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.