Banking Culture – Page 40 – Digital Finance Analytics (DFA) Blog

ASIC releases guidance on code of ethics compliance schemes for financial advisers

ASIC has today released guidance on its proposed approach to approving and overseeing compliance schemes for financial advisers (RG 269).

The financial advice professional standards reforms include obligations for financial advisers to, from 1 January 2020, comply with a code of ethics and be covered by an ASIC-approved compliance scheme under which their compliance with the code of ethics will be monitored and enforced.

RG 269 explains our process and criteria for determining whether to grant approval to a compliance scheme. It also sets out:

our expectations for the governance and administration, monitoring and enforcement processes, and ongoing operation of compliance schemes

how we will exercise our powers to revoke the approval of a compliance scheme and to impose or vary conditions on the approval, and

the notifications that monitoring bodies must make to ASIC.

ASIC Deputy Chair Peter Kell said that ASIC is committed to ensuring robust, transparent, fair and consistent compliance schemes that effectively monitor and enforce compliance with the code of ethics.

‘Effective compliance schemes are a key component of the reforms that will require higher standards of ethical behaviour and professionalism among financial advisers.’

‘Our guidance requires high standards for compliance schemes, reflecting the significant responsibility that monitoring bodies operating compliance schemes will have. This includes the responsibility to effectively monitor and sanction adviser members if required,’ he said.

The code of ethics is being developed by the Financial Adviser Standards and Ethics Authority (FASEA). Consultation on an exposure draft of the code of ethics released by FASEA closed on 1 June 2018. At this time, FASEA has not released the final code. If there are significant changes from the draft code, we may need to revise our guidance when the final code is released.

Download

Regulatory Guide 269 Approval and oversight of compliance schemes for financial advisers (RG 269)

Report 595 Response to submissions on CP 300 Approval and oversight of compliance schemes for financial advisers (REP 595)

Consultation Paper 300 Approval and oversight of compliance schemes for financial advisers (CP 300) and submissions

Background

The Corporations Amendment (Professional Standards of Financial Advisers) Act 2017 amended the Corporations Act 2001, and commenced on 15 March 2017. It introduced a number of new requirements for financial advisers who provide personal advice to retail clients on more complex financial products.
From 1 January 2020, all financial advisers must be covered by an ASIC-approved compliance scheme under which their compliance with a new single, uniform code of ethics will be monitored and enforced. These compliance schemes will be operated by monitoring bodies.
In May 2018, ASIC released Consultation Paper 300 Approval and oversight of compliance schemes for financial advisers (CP 300) which sought feedback on a number of proposals in relation to the approval and oversight of compliance schemes for financial advisers.
The consultation period for CP 300 closed in June 2018 and we received 11 submissions.

APRA Releases 2017 Stress Test Summary

APRA has released some information relating to their 2017 stress tests in their “APRA Insight Issue Three 2018“. We discussed the results in a recent Adams/North video. We were not impressed!

This is what APRA has now released. Compared with the bank by bank data the FED releases, its VERY high level!

Stress testing plays an important role for both banks and APRA in testing financial resilience and assessing prudential risks. This article provides an overview of APRA’s approach to stress testing, with insights into how APRA developed the 2017 Authorised Deposit-taking Institution (ADI) Industry Stress Test. This builds on the recent speech by APRA Chairman Wayne Byres, “Preparing for a rainy day” (July 2018), which outlined the results from the 2017 exercise.

Why stress test

The aim of stress testing is, broadly, to test the resilience of financial institutions to adverse conditions, including severe but plausible scenarios that may threaten their viability. The estimation of the impact of adverse scenarios on an entity’s balance sheet provides insights into possible vulnerabilities and supports an assessment of financial resilience. It can be a key input into capital planning and the setting of targets, and in developing potential actions that could be taken to respond and rebuild resilience if needed.

Stress tests are particularly important for the Australian banking system, given the lack of significant prolonged economic stress since the early 1990s. As a forward-looking analytical tool, stress testing can help to improve understanding of the impact of current and emerging risks if a downturn were to occur. Stress tests provide an indication, however, rather than a definitive answer on the impact of adverse conditions, and the results will always reflect the inherent uncertainty that exists in any scenario.

Scenarios – the starting point

The starting point in developing a stress test is to design the scenarios. This is the foundation of the exercise, and it is important that scenarios are calibrated effectively and are well targeted. For industry stress tests, APRA collaborates with both the Reserve Bank of Australia (RBA) and Reserve Bank of New Zealand (RBNZ) on the design of scenarios and the economic parameters that define them. In 2017, APRA also engaged with the Australian Securities and Investments Commission (ASIC) in the design of the operational risk scenario.

Scenarios should be aligned to the purpose of the exercise. At a high level, these are guided within APRA by several objectives – namely to:

assess system-wide and entity-specific resilience to severe but plausible scenarios;

improve stress testing capabilities across the industry; and

support the identification and assessment of core and emerging risks.

In line with these objectives, APRA developed two scenarios for the 2017 industry stress test. The first was a macroeconomic scenario with a China-led recession in Australia and New Zealand. This was considered the most severe but plausible adverse economic scenario for the banking system at the time.[1] In this scenario, there was assumed to be a fall in Australian GDP of 4 per cent, while house prices declined 35 per cent nationally over three years. The chart below provides an indication of the severity of the scenario: it shows that the assumed peak unemployment rate in the scenario was similar to the 1990s recession in Australia, the United States’ experience in the global financial crisis (GFC), as well as recent overseas regulatory stress tests.

Chart 1: International comparison: Peak unemployment rate

The second scenario involved the same macroeconomic parameters, with an additional operational risk event added. This was designed to test bank resilience beyond traditional economic risks and to consider other vulnerabilities. In this operational risk scenario, APRA asked the participating banks to identify a material operational risk event involving conduct risk and/or mis-selling in the origination of residential mortgages.[2]

The banks chosen for the exercise were selected based primarily on scale, enabling a clear system-wide view to be generated. The 2017 stress test covered 13 of the largest banks with aggregate assets of nearly 90 per cent of the system, as well as the leading lenders mortgage insurers. It included both the major banks and smaller entities that have a significant presence in particular regions or asset classes.

The testing process

The 2017 stress test was run in two phases. In the first phase, banks generated results using their own stress testing methodologies and models.[3] The results of this phase varied by differences in the risk characteristics of each bank, as well as by how they interpreted and modelled the scenarios.

In the second phase, APRA provided more prescription with specified risk estimates for loan portfolios and other assumptions. This enabled greater comparability across the banks and more consistency in the results. The APRA estimates were developed based on the banks’ results from the first phase, APRA’s own internal modelling, historic and peer stress testing benchmarks, internal and external research and expert judgement.

The estimates were also differentiated based on inherent risk characteristics. For example, riskier interest-only loans were assumed to be more likely to default and losses were estimated to be greater for loans with higher Loan to Valuation Ratios (“LVRs”). For the operational risk scenario, APRA defined key elements and estimates to be applied by the banks, based on research of overseas experience as benchmarks for potential impacts.

Interpreting the results

The table below summarises some key results from the macroeconomic scenario. As important as the quantified outcomes are the lessons learned and implications of the exercise. Stress testing should not be an academic exercise, but should be used to inform assessments of resilience, risks and capacity to respond to stress.

In analysing the results, APRA assessed not only the impact on capital, but also the effects on profitability and loan portfolios. The differences between phase 1 (based on bank’s own modelling) and phase 2 (based on APRA risk estimates) can also shed light on bank stress testing modelling capabilities.

Macroeconomic scenario – aggregate results Phase 1 Phase 2

Peak to trough decline in Common Equity Tier 1 capital -2.87% -3.21%

Peak to trough decline in Return on Equity -9.86% -12.05%

Peak credit loss rate[4] 0.81% 0.90%

Macroeconomic scenario

Given the design of the scenario, the impact on the participating banks was material. The results show that in this scenario the decline in profitability was severe and occurred quickly. Return on equity (ROE) in aggregate fell materially in the first two years before recovering after year three. The impact on profitability led to a significant fall in capital in both phases, as shown in Chart 3. There was, however, a wide range in results across banks in both phases.[5]

Macroeconomic scenario – aggregate results	Phase 1	Phase 2
Peak to trough decline in Common Equity Tier 1 capital	-2.87%	-3.21%
Peak to trough decline in Return on Equity	-9.86%	-12.05%
Peak credit loss rate[4]	0.81%	0.90%

Chart 2: Aggregate return on equity

Chart 3: Cumulative CET1 impact – Macroeconomic scenario

The losses were driven by bad debts in residential mortgage lending, corporate lending and other credit portfolios, as well as lower net interest income and losses on large single counterparties. Across the mortgages portfolios of the banks, aggregate losses were similar in both phases and although the mortgage portfolio contributed the largest aggregate loss, the loss rate was lower than business lending and other consumer lending portfolios.[6] The banks also modelled the impact of the scenario on liquidity and funding positions; most banks were able to maintain their liquidity with a liquidity coverage ratio (LCRs) above 100 per cent (or initiated strategies to restore their LCR within a reasonable timeframe).

Chart 4: Aggregate cumulative credit losses

Operational risk scenario

In the second scenario, the impact of the operational risk event led to a more severe capital outcome, as shown in Chart 5. The operational risk events modelled by the banks in Phase 1 represented a wide range of potential risks, including broker fraud, inappropriate product design and sales practices, inappropriate verification and documentation, overstatement of valuation errors at origination, and serviceability errors. The impact of the operational risk event in Phase 2 based on APRA-defined assumptions was, however, more severe.

Chart 5: Cumulative CET1 impact – Operational risk scenario

Conclusions and lessons learned

Following industry stress test exercises, APRA provides participating entities with formal feedback. In the 2017 stress test, APRA noted the importance of ongoing improvements in modelling capabilities and developing better internal model governance and discussions on results. In practice, a stress event is unlikely to play out exactly as designed and simulated in hypothetical scenarios, reinforcing the need to continue to stress test and enhance stress testing capabilities.

In APRA’s view, the results of the 2017 exercise provide a degree of reassurance: ADIs remained above regulatory minimum levels in what was a very severe stress scenario. In addition, the results were presented before taking into consideration management actions that would likely be taken to rebuild capital and respond to risks in the scenarios.[7] The impact on profitability, loan portfolios and capital would, however, be substantial: this underlines the importance of maintaining strong oversight and prudent risk settings, unquestionably strong capital and ongoing crisis readiness.

Footnotes

The RBA’s Financial Stability Review in October 2016 highlighted the risks posed by high and rising levels of debt in China, at a time of slowing growth and signs of excess capacity.
Overseas experience in the GFC has highlighted that operational risk events can impact the financial system alongside an economic downturn. For example, in the US, there was a significant impact from sub-prime mortgage lending, while in the UK, there was additional stress related to the mis-selling of payment protection insurance.
In order to ensure consistency for the exercise, APRA provided guidance and templates for results.
This represents the credit loss rate in the most severe year of the stress. Aggregate losses over the duration of the stress period were higher.
The range presented in the charts is the interquartile range (middle 50 per cent of entities).
Banks determine credit losses by calculating the likelihood of the loans defaulting (“probability of default”) and then the actual loss on the defaulted loans (“loss given default”) which is then applied to the stressed value of the asset. For mortgages, insurance on higher LVR loans helps to mitigates losses.
These actions include raising equity, loan repricing, cost cutting, tightening lending standards and balance sheet measures. Within this set, the cornerstone action was typically equity raisings, as a relatively quick step. In the operational risk scenario, the participating banks raised around $40bn in equity, almost twice the level as during the GFC. The assumption that banks were last to market challenged thinking around the potential capacity and pricing implications.

Westpac Puts Aside Another $235 Million For Remediation

Westpac Banking Corporation has today announced that it’s Cash earnings in Full Year 2018 will be reduced by an estimated $235 million following continued work on addressing customer issues and from provisions related to recent litigation.

The key elements include:

Increased provisions for customer refunds associated with certain advice fees charged by the Group’s salaried financial planners due to more detailed analysis going back to 2008. These include where advice services were not provided, as well as where we have not been able to sufficiently verify that advice services were provided;

Increased provisions for refunds to customers who may have received inadequate financial advice from Westpac planners;

Additional provisions to resolve legacy issues as part of the Group’s detailed product reviews;

Provisions for costs of implementing the three remediation processes above; and

Estimated provisions for recent litigation, including costs and penalties associated with the already disclosed responsible lending and BBSW cases.

Details of the provisions/costs are still being finalised and the Group expects to provide more information when it releases its Full Year 2018 Results template, later in October 2018. As a guide, approximately two thirds of the impact is expected to be recorded as negative revenue while the remainder will be recorded in costs. Costs associated with responding to the Royal Commission are not included in these amounts

The program of reviews will continue into Full Year 2019. This includes continuing to investigate and consider potential further costs associated with advice fees charged by our aligned planners.

Westpac is scheduled to report its Full Year 2018 results on 5 November 2018.

Notwithstanding these new provisions, Westpac remains well placed to meet APRA’s unquestionably strong capital benchmark.

Westpac first commenced its “get it right put it right” initiative in early 2017 to address legacy issues in some products and practices.

Westpac Chief Executive Officer, Brian Hartzer said “It is disappointing some of our past practices have not lived up to appropriate standards. We are committed to fixing any issue identified, as well as ensuring that any customer affected has not been disadvantaged.”

Class Action Suit Launched Against NAB, MLC On Worthless Credit Card Insurance

Law firm Slater and Gordon has filed class action proceedings in the Federal Court against National Australia Bank and MLC on behalf of customers sold worthless credit card insurance.

Slater and Gordon Class Actions Principal Lawyer Andrew Paull said the action alleges MLC and NAB engaged in unconscionable conduct, in contravention of the Australian Securities and Investment Commission Act 2001 (Cth) (ASIC Act), by selling insurance to card holders who were ineligible to claim under the terms of the policy.

“All of the claimants had a NAB credit card and were then offered NAB credit card insurance,” Mr Paull said.

“However it was highly unlikely that they would benefit from this policy.

“Most were existing NAB customers and the bank should have known the insurance was likely to be of little or no benefit to them. Despite knowing this, NAB have continued to push the insurance widely, reaping millions in premiums while doing so.”

Mr Paull said most people were sold the insurance over the phone and were not given a reasonable opportunity to understand the terms and conditions of the policy.

“In the case of the life cover, the policy was of minimal value to many customers. NAB admitted as much in the Royal Commission.

“Both NAB and MLC were in much stronger bargaining positions than any of the people they were contacting and selling this insurance to.

“They have taken advantage of hundreds, potentially thousands of their loyal customers.”

Customers sold insurance included students and people without gainful employment, and people on disability pensions; all of whom were ineligible to claim the main benefits under the policy.

“Casual, contract or self-employed workers were subject to exclusions from the income protection coverage, but were not made aware of this fact when they agreed to purchase the insurance.

Jessica Purcell was a full time university student when she was pressured to take out consumer credit insurance, despite being a casual employee at the time and ineligible to claim certain aspects of the policy.

“It was sold to me like it was something that I had to take out. I honestly wouldn’t have thought twice about it if I hadn’t heard about the class action. I would have just kept paying it,” she said.

Customers with existing life and/or income protection insurance were also encouraged to take out insurance on their credit card, despite already being covered by their existing policies.

Mr Paull said Slater and Gordon believes these practices amount to unconscionable conduct in breach of section 12CB of the ASIC Act.

“We believe NAB’s and MLC’s conduct falls well short of the standard of behaviour the industry expects.

“In short they have taken advantage of people knowing that they can’t cover them.

“NAB and MLC have been fleecing consumers of millions and it’s only right that they pay it back.”

Which customers are included in the class action?

Group members include:

people who did not meet the employment criteria, eg. unemployed persons, casuals, students, seasonal workers, self-funded retirees, dependent spouses

people who were employed by their family

people who were self-employed

people with a pre-existing medical condition, or critical illness

people who were otherwise ineligible to claim one or more of the main benefits of the policy

people who were otherwise highly unlikely to require, or be able to benefit from the policy, such as people who held effective income protection policies

Getting To Grips With Credit Regulation – Part 3 – The Australian Context

On the day before the Royal Commission is set to release their draft report, we have released the latest in our series of segments on Credit Regulation.

This time we look in detail at the Australian context as Professor Gill North discusses the critical issues relating to “Responsible Lending”.

She makes some predictions about what may be coming out from the Commission.

Please consider supporting our work via Patreon

Please share this post to help to spread the word about the state of things….

[This is the version less music.]

The previous videos are also still available:

The International Context.

An Introduction.

ASIC Finds Unacceptable Delays By Financial Institutions Breach Management

In a report released today, ASIC has identified serious, unacceptable delays in the time taken to identify, report and correct significant breaches of the law among Australia’s most important financial institutions.

It can they say take over 4 years to identify that a breach incident has occured!

The report REP 594 Review of selected financial services groups’ compliance with the breach reporting obligation examined the breach reporting processes of 12 financial services groups, including the big four banks (ANZ, CBA, NAB and Westpac) and AMP.

Key findings from the report include:

Financial institutions are taking too long to identify significant breaches, with the major banks taking an average time of 1,726 days (over 4.5 years).

There were delays in remediation for consumer loss. It took an average of 226 days from the end of a financial institution’s investigation into the breach and first payment to impacted consumers. (This is on top of the average across all institutions of 1,517 days before the breach is discovered and the time taken to start and complete an investigation.)

The significant breaches (within the scope of the review) caused financial losses to consumers of approximately $500 million, with millions of dollars of remediation yet to be provided.

The process from starting an investigation to lodging a breach report with ASIC also takes too long, with major banks taking an average of 150 days.

Once a financial institution has investigated and determined that a breach has occurred and that it is significant, the law requires that the breach be then reported to ASIC within 10 business days. One in seven significant breaches (110 of 715) were reported later than that 10-business day requirement.

ASIC Chair James Shipton said:

‘Breach reporting is a cornerstone of Australia’s financial services regulatory structure.

‘Many of the delays in breach reporting and compensating consumers were due to the financial institutions’ inadequate systems, procedures and governance processes, as well as a lack of a consumer orientated culture of escalation.

‘Our review found that, on average, it takes over 5 years from the occurrence of the incident before customers and consumers are remediated, which is a sad indictment on the financial services industry. This must not stand.

‘There are two related problems here and ASIC wants change to address both of these:

The first is that industry is taking far too long to identify and investigate potential breaches. Whilst this is not of itself a breach of the reporting requirement, this is the source of longest delay and thus of most detriment for consumers.

The second problem is that even having identified an issue and concluded following an investigation that it is a breach, institutions are failing to then report it to ASIC within the required 10 business days. The delays here are much shorter (75% were late by 1 – 5 days) but this is still a breach of the legal requirements.

‘Accordingly, there is an urgent need for investment by financial services institutions in systems and processes as well as commitment and oversight from boards and senior executives to address these significant failings.’

In response to the review’s findings, ASIC will ensure there is a strong focus on compliance with breach reporting requirements in its new Close and Continuous Monitoring approach to supervising major institutions. ASIC is also actively considering enforcement action for failures to report breaches on time.

The review underscores the need for law reform of the breach reporting requirements, that the Government has committed to, in principle, following the ASIC Enforcement Review. Currently, there are three factors that are barriers to enforcement action which would be addressed by the proposed reforms:

The test as to whether a breach is significant and therefore is legally required to be reported is subjective. That is, the licensee makes that decision based on its own assessment, not based on objective grounds.

The 10-business day period for reporting only begins once an institution has determined that there is a breach and that it is significant. Institutions can delay making those decisions without breaching the law.

Failures to report can only be prosecuted on a criminal basis with the associated high standard of proof. At the same time the existing penalty is relatively modest.

Background

The review

Following the Government’s announcement in April 2016 of new measures to protect Australian consumers by improving outcomes in financial services, ASIC undertook a breach reporting review of 12 financial services groups.

The financial services groups were: the four major banks ANZ, CBA, NAB and Westpac; as well as eight others – AMP, Bank of Queensland, Bendigo Bank, Credit Union Australia, Greater Bank, Heritage Bank, Macquarie and Suncorp.

The review considered the institutions’ compliance with reporting requirements under section 912D of the Corporations Act. The law requires all Australian Financial Services (AFS) licensees to report to ASIC a ‘significant breach’ within 10 business days of becoming aware of it.

Methodology

ASIC analysed the financial services groups’ breach data from 2014 to 2017, covering a total of 715 significant breaches. ASIC also examined internal policies and evaluated specific scenarios using case studies.

The review covered key stages of the breach management process – from identifying an issue or incident to reporting the significant breach to ASIC; and rectifying the breach including remediating consumers.

Breach reporting law reform

Subjectivity and ambiguity in the current legal requirements have led to inconsistent decisions about what breaches are ‘significant’ across different financial services groups. As noted by the ASIC Enforcement Review Taskforce, this has undermined ASIC’s ability to take enforcement action for non-compliance.

The Taskforce in its report to the Government concluded that ‘the current regime is not conducive to pursuing action against non-compliant licensees’. [Page 11 of the report]

Law reform has been recommended by the Taskforce and accepted in-principle by the Government. This reform would make breach reporting rules stronger, clearer, and more enforceable as well as extending the requirement to cover breaches of credit laws and introducing a civil penalty for failure to report.

Close and continuous monitoring

The review’s findings re-emphasise the need to implement new and more intensive supervisory approaches.

ASIC will now be regularly placing ASIC staff on site in major financial institutions to closely monitor their breach management, governance and compliance with laws – this new programme of work is called Close and Continuous Monitoring.

Downloads

Report 594 Review of selected financial services groups’ compliance with the breach reporting obligation
Infographic
ASIC’s submission to the ASIC Enforcement Review Taskforce: Self reporting of contraventions by financial services and credit licensees (May 2017)

The Sheep and the Goats

Intelligence suggests that some interest only loan borrowers are being encouraged to change lenders as their loans come up for review, across a number of banks.

This video summarises our research, based on feedback from 13 individual borrowers, who have confidentially messaged me over the past couple of weeks. Three respondents did not know they had an IO loan, so it came as a bolt from the view. They have a month to consider their alternatives.

I cannot independently validate their situations, but I ask whether this could be the start of a trend in the months ahead.

APRA Says Digital Distribution Removes the Need for Branch and Broker Networks

The chairman of APRA has suggested that digital distribution and servicing could threaten the existence of branch and broker networks.

From The Adviser.

The chairman of the prudential regulator, Wayne Byres, was speaking at the 2018 Curious Thinkers Conference in Sydney on Monday (24 September) when he outlined a “clash of predictions” for the future of the financial sector.

Stating that the pace of change “makes predicting the future difficult, and is why the crystal balls of even the most well informed are cloudy”, Mr Byres said that “everyone agrees major change is inevitable”.

Noting that it was “clear” that companies, regulators and international agencies are “all grappling to predict the impact that technology-enabled innovation will have on the structure of the financial sector and the viability of existing business models”, Mr Byres conceded that the “consensus also seems to be that it is too soon to tell whether the financial world faces evolution or revolution”.

Despite this, the chairman of the Australian Prudential Regulation Authority (APRA) told delegates that whatever the future scenario is, the “production and delivery of financial services will change”.

“Put simply, many traditional business models will no longer be competitive without significant change driven by technological investment,” Mr Byres said.

“Moreover, some incumbents will struggle to afford that investment; for others, the challenge will be successfully managing a large transformation program.”

Later in his speech, the APRA chairman forewarned that while most technological advancements in finance have previously “worked to enhance the market positioning of the major incumbents”, the future will “likely be different”.

Despite several futurists suggesting that brokers will survive digital disruption and others outlining that brokers will become more crucial in the future as trust in finance deteriorates, Mr Byres suggested that broker networks could be under threat in the future.

He stated: “New technologies have dramatically lowered barriers to entry. Cloud computing, for example, allows small organisations to operate innovative financial services without the need to maintain their own costly infrastructure and support staff.

“The advent of digital distribution and servicing removes the need for branch and broker networks.

“Open banking and comprehensive credit reporting will help new competitors to challenge established players. And, of course, regulators are making it easier to navigate the process of entry into the regulated financial system. Taken together, competition in the supply of financial services will only intensify.”

In conclusion, Mr Byres said that APRA’s role was to “make sure regulated entities are resilient and responsive to change, but not protected from it”, adding that while the regulator is responsible for promoting stability, “that does not mean standing in the way of change”.

He added: “Ensuring regulated entities are well managed, soundly capitalised and able to withstand severe stresses is designed to protect the interests of their depositors, policyholders or members.

“But to be clear, it is not APRA’s role to protect incumbent players when better, safer and more efficient ways of doing business emerge.

“Ultimately, we seek to look at it with a sharp focus on what is in the longer-run interests of their depositors, policyholders or members — not the business itself, or its owners — and make sure that boards and management are doing likewise.

“If that means their time is up, so be it. Our role then becomes ensuring they make an orderly exit from the industry.”

FBAA hits out at comments

The executive director of the Finance Brokers Association of Australia (FBAA), Peter White, hit out at the comments made by Mr Byres yesterday, telling The Adviser: “As it is, I certainly and completely disagree with this as being a current or near-term situation.”

The head of the FBAA highlighted that its research had recently showed that nearly 95 per cent of broker clients were satisfied with their broker, adding that more than half of the borrowing population uses a broker.

“So, digital distribution is not supported by fact,” Mr White said.

While the head of the FBAA suggested that digital home loans without any human intervention may be commonplace in 20 years’ time, he added that “we are a long way from this” in the near future.

Mr White told The Adviser: “For now, most people want to transact their home loan with a person, not a screen, and this won’t change for some time. Let alone the technical and legal barriers that still exist, the human element is still far more desired.”

In a shot across the bow, Mr White concluded: “So, for now (and once again), APRA seems to be out of touch with reality and people. Possibly they should be more so focused on their governance of ADIs given what we’ve all witnessed in the [banking] royal commission rather than out-of-focus speculation.”

UBS Sounds IO Mortgage Alarms

According to UBS’ Australian Banking Sector Update on 19 September, which involved an anonymous survey of 1,008 consumers who took out a mortgage in the last 12 months, 18 per cent stated that they “don’t know” when their interest-only (IO) loan expires, while 8 per cent believed their IO term is 15 years, which doesn’t exist in the Australian market, via InvestorDaily.

The research found that less than half of respondents, or 48 per cent, believed their IO term expires within five years.

The investment bank said that it found this “concerning” and was worried about a lack of understanding regarding the increase in repayments when the IO period expires.

The Reserve Bank of Australia (RBA) earlier this year revealed that borrowers of IO home loans could be required to pay an extra 30 per cent to 40 per cent in annual mortgage repayments (or an additional “non-trivial” sum of $7,000 a year) upon contract expiry. The central bank noted that the increase would make up 7 per cent, or $120 billion, of the total housing credit outstanding.

According to the RBA, 2020 is the year that most of the 200,000 at-risk IO loans will reset.

UBS’ research, which was conducted between July and August this year, revealed that more than a third of respondents, or 34 per cent, “don’t know” how much their mortgage repayments will rise by when they switch to principal and interest (P&I) contracts.

More than half, or 53 per cent, estimated that their repayments will increase by 30 per cent once their IO term ends, while 13 per cent expected their repayments to rise by more than 30 per cent, which is the base case for most IO borrowers.

“This indicates that the majority of IO borrowers remain underprepared for the step-up in repayments they will face,” UBS stated in its banking sector update report.

Further, nearly one in five respondents to the UBS survey, or 18 per cent, said that they took out an IO loan because they can’t afford to pay P&I.

“With a lack of refinancing options available and the banks reluctant to roll interest-only loans, these mortgagors will have to significantly pull back on their spending, sell their property, or [they] could potentially end up falling into arrears,” the investment bank stated in its report.

UBS also found it concerning that 11 per cent of respondents said they expected house prices to rise and planned to sell the property before the IO period expires.

“This is a risky strategy given how much the Sydney and Melbourne property markets have risen, and have now begun to cool,” the investment bank said.

Overall, the top two motivations for taking out an IO loan, according to UBS survey participants, were “lower monthly repayments gives more flexibility on my finances” (44 per cent) and “to maximise negative gearing” (43 per cent).

The second motivation was selected by 32 per cent of owner-occupier borrowers who cannot benefit from negative gearing as the tax incentive applies to investors, 53 per cent of which cited this benefit.

Most banks yet to implement tighter expense checks

The investment bank reiterated in its banking sector update that it expects mortgage underwriting standards to tighten further in the next 12 months. It claimed that, contrary to comments by regulators that “heavy lifting on lending standards is largely done”, most banks are yet to fully verify a customer’s living expenses and a large number of customers are still not submitting payslips and tax returns.

“As a result, we believe there is likely to be much work required for the banks to comply with the royal commission’s likely more rigorous interpretation of responsible lending and improve mortgage underwriting standards. We expect this is likely to play out over the next 12 months,” UBS stated in its update report.

UBS went on to maintain its belief that Australia is at risk of experiencing a “credit crunch” in the next couple of years, but it is waiting on a number of “signposts” to make a more calculated judgement. These include the Hayne royal commission’s interim and final report, major bank policies around living expenses, details from the Australian Prudential Regulation Authority on debt-to-income caps, the federal election, changes in property prices, and sentiments from the RBA.

“We remain very cautious on the Australian banks,” the investment bank concluded in its update report.

“After a prolonged 26 years of economic growth, many excesses have developed in the Australian economy, in particular the Sydney and Melbourne housing market.

“We believe the royal commission creates an inflection point and credit conditions are tightening materially. Whether Australia can orchestrate an orderly housing slowdown remains to be seen, and we think the risks of a credit crunch are rising given the significant leverage in the Australian household sector.”

Fees for no service: how ASIC is trying to make corporate misconduct hurt

From The Conversation.

On September 6, 2018, the Australian Securities and Investments Commission launched proceedings against two arms of the National Australia Bank alleging a widespread and long standing practice of charging fees for no service.

An intriguing aspect of the action is that the claim acknowledges that the two firms have already agreed to pay back around A$87 million to the affected customers. So ASIC isn’t seeking compensation.

Instead, it wants declarations that the NAB subsidiaries breached the law and engaged in “misleading or deceptive” conduct under the ASIC Act and “false or misleading” conduct under the Corporations Act.

More than compensation

It is seeking penalties in respect of those breaches.

Declarations and penalties are important because they can inflict reputational damage.

This can send a powerful message to the rest of corporate Australia about the need to observe and respect the law, something that appears to have been missing in the financial sector to date.

Also, the greater the penalties imposed, the less financially attractive the behaviour becomes to other corporations, who, after all, are chiefly motivated by profit.

Penalties are typically low

However, to date it is arguable that the level of penalties sought by ASIC and imposed by the courts have been too low to act as an effective deterrent.

ASIC’s latest claim is a significant step forward.

It is seeking penalties that are likely to hurt, and as a result more likely to make a difference to corporate behaviour.

Its Concise Statement of Claim points to the purpose of its legislation which is to protect consumers and promote fair and efficient market economies.

In essence, it is asking the Federal Court to make orders directed at changing corporate practices that undermine that purpose.

Its challenge will be to persuade the court to take seriously the need for deterrence and for punitive penalties in addition to compensation.

Interestingly, it isn’t alleging that the NAB subsidiaries made misrepresentations dishonestly, knowingly or recklessly. Its focus is on “misleading” rather than “deceptive” conduct.

Dishonesty is hard to prove

This is likely to be because personal dishonesty is notoriously difficult to prove against corporations, whose human agents (employees, managers and the like) are often engaged in independent activities and are not be able to “connect the dots” about broader corporate dishonesty.

It might be time for the law to move away from questions of personal dishonesty and instead look at the objective nature of corporate behaviour. Longstanding practices and systems that are designed to and are inherently likely to mislead fall below the standards Australians expect, whether or not any of the individuals involved act dishonestly.

The case against the subsidiaries of NAB might provide the perfect opportunity for ASIC and the courts to take an important step in the right direction.

Author: Elise Bant Professor of Law, University of Melbourne