Westpac incurred a first strike against its remuneration report at its annual general meeting this week, where chairman Lindsay Maxsted said the ruling would send a strong message to the board; via InvestorDaily.
CEO Brian Hartzer along with Mr Maxsted also addressed the royal
commission, the bank’s financial performance for the past year and the
executives’ remuneration in the company’s AGM.
Peter Hawkins, non-executive director, retired following the AGM,
after 10 years of being on the board. Westpac will be electing two new
non-executive directors in the first half of calendar 2019.
While the poll on the remuneration report among shareholders had not
been completed at the time of the chairman’s address, more than half of
the votes already received were against the resolved salaries.
“Feedback from shareholders has varied, but the key point from those
voting against the remuneration report has been that although the board
took events over the year into account, many have questioned whether we
went far enough, particularly in reducing short-term variable reward
paid to the CEO and other executives,” Mr Maxsted said.
The short-term variable reward for the Westpac CEO and group
executives in Australia were on average, 25 per cent lower than last
year.
No long-term variable reward was vested in 2018. Around one-third of
the board’s potential remuneration forfeited, which Mr Maxsted said was
equivalent to about $18 million.
The CEO saw his short-term variable reward outcome cut by 30 per cent, or $900,000 over the past year.
The largest individual year on year reduction was 50 per cent, although Westpac did not disclose who it was, or for what reason.
“This is entirely consistent with the relatively weak performance of
shares in the banking sector, including Westpac, over the last few
years, including the 2018 financial year,” Mr Maxsted said.
“Putting this another way, for the CEO, his total variable reward outcome was 36 per cent of his total target variable reward.”
The chairman said the key failings from Westpac in light of the royal
commission were not fully appreciating the underlying risks in the
financial planning business, employee remuneration contributing to poor
behaviour and inadequacy in dealing with complaints.
“Better training and supervision, changes to the way financial
planners were remunerated, and better documentation of advice was
required,” Mr Maxsted said.
“As we have seen across the industry, where we get it wrong, the remediation is costly,” Mr Hartzer said.
“What has been clear is that we have not always embedded strong
enough controls and record-keeping around ensuring that customers
received the advice they had signed up for.”
Mr Maxsted also cited Westpac’s slowness in focusing on non-financial risks.
“In 2018, our financial performance was mixed; we have further built
on the balance sheet and financial strengths that are a hallmark for
Westpac but our annual profit was relatively flat over the year,” Mr
Maxsted said.
Cash earnings for the year ended 30 September was $8 billion, $3
million up on the year before. Reported profit reached $8.1 million,
increasing by 1 per cent from the prior corresponding period.
Business Bank grew profits by 8 per cent and New Zealand was up 5 per
cent. Excluding the cost of remediation provisions, BT’s profit was
down 1 per cent.
Institutional Banking saw its profit go down by 6 per cent, which Mr
Hartzer said largely represents a slowdown in financial markets
activity.
The bank also saw a slowdown in housing lending, with credit growing
5.2 per cent in the past 12 months, when it was 6.6 per cent in 2017.
“The group began the year solidly with good growth and well-managed
margins in the first half. Conditions in the second-half, however, were
more difficult with higher funding costs, lower mortgage spreads, and a
reduced markets and treasury contribution,” Mr Maxsted said.
“In addition, we needed to lift provisions associated with customer
refunds and regulatory/litigation costs as we address some of the legacy
issues alluded to earlier.”
The board determined a final dividend of 94 cents per share,
unchanged over the prior half and consistent with the final dividend for
2017. The full year dividend comes to 188 cents per share, unchanged
from the year before.
Mr Maxsted also noted Westpac removing grandfathered commission
payments in the past year, saying it was the first in the market to do
so.
“With revenue growth continuing to be a challenge, we have re-doubled
our efforts to reduce costs by simplifying our products, automating
process and modernising our technology platform,” Mr Hartzer said.
“Over recent years, we have delivered productivity savings of around
$250-300 million per year. In 2019, we aim to lift that to more than
$400 million – almost one third higher than 2018.”
Mr Maxsted also mentioned the bank’s development of its new Customer
Service Hub, the group’s multibrand operating system. The system is now
in pilot and will go live with new Westpac mortgages in 2019.
In terms of outlook, Mr Hartzer said that while it seemed positive as
a whole for the Australian economy, for banks, it looked more
challenging.
“Although credit quality is likely to remain a positive, low interest
rates, slowing credit growth, and a fall in consumer and business
confidence – especially about house prices – puts pressure on bank
earnings growth,” he said.
In a statement this morning, Bank of Queensland said the BOQ and Freedom had mutually agreed to terminate the St Andrews Insurance sale and purchase agreement.
“Following the termination of the agreement with Freedom, BOQ will continue to assess its strategic options in relation to St Andrew’s. In the meantime, St Andrew’s continues to be a strongly capitalised business that remains focused on delivering for its customers and corporate partners,” BOQ said.
The troubled Freedom Insurance Group last week completed its
strategic review, which was prompted by ASIC’s recommendations about the
life insurance industry.
As part of the review, which was conducted in collaboration with
Deloitte, the Freedom board identified that the company may face a
liquidity shortfall during calendar year 2019 arising from the timing of
payments of commission clawbacks in the absence of receipts of
commissions from new business sales.
Freedom had been pursuing equity funding for the purposes of the St Andrews acquisition, the process of which has included the provision of confidential due diligence to prospective third-party investors and negotiation of related transaction documentation.
it became clear that the conditions of the transaction would not be satisfied within the time limits contained in the sale agreement they said..
“In this regard, the company is considering alternate options to address the potential shortfall,” the group said in a trading update”.
“In addition, Freedom is implementing initiatives to improve operational efficiency and reduce costs.”
Freedom expects to make a provision for net remediation costs in its
financial accounts for the period ending 31 December 2018 of between
approximately $3 million and $4 million.
He concludes that “Global developments undoubtedly influence Australian financial conditions. In particular, developments abroad can influence the value of the Australian dollar and affect global risk premia. But changes in monetary policy settings elsewhere need not, and do not, mechanically feed through to the funding costs of Australian banks, and hence their borrowers are insulated from such changes”.
But the higher bank funding rate spreads which see here are perhaps more of a reflection of the risks the markets are pricing in, than anything else. Yet this was not discussed. Too low rates here for several years are the root cause (and guess where the buck for that stops?). This led to overheated lending, and home prices, which are now reversing, with obvious pressures on the banks. This leaves the economy open to higher rates, from overseas ahead.
This is the speech:
Australia is a small open economy that is influenced by developments in the rest of the world.
Financial conditions here can be affected by changes in monetary policy settings elsewhere, most
particularly in the United States given its importance for global capital markets. However,
Australia retains a substantial degree of monetary policy autonomy by virtue of its floating
exchange rate. In other words, a change in policy rates elsewhere need not mechanically feed
through to Australian interest rates. While Australian banks raise significant amounts of
funding in offshore markets, they are able to insulate themselves – and by extension
Australian borrowers – from changes in interest rates in other jurisdictions.
Just before delving into the details, some context is in order. First, Australian banks have long
borrowed in wholesale markets, including those offshore. However, they do so much less than used
to be the case (Graph 1).[1]
For a number of reasons, domestically sourced deposits have become an increasingly large share of
overall funding for banks.[2]
Graph 1
Second, to the extent that Australian banks have continued to tap offshore wholesale markets, it
is worth reflecting on some of the characteristics of this borrowing. For instance, some
banking sectors around the world borrow in US dollars in order to fund their portfolios of US
dollar assets.[3] This
can leave them vulnerable to intermittent spikes in US interest rates. However, this is
generally not the case for Australian banks. Rather, a good deal of the borrowing by Australian
banks in US dollars reflects the choice of the banks to diversify their funding base in what are
deep, liquid capital markets. By implication, if the costs in the offshore US dollar funding
market increased noticeably relative to the home market, then Australian banks can pursue other
options. They might opt to issue a little less in the US market for a time, switching to other
markets or even issuing less offshore. They are not ‘forced’ to acquire US dollars
at any price, as some other banks may be. Another important feature of this offshore funding, as
I will address in detail in a moment, is that the banks are not exposed to exchange rate risks
as they hedge their borrowings denominated in foreign currencies.
Independence – It’s an Australian Dollar Thing
As you are well aware, the US Federal Reserve has been raising its policy rate in recent years,
and interest rates in the United States are now higher than in Australia. These developments
reflect differences in spare capacity and inflation: unemployment in the United States is at
very low levels, inflation is at the Fed’s target and inflationary pressures appear to be
building. Since August 2016 – the last time the Reserve Bank changed its cash rate
target – the Federal Reserve has raised its policy rate seven times, by 175 basis points
in total (Graph 2). Yet while Australian banks raise around 15 per cent of their
funding in US dollars, interest rates paid by Australian borrowers since then have been little
changed.
Graph 2
How is it that interest rates for Australian borrowers have been so stable, despite Australian
banks having borrowed some US$500 billion in the US capital markets, in US dollars, paying US
dollar interest rates? The answer lies in the hedging practices of the Australian financial
sector. As I’ll demonstrate, Australian banks use hedging markets to convert their US
interest rate obligations into Australian ones.
The Australian banks fund their Australian dollar assets via a number of different sources. Some
of their funds are obtained in US dollars from US wholesale markets. In order to extend these
USD funds to Australian residents, they convert the US dollars they have borrowed into
Australian dollars soon after the securities are issued in the US. On the surface it would
appear that such transactions could give rise to substantial foreign exchange and interest rate
risks for Australian banks given that:
the banks must repay the principal amount of the security at maturity in US dollars. So an
appreciation of the US dollar increases the cost of repaying the loan in Australian dollar
terms; and
the banks must meet their periodic coupon (interest) payments in US dollars, which are tied to
US interest rates (either immediately if the security has a floating interest rate, or when
the security matures and is re-financed). So a rise in US interest rates (or an appreciation
of the US dollar) would increase interest costs for Australian banks that extend loans to
Australian borrowers.
However, it is standard practice for Australian banks to eliminate, or at least substantially
reduce, these risks. They can do this using a derivative instrument known as a cross-currency
basis swap. Such instruments are – when used appropriately – a relatively
cost effective way of transferring risks to parties with the appetite and capacity to bear them.
Simply put, cross-currency basis swaps allow parties to ‘swap’ interest rate streams
in one currency for another. They consist of three components (Figure 1):
first, the Australian bank raises US dollars in the US wholesale markets. Next, the
Australian bank and its swap counterparty exchange principal amounts at current spot
exchange rates; that is, the Australian bank ‘swaps’ the US dollars it has just
borrowed and receives Australian dollars in return. It can then extend Australian dollar
loans to Australian borrowers;
over the life of the swap, the Australian bank and its swap counterparty exchange a stream
of interest payments in one currency for a stream of interest receipts in the other. In this
case, the Australian bank pays an Australian dollar interest rate to the swap counterparty
and receives a US dollar interest rate in return. The Australian bank can use the interest
payments from Australian borrowers to meet the interest payments to the swap counterparty,
and it can pass the interest received from the swap counterparty onto its bondholders;
At maturity of the swap, the Australian bank and its swap counterparty re-exchange principal
amounts at the original exchange rate. The Australian bank can then repay its bond
holders.[4]
In effect, the Australian bank has converted its US dollar, US interest rate obligations into
Australian dollar, Australian interest rate obligations.
Figure 1
An analogy related to housing can help to further the intuition here. Imagine a
Bloomberg employee who owns an apartment in New York but has accepted a temporary job in Sydney.
She fully expects to return to New York and wishes to keep her property, and she does not wish
to purchase a property in Sydney. The obvious solution here is for her to receive rent on her
New York property and use it to pay her US dollar mortgage. Meanwhile, she can rent an apartment
in Sydney using her Australian dollar income. In other words, our relocating worker can
temporarily swap one asset for another. As a result, she can reduce the risks associated with
servicing a US mortgage with an Australian dollar income.
As I mentioned earlier, it is common practice for Australian banks to hedge their foreign
currency borrowings with derivatives to insulate themselves and their Australian borrowers from
fluctuations in foreign exchange rates and interest rates. The most recent survey of hedging
practices showed that around 85 per cent of banks’ foreign currency liabilities
were hedged (Graph 3). Also, the maturities of the derivatives used were well matched to
the maturities of the underlying debt securities.[5]
This means that banks were not exposed to foreign currency or foreign interest rate risk for the
life of their underlying exposures. By matching maturities, banks also avoided the risk that they
might not be able to obtain replacement derivatives at some point in the future (so called
roll-over risk).
Graph 3
For the very small share of liabilities that are not hedged with derivatives, there is almost
always an offsetting high quality liquid asset denominated in the same foreign currency of a
similar maturity, such as US Treasury Securities or deposits at the US Federal Reserve. Taken
together, these derivative hedges and natural hedges mean than Australian banks have only a very
small net foreign currency and foreign interest rate exposure overall (Graph 4).
Graph 4
So who is bearing the risk?
Despite Australia’s external net debt position,
in net terms Australian residents have passed on – for a cost, as we shall see – key
risks associated with their foreign currency liabilities to foreign residents. Australian
residents have found enough non-residents willing to lend them Australian dollars and to receive
an Australian interest rate to extinguish their foreign currency liabilities. As a result,
Australians are net owners of foreign currency assets, not borrowers.[6] Collectively,
Australians have used hedging markets and natural hedges to (more than) eliminate their
exchange-rate exposures associated with raising funds in offshore markets.
Australians’ ability to find non-residents willing to assume Australian dollar and Australian
interest rate risks is a reflection of the willingness of non-residents to invest in Australian
dollar assets. This in turn reflects Australia’s status as a country that has long had strong
and credible institutions, a high credit rating and mature and liquid capital markets. The
willingness of these non-resident counterparties to assume these risks via a direct exposure to
Australia’s banking system – sometimes for as long as thirty years – reflects the fact that
Australia’s banks are well-capitalised and maintain high credit ratings. In short, Australians
have found a source of finance unavailable domestically (at as reasonable a price), and
non-residents have found an asset that suits their portfolio needs.
Since there are no free lunches in financial markets, there is the question of the cost for
Australian banks to cover these arrangements. One part of this cost is known as the basis.
An imperfect world
Some swap counterparties have an inherent reason to enter into
swap transactions with Australian banks. In other words, such exposures actually help them to
manage their own risks. Non-residents that issue Australian dollar debt – in the so called
Kangaroo bond market – are a case in point. These issuers raise Australian dollars to fund
foreign currency assets they hold outside of Australia. This makes them natural counterparts to
Australian banks wanting to hedge their foreign currency exposures. Similarly, Australian
residents invest in offshore assets. To the extent that they want to hedge the associated
exchange rate exposures, they too would be natural counterparties for the Australian banks.
However, it turns out that these natural counterparties do not have sufficient hedging needs to
meet all of the Australian dollar demands of the Australian banks. So in order to induce a
sufficient supply of Australian dollars into the foreign exchange swap market, Australian banks
pay an additional premium to their swap counterparts on top of the Australian dollar interest
rate. This premium, or hedging cost, is known as the basis. Simply put, the basis is the price
that induces sufficient supply to clear the foreign exchange swap market.[7]
Since the start of the decade, the basis has oscillated around 20 basis points per annum (Graph 5).
Typically, though not always, the longer a bank wishes to borrow Australian dollars, the higher
the premium it must pay over the Australian dollar interest rate.
Graph 5
You may be wondering why Australian banks are willing to pay this premium; why don’t they
instead only borrow Australian dollars in the Australian capital markets to meet their financing
needs? In addition to the prudent desire to have a diversified funding base as I mentioned
earlier, the short answer is that it may not be cost-effective to raise all their funding at
home. What tends to happen is that banks – to the extent possible – seek to equalise
the marginal cost of each unit of funding from different sources. If they were to obtain all of
their funding at home, that would be likely to increase the cost of those funds relative to
funds sourced from offshore. So the all-in-cost of the marginal Australian dollar from domestic
sources will tend to be about the same as the marginal dollar obtained from offshore.
Astute students of finance will also wonder why the basis is not arbitraged away.[8]
The answer is that structural changes in financial markets have widened the scope for market
prices to deviate from values that might prevail in a world of no ‘frictions’. This
is consistent with the concept of ‘limits to arbitrage’ (which the academic
community only started to re-engage with in the past couple of decades). Arbitrage typically
requires the arbitrageur to enlarge their balance sheet and incur credit, mark-to-market and/or
liquidity risk. As Claudio Borio of the BIS has noted: balance sheet space is rented, not free.
And the cost of that rent has gone up.[9]
What about financial conditions more generally?
None of this is to suggest that
monetary policy settings in the United States (and elsewhere for that matter) have no impact on
financial conditions here in Australia. But the link is neither direct nor mechanical.
The primary channel through which foreign interest rates influence Australian conditions is
through the exchange rate. An increase is policy rates elsewhere will, all else equal, tend to
put downward pressure on the Australian dollar, because capital is likely to be attracted to the
higher rates of return available abroad. A depreciation of the Australian dollar in turn will
tend to enhance the competitiveness of our exporters, including those services priced in
Australian dollars like tourism and education. Through various channels, exchange rate
depreciation can also loosen financial conditions in Australia, which is not always the case in
other countries, particularly those for which inflation expectations are not well anchored and
where there are substantial foreign currency borrowings that are unhedged.[10]
Foreign monetary policy settings, particularly those in the United States, can also affect global
risk premia. We are now approaching a period when US monetary policy is moving to a neutral
stance. This follows a lengthy period of very easy monetary conditions, which may have
encouraged investors to ‘search for yield’ to maintain nominal portfolio returns in
an environment of low interest rates. The expectation of low and stable policy rates and
inflation outcomes in turn compressed risk premia across a range of asset classes. In the period
ahead, it seems plausible that term and credit risk premia will rise, which will increase costs
for all borrowers, Australian banks included.
The board of IOOF Holdings has today announced that IOOF managing director, Christopher Kelaher and chairman, George Venardos, have agreed to step aside from their respective positions effective immediately, pending resolution of proceedings brought by the Australian Prudential Regulation Authority (APRA) and announced last Friday, 7 December.
Mr Renato Mota, currently group general manager – wealth management,
has been appointed acting chief executive officer and Mr Allan
Griffiths, a current non-executive director of IFL, is acting chairman.
Both Mr Kelaher and Mr Venardos will be on leave while they focus on
defending the actions brought against them by APRA.
Chief financial officer David Coulter, company secretary Paul Vine
and general counsel Gary Riordan will remain in their positions, however
will have no responsibilities in relation to the management of the IOOF
trustee companies and will have no engagement at all with APRA during
this period, including in relation to the matters the subject of APRA’s
announcement of Friday 7 December.
“We maintain our position that the allegations made by APRA are
misconceived, and will be vigorously defended. The Board believes that,
in the interests of good governance, it is appropriate that Chris and
George step aside from their positions. The Board will also commence a
search for an additional non-executive Director,” Acting chairman, Allan
Griffiths said
“We acknowledge the seriousness of these allegations. We have a
responsibility to our superannuation members, shareholders, advisers,
employees and the wider community, to take decisive action.
“We are entirely focused on addressing the governance issues in the
interests of all stakeholders and will do so in an orderly manner.
“I will personally lead our review of the situation and, alongside
acting CEO Renato Mota, will work cooperatively with APRA to continue to
implement previously agreed initiatives. Many of these actions are
already complete.”
IOOF posted an underlying net profit after tax result in financial
year 2018 of $191.4 million, up 13 per cent on the financial year 2017
result.
“These results have been delivered by our unwavering commitment to
our clients, driven by our talented people and a recognition of the
importance of advice. We remain committed to the ANZ transaction and we
are working cooperatively with ANZ as they consider their position,” Mr
Griffiths said.
The prudential regulator is seeking to impose additional licence
conditions and issue directions to APRA-regulated entities in the IOOF
group.
The proceedings in the Federal Court seek to disqualify five
individuals that were responsible persons at IOOF Investment Management
Limited (IIML) and Questor Financial Services.
The proceedings are also seeking a court declaration that IIML and Questor breached the SIS Act.
The announcement drove ANZ to rethink the sale of its wealth business
to IOOF. ANZ released an update on its sale following APRA’s move to
disqualify IOOF individuals and its move to apply licence restrictions
on the group.
ANZs deputy chief executive Alexis George said ANZ would reassess the
sale of its OnePath Pensions and Investments business to IOOF.
“Given the significance of APRA’s action, we will assess the various
options available to us while we seek urgent information from both IOOF
and APRA.
“The work to separate Pensions and Investments from our Life
Insurance business continues. There is a framework available to complete
the Zurich transaction that does not involve IOOF,” he said.
The Australian Prudential Regulation Authority (APRA) has announced a number of actions against IOOF entities, directors and executives for failing to act in the best interests of superannuation members.
APRA has commenced disqualification proceedings and is seeking to impose additional licence conditions and issue directions to APRA-regulated entities in the IOOF group.
APRA has issued a show cause notice setting out APRA’s intention to direct IOOF Investment Management Limited (IIML) to comply with its Registrable Superannuation Entity (RSE) Licence and impose additional conditions on the licenses of IIML, Australian Executor Trustees Limited (AET) and IOOF Ltd (IL). These entities have 14 days to respond to this notice.
The proposed conditions and directions to comply with conditions seek to achieve significant changes to the identification and management of conflicts of interest by IIML, AET and IL and facilitate APRA’s ability to take further enforcement action should this not occur. The proposed additional conditions on the licences of IIML, AET and IL are based on issues and concerns raised by APRA since 2015 relating to the entities’ organisational structure, governance and conflicts management frameworks, and require the entities to address these within specified timeframes. The proposed directions for IIML relate to an independent report issued by Ernst & Young, the findings of which provide a reasonable basis to conclude that IIML has breached section 52 of the Superannuation Industry (Supervision) Act 1993 (SIS Act), Prudential Standard SPS 520: Fit and Proper and Prudential Standard SPS 521: Conflicts of Interest.
APRA has also commenced proceedings in the Federal Court of Australia to seek the disqualification of five individuals that, at relevant times, were responsible persons of IIML and Questor Financial Services Limited (Questor). The proceedings also seek a court declaration that IIML and Questor (which at the material times were RSE Licensees owned by IOOF Holdings Limited) breached the SIS Act.
The individuals included in the disqualification proceedings are Managing Director Chris Kelaher, Chairperson George Venardos, Chief Financial Officer David Coulter, General Manager – Legal, Risk and Compliance and Company Secretary Paul Vine, and General Counsel Gary Riordan.
The Concise Statement seeks disqualification orders and declarations in relation to breaches of sections 52 and 55 of the SIS Act and Prudential Standards, and associated conduct. As outlined in the Concise Statement, APRA considers that IIML, Questor and the relevant individuals did not appropriately acknowledge and address issues concerning conflicts of interest raised by APRA from 2015 to date. In particular, APRA identified that on three separate occasions in 2015, Questor and IIML contravened the SIS Act by deciding to differentially compensate superannuation beneficiaries and other non-superannuation investors for losses caused by Questor, IIML or their service providers, with superannuation beneficiaries being compensated from their own reserve funds rather than the trustees’ own funds or third-party compensation.
If successful, the disqualification proceedings would prohibit the above individuals from being or acting as a responsible person of a trustee of a superannuation entity.
APRA Deputy Chair Helen Rowell said APRA had sought to resolve its concerns with IOOF over several years but considered it was necessary to take stronger action after concluding the company was not making adequate progress, or likely to do so in an acceptable period of time.
“APRA’s efforts to resolve its concerns with IOOF have been frustrated by a disappointing level of acceptance and responsiveness to the issues raised by APRA, which is not the behaviour we expect from an APRA-regulated entity,” Mrs Rowell said.
“The actions we are now taking are aimed at achieving enduring change to ensure that the trustees of the superannuation funds operated by IOOF fully meet their obligation to put the interests of members ahead of all other interests.
“Furthermore, the individuals included in the proceedings have shown a lack of understanding of their personal and trustee obligations under the SIS Act and at law, and a lack of contrition in relation to the breaches of the SIS Act identified by APRA.”
The Central Bank has finally released details of the landmark prosecution that involved two of its subsidiary companies involved in bribing overseas officials for note-printing contracts, via InvestorDaily.
Following a decision by the Supreme Court of Victoria this week, the Reserve Bank of Australia (RBA) is able to disclose that in late 2011, its subsidiaries – Note Printing Australia (NPA) and Securency – entered pleas of guilty to charges of conspiracy to bribe foreign officials in connection with banknote-related business.
The offences were committed over the period from December 1999 to September 2004.
The RBA and the companies were not permitted to disclose these pleas prior to today due to suppression orders, which have now been lifted. The orders were not sought by the RBA or the companies.
In a statement this week, the RBA said the boards of NPA and Securency decided to enter guilty pleas at the earliest possible time rather than to defend the charges, reflecting an acceptance of responsibility and genuine remorse.
“The decisions to plead guilty were based on material that became available to the boards after allegations about Securency had been referred to the Australian Federal Police (AFP) and followed extensive legal advice. The decisions also took into account the public interest in avoiding what was expected to be a costly and lengthy court process,” the central bank said.
No evidence of knowledge or involvement by officers of the RBA, or the non-executive members of either board appointed by the RBA, has emerged in any of the relevant legal proceedings or otherwise.
“The Reserve Bank strongly condemns corrupt and unethical behaviour,” Reserve Bank governor Philip Lowe said.
“The RBA has been unable to talk about this matter publicly until today, although the guilty pleas were entered in 2011. The RBA accepts there were shortcomings in its oversight of these companies, and changes to controls and governance have been made to ensure that a situation like this cannot happen again.”
In 2011, the Reserve Bank Board commissioned a thorough external review of the RBA oversight of the companies. The RBA oversaw a comprehensive strengthening of governance arrangements and business practices in the two companies.
In early 2013, the RBA sold its interest in Securency, having ensured that all the compliance issues of which the RBA was aware had been addressed.
With the lifting of the suppression orders, the RBA is now also able to disclose that the companies paid substantial penalties as a result of the court proceedings.
NPA paid fines totalling $450,000 and a pecuniary penalty under the Proceeds of Crime Act 2002 of $1,856,710. Securency paid fines totalling $480,000 and a pecuniary penalty under the Proceeds of Crime Act of $19,809,772.
Since the companies entered their pleas, four former employees of Securency have pleaded guilty to charges of conspiring to bribe and/or false accounting. Charges against four former employees of NPA were permanently stayed on the basis that continued prosecution of these individuals would bring the administration of justice into disrepute.
The use of the Household Expenditure Measure to assess serviceability was initially less common for broker-originated loans, but such is no longer the case, ANZ chief Shayne Elliott has revealed, via The Adviser.
Appearing before the financial services royal commission in its seventh and final round of hearings, ANZ CEO Shayne Elliott was questioned over the bank’s use of the Household Expenditure Measure (HEM) to assess home loan applications.
In round one of the commission’s hearings, ANZ general manager of home loans and retail lending practices William Ranken admitted that the bank did not further investigate a borrower’s capacity to service a broker-originated mortgage.
In his interim report, Commissioner Kenneth Hayne alleged that using HEM as the default measure of household expenditure “does not constitute any verification of a borrower’s expenditure”, adding that “much more often than not, it will mask the fact that no sufficient inquiry has been made about the borrower’s financial position”.
Counsel assisting the commission Rowena Orr QC pointed to a review of ANZ’s HEM use by consultancy firm KPMG upon the Australian Prudential Regulation Authority’s (APRA) request.
The KPMG review found that 73 per cent of ANZ’s loan assessments defaulted to the HEM benchmark.
Mr Elliott noted that since the review, ANZ has taken steps to reduce its reliance on HEM, with the CEO stating that the bank plans to reduce the use of HEM for loan assessments to a third of its overall applications.
When asked if there was a disparity between the use of HEM through the broker channel and branch network, Mr Elliott revealed that prior to the bank’s move to reduce its reliance on the benchmark, the use of HEM was less prevalent for broker-originated loans.
“Perhaps surprisingly, when we did the review, when we were talking about the mid-70s [percentage], the branch channel actually had slightly higher usage or dependency on HEM as opposed to the broker [channel].
“[That] actually is counterintuitive,” he added. “I think it would be reasonable to expect that if [ANZ] knows these customers, one might expect to use HEM less.”
Mr Elliott attributed the disparity to the higher proportion of “top-ups” for existing loans through the branch network, noting that ANZ’s home loan managers would be more likely to “shortcut the process” through the use of the HEM benchmark.
However, the CEO said that according to the latest data that he’s reviewed, the branch network’s reliance on HEM is lower than in the broker channel.
“[It’s] changing as we speak,” he said.
“As in the latest data I saw, the branch network is now lower in terms of its usage or reliance on HEM versus the broker channel. And that’s because we are in, if you will, greater control of that process in terms of our ability to coach and send signals to our branch network.”
However, he added that the use of the benchmark for broker-originated loans is “coming down rapidly” in line with the bank’s overall commitment to reduce its reliance on HEM.
Flat-fee ‘credible alternative’ to commission-based model
Further, as reported on The Adviser’s sister publication, Mortgage Business, Mr Elliott told the commission that a flat fee paid by lenders to brokers is a “credible alternative” to the existing commission-based remuneration model.
When asked by Ms Orr about his view on broker remuneration, Mr Elliott said that a flat fee paid by lenders is a “credible alternative” to the current commission-based model.
In a witness statement provided to the commission, Mr Elliott said that there’s “merit in considering alternative models for broker remuneration to ensure that the current model remains appropriate and better than any alternative”.
Reflecting on his witness statement, Ms Orr asked: “Is that because you accept that there’s an inherent risk that incentives might cause brokers to behave in ways that lead to poor customer outcomes?”
The ANZ CEO replied: “There is always that risk. [The] term incentive is to incent behaviour. Therefore, it can be misused or it can cause unintended outcomes if the broker is apt to be led by their own financial reward.”
Mr Elliott acknowledged that “no system’s perfect” and that a “fixed fee is also capable of being misused and leading to unintended outcomes”.
However, he added: “It is just my observation that there is at least some data on this from other markets, most notably in northern Europe. It seems a model that’s worth looking at.”
Mr Elliott continued: “I’m not suggesting it’s necessarily an improvement. It just feels like a credible alternative.”
The ANZ CEO compared a flat-fee model in the broking industry to the financial planning industry.
“The service is the work you are paying for, and perhaps the fee should not necessarily be tied to the outcome.
“I think that’s not an unreasonable proposition.”
However, the ANZ chief noted the negative implications of a flat-fee model, stating that with lenders ultimately passing on costs to consumers, the model would be a “major advantage” to higher income borrowers.
“The difficulty with the fixed fee, if I may, is it essentially is of major advantage to people who can afford and have the financial position to undertake large mortgages,” he said.
“[A] subsidy would be paid by those least able to afford it, and it runs the risk of making broking a privilege for the wealthy.”
There’s ‘merit’ in a fees-for-service model
Ms Orr also asked Mr Elliott for his view regarding a consumer-pays or “fees-for-service” model.
The QC asked whether such a model would address some of the concerns expressed by Mr Elliott about a flat-fee model.
Mr Elliott said that if a fee is paid by borrowers, it would be “uneconomic” for people seeking a loan to visit a broker, repeating that using a broker would become a “service for the wealthy”.
Ms Orr then asked the CEO for his thoughts on a Netherlands-style fees-for-service model, supported by Commonwealth Bank CEO Matt Comyn, in which both branches and brokers would charge a fee for loan origination.
Mr Elliott replied: “There’s merit in looking at that, [but] it still is an imposition of cost that would otherwise not have been there.”
Mr Elliott added that there would be “new costs” associated with a Netherlands-style model, noting that borrowers seeking a “top-up” for an existing loan would need to pay an additional fee.
In response, Ms Orr alleged that under the current commission-based model, costs are also “filtered back down” to consumers.
To which Mr Elliott replied: “In general terms, yes. Not necessarily in direct terms like that fee I charge you as a borrower, [and] at ANZ, we have, for some time, disclosed [commissions]. So, when you do get a mortgage through a broker, we do advise the customer what we have paid that broker. So, it is disclosed to them.”
The ANZ CEO also said that under a fees-for-service model, consumers could be incentivised to take out larger loans to avoid paying a fee if they wish to top up their loan.
Conversely, Mr Elliott added that if a flat fee is paid by lenders, some brokers may be incentivised to encourage clients to borrow less and “come back for more top-ups so that they get more fees”.
Mr Elliott reported that top-ups on existing loans make up 30 per cent ($17 billion) of total volume settled by ANZ.
The ANZ chief also told Ms Orr that he doesn’t believe a move to introduce an alternative remuneration model would be “hugely successful” without regulatory intervention.
This is probably one of the most significant speeches on the issue, as it gets to the core thinking driving bank regulation. Essentially it is this. If there were to be a financial crisis, experience has shown the costs to the broader economy are substantial, and are born by society.
As a result, Orr argues that while a significant toolkit is available to lean against these risks, the cornerstone is lifting bank capital.
Note though that the toolkit includes under crisis management OBR – deposit bail-in!
As a result, the amount of capital required will be significantly higher.
Implicitly, this approach enables the financial system to continue to expand, to drive debt higher (as we saw in his recent post), with the financial stability risks offset by higher capital. But as we have said many times, this faith in ever great debt as a growth lever is deeply flawed. And those borrowing will be required to pay more, as higher capital costs!
Here is the speech in full.
The Reserve Bank is tasked with ensuring the banking system is both sound and efficient. To achieve our task we have a range of tools (see Table 1). The most important tool in our kit is ensuring banks hold sufficient capital (equity) to be able to absorb unanticipated events. The level of capital reflects the bank owners’ commitment – or skin in the game – to ensure they can operate in all business conditions, bringing public confidence.
Given its importance, we have been undertaking a review of the optimal level of capital for the New Zealand system. We conclude that more capital is better. We are sharing our work with the banking sector and public, and expect to hear one side of the story loud and clear, that capital costs banks. We need to hear a broader perspective than that, to best reflect New Zealand’s risk appetite.
What have we done in practice?
The Reserve Bank needs to ensure there is sufficient capital in the banking “system” to match the public’s “risk tolerance”. This is because it is the New Zealand public – both current and future citizens – who would bear the social brunt of a banking mess.
We know one thing for sure, the public’s risk tolerance will be less than bank owners’ risk tolerance. How do we know this? Surely the more capital a bank has the safer it is and the more it can lend. Why don’t banks hold as much capital as they can?
First, there is cost associated with holding capital, being what the capital could earn if it was invested elsewhere. Second, bank owners can earn a greater return on their investment by using less of their own money and borrowing more – leverage. And, the most a bank owner can lose is their capital. The wider public loses a lot more (see Figure 2).
Hence, we need to impose capital standards on banks that matches the public’s risk tolerance. We have been reassessing the capital level in the banking sector that minimises the cost to society of a bank failure, while ensuring the banking system remains profitable.
The stylised diagram in Figure 3 highlights where we have got to. Our assessment is that we can improve the soundness of the New Zealand banking system with additional capital with no trade-off to efficiency.
In making this assessment, our recent work makes the explicit assumption that New Zealand is not prepared to tolerate a system-wide banking crisis more than once every 200 years. We have calibrated our ‘sweet spot’ thinking about economic ‘output’ and financial stability benefits.
How did we arrive at this position?
Current levels of capital are based on international standards, and are not optimal for any one country. The standards are also a minimum. There is a clear expectation that individual countries tailor the standards to their financial system’s needs.
Banks also hold more capital than their regulatory minimums, to achieve a credit rating to do business. The ratings agencies are fallible however, given they operate with as much ‘art’ as ‘science’.
Bank failures also happen more often and be more devastating than bank owners – and credit ratings agencies – tend to remember. The costs are spread across the public and through time.
Many large banks are foreign owned – especially in New Zealand. Their ‘parents’ are subject to capital requirements in their home and host country. This creates continuous tension as to who gets the lion’s share of capital and failure management support. It would be naïve to expect a foreign taxpayer to bail out a domestic banking crisis.
Hence, New Zealand needs to assess its own risk tolerance, and decide who pays to clean up any mess and the scale of that mess.
A word of caution. Output or GDP are glib proxies for economic wellbeing – the end goal of our economic policy purpose. When confronted with widespread unemployment, falling wages, collapsing house prices, and many other manifestations of a banking crisis, wellbeing is threatened. Much recent literature suggests a loss of confidence is one cause of societal ills such as poor mental and physical health, and a loss of social cohesion. If we believe we can tolerate bank system failures more frequently than once-every-200 years, then this must be an explicit decision made with full understanding of the consequences.
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.
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.”
