Category: Banking Culture

RC – But What Of The Structural Issues?

As the dust settles following the final Royal Commission Report, its clear that the recommendations have carefully avoided the root cause of the wells of pain which the hearings revealed. In fact the force of evidence from those hearings will be what sits in the memory, not the final report. Perhaps some of this was created by the carefully crafted terms of reference, which made it hard for the Commission to get to root causes; perhaps deliberately?

The report puts the onus on financial institutions and boards to change the culture. Good luck with that, on past experience. Especially if bonus payments are a critical part of remuneration.

Criminal proceedings may follow, and more than 20 institutions are there, but these now are referred back to the very regulators who were found wanting in the first place. And cases though the courts will take years. Will any bankers actually cope it for their illegal behaviour – we doubt it. NAB appears to have been called out for special mention.

ASIC and APRA clearly failed in their respective (if confused) roles and getting greater clarity via a super-regulator may help. But I am not sure the twin peaks model works nor are the regulators sufficiently resourced; and the big missing in action figure is the RBA, who leads the Council of Financial Regulators, along side the Treasury. They drove the debt bubble, and the banks responded. This whole structure is complex, opaque and can be gamed. In the new world, ASIC it seems will have clearer leadership in terms of legal compliance; good luck with that!

Removing commissions from Mortgage Brokers (over time) makes sense as it is clearly a case of conflicted remuneration. And pushing towards a unified best interests duty across mortgage and financial advice makes sense. I still do not know why we have put up with two regimes for so long, it was an accident of history which ASIC should have addressed.

Anti-hawking rules for insurance and superannuation makes sense and should always have been there. SME’s need more protection than they have, but this was not recommended.

The BEAR regime, is centred around compliance, and its extension to insurance and wealth management helps, a little. But the basis of assessment remains narrow and is thus incomplete.

And the big question, which was hooked into the long grass, was structural separation, between product sales and manufacturer; and advice. This to me is a root cause of the conflicts and bad behaviour. Hayne says:

Enforced separation of product and advice would be a very large step to take. It would be both costly and disruptive. I cannot say that the benefits of requiring separation would outweigh the costs, and the Productivity Commission concluded that ‘forced structural separation is not likely to prove an effective regulatory response to competition concerns in the financial system’.

I observe, however, that the Productivity Commission recommended, and I agree, that commencing in 2019, the Australian Competition and Consumer Commission (the ACCC) ‘should undertake 5 yearly market studies on the effect of vertical and horizontal integration in the financial system’.

I am not persuaded that it is necessary to mandate structural separation between product and advice.

Now some entities have already jettisoned wealth management businesses for example, but consumers may well still face inherent and undisclosed conflicts. Our large opaque integrated financial services players remain just that.

Thus bankers can issue a sigh with relief, despite the estimated $6 billion + and counting remediation bill. And I do not see anything here to reverse the tighter lending standards which are now rightly in force, so expect mortgage growth, and home prices to slide further.

But the once in a generation opportunity to fundamentally reform the financial system has been missed, I am afraid, and as a result consumers will continue to pay more than they should for their financial services, big players will still dominate, and regulators will remain pussycats. Not a good outcome in my view.

We will see the Polys mouth words about “consumer trust and protection”, yet in practice do very little. I have a diary card for 5 years from now, for the next review, and one 5 years after that.

The Royal Commission Recommendations

The final report from the Banking Royal Commission has been released, and it makes interesting reading. Here is a brief summary of the 950 pages. More to follow.

At the high level, the greed driven attitudes of the industry are highlighted as leading to the poor practice and illegal behaviour. This was driven by high pressure sales tactics. As a result the community trust in the financial sector has been lost. Change is needed – and culture of the entities and their boards are at the heart of it.

Consumers must be treated honestly and fairly.

The Treasurer says it was a scathing assessment driven by greed and poor behaviour. The price paid was financial, but also hitting people directly. Trust needs to be restored, whilst keeping competition, and the flow of credit.

Consumers will benefit from better protection. It will raise accountability and governance, enhance regulation, and provide for effective remediation.

It does not remove the twin peaks model, (APRA and ASIC).

More than 20 referrals to the regulators for criminal charges. No individuals were named.

The report has 76 Recommendations covering a wide range of issues. The Government says its will “take action” on them all. (Does not mean full implementation).

Of note is the establishment of a new super regulator to sit across APRA and ASIC to gauge their effectiveness and clarify roles and responsibilities. The Federal Court will have extra responses to progress the referrals.

Mortgage brokers will have a best interests duty and trailing commission will be banned in due course (July 2020). In addition there is a recommendation to move to fee for service paid by customers though the Government is slowing any such change (a 3 year review in the view of the impact of competition).

There will be one account for new superannuation savers and fees to be banned from My Super accounts. Changes to the add on to insurance via a cooling off period.

A Compensation scheme of last resort.

Expansion of the BEAR cultural framework.

No changes to responsible lending – its all about policing and compliance.

Nothing on structural separation, or horizontal or vertical integration. So the industry structure remains untouched.

The legislative response seems muted, and delayed to kick the burden down the track, after the election.

So my take is some progress, but not as much as perhaps many will wish for….

ASIC requires Commonwealth Financial Planning Limited to stop charging fees for ongoing services

ASIC says Commonwealth Financial Planning Limited (CFPL) has failed to provide ASIC with an attestation and with an acceptable Final Report from the independent expert, both of which were required under a Court Enforceable Undertaking (EU) entered into with ASIC in April 2018 in relation to CFPL’s fees for no service conduct.

As a result, CFPL is now required under the EU to immediately take all necessary steps to:

  • stop charging or receiving ongoing service fees from its customers; and
  • not enter into any new ongoing service arrangements with customers.

The EU, which commenced on 9 April 2018 and was varied on 20 December 2018, required CFPL to provide to ASIC by 31 January 2019:

  • a Final Report by the independent expert, Ernst & Young, on whether CFPL had taken reasonable steps to remediate customers impacted by CFPL’s fees for no service conduct and on the adequacy of CFPL’s systems, processes and controls; and
  • to provide an attestation from a Commonwealth Bank ‘accountable person’ under the Banking Executive Accountability Regime as to CFPL’s remediation program, and the adequacy of CFPL’s systems, processes and controls.

On 31 January 2019, Ernst & Young issued its second report under the EU, identifying further concerns regarding CFPL’s remediation program and its compliance systems and processes – including that there remains ‘a heavy reliance’on manual controls, which ‘have a higher inherent risk of failure due to human error or being overridden’.  Ernst & Young recommended CFPL address these issues within a further 120 days. 

On the same day, CBA’s accountable person provided a written update to ASIC on the remediation program and work being done in relation to CFPL’s systems, processes and controls. Having regard to the concerns raised by the independent expert and the contents of CBA’s written update, ASIC considered that the notification did not meet ASIC’s requirements under the EU for an acceptable attestation.

As a result, ASIC’s requirement under the EU that CFPL stop charging or receiving ongoing service fees and not enter into any new ongoing service arrangements, has been triggered. ASIC included this requirement in the EU to ensure that if CFPL were not able to satisfy ASIC that the fees for no service conduct would not be repeated, CFPL would have to stop charging ongoing service fees so as to significantly reduce any further risk to clients. Existing clients will continue to receive services under their ongoing service agreements but will not be charged by CFPL.

ASIC has received CFPL’s confirmation that it is complying with this requirement to stop entering into new ongoing service agreements and to cease charging existing clients fees under these agreements. This requirement will continue until CFPL is able to satisfy ASIC that all of the outstanding issues have been remedied. ASIC will be monitoring CFPL’s compliance with this obligation.

ASIC has also been informed by CFPL that it is now in the process of transitioning its ongoing service model to one whereby customers are only charged fees after the relevant services have been provided. ASIC will monitor CFPL’s transition to the new model.

Background

Under CFPL’s remediation program overseen by ASIC, CFPL has to date reported to ASIC that it has paid approximately $119 million to customers impacted by its fees for no service conduct.

Could Hayne destroy AMP’s wealth model?

In a research note published on Thursday, Morningstar analyst Chanaka Gunasekera said the most immediate near-term risk for AMP will be the royal commission’s final report, which the government will release after the market closes on Monday, 4 February; via InvestorDaily. 

“We expect the report to be highly critical of AMP’s governance and conduct,” the analyst said. 

“However, the key risk remains the potential for the royal commission to recommend the dismantling of the company’s vertically integrated wealth management business mode.

“While we think the most likely outcome is that a wholesale separation of its advice, platform, product manufacturing and other businesses will not be recommended, we nevertheless expect the recommendations will lead to a reduction in the competitive advantage of operating this vertically integrated model.”

In his interim report to the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry, Commissioner Hayne questioned vertical integration as it relates to financial advice.

“The one-stop shop has an incentive to promote the owner’s products above others, even where they may not be ideal for the consumer,” Mr Hayne said.

Morningstar also flagged the uncertainty around the strategy of AMP’s new chief executive Francesco De Ferrari, who has just taken up the reins and has been tasked with being a change agent for the group. 

While the new CEO’s strategy will largely depend on Hayne’s final report, there are other risks at play. 

“The political risks are heightened by the fact that a pseudo federal election campaign has commended, with the poll expected by the middle of May 2019,” Mr Gunasekera said. 

Morningstar will review the outlook for Aussie wealth managers following the publication of the royal commission final report. 

“From the perspective of banks, vertical integration always promised the benefit of cross-selling opportunities (the opportunities for cross-selling financial products to existing and new customers).

Evidence about platform fees and the provision of financial advice at the royal commission posed significant questions about the aspects of ‘one-stop shop’ models in advice industry.

In particular, it invited attention to how the vertical integration of the industry may harm clients by protecting platform entities associated with advice licensees from competitive pressures.

The commissioner claimed that clients end up paying more for platform services than other providers would charge for the same service.

In their response to the interim report, Australia’s largest financial institutions acknowledged that conflicts of interest exist but stressed that they can be managed effectively.

AMP’s submission argued that “there are many advantages of vertically integrated structures and that no recommendation should be made by the commission which would limit an entity’s commercial flexibility to adopt a vertically integrated model, as and when it considers it appropriate to do so.”

In an earlier submission to the royal commission, AMP outlined the following benefits to consumers of a vertically integrated model: 

– economies of scale which benefit consumers;

– potentially lowering the cost of advice;

– convenience of a relationship with a single financial institution;

– perceived safety in dealing with a large institution;

– having access to different forms of advice (e.g. phone, on-line, face to face);

– having trust in the institution; and

– that large institutions stand behind the advice that authorised representatives provide to customers and have the capacity to do so

Royal Commission Report Public Release Delayed

The office of the Treasurer has revealed that the final report will not be released on Friday. 

According to the release, the Australian Government will still receive the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry on Friday 1 February 2019.

However, it will not be released publicly until 4.10pm on Monday, 4 February. Following its release, the Treasurer will hold a press conference at Parliament House.

The interim report was released in September, when Treasurer Josh Frydenberg released the report the same day. 

During his speech at the time he called the report “frank and scathing” and thanked the commissioner for his work. 

He said the Royal Commission was announced last year because “the culture, conduct and the compliance of the sector is well below the standard the Australian people expect and deserve”.

Via Australian Broker.

APRA Holds Countercyclical Capital Buffer; Releases Assessment Of Measures To Lift Home Lending Standards

APRA has provided a justifying summary of their actions relating to home lending regulation, but warns that “many of the underlying structural risks associated with high household debt remain and will do so for some time”.

Despite this, they have chosen to keep the countercyclical capital buffer at zero. Housing credit growth is slowing, but there is nothing in this document to suggest APRA intends to loosen the requirements relating to home lending further – (unlike some of the commentators have been suggesting they should reduce the 7% floor rate).

So, as credit availability drives home prices, as we recently discussed, and underwriting is now in a new normal, we should expect more home price falls ahead. We discussed this is our recent video. And this before the Royal Commission reports!

The Australian Prudential Regulation Authority (APRA) has announced its decision to keep the countercyclical capital buffer (CCyB) for authorised deposit-taking institutions (ADIs) on hold at zero per cent.

The CCyB is an additional amount of capital that APRA can require ADIs to hold at certain points in the economic cycle to bolster the resilience of the banking sector during periods of heightened systemic risk. APRA reviews the buffer quarterly. It has been set at zero per cent of risk-weighted assets since it was introduced in 2016.

In its annual information paper on the CCyB released today, APRA outlined the core economic indicators that contributed to the decision, including:

  • moderate growth in housing and business credit over 2018;
  • a decline in higher-risk categories of new housing lending, including interest-only loans, investor loans and lending at high loan-to-value ratio (LVR) levels; and
  • continued strengthening in ADIs’ capital positions as they move to implement the requirements of “unquestionably strong” capital ratios.

Also influencing APRA’s judgement that a zero per cent CCyB setting remained appropriate has been the impact of measures that APRA has taken since 2014 to address systemic risks related to residential mortgage lending standards.

In a separate but related information paper also released today, APRA detailed its objectives for its interventions in the residential mortgage lending market in recent years, which were aimed at reinforcing sound mortgage lending standards and increasing the resilience of the banking sector in the face of heightened risks. These risks included an environment of rising household debt, subdued wage growth, rising house prices, and an erosion of bank lending standards at a time of historically low interest rates. Concerned that the banking sector may be increasing its vulnerability to future shocks, APRA’s response was to undertake a program of work to strengthen and embed sound lending policies and practices, particularly in relation to borrower serviceability, supported by temporary benchmarks to incentivise lenders to moderate the growth in lending to investors and the volume of interest-only lending.

Some of the key findings within the paper include:

  • ADIs have lifted the quality of their lending standards, with improvements in policies and practices across the industry;
  • During the period in which the adjustments were occurring (2015-2018), the growth in total credit for housing was stable;
  • The composition of credit for housing, however, changed notably: the rate of growth of lending to investors fell considerably, and the proportion of loans written on an interest only basis roughly halved (although, given the high starting point, one in five loans is still made on an interest-only basis);
  • Although APRA did not introduce measures to specifically target lending with high loan-to-value (LVR) ratios, there has been a moderation in high LVR lending in recent years;
  • Initially, ADIs sought to adjust lending practices without resorting to interest rate increases. Ultimately, however, interest rates were used to help manage demand for credit. The pricing differential that has emerged between owner-occupied and investor loans, and between amortising and interest-only loans, is often seen to be a product of the APRA benchmarks, but is also reflective of changes to capital requirements that will likely see differential pricing for higher risk lending continue into the future; and
  • APRA’s actions revealed a number of system and data deficiencies within ADIs that constrained their ability to adjust their practices. In addition, smaller ADIs tended to find it more difficult to manage quantitative-based constraints. That said, the period in which the benchmarks were in place saw small ADIs increase their market share slightly, partly reflecting APRA’s approach, which provided more flexibility for smaller ADIs.

Chairman Wayne Byres said that after the announcement of the removal of the investor and interest-only benchmarks last year, it was appropriate for APRA to review the impact of its regulatory actions, and reflect on whether their objectives had been achieved.

“APRA could have chosen to utilise the countercyclical capital buffer as a means of building resilience in the banking system. However, APRA took the view that the better course of action was to address, through targeted measures, the underlying concern – the erosion in lending standards driven by strong competitive pressures amongst housing lenders.

“APRA’s assessment is that, collectively, its interventions achieved the necessary objective of strengthening lending standards and reducing a build-up of systemic risk in residential mortgage lending. The review provides some valuable insights on the impact of the measures, which have necessarily involved some trade-offs and judgement in the process of strengthening the resilience of the banking sector.

“Importantly, while the temporary lending benchmarks are being removed, the changes we have made to lift lending standards are designed to be permanent, continuing to support the resilience of the banking system and ultimately the protection of bank deposits,” Mr Byres said.

In conjunction with the other agencies on the Council of Financial Regulators, APRA will continue to closely monitor economic conditions, and will adjust the CCyB if future circumstances warrant it. Separately, APRA is also considering setting the buffer at a non-zero default rate as part of its ongoing review of the ADI capital framework.

The countercyclical capital buffer information paper, and the review of APRA’s prudential measures for residential mortgage lending risks can be viewed on the APRA website at https://www.apra.gov.au/information-papers-released-apra.

RBNZ Bank Financial Strength Dashboard wins international award

Central Banking Publications has named the Bank Financial Strength Dashboard as ‘Initiative of the Year’ in its annual awards.

In announcing the award, Central Banking commented that very few central banks have opened up their financial system to public scrutiny to quite the same level as the Reserve Bank of New Zealand.

They said that by revealing key metrics on the banking sector in a visual format that can be taken in at a glance, the Reserve Bank has hit on a simple method of boosting discipline among banks.

Reserve Bank Governor Adrian Orr said the award was a great honour.

“We aspire to be a ‘Great Team, Best Central Bank’ and the award recognises a significant step towards that goal,” Mr Orr said.

“Awareness among consumers and investors is an important aspect of ensuring a sound financial system. The Dashboard is designed to make it easy to access and understand the financial position of New Zealand banks. By keeping the public informed about risks to the sector, banks themselves are held to greater market discipline.

“The Dashboard has proven very popular, with more than 10,000 visits per quarter since its launch and we believe this has significantly broadened the audience for prudential disclosures.

“It is the result of huge effort and dedication from many people in our organisation and the sector at large. I congratulate them all and encourage people to use the Dashboard when making banking decisions,” Mr Orr said.

Background

Central Banking Publications is a financial publisher owned by Incisive Media and specialising in public policy and financial markets, with emphasis on central banks, international financial institutions and financial market infrastructure and regulation.

Central Banking Publications was founded in 1990, and makes a number of annual awards to central banks and market participants over a range of categories. This is the sixth year of the awards.

The Reserve Bank previously won the ‘Initiative of the year’ award in 2016 for its enterprise risk management system. It has also won ‘Central Bank of the Year’ in 2015 and Reserve Bank senior adviser Leo Krippner won the award for ‘Economics in Central Banking’ in 2017.

Judging was by the Central Banking Awards Committee, which is made up of the Central Banking Editorial Team and Editorial Advisory Board, comprising former senior central bank governors from around the world. The awards will be presented at a gala dinner in London on 13 March.

We Need To Think Differently About Our Banking System – Part 2 – The rise of the neobank

Could new innovators create a wave of disruption in the banking sector? APRA’s new rules provides an on-ramp and players are already appearing. The high penetration of mobile devices offers potential, perhaps. This from Investor Daily.

On Tuesday (18 December), the prudential regulator announced that Xinja Bank Limited has been officially authorised as a restricted deposit-taking institution (RADI). 

Xinja is only the second Australian neobank to receive this status. Volt Bank was granted a RADI in May, literally days after APRA finalised the framework, which was created in response to the government’s push for greater innovation and new entrants to the banking industry. 

However, as its name suggests, a restricted ADI licence has significant limitations. A RADI is really a stepping stone on the journey to acquiring a full banking licence. It allows neobanks like Xinja and Volt to conduct limited banking capabilities for a maximum period of two years while they develop their capabilities and resources. It also gives them time to raise the significant levels of capital required to meet APRA’s demands for a full banking licence. 

RADI’s must hold a minimum $3 million in capital, or 20 per cent of adjusted assets, and can only hold $2 million worth of customer deposits. When you consider that Australia’s largest bank, CBA, holds more than $150 billion in customer deposits, you get an idea of the competitive dynamics at play here. 

However, the royal commission has severely damaged the reputations of the incumbent banks like CBA and customers are arguably more open to alternative offerings. Neobanks like Volt and Xinja could be poised to capture a decent share of the banking sector – provided they have their ducks in a row. 

Volt, led by former NAB and Barclays executive Steve Weston, is arguably the frontrunner in the race to obtain the much-coveted full banking licence. The speed at which Volt was able to secure a RADI is worth noting. Investor Daily understands that the group has been working tirelessly to secure a banking licence as soon as possible. 

The word on the street is that Volt could be given full ADI status by the end of the year after it brought in KPMG’s corporate finance team to facilitate a capital raise of around $40 million. 

Anyone looking to make a bet on whether or not a brand-new challenger bank can succeed in a market as oligopolistic at Australia’s needs to consider two things: how willing customers are to try them out and if they have succeeded in other markets. 

The customer demand is clearly there. The royal commission has provided the perfect platform for neo-banks tell their story, which is the antithesis of what we heard from the banks during the Hayne inquiry.

A quick look at Volt’s website shows the bank is tapping directly into the complaints of Australian banking customers and addressing them head-on. 

“We’ll always give you honest recommendations to protect your money and your data,” the company promises. 

“We’ll remove speed bumps and will use the best available tech to make things easy and simple.

“We’ll suggest ways to save you time and money, both when you borrow and when you spend.”

Where incumbents have been slammed for predatory lending tactics and high credit card fees, neobanks are looking at ways to harness technology to provide a disciplined approach to lending, saving, spending and investing money. Responsibility is high on their agenda. I’ve heard that one potential Volt Bank feature will allow customers to set parameters that lock them out of their account for a 24-hour period if they know they’ll be in a situation where spending could get out of control, like a pub or casino. 

Challenger banks have made significant inroads in the UK, which is always a good market to follow for clues about what will happen in Australia. Our British cousins were a few years ahead of us on mortgage reform, macro prudential measures and the rise of the neobank. 

Groups like Aldermore, Atom Bank, Metro Bank and Monzo have cropped up since the GFC. Metro Bank launched in 2010, when the shocks of the financial crisis were still being felt by many, and became the first new ‘high street’ bank to launch in Great Britain in over 100 years. 

From a standing start less than a decade ago, the bank has grown customer deposits to over £11.7 billion ($20.6 billion) and recorded £16.4 billion ($28.8 billion) in asset in FY17. 

While Metro Bank competes directly with the UK’s high street incumbents like HSBC and Santander, Australia’s neo-banks will offer a completely digital service. 

With more and more Australians using their smartphone for everyday banking, a simplified customer-friendly approach to financial services could be the winning ticket for groups like Volt and Xinja. Particularly as the majors face the challenging task of transforming from large, slow-moving machines to nimble, more efficient operators.