Banking Culture – Page 58 – Digital Finance Analytics (DFA) Blog

Fed Lifts Commercial Real Estate Limit

In a further sign of loosening of rules in the US, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency issued a final rule that increases the threshold for commercial real estate transactions requiring an appraisal from $250,000 to $500,000.

They say the increased threshold will not pose a threat to the safety and soundness of financial institutions. “Commenters opposing an increase to the commercial real estate appraisal threshold asserted that an increase would elevate risks to financial institutions, the banking system, borrowers, small business owners, commercial property owners, and taxpayers. Several of these commenters asserted that the increased risk would not be justified by burden relief”.

The agencies originally proposed to raise the threshold, which has been in place since 1994, to $400,000, but determined that a $500,000 threshold will materially reduce regulatory burden and the number of transactions that require an appraisal. The agencies also determined that the increased threshold will not pose a threat to the safety and soundness of financial institutions.

The final rule allows a financial institution to use an evaluation rather than an appraisal for commercial real estate transactions exempted by the $500,000 threshold. Evaluations provide a market value estimate of the real estate pledged as collateral, but do not have to comply with the Uniform Standards of Professional Appraiser Practices and do not require completion by a state licensed or certified appraiser.

The final rule responds, in part, to concerns financial industry representatives raised that the current threshold level had not kept pace with price appreciation in the commercial real estate market in the 24 years since the threshold was established and about regulatory burden during the Economic Growth and Regulatory Paperwork Reduction Act review process completed in March 2017.

Would A Loan Comparison Tool Compete With Brokers?

From The Adviser.

A loan comparison tool proposed by the Productivity Commission could compete with the broker channel, according to six of Australia’s largest non-major banks.

In a joint submission to the Productivity Commission (PC), AMP, the Bank of Queensland, Suncorp, Bendigo Bank, MyState and ME Bank warned that an online loan comparison tool could undermine the broking industry.

In its draft report, the PC called for the Australian Prudential Regulation Authority (APRA) to collect interest rate and fee data and use it to determine a median rate that would be published via an online tool.

The PC claimed that such a reform could help increase transparency for customers and enhance competition.

The non-majors claimed that a proposed comparison tool with the “authority of a government agency” could undermine the broker channel.

“[The] online tool would, in some respects, compete with the broker channel, particularly given the proposal is for the comparison tool to have the authority of a government agency standing behind it,” the banks stated.

“Such an approach could potentially undermine the broker industry and eventually favour the banks with larger bricks and mortar networks,” the banks added.

Further, the lenders argued that the publication of a median interest rate could “mislead customers”.

“While this has the potential to improve competitive pressure from the demand side of the market, it may also involve considerable practical difficulties,” the submission read.

“More importantly, it may mislead customers as to the true cost of a product. The main problem with such tools is that they have a tendency to lead to ‘gaming’, whereby suppliers develop products that rate well on the tool but have shortcomings in other areas.

“For example, comparison tools have difficulty capturing the full benefits of a ‘bundle’ of services offered by a financial institution.”

The banks claimed that the tool could also create an incentive for some lenders to “shift costs” to products and services outside the tool’s scope.

“They also provide an incentive for suppliers to increase costs for services outside the scope of required disclosures. For example, in the case of mortgages, suppliers could shift costs to account closing or switching fees,” the submission said.

Additionally, the banks claimed that the tool could instigate a “race to the bottom”, with lenders creating products that “fall short of expectations”, potentially requiring regulatory intervention.

The lenders said: “[Some] financial institutions may respond by choosing not to offer services outside what the tool requires, and consumers could end up with products that fall short of expectations.

“Such an approach could see suppliers in a race to the bottom, offering only the most basic and feature-free products in order to present the most attractive median interest rates to the comparison tool.

“This would then inevitably result in additional regulatory interventions as governments attempt to patch over the shortcomings of the tool.”

Broker remuneration

Moreover, the banks advised against changes to the broker remuneration model, claiming that “consumers have a strong tendency to resist paying for services”.

The lenders added that “disruption” to the broking industry’s remuneration model could have a “material” impact on market competition.

“A significant disruption to the economic viability of the broker industry would be a material competitive neutrality issue for smaller banks.”

“Disclosure of mortgage broker ownership is a priority”

In their submission, the banks also expressed support for the PC’s call for increased disclosure for mortgage brokers.

The non-majors noted that they believe customers should “know the identity of the broker’s owner”, and they claimed that the level of business activity directed to an aggregator’s owner or associated company should also be published.

“[We] believe it is important to ensure that the customers of mortgage brokers know the identity of the broker’s owner so they can factor this information into their decision-making process.

“In addition to ownership disclosure, [we] recommend that broker networks and aggregators publish information showing the amount of business directed towards their owners or associated companies, relative to the proportion directed elsewhere.”

Deja Vu All Over Again? Subprime MBS Demand “Oversubscribed” And S&P Says Risk Is “Contained”

From Zero Hedge.

The stock market is at record highs and people with FICO scores as low as 500 are once again happily obtaining mortgages. Not only that, but these mortgages are once again being securitized and are in demand by yield chasers.

All of the elements that are necessary for the 2008 subprime crisis to repeat itself are starting to fall back into place. Aside from the fact that we have inflated bubbles across basically all asset classes for the most part, not the least of which is evident in the stock market, the Financial Times reported today that not only are subprime mortgage backed securities becoming prominent again, but that the chase for yield was what fueling demand:

Issuance of securities backed by riskier US mortgages roughly doubled in the first quarter from a year earlier, as investors lapped up assets blamed for bringing the global financial system to the brink of collapse a decade ago. Home loans to people with scratches and dents in their credit histories dwindled to almost nothing in the aftermath of the crisis, as litigation-weary lenders retreated to patch up their balance sheets.

But over the past couple of years a group of specialist firms has begun to bring the loans back, navigating a dense web of new rules drawn up to protect borrowers and investors in the $9.3tn US home-loan market. Last year saw issuance of $4.1bn of securities backed by loans that would have been called “subprime” before the last financial crisis, according to figures from Inside Mortgage Finance, with the pace picking up in the latter half of the year. The momentum has continued into 2018, with deals worth $1.3bn in the first quarter — twice the $666m issued in the same period a year earlier.

Our central banks have done such a great job of getting us out of our last crisis that the recovery has prompted a mortgage originators and real estate investors to basically do the same exact thing that they were doing 2006 to 2007. After all, mortgage levels are already almost back to 2008 levels.

If that wasn’t disturbing enough, the hedge fund partner that FT quotes in the article says that the subprime market has “a lot of room to grow“ as if it were some type of new emerging market generating productivity, and not just a carbon copy repeat of exactly what happen nearly 10 years ago.

“The market is . . . starting from such a small base that it has a lot of room to grow,” said Jamshed Engineer, a partner at Axonic Capital, a New York hedge fund with more than $2bn in assets under management.

“[Investors] are definitely chasing yields. Whenever these deals come out, for the most part, they are oversubscribed.”

The Financial Times article tries to couch the fact that all hell could be breaking loose yet again at some point soon by citing Dodd Frank reforms that we reported in March are already past the Senate. The key provisions of the rollback are:

Relaxes a host of reporting requirements for small – medium banks, and to a smaller extent, large banks
Eliminates a reporting requirement introduced by Dodd-Frank designed to avoid discriminatory lending
Relaxes stress testing requirements intended to show how banks would survive another financial crisis
Raises the threshold for banks which are not subject to enhanced liquidity requirements, stress tests, and enhanced risk management, from $50 billion to $250 billion – exempting several institutions which could pose systemic risks down the road.
Allows megabanks such as Citi to count municipal bonds as “highly liquid assets” that could be used towards the “liquidity coverage ratio,” – assets which can be quickly liquidated during a crisis.
Calls for a report on the risks and benefits of algorithmic trading within 18 months

Despite the fact that the FT states that 500 FICO scores are getting approved for mortgages, S&P, one of the willfully ignorant and blind rating agencies that missed the subprime crisis thinks that everything is going to be fine:

“The risk is contained, in our view,” said Mr Saha.

For the way that our Federal Reserve has addressed the problems of 2007 or 2008, these are the end results that they deserve, but the American people ultimately do not.

ABC The Business Does Mortgage Brokers

A brief segment on Thursday’s programme discussed the Royal Commission in Financial Services Misconduct examination of the mortgage broking industry.

The segment highlighted the significant fees, and the risks of misaligned incentives.

Questions over just who’s interest mortgage brokers act in have reverberated through the $50-billion industry. The broking industry has hit back insisting the customer comes first.

Satisfaction with banks down marginally in February – Roy Morgan

From Roy Morgan Research.

New results from Roy Morgan show that customer satisfaction with banks in the six months to February 2018 was 81.0%, down marginally from 81.2% in January. This level still represents a positive result when seen in the context of the long term monthly average of 73.8% calculated since 2001.

ING, St George and Westpac show improved satisfaction

Of the ten largest consumer banks, ING showed the biggest improvement in satisfaction over the last month, up 1.1% points to 86.3%, followed by St George up 0.6% points (to 83.9%) and Westpac up 0.2% points (to 78.1%). The remainder of the big four showed only marginal declines, with CBA down 0.1% points (to 80.0%), NAB down 0.2% points (to 78.9%) and ANZ down 0.2% points (to 78.4%). Each of the big four remain below the overall bank satisfaction level of 81.0%.

Consumer Banking Satisfaction – 10 Largest Consumer Banks¹

Source: Roy Morgan Single Source (Australia). 6 months to January 2018. n= 23,945; 6 months to February 2018, n = 23,887. Base: Australians 14+. 1. Based on customer numbers. 2. Includes banks not shown.

Bendigo Bank retained the highest satisfaction rating among the ten largest banks with 87.8%, followed by ING (86.3%), St George (83.9%), Bankwest (83.7%) and Bank of Queensland (83.6%).

Satisfaction with mobile banking is well ahead of branches

The rapid increase in the use of mobile banking, with its higher satisfaction levels compared to branches, appears to have the potential to positively impact overall bank satisfaction. All four of the major bank’s customers have higher satisfaction with their mobile banking compared to those using branches. Internet banking users also have higher satisfaction than those using branches but on average remain a little below that of mobile bankers. The fact that around two thirds (65.3%) of the population now use either mobile banking or internet banking in an average four week period (and showing an upward trend) is a positive for bank satisfaction as these channels have satisfaction ratings of up to 92% compared to around 86% for branches.

Satisfaction with Banking Channel Used in the Last 4 Weeks

Source: Roy Morgan Single Source (Australia). Six months ended February 2018, n = 23,887. Base: Australians 14+.1. Using an App on a mobile phone or tablet. 2. Using an institutions website. 3. Includes Banks not shown, Building Societies and Credit Unions

The CBA has the highest satisfaction of the four majors for mobile banking with 92.9% and for internet banking (91.1%) and is a close second for branch banking with 86.0%. NAB with 90.8% and Westpac with 91.0% have their highest satisfaction ratings for mobile banking, while the ANZ scored their highest satisfaction with 89.2% for internet banking.

These latest results are from Roy Morgan’s Single Source survey of over 50,000 consumers per annum.

The Gems In Wayne Byers Opening Statement

APRA Chairman Wayne Byers made an interesting opening statement today in his appearance before the House of Representatives Standing Committee on Economics, Canberra

First he assures that lending tightening is going to plan, and second there are no plans for a deposit bail-in as might be needed to save a bank from collapse.

But, hold on, listen to his recent reply to the senate on mortgage fraud. There the question was “has APRA found any evidence of misconduct among the major lenders?” Answer, essentially was NO.

Now compare that with the evidence from the Royal Commission, where fraud was well among the collection of significant issues explored.

So I simply ask. Did APRA really not know about the fraud which is clearly in the system? If they did, then the reply to Parliament looks dodgy. But worse, if they really did not have evidence of fraud, then we ask, should they have? To which I think the answer is YES, after all you are the regulator!

Either way this looks really shoddy. Come on APRA. Time to come clean!

Anyhow, here is is statement:

APRA’s 2016/17 Annual Report was tabled some months ago but many of the issues discussed within it remain highly relevant today, reflecting APRA’s ongoing agenda to continue to build resilience in the financial system. As we said in the Report, and I repeat regularly in speeches, building resilience when times are relatively favourable is far easier than trying to restore resilience after a period of adversity.

While there has been a great deal of focus in recent weeks on past conduct being examined by the Royal Commission, there are many other issues that are critical into the future for establishing and maintaining a financial system in which the Australian community can have confidence as to its resilience and safety. I would like to say a few words about some of those areas this morning.

As we have regularly discussed at past hearings, APRA is maintaining a strong focus on the quality of new mortgage lending, and measures to reinforce sound lending standards. Although there are differing views as to the level of competition in the housing lending market, we observed that the type of competition that was occurring was clearly unhealthy: the steady erosion of lending standards in the face of strong competitive pressures to generate volume and grow market share. As a result, we have taken a range of measures to moderate the volume of new lending with higher risk characteristics while stronger lending standards are being reintroduced, backed by higher capital requirements for higher risk portfolios.

In our view, these interventions are achieving their purpose. The quality of new lending today is higher than it has been for some time. However, there is more to be done to make sure the improvements in policies are truly embedded into ongoing practices. So we will inevitably need to continue to allocate significant resources to this issue in the year ahead, making sure the industry delivers on its commitment to do better in the future.

Another critical component of a resilient financial system is ensuring we have a strong regulatory framework, particularly in times of crisis. This framework has been strengthened with the recent passage of the Financial Sector Legislation Amendment (Crisis Resolution Powers and Other Measures) Bill 2017. The Bill provides a welcome and substantial improvement to APRA’s crisis management powers, better equipping us to deal with the actual or imminent failure of a financial institution. It is an underappreciated but essential piece of infrastructure that maximises the public sector’s ability to preserve an orderly financial system in times of stress.

Concerns have been expressed in some quarters that the Bill might allow APRA to confiscate or otherwise use depositors’ money to save a failing bank. I would therefore like to use this opportunity to state clearly that that is most definitely not the case. There is no such power in the Bill. Indeed, APRA’s purpose under the Banking Act is to protect depositors, and the idea of ‘bailing in’ deposits would be anathema to that core purpose.

The third important matter that I’d like to highlight this morning is cyber risk. Earlier this month, APRA proposed its first cross-industry prudential standard on information security management, in response to the growing threat of cyber-attacks. The package of measures is aimed at shoring up the ability of APRA-regulated entities to both repel cyber adversaries and respond swiftly and effectively in the event of a breach of their defences.

Australian financial institutions are among the top targets of cyber criminals seeking money or customer data, and evidence suggests the threat is accelerating. This is increasingly one of the most important risks the financial system faces – affecting large and small institutions alike, and stretching across all industries. It is almost inevitable that institutions’ defences will be breached in some way at some time, and no longer implausible to suggest that a cyber-attack could be sufficiently severe to take a regulated institution out of business entirely, with significant losses as a result. The financial institutions we supervise will need to place greater emphasis on, and devote more resources to, this risk into the future, as will APRA. The new standard provides an important new framework within which this will occur.

The fourth area I’d like to mention is the issue of governance. In February this year, APRA announced a package of proposed measures designed to build resilience and improve governance and decision-making in the private health insurance sector. The measures are aimed at introducing stronger prudential standards that have successfully lifted capabilities across other APRA-regulated industries, at a time when the private health insurance sector faces significant strategic and operational challenges. Our emphasis on a strong strategic focus also extends to superannuation. As we said in our Annual Report, we have upped the ante on RSE licensees that appear not to be consistently delivering quality member outcomes, or are not appropriately positioned for future effectiveness and sustainability. To that end, it is pleasing to note that this work is delivering results, with a number of superannuation funds restructuring activities and products in order to deliver better member outcomes, in response to APRA’s observations.

Also related to governance is a review we are close to finalising on the policies and practices in setting senior executive remuneration at large financial institutions. This examined the extent to which remuneration outcomes were consistent with good risk management and long-term financial soundness. We will be publishing the results of this study shortly.

The final major initiative that I would like to mention is the major data transformation program we are undertaking to ensure APRA itself keeps pace with advancements in data, analytics and technology. As part of this program, we have recently embarked on our most substantial program of stakeholder engagement to date as we seek input from the industry into the design and implementation of our next generation data collection tool. This will be the foundation by which we are able not just to improve our own supervisory effectiveness, but also provide more information and transparency to the broader community about the financial health of the industries we supervise.

With those remarks on some of our major work streams, my colleagues and I are happy to answer the Committee’s questions.

Royal commission: The main takeaways for brokers

With the royal commission’s first round of hearings now over, industry leaders have taken a step back to assess what happened and how the latest revelations will impact the third-party channel.

The commission covered a lot of ground over the last two weeks examining the banks and their dealings in the home loans sector, and brokers are a big part of that. The commission identified issues with how household expenses are verified, questioned CBA about its broker accreditation process, scrutinised upfront and trail, and zeroed in on Aussie Home Loans for broker misconduct.

There’s no doubt that brokers will be included in the interim report due by the end of September. So what should brokers know and takeaway from what just happened?

Higher expectations for living expenses and trail

Connective’s group legal counsel, Daniel Oh, said living expenses and how they’re verified will be heavily scrutinised following the royal commission’s examination of ANZ. During that hearing, it was revealed that ANZ failed to follow processes to verify customers’ financial situations. Stating living expenses at or below HEM can no longer be a mechanical process on loan applications, he said.

“You need to ensure that you have done the work to verify and have the necessary evidence to support this figure. If the figure is at or below HEM, expect greater scrutiny,” Oh said.

On trail, Oh expects that at a minimum there will be more scrutiny as to what brokers do post-settlement to justify their earnings.

“Our position on the topic is that you should speak or meet your existing clients at least once a year, if not more, to ensure that client’s needs continue to be met.”

Customer at the centre of everything

William Lockett, managing director of Specialist Finance Group, said the most important takeaway from the royal commission is to always ensure that the customer and their needs are the sole focus of the bank, financial planner or finance broker.

Banks and brokers need to work more constructively together to ensure they are achieving the best outcome for the consumer, he said.

But he also said both need to fess up if they’re at fault. “Banks also need to take sole responsibility for their own failings and shortfalls and likewise finance brokers need to do the same.”

Both groups also need to embark on a mission to restore trust with customers.

“All parties within the financial services industry should continue to look at improving their business model and how they engage with all other parties and ultimately the consumer,” he said.

Accountability and transparency need to be restored

Peter White, executive director of the FBAA, said the banks need to be completely transparent about the issues being revealed at the royal commission and then put positive actions in place to remedy them.

“It doesn’t matter how big you are or how well recognised your brand is, you are accountable for your actions every single time.”

“Also as much as there are issues on our own doorstep, the banks need to make some serious cultural and process changes and ensure those who should be are held very much accountable,” White said.

What’s next for brokers and banks?

Influenced by the quest for ever greater profits, cultural norms in banking have strayed too far from good customer outcomes, and as a result, some households are in strife, said Martin North, principal at Digital Finance Analytics.

The royal commission has and will continue to examine the root causes of this— some of which have been known for a long time— but North said it seems “we need considerable changes”.

“I also feel that the role of brokers will change on the back of this – still a role for them – but on a different basis. Also it raises questions about vertical integration.”

North believes there is still more to come out, and that the focus will be on the cultural practices and remuneration models of the executives in these banks.

“There has been a credit fest, and it’s time for this to be normalised. Regulators were also asleep at the wheel and only reactive to events as they appeared. No one is the customer’s champion – that’s what we need.”

Royal commission: Banks bashed, brokers blamed

From Otiena Ellwand at MPA.

During the royal commission’s last two weeks of public hearings into the consumer and home lending space, the banks have regularly pointed the finger at mortgage brokers over such things as trail commissions leading to poor consumer outcomes and poorly verified expenses in customers’ loan applications.

Not only did this look bad for brokers, but it also demonstrated the gaps in bank executives’ knowledge of what their banks have or still do, and forced them to confront how they have— or have failed— to deal with those breaches. Overall, it revealed a major lack of transparency among the banks, which brokers were inevitably linked.

How did banks and brokers fare?

William Lockett, managing director of Specialist Finance Group, said brokers were perceived by the banks as an “easy target” to take the heat and blame off their own conduct, particularly in a forum where brokers had no way of defending themselves.

“Given that the banks ultimately have the one and only say when approving any loan application, loan size and purpose of the loan, yet the banks still unfairly attack finance brokers at most given opportunities,” he said.

Tanya Sale, CEO of Outsource Financial, said it was frustrating that the facts about the industry didn’t surface to the top.

“Our industry has just been through two years of working with our regulator ASIC to provide them with all the information and data they required to understand our complex industry. One gets tired of reading and listening to ill-informed critics who clearly have not done their homework and are only looking for sensationalism,” she said.

Martin North, principal at Digital Finance Analytics, a research and consulting firm covering the financial services sector, said the major impact for brokers was that the royal commission highlighted “the inherent conflicts based on the remuneration model”. The commission made a strong case for a fee-for-service model and a switch to the ‘best interest’ legal duty from ‘not unsuitable’, which could significantly alter the current broking landscape.

But North said the banks fared even worse than brokers.

“They were criticised for not providing all the information required by the royal commission, relying on brokers to satisfy their responsible lending obligations, and in some cases ignoring expenditure information, and relying on HEM, a poor substitute for real analysis. As a result, we can certainly conclude that there have been loans written which should not have been written.”

So what now?

Executive director of the FBAA Peter White said brokers need to take careful note of how these matters could play out when the commission formalises its position to government in its interim report, which is expected no later than 30 September.

In the meantime, brokers must ensure they are looking after their clients with ongoing support and annual reviews of facilities to ensure these are still appropriate for the client’s circumstances, which is why trail is paid, White said.

Fraud is another issue that needs to be addressed with zero tolerance.

“We must work even harder to see this eradicated from our industry and those minority that do not accurately or fraudulently construct applications need to be, at a minimal level, permanently removed from our industry and the full recourse of the law applied,” he said.

While most headlines focused on the royal commission, two other significant things occurred over the last two weeks, AFG’s CEO David Bailey pointed out.

The ACCC released its interim report revealing the lack of transparency around how the big banks set interest rates on mortgage products and APRA revealed the closure of 100 bank branches over the last 12 months.

Bailey said these matters raise two questions: Without a broker helping their client to navigate the more than 3,800 offerings in the marketplace, how are they expected to get the right product? And if the proprietary channel is an efficient means of origination, why are branches being shut down?

“It is important that any proposed changes to the structure of our industry should not result in an economic drift away from the broker to the lender,” he said.

“Devaluing the service provided by brokers would have significant and long term detrimental effects for consumers by lessening the competitive tensions that currently exist in the credit industry. It is essential that anticompetitive conduct is not permitted to proliferate under the guise of regulatory reform.”

ABA Says New Banking Code of Practice will be compulsory, binding and enforceable

The ABA says that in a first for the industry, retail banks in Australia will be required to sign up to the new Banking Code of Practice as a condition of membership to the Australian Banking Association.

Anything which improves the cultural norms of banking should be welcomed, but this is very little and very late – and could be interpreted as a reaction to the Royal Commission evidence in the past few days.

Acting ethically is certainly helpful, but banks should be putting the interests of their customers first and foremost. This can build trust, one brick at a time. All the evidence shows that do this, customers win, and benefits also flow to shareholders thanks to greater customer loyalty and brand value. We need cultural reform from within the banks and the rate of reform needs to be accelerated significantly.

This is what the ABA has said.

The new Code, currently awaiting ASIC approval, has been completely rewritten and updated to better meet community standards and will be binding and enforceable.

CEO of the Australian Banking Association Anna Bligh said the new Code, now to become a requirement of ABA membership, was a significant ramp up of the industry’s efforts to improve conduct and culture.

“In the past it was up to each individual bank if they wanted to sign up however this new customer focussed Code will become compulsory for all ABA members with a retail presence,” Ms Bligh said.

“This new code will be binding, forming part of relevant customer contracts, enforceable by law and will be monitored by an independent body.

“Australians expect their banks to operate in an ethical and appropriate way when they apply for a credit card, home, small business loan or other financial product.

“While there is much work still to be done, Australia’s banks are serious about genuine reform which addresses conduct and culture, with the Banking Code of Practice a cornerstone of these efforts.

“The industry is committed to genuine reform which will rebuild trust with the Australian community, with the new Code an important step in the right direction.

“Once approved by ASIC, the Code will deliver changes across the board with plain English contracts for small business, no more unsolicited offers to increase credit card limits, greater transparency around fees and customers having an ability to cancel a card online – just to name a few,” she said.

Finalised and lodged with ASIC in December the new Code outlined important changes for individuals and small businesses, including:

Plain English contracts

Ending unsolicited offers of credit card increases

The mandated ability for customers to cancel a credit card online

Improved transparency around fees by telling customers about service fees immediately before they occur.

Bank who have signed up are required to include in its contracts a statement that the Code applies, which in turn is a legally enforceable document. This new industry code will have the force of the law. There will be a 12 month implementation period for the Code once ASIC has given its approval.

In addition, an independent body, the Banking Code Compliance Committee (BCCC) will monitor and oversee compliance with the code. The committee has power to investigate breaches of the Code and apply sanctions if necessary.

The way banks are organised makes it hard to hold directors and executives criminally responsible

From The Conversation.

The Financial Services Royal Commission has seen evidence that bank directors and executives deliberately put in place policies to ignore the law.

But research suggests the very organisational structure of banks makes it difficult to hold directors and senior executives criminally responsible for systemic misconduct.

The way corporations are arranged, how decision-making is delegated, and information is gathered and distributed, appears to fragment and diffuse individual responsibility.

This makes it hard to establish criminal culpability (the standard of proof is “beyond a reasonable doubt”), even if directors and executives remain in control of processes and are paid bonuses based on organisational performance.

Certain clauses in commercial contracts and the structuring of corporate groups across multiple jurisdictions can also be used to frustrate investigations.

In cases where corporate criminality can be more directly tied to decisions by executives or directors, subsidiaries (or internal divisions) can be dissolved or sold.

A senior ANZ executive admitted to the Royal Commission that the bank has no process to verify income and expenditure statements in loan applications.

This is despite laws requiring lenders to take reasonable steps to establish borrowers’ ability to service loans.

Moreover, this was not an oversight but a deliberate decision to substitute regulatory requirements for less rigorous internal practices.

This is an example of “decoupling”.

Decoupling occurs when corporations say publicly that they follow the law, and even create policies to tick regulatory boxes, but then do something entirely different as a matter of standard practice.

With existing corporate governance structures in place decoupling is extremely difficult to detect from the outside. It takes active oversight by regulators, internal whistleblowing or public inquiries with coercive powers to gather evidence to identify it.

Certain types of (re)organisation also enable systemic misconduct because they diffuse responsibility and diminish individual culpability.

These include sub-contracting, the use of consultants, creation of subsidiaries and transnational structures, relocating work to low transparency jurisdictions, and the use of franchising systems, dealer networks and agents.

These decisions about organisational structure are made at the board or senior executive levels.

Implications for the Royal Commission

The banks have publicly asserted that their boards are focused on ensuring good corporate governance, and that they have the structure (explicit policies, clear lines of reporting/delegation) to ensure regulatory compliance.

But what has emerged at the Royal Commission shows these structures either don’t exist or don’t function as they should.

Although Australia has strong laws to jail company directors for policies that facilitate systemic misconduct, this rarely occurs.

The lack of prosecutions, convictions and commuting of jail time embolden other senior executives and help them rationalise away the seriousness and impact of similar conduct.

There are a number of factors that the Royal Commission and federal government should address to prevent future systemic misconduct, beyond just creating a temporary lull before a return to business as usual.

Australian companies only have one board and that is at the heart of the problem. While all board directors are responsible for the management and governance of corporations, in practice they delegate authority to executive directors who then operate with wide discretion. This includes enacting policy and reorganising the corporation in ways that diffuse accountability and criminal culpability.

While all corporate governance systems have their weaknesses, in two-tiered boards, executive directors are overseen by supervisory boards who appoint their own auditors. These kinds of boards constrain executive director discretion, making decoupling more difficult.

This is one possible reason why countries like Germany, with two-tiered boards, have fewer and less costly systemic governance failures.

The use of executive performance incentives has also been strongly associated with corporate criminal behaviour. Evidence suggests remuneration should be fixed and capped.

In addition to changing the governance of organisations, regulators must be given more resources, greater powers to collect evidence and explicit directions to mount investigations before and not after the systemic misconduct has been identified.

The use of consultants and the rapid expansion of their business model which bundles accounting, audit and legal services together presents is another threat to accountability and transparency. It is also an obstacle to investigating and successfully prosecuting systemic corporate misconduct.

Governments may have to legislate to outlaw the bundling of consultancy services, and abandon accounting industry self-regulation.

Andrew Linden, Sessional/ PhD (Management) Candidate, School of Management, RMIT University; Warren Staples, Senior Lecturer in Management, RMIT University