assessed as part of a banking executive’s day job”.

Mr Johanson said he believes, to the contrary of the ISS recommendation, that customer centricity is linked to the long-term viability and profitability of the bank.

“The ‘day job’ as is were includes thinking about how all parts of the remuneration package are working together to achieve common outcomes,” he said.

“The proxy advisers of course are employed by institutions. It provides a pretty rigorous way for large numbers of institutions to get to grips with these questions when historically they haven’t been that interested in them.

“But the people who pay the proxy advisers themselves are assessed typically on short-term financial outcomes. So it’s no surprise that a fund manager is interested in short-term financial outcomes because we all as investors, through our superannuation funds, are concerned about whether our fund has done well over the last six months or not.

“There is a dilemma in all this.”

Mr Hayne suggested the process was “reducing some quite complex problems to binary outcomes”.

Approximately 40 per cent of Bendigo and Adelaide Bank is held by institutions.

Bank branches becoming ‘uneconomic’ says ANZ CEO

ANZ chief executive Shayne Elliott has conceded that branches are losing their lustre as cash becomes a niche payment solution and consumers opt to bank online, via InvestorDaily.

Counsel assisting Rowena Orr asked why the major bank has been reducing its retail footprint during Mr Elliott’s time on the stand at the royal commission this week.

Mr Elliott estimated 35 ANZ branches closed this year and up to 50 had ceased operating last year.

ANZ has closed around 110 branches in the past decade: 55 in inner regional Australia, 44 in outer regional areas, six in remote locations and four in very remote areas.

Mr Elliott noted that some branches had also opened in that time, describing it as a redistribution of its network.

“Why so many branches this year, Mr Elliot?” Ms Orr asked.

“Well, consumer behaviour is changing very quickly. And not that it has changed just this year but over the last few years we’re seeing a number of fundamental changes,” Mr Elliott said.

“The Reserve Bank governor the other day referred to the fact that the usage of cash is almost becoming a niche payment solution.”

Mr Elliott added that most of what people are doing in branches is cash related, in deposits and withdrawals. He also noted a decrease in retail traffic of around 20 to 30 per cent over the last couple of years in areas where the bank had closed shops.

However, small business usage was said to remain reasonably solid.

“So essentially, we are confronted with a dilemma where we have shops and a distribution network with less and less people in it, and therefore, at some point they become uneconomic,” he said.

“At the same time, what we have seen is a rapid increase in the use of technology for people who prefer to do their banking on their phone or at home, or even in some cases, on the phone.”

Ms Orr asked if people still go into branches to inquire about loans.

“Yes, perhaps, although I would say for ANZ – and we may be different from our peer group – our home loan book only – less than a third of home loans are originated through a branch,” Mr Elliott said.

“Around 55 per cent come through brokers and another roughly 15 per cent come through our mobile banking network, ie, we send somebody to you. So the branch network is not a terribly efficient or well-used avenue for home loans.”

ANZ had considered two proposals with closing branches, one to sell and the other to continue with a branch by branch closure program. Mr Elliott said the organisation had chosen to continue with closures based on customer behaviour and impact data.

Mr Elliott was also asked about the considerations that ANZ takes into account during branch closures. He responded by saying the bank does not consider the financials of the branch, rather the transactions that are available in the area and local alternatives in close by branches and ATMs.

“There’s very little correlation between what happens in the branch and the economic outcome to the bank. What most people do in a branch drives very little value,” he said.

“We don’t charge fees for most of what they do. It is a service that is not necessarily correlated to where we generate our profits or earnings.”

He added that delinkage is accelerating, with more people using brokers.

ANZ’s attitude towards its retail banking division is in stark contrast to that of its largest competitor, CBA.

When CBA boss Matt Comyn gave evidence before the Hayne inquiry last week he made clear the group’s preference for consumers to use its extensive branch network.

Mr Comyn revealed that CBA had sought to introduce a “flat fee” commission-based model in January 2018, before choosing not to go ahead with the change in fear that the rest of the sector would not follow suit.

MFAA CEO Mike Felton said that CBA’s position was “not surprising”, but was “entirely self-serving” and was “designed to destroy competition and reduce the bank’s reliance on the broker channel”.

Commenting on CBA’s attempt to introduce a flat-fee remuneration model, Mr Felton said: “CBA’s model is anti-competitive and designed to drive consumers back into their branch network, which is the largest branch network of the major lenders.

“Mr Comyn’s solution for better customer outcomes is a new fee of several thousand dollars to be paid by consumers to CBA for the privilege of becoming a CBA customer.”

Mr Felton added: “Cutting what brokers earn by two-thirds would save CBA $197 million, which is good for CBA’s shareholders. However, it would destroy competition, leaving millions of customers without access to credit outside of major lenders.”

ASIC’s recent initiatives to strengthen underwriting standards

Cathie Armour, Commissioner, Australian Securities and Investments Commission spoke at at the Australian Securitisation Conference 2018.

She updated their views on responsible lending, and their new approach to getting better data on the sector.  They also to publish a consultation paper on RG 209 revisions and enhancements.

Responsible lending

The National Consumer Credit Protection Act includes an array of obligations designed to protect consumers. Chief among them are the responsible lending provisions – a set of obligations that require lenders and mortgage brokers to do three things before offering a loan to a consumer:

  • One – the lender or broker must make reasonable inquiries into the requirements, objectives and financial situation of the consumer.
  • Two – they then need to verify the financial situation of the consumer.
  • Three – the lender or broker must then make an assessment or preliminary assessment (respectively) of whether the proposed loan is unsuitable for the consumer.

Lenders also have an obligation not to enter into an unsuitable loan contract with the consumer.

The responsible lending provisions are not designed to protect those who invest in residential mortgage-backed securities or other consumer debt securities. However, by protecting consumers in the manner I’ve just described, the provisions necessarily afford investors some secondary protection.

This also means that a failure by a bank that either issues, or sells loans to issuers of, residential mortgage-backed securities to lend responsibly harms both borrowers and investors. As ASIC goes about its responsible lending work, we are cognisant of this fact.

That said, as we all appreciate, compliance with the responsible lending provisions by securitisers alone does not automatically mean a AAA grade rating for a tranche of securities. The provisions set the minimum standard.

ASIC expects and encourages lenders to think about how they can ensure loans provided to consumers are not only ‘not unsuitable’ in accordance with the language of the National Credit Act, but also ‘suitable’ – properly designed and priced to meet the needs of the consumer.

Responsible lending should not be a static, mechanical process devoid of common sense, nor a checkbox exercise. It should be a dynamic, evolving process that looks to continually improve credit quality through the adoption of new practices and new technology, underpinned by basic common sense.

Investors in residential mortgage-backed securities should be looking to those lenders that make this commitment to ongoing improvement.

I should also say something about low-doc loans at this point. As you’ll be aware, many mortgage pools will include some portion of low-doc loans. The definition of a low-doc loan can vary. Nevertheless, it must be said that the idea of a loan provided to a consumer after taking less than reasonable steps to verify the consumer’s financial situation (by obtaining and reviewing reliable documentation) is fundamentally incompatible with responsible lending.

Investors should be wary of the additional credit and regulatory risks that low-doc loans involve.

There is also a move away from what’s termed ‘low-doc loans’ to the more popular ‘non-confirming loans’. It is fair that all consumers capable of repaying a loan have the opportunity to apply for one, even where the consumer’s circumstances are unusual. But insofar as the phrase ‘non-conforming loans’ could be used as a euphemism for a low-doc or risky consumer loan, our warning remains: lenders and investors face not only higher credit risks, but also the risk of a regulatory response in these situations.

As we begin to see some examples of mortgage stress, particularly as interest rates rise, it becomes more important for investors to be discerning about the securities they invest in. Investors must consider how the mortgage lender goes about lending responsibly.

ASIC’s recent responsible lending initiatives

ASIC’s recent responsible lending initiatives have been informed by three priorities:

  1. Promote responsible lending and appropriate responses to financial difficult
  2. Address the mis-selling of products and promote good consumer outcomes, and
  3. Respond to innovation in financial services and consumer credit and facilitate appropriate reform.

Let me update you on some our initiatives now.

Loan application fraud

ASIC has focused on loan application fraud for some time.

The falsification of loan documents by brokers and lender employees can undermine the integrity of the responsible lending provisions and lead to consumer harm where borrowers obtain loans they can’t afford. It can also harm investors if the loan is securitised.

Insufficient controls to address the risk of loan application fraud and incentive structures that reward poor behaviour jeopardise trust and confidence in the financial sector.

We recognise that lenders have a significant interest (both financial and regulatory) in detecting and responding to loan fraud and ensuring consumers can repay the loans offered to them.

In many cases where we are alerted to alleged loan fraud involving brokers or lender employees, the matters have been brought to our attention by industry, or an industry association, which has already suspended or terminated the individual’s employment, accreditation or aggregator agreement.

We have taken a strategic approach, including civil penalty proceedings against ANZ (Esanda) for breaches of the responsible lending provisions, as they relied on information in falsified payslips submitted by brokers where it had reason to doubt the reliability of that information.

In its judgment, the Court made clear that where unlicensed brokers submit loan applications in reliance on the ‘point of sale’ exemption in regulation 23 of the National Credit Consumer Protection Regulations, lenders have a greater obligation to exercise care. This was the basis for the higher penalties imposed on ANZ relating to the loans submitted by one of the brokers under the point of sale exemption.

In line with our strategic approach, we are undertaking an industry review to better understand the type and level of fraud faced by industry, and how industry goes about preventing, detecting and responding to it.

We are collecting information on industry controls and processes, with a view to promoting best practice. This will help us to improve public confidence in controls for preventing, detecting and responding to loan fraud.

We have met with all of the review participants and have commenced a data collection phase involving selected lenders and aggregators. We expect to release a report next year.

Motor vehicle finance

We are undertaking a review of the car finance industry’s compliance with regulatory obligations relating to responsible lending, collections and hardship.

Our recent work in the car finance industry has identified poor practices such as:

  • lenders offering loans to consumers that they cannot afford
  • lenders failing to make reasonable inquiries into, and to verify information about, the consumer’s financial situation, and
  • consumers being denied important protections under the National Credit Act because of car dealers misrepresenting the loan as a business loan.

We are collecting information from several car financiers to:

  • understand current trends and practices in the car finance industry
  • assess the adequacy of their responsible lending, hardship and debt collection processes, and
  • identify areas of concern or risks that might affect consumers.

We plan to use the findings from the review to drive improved standards of conduct and compliance with regulatory obligations across the industry, including financiers who regularly issue consumer debt securities.

We expect all participants will improve their practices and develop remediation programmes to respond to past instances of poor conduct.

Where we identify concerns, we will be commencing investigations with a view to enforcement action. We have already seen BMW Finance pay $77 million in Australia’s largest consumer credit remediation program. Other financiers engaging in similar conduct can expect a strong response.

We recently issued pilot surveys to participants to obtain feedback on the availability of the data required for the review, with the aim of understanding the systems and methods of data collection and storage. We will use the information provided to further refine our future data requests.

Recurrent data requests

We have also commenced a pilot to obtain home loan data on a recurrent basis.

We will review the results of the pilot in 2019 to assess how to roll out recurrent data requests more broadly.

We will be able to use this data in a number of ways, including to identify potential trends and issues that can help us prioritise regulatory actions and provide feedback to industry. We also envisage releasing the aggregated data to inform consumers and investors more broadly.

We acknowledge that recurrent data collection will have a cost impact on industry, which is why conducting the pilot is so important. We are working with industry and other parts of the government to do this in the most efficient way possible.

By obtaining recurrent granular data, our vision is to reduce the need for ad-hoc and bespoke data collection exercises. This may reduce some costs for the industry in the long run.

Review of Regulatory Guide 209

We are planning to consult on our responsible lending guidance in Regulatory Guide 209 (RG 209).

ASIC first published RG 209 in February 2010 to provide guidance on the processes that we expect licensees to have in place to ensure that consumers are not provided with unsuitable loans.

The Regulatory Guide was last updated in November 2014 following the Cash Store decision.

We believe it’s timely to review the guide, so we can ensure our guidance remains current, addresses emerging issues, and provides a clear indication of what our expectations are.

Since the last revision, there have been a range of developments, including:

  • thematic ASIC reviews, including ASIC Report 445 and Report 493, which looked at interest-only lending and the conduct of lenders and brokers respectively
  • law reform in relation to credit cards, with the potential for small amount credit contract and consumer lease reforms
  • judicial commentary and enforcement outcomes, such as in the Channic, Esanda and Thorn matters, and
  • commentary from the Royal Commission.

We are still at a reasonably early stage in scoping the kinds of changes or additions that we think would be useful to update.

We intend to engage quite actively about the range of issues that should be addressed, and the approach that we propose to take.

We hope to publish a consultation paper on RG 209 later this year or early next year and will give stakeholders such as the Australian Securitisation Forum the opportunity to make submissions.

Product intervention powers

Treasury recently released draft legislation to introduce design and distribution obligations for persons providing financial services, and a product intervention power for ASIC.

The design and distribution obligations will apply to issuers or distributors of financial products. It is not proposed that these obligations will apply to credit licensees.

However, to complement these obligations, the Government is also introducing a product intervention power for ASIC. This power would enable us to make orders for up to 18 months prohibiting specified conduct in relation to a product, or even ban a product, where we identify a risk of significant consumer detriment. This power is proposed to apply to both financial and credit products.

Under the proposed legislation, this power will only apply prospectively; that is, it will not apply to products that have already been provided. We will need to consult the affected parties prior to making an order.

While the current proposed changes are welcome, we have submitted to the Government that we think the design and distribution obligations should be expanded to cover products regulated by the National Credit Act.

Responsible lending surveillance

Very briefly, I also want to mention a targeted surveillance activity we undertook last year. We reviewed the credit assessment processes of several lenders to assess their compliance with the responsible lending provisions. The participating entities included some issuers of residential mortgage-backed securities.

Following our work, we have seen the participating credit providers improve their processes for the collection and verification of information about the consumers’ financial situation. Industry can expect these kinds of surveillance activities to continue, and regulatory action to follow where breaches of the responsible lending provisions are identified.

Regulatory environment and the future

This is a unique and turbulent time for the financial services industry.

Royal Commission

Three of the rounds of hearings of the Royal Commission have touched on credit matters. Many of the issues raised were already under consideration by ASIC and our work on some of these matters is continuing.

The Royal Commission has produced an interim report that covers the first four rounds of public hearings, including the first round on consumer credit. We have made submissions to the Royal Commission on the content of the interim report.

We look forward to continuing to assist the Government in improving the regulatory framework for financial services in Australia.

ASIC’s enforcement initiatives

ASIC has received additional funding from Government to assist ASIC to accelerate its enforcement in financial services and credit.

Industry should recognise that ASIC will have even greater capacity to pursue breaches of the law we administer and we have very clearly heard the message that the community expects us to utilise court processes as much as possible.

Implementing new supervisory approaches

A key part of our work over the next year will be implementing new supervisory approaches. This work follows additional funding which was recently announced by Government to progress our strategic priorities.

One of our key new initiatives is a Corporate Governance Taskforce, which will undertake targeted reviews of corporate governance practices in large listed entities. This will allow us to shine a light on ‘good’ and ‘poor’ practices observed across these entities.  Poor corporate governance practices have led to significant investor and consumer losses as well as a loss of confidence in our markets.

We are also implementing a new and more intensive supervisory approach by regularly placing ASIC staff onsite in major financial institutions to closely monitor their governance and compliance with laws – we call this new programme of work close and continuous monitoring.

These new approaches will help us realise our vision for a fair, strong and efficient financial system for all Australians.

Other initiatives of interest to ASF members

Before I go, there are just a couple of other areas of ASIC work that I want to highlight to you.

  • Benchmarks Reforms : In July ASIC established a comprehensive regulatory regime for financial benchmarks. This followed on from the work of industry and ASX in May when the new methodology for BBSW came into effect.  But it is important for Australian market participants to engage with the changes to LIBOR which will occur at end of 2021. It is critical for all market participants to plan for a post LIBOR world.
  • Wholesale Market Conduct:  We are examining aspects of conduct in the FX Market. We recently reported on High Frequency Trading in the AUD/USD cross rate (Report 597) and we found high frequency trading was 25% of the total, down from a high of 32% in early 2013. We are also examining the practice ‘last look’ and plan to publish our observations and findings in due course.

RBNZ To Ease Loan To Value Restrictions

The Reserve Bank New Zealand says that risks to New Zealand’s financial system have eased over the past six months, but vulnerabilities persist. In particular, households remain exposed to financial shocks due to their large mortgage debt burden.

But they are easing the loan to value restrictions from January 2019.

  • Up to 20 percent (increased from 15 percent) of new mortgage loans to owner occupiers can have deposits of less than 20 percent.
  • Up to 5 percent of new mortgage loans to property investors can have deposits of less than 30 percent (lowered from 35 percent).

They say that both mortgage credit growth and house price inflation have eased to more sustainable rates, reducing the riskiness of banks’ new housing lending. In response, we are easing our loan-to-value ratio (LVR) restrictions on banks’ new mortgage loans. If banks’ lending standards are maintained we expect to further ease LVR restrictions over the next few years.

Debt levels also remain high in the agriculture sector, particularly for dairy farms, implying ongoing financial vulnerability. Balance sheets need to be further strengthened. In the medium-term, an industry response to a variety of climate change-related challenges appears likely, requiring investment.

While domestic risks have eased, global financial vulnerability has risen. Significant build-ups in debt and asset prices, and ongoing geopolitical tensions, overhang financial markets. This vulnerability is highlighted by the current elevated price volatility in equity and debt markets. New Zealand’s exposure to these global risks has reduced somewhat, as New Zealand banks have become less reliant on short-term, and foreign, funding.

The domestic banking system remains sound at present. We are using this period of relative calm to reassess whether the banking system has sufficient capital to weather future extreme shocks. Our preliminary view is that higher capital requirements are necessary, so that the banking system can be sufficiently resilient whilst remaining efficient. We will release a final consultation paper on bank capital requirements in December.

The banking system remains profitable, reflecting banks’ low operating costs and strong asset performance. While positive overall, banks’ low costs have been partly achieved through underinvestment in core IT infrastructure and risk management systems in New Zealand. This was highlighted in our review of bank’s conduct and culture with the Financial Markets Authority. We will be jointly reviewing banks’ responses to our review in March 2019, and following up as required.

CBL Insurance Ltd was placed into full liquidation by the High Court on 12 November. Aside from CBL, the insurance sector as a whole is meeting its minimum capital requirements. However, capital strength has declined and a number of insurers are operating with small buffers. The insurance industry must ensure it has sufficient capital to maintain solvency in all business conditions. Our ongoing review of conduct and culture in the insurance sector with the Financial Markets Authority will illuminate the industry’s risk management capability. The review will be released in January 2019.

 

Ken Henry calls time on capitalism

The NAB chairman has suggested that it is time for the traditional capitalist model to be flipped on its head; via Investor Daily.

 Dr Ken Henry, chairperson at National Australia Bank, suggested during round seven of the royal commission that maybe it was time for the banks to rethink its capitalist model.

“The capitalist model is that businesses have no responsibility other than to maximise profits for shareholders. A lot of people over the past 12 months have said that’s all that you should hold boards accountable for.”

Dr Henry said that some people would argue customers were part of pleasing shareholders as treating customers well was important to the long-term interests of shareholders.

“But that approach sees customers as instruments in an instrumental fashion, that the customers are seen as the means by which shareholder profits are secured, rather than the customer being the focus,” he said.

Dr Henry said a debate was now being had over what businesses should be accountable for and the possibility of an alternative solution.

“Within NAB we have thought very deeply about whether we should see our customers in purely instrumental terms, as a means to the end rather than the end to itself.”

Dr Henry noted that views within the bank differ, but added that NAB had realigned its incentives to focus on its customers.

“For what it’s worth, NAB’s view clearly today is that incentives should be aligned with customer experience, customer outcomes to be clear,” he said.

However, as Dr Henry demonstrated on the stand, this has not always been the case for NAB, as counsel-assisting Rowena Orr showed that APRA held the view that NAB’s remuneration was not appropriate.

“APRAs view was that NAB’s remuneration arrangements weren’t operating as they should to support the prudent management of risk at NAB?” said Ms Orr

“That was their view, yes,” said Dr Henry.

As Ms Orr pointed out, APRA’s review of NAB claimed that the bank had a heavy emphasis on profitability measures in individual performance assessments and unlike its peers had no risk-adjusted measures of profitability.

“Well, it was no surprise. Concerning. Absolutely concerning, but not a surprise,” said Dr Henry.

Evidence of the remuneration model was presented by Ms Orr when she questioned Dr Henry why NAB in 2016 gave its executives their full short-term variable remuneration.

Ms Orr pointed out that in 2016, NAB’s bonus pool was set at 100 per cent and that CEO Andrew Thorburn did not even mention the matters when stating the decision.

“So, he (Mr Thorburn) didn’t mention any of those matters, adviser service fees, plan service fees, the bank bills swap rate, the foreign exchange breaches,” said Ms Orr.

Dr Henry said that there was enough information about the issues to have impacted the decision, but it did not concern him that it wasn’t raised.

“You said earlier Dr Henry, that you weren’t sure what the board could have done differently or when it could have. I want to suggest to you squarely that this was a point at which the board could have conducted itself differently. It could have sent a strong message by reducing the pool in response to these very significant compliance issues,” Ms Orr said.

“Of course, we could have, and we decided not to. For very good reasons and I’m still happy with those reasons,” said Dr Henry

UK Bank “Ring Fencing” Goes Live In 6 Weeks

In less than six weeks, ten years on from the financial crisis, one of the largest ever reforms to the structure of the UK banking industry comes into force. While most will notice little difference on day one, ring-fencing
the largest UK banks has involved significant changes behind the scenes.

The Bank of England says this reform will make the provision of core banking services more resilient, and protect taxpayers from further bail outs. These are real benefits but are conditional on the ring-fence being maintained over time, meaning this will be a continuous process for both the PRA and the banks.

This was outlined in a speech “From Construction to Maintenance: Patrolling the ring-fence” given by James Proudman, Executive Director, UK Deposit Takers Supervision.

Financial crises generate significant and persistent costs. The Bank of England has estimated that the costs of crises amount to 75% of GDP on average. The previous crisis resulted in the Government providing £65 billion of capital to RBS and Lloyds to prevent them failing and disrupting the provision of vital banking services to their customers. Since then, a  comprehensive regulatory reform package was developed – which in large part has now been implemented – to reduce the likelihood that such a crisis could happen again.

A decade on from the financial crisis, one of the largest ever reforms to the structure of the UK banking industry is coming into force. By 1 January 2019, the largest UK banking groups must have implemented the ‘ring-fencing’ – or separation – of their UK retail business from their international and investment banking operations. This means that the core banking services on which retail and small business customers depend should not be threatened should things go wrong in wholesale financial markets or the global economy.

Banks have now largely completed the ring-fencing of their retail operations, and have done so with little disruption to their customers and counterparties. The PRA’s supervisory focus will turn to ensuring the ring-fences that have been established are effective in practice, and remain so. Ring-fencing both broadens the range of regulatory requirements, and increases the intensity of supervision, for the groups in scope. As such, ring-fencing will remain a focus for the PRA – as well as for the banks themselves – in the coming years.

All large UK banking groups – defined as those with ‘core’ retail deposits greater than £25 billion – are required to implement ring-fencing by 2019. Currently, seven banking groups cross this threshold. Between them, these groups have around £5 trillion of assets, both in the UK and overseas.

The ring-fencing regime is designed to be consistent with the other parts of the post-crisis regulatory framework. The most systemically-important ring-fenced banks will be held to higher capital requirements. The Systemic Risk Buffer will be applied to ring-fenced banks to ensure they are adequately capitalised and resilient to shocks. We expect ring-fenced banks to have, on average, around 1.5 percentage points more high-quality ‘Tier 1’ capital than non-systematically important banks.  And a ring-fenced bank will not be able to be capitalised by debt raised externally by its group, which would give rise to so-called ‘double leverage’.

Overall, the Bank estimates that ring-fenced banks’ total loss absorbency will be, on average, around 27% of their risk-weighted assets, higher than the 17% recommended by the ICB. Ring-fencing also helps improve the resolvability of the big UK banking groups. The resolution strategy for groups including ring-fenced banks will typically involve a bail-in at the level of the holding company. Bail-in would recapitalise the relevant entity by passing losses up to the holding company to be borne by shareholders and debt-holders. This should stabilise the group. Structural separation then provides authorities with additional options as part of any subsequent restructuring.

Ring-fencing, together with other elements of the post-crisis regulatory landscape, means that the key providers of important retail banking services are less likely to fail following a shock to the economy or the financial system. But if banks do get into trouble, there will be greater certainty that important banking services will continue to be provided without disrupting customers and without the need for Government bail-outs. This is the key difference ring-fencing delivers should we experience a repeat of the financial crisis.

To comply with the legislation, each banking group has had to restructure to ensure that their new ring-fenced banks can meet prudential requirements on a standalone basis, have their own governance arrangements and have viable business models.

In some cases, a banking group’s ring-fenced bank has been established as a brand new legal entity. Setting up a bank from scratch is a considerable undertaking, even more so for a bank which will have millions of customers from day one. In fact, last year the PRA authorised the three largest new banks ever established in the UK. And by the end of this year, we will have assessed and approved more than 50 applications for senior management positions within these groups, and considered the suitability of their proposed prudential sub-groups, containing hundreds of entities between them. Ring-fencing also resulted in the Bank helping ring-fenced banks undertake around 20 on-boarding operations to payment systems settling across the books of the Bank, and admitting six banks to the Sterling Monetary Framework.

We’ll wait an eternity for the banks to fix themselves

From The Conversation.

Asked at the banking royal commission how long it might take to embed the right culture in the National Australia Bank, its chairman Ken Henry replied: ten years.

As head of the Commonwealth Treasury before he left to join the NAB board in 2011, Dr Henry was regarded as a good, if cautious, forecaster. So ten years might be about the right answer.

He said there were “cultural inhibitors” at the bank, and he is right.

Deeply embedded within the workings of many financial institutions is a corrupt ethos of client exploitation.

These words might seem harsh, a kneejerk reaction to outrageous and possibly transient circumstances.

But they are neither my words, nor new ones.

Commissions corrupt, inevitably

Way back in 1826, when life insurance was in its infancy, it was already apparent that many policies were being mis-sold.

Charles Babbage, better known as the inventor of the first programmable computer, but also actuary of the Protector Life Assurance Society of London, identified the fundamental problem with commission-based selling of financial products, which he likened to “the acceptance of a bribe”.

It is a system, said Babbage, that will inevitably “corrupt and debase those through whom it is carried on”.

What Babbage described is what economists have subsequently called the “agency problem”, and it is endemic to commission-based remuneration where the agent is supposed to be working in the best interest of the client, but will gain greatest personal benefit by selling the product that offers the largest commission.

It is present whether the product is insurance, or financial advice, or a mortgage.

Bankers’ codes of ethics don’t work

The Royal Commission has shown that insurance companies, banks, brokers and advisers are prepared to trample on the trust placed in them by millions of Australians by putting their own income and interests ahead of their clients’.

The way professions have typically addressed the agency problem is by constructing a set of moral codes and formal regulations to prevent (or at least limit) bad behaviour.

Medics have their Hippocratic Oath; lawyers have their Code of Ethical Conduct, and in large measure they seem to work.

Insurers, bankers, brokers and financial planners have less formal codes of conduct, but it is now clear that they don’t work – they are little more than smokescreens to conceal self-interested avarice.

As Babbage noted almost two centuries ago, wherever financial products are sold on commission, the payment received by the agent or broker has all the characteristics of a bribe.

What will work is removing temptation

These habits of rapacity are so deeply ingrained in the culture and operation of financial institutions that no amount of self regulation, no elaboration or reinforcement of voluntary codes of conduct, has been able to spare the sector from the corruption and debasement that Babbage foresaw.

More self regulation won’t help.

Here’s what would.

First, ban commissions of all types

The government should impose an outright ban on the payment of any commission of any kind with respect to any consumer financial transaction.

The cost of the work should be transparently priced, and should be paid for at the point of delivery.

It would, at a stroke, end high-pressure selling and would reward financial advisers and brokers for the service they actually deliver to clients.

Those who deliver good advice would prosper. The rest would go out of business.

The idea lies at the heart of the banning of commissions in Labor’s Future of Financial Advice Act, which unfortunately did not extend its ban on commissions to those for insurance.

Then report fees as dollar amounts

Second, where clients buy a financial product that charges an annual management fee, such as a superannuation account, the fee should be reported to the client in dollar terms rather than the percentage of funds under management.

Each year the client should be given the option of a “free transfer” of their funds to an alternative provider that can offer the same product for a lower fee.

It would open up the opaque structure of management fees to critical review by clients, and would impose competitive pressure to drive down fees, which in Australia’s bloated superannuation sector are more than double the OECD average.

Such reforms would be greeted with howls of protest from super funds (and banks, where banks still control them) but as Babbage foresaw and the Royal Commission has demonstrated, the industry has become so beholden to its own self-interest that it has forfeited the right to control its future.

Author: Paul Johnson Warden, Forrest Research Foundation, University of Western Australia

ASIC ‘strongest message’ to banks was a press release

The chair of ASIC told the royal commission that ASIC’s strongest message to banks was an expression of disappointment in a press release, via  InvestorDaily.

James Shipton, chair of ASIC, was again on the stand during day five of the seventh round of the royal commission and told the commission that ASIC often sent to the banks the strongest message it could.

“We sent the strongest message we could have which was a public expression of disappointment, and also a private expression of disappointment,” said Mr Shipton.

“That is the strongest message you could have sent Mr Shipton?” said Ms Orr.

“That is what I have been advised,” said Mr Shipton.

Mr Shipton was responding to questions from counsel assisting Rowena Orr about the commissions response to NAB’s spot foreign exchange business.

ASIC entered an enforcement undertaking with NAB and it was negotiated that the bank would pay a $2.5 million community benefit and develop a program of changes within its foreign exchange business to prevent, detect and respond to conduct.

It was to be assessed by independent expert Promontory in November 2017, yet the commission heard that by March 2018, Promontory produced a report that it was unable to assess the program.

“Progress in developing the program has been slow. There appears to have been no comprehensive risk assessment across NAB’s spot foreign exchange business against the enforceable undertaking requirements and relevant regulatory standards and guidance,” said Promontory.

It was then decided that, despite the enforceable undertaking requiring it to take action, ASIC gave NAB another three months to deliver the program without any action taken against them for not complying.

Mr Shipton said that it was a reasonable decision and that NAB did face negative consequences for their failure to comply with the undertaking.

“Our approach, we wish our approach was stronger, but we sent the strongest message we could,” he said.

Mr Shipton throughout day 5 continued to assert that ASIC had made mistakes but that it hadn’t failed.

“I prefer mistakes. I use the expression mistakes because failings to me means there has been no success, no functioning and that we haven’t been doing it at all. And we have,” he said.

Another ‘mistake’ of ASICs was to offer infringement notices ahead of litigation, suggested Ms Orr, who questioned why the notices had to be voluntarily entered into by the entity.

“Why do you need to get an indication as to whether they will accept and pay it?  The parking inspector doesn’t seek an indication from the person he’s giving a parking fine to as to whether they will accept and pay it,” she said.

Mr Shipton blamed ASICs response on limited resources but said they did not cosy up to the banks.

Mr Shipton said the commission still sought indication from entity’s around infringement notices but that it had changed the mindset around litigation.

“The starting point today would be to ask the question and turn our minds to why not litigate this demonstrable breach,” he said.

Broker Commission Stoush Continues

From Australian Broker.

The Mortgage & Finance Association of Australia (MFAA) has responded to the comments made by Commonwealth Bank of Australia (CBA) CEO Matt Comyn during yesterday’s Royal Commission hearings.

During the hearing, Comyn expressed his preference to scrap broker commissions and implement a fee for service. The MFAA has said it clearly demonstrates that CBA’s priority is shareholder returns.

MFAA CEO Mike Felton said the CBA’s position was not surprising, but was “entirely selfserving”, in that it is designed to destroy competition and reduce the bank’s reliance on the broker channel.

He said, “CBA’s model is anti-competitive and designed to drive consumers back into their branch network, which is the largest branch network of the major lenders.

“Mr Comyn’s solution for better customer outcomes is a new fee of several thousand dollars to be paid by consumers to CBA for the privilege of becoming a CBA customer.

“Cutting what brokers earn by two-thirds would save CBA $197 million, which is good for CBA’s shareholders. However, it would destroy competition, leaving millions of customers without access to credit outside of major lenders.

“In addition, as has been highlighted by both the Productivity Commission and Treasury, consumers are simply not willing to pay significant up-front fees for access to a home loan.”

Felton has also addressed Comyn’s recommendation to follow a model adopted in the Netherlands, under which consumers pay the same fee whether they use a broker or a branch, to ensure channel parity.

He said, “The proposal to adopt the Netherlands strategy is designed to maximise lender revenue. Under this model, broker customers pay the broker’s costs – instead of the bank – or branch customers pay a new fee that will substantially add to the bank’s revenue line and add thousands of dollars to the cost of getting a home loan from a lender directly.

“This is a fantastic win-win for CBA but a massive lose-lose for consumers regardless of whether or not they use a mortgage broker. CBA either acquires a new customer with zero acquisition cost, or it receives a new fee and massively decreased competition, so it can return to the days of four lenders in Australia. It’s a great deal for the bank.

“Any suggestion that this profit will be passed back to customers in the form of lower interest rates is fanciful.”

Felton also questioned the idea that brokers should earn the same as an in-house branch lender, whose overheads are paid by the bank.

He said, “Brokers are small business owners. They are not employees offering one product to customers. They pay rent, and staff, and electricity bills. They have to find every dollar they earn through servicing customers well and developing a strong reputation and referral network.”

The MFAA challenged the statements by CBA that brokers are causing systemic issues in the home lending market – and that it should be a lender who is tasked with ensuring good consumer outcomes for the entire Australian home lending market.

He said, “ASIC’s extensive, data-driven review of mortgage broker remuneration concluded that there was no finding of systemic harm caused by the broker channel,” Mr Felton said. “Additionally, as noted by Treasury in its background paper to the Royal Commission in July 2018: ‘Following a comprehensive report by ASIC in 2017 on mortgage broker remuneration, the industry is progressing reforms that could address the most significant misconduct with the current remuneration model’.”

“Frankly, we were surprised that it is being suggested that one of the major lenders should be tasked with reforming Australia’s home lending market, given the revelations of the past 12 months.

“The Productivity Commission found that: ‘Fixed fees paid by customers rather than commission structures have been proposed, and would eliminate conflicts, but the cost to competition would be high. Consumers would desert brokers, and smaller lenders (and regional communities with few or no bank branches) would suffer much more than larger lenders, if customers were required to pay for broker advice’.”

CBA Had Suggested Broker Fee For Service

Commonwealth Bank’s CEO Matt Comyn spent yesterday (19 November) in front of counsel assisting Rowena Orr QC, discussing many of the issues which came about in commissioner Kenneth Hayne’s interim report, via Australian Broker.

During the hearing Comyn said he supported a flat fee for service remuneration model for brokers and regulation change over trail commission.

He also said he had been in talks as far back as April 2017 considering making the change for CBA, but in the week before feared a “first mover disadvantage” if no one else made the same move.

Comyn was quizzed on research he had put forward to both the Sedgewick review and ASIC’s review into broker remuneration and said that brokers were “sensitive to where the commission structure is set”.

This was due to the findings of one report which suggested that broker flows to lenders increased with higher broker commissions. According to this evidence, one lender gained a 5.9% market share when they offered a limited time commission increase and then lost 5.1% when it stopped.

Orr went on to ask Comyn about emails sent to former CEO Ian Narev, where Comyn had suggested a fee for service model as seen in the Netherlands.

He said it would work the same in Australia, where to level the playing field and “preserve” mortgage brokers, banks would also need to offer a fee to customers for the execution of a mortgage.

He said, “I think it would put a material disadvantage to the brokers if customers paid a broker but they didn’t have to pay a similar amount to a financial institution. I think that would create a distortion.”

Comyn said CBA had been looking at moving to a flat fee model back in April 2017, but was concerned other institutions would not follow.

He said, “We were struggling or grappling with how to implement, and I’m sure we will return to it, we felt there was a genuine first mover disadvantage.

“We didn’t think it would be replicated, absent regulatory intervention. Therefore, we didn’t think we would improve customer outcomes because, effectively, no one else would change their model. We would just originate fewer loans through that channel.”

Confirming Comyn’s stance on the broker remuneration model Orr said, “So you would like to change to a flat fee model?”

Comyn said, “I can certainly see advantages in that model, yes. I would add that that view would not be supported by other participants in the industry but my personal…”

Interrupting, Orr said, “I am asking you about your view, Mr Comyn?”

Comyn replied, “Yes, that is my view.”

Orr said, “You would prefer to move to that sort of model?”

To which Comyn said, “Yes, I would.”

Looking specifically at trail commission, Orr asked Comyn about the services brokers continue to provide after the loan is complete if that was the argument for trail.

Commissioner Hayen interjected and asked if there were any ongoing services supplied by a mortgage broker.

Comyn replied, “I think they would be limited, Commissioner.”

When asked if that meant “limited or none”, Comyn said, “Much closer to none”.

When Orr asked Comyn if he thought trail commissions needed regulatory change, he said “Yes”.

The emails to Narev also discussed how much revenue the broker would lose on an average loan. The broker revenue on an average loan at the time of the email written was $6627 and would be expected to reduce to $2310, in line with the “acceptable band for the price of financial advice”.