Category: Banking Culture

Financial Services Competition Reform Needed – Productivity Commission

The Productivity Commission, Australian Government’s independent research and advisory body has released its draft report into Competition in the Australian Financial System. It’s a Doozy, and if the final report, after consultation takes a similar track it could fundamentally change the landscape in Australia. They leave no stone upturned, and yes, customers are at a significant disadvantage. Big Banks, Regulators and Government all cop it, and rightly so.

Australia’s financial system is without a champion among the existing regulators — no agency is tasked with overseeing and promoting competition in the financial system. The Commission’s draft report into Competition in the Australian Financial System recognises that both competition and financial stability are important to the Australian financial system, and are an uncomfortable mix at times. It has also found that competition is weakest in markets for small business credit, lenders’ mortgage insurance, consumer credit insurance and pet insurance.

Here are some of the key findings.

Whilst there has been significant innovation (enabled by technology), the financial system is highly profitable and concentrated.  It lacks strong pricing rivalry – and evidence that it exploits loyal customers.

It questions whether the four pillars policy is still relevant.  It is an ad hoc policy that, at best, is now redundant, as it simply duplicates competition and governance protections in other laws. At worst, in this consolidation era it protects some institutions from takeover, the most direct form of market discipline for inefficiency and management failure. All new entrants to the banking system over the past decade have been foreign bank branches, usually targeting important but niche markets (and these entrants have evidenced only limited growth in market share).

Australia’s financial system is dominated by large players — four major banks dominate retail banking, four major insurers dominate general insurance, and some of these same institutions feature prominently in funds and wealth management. A tail of smaller providers operate alongside these institutions, varying by market in length and strength.

Across the financial system, there is a continual flow of new products and a re-packaging of existing products to appeal to specific groups of consumers. As a consequence, there is a very large number of products in financial markets, with sometimes only marginal differences between them: nearly 4000 different residential property loans and 250 different credit cards are on offer, for example. The same situation is apparent in insurance markets: the largest 4 general insurers hold more than 30 brands between them. In the pet insurance market this is particularly pronounced — 20 of the 22 products (with varying premiums) on offer are underwritten by the same insurer.

Banks can price as they want. Little switching occurs — one in two people still bank with their first-ever bank, only one in three have considered switching banks in the past two years, with switching least likely among those who have a home loan with a major bank. ‘Too much hassle’ and a desire to keep most accounts with the same institution are the main reasons given for the lack of switching, with home loans being a particularly difficult product for consumers to switch.

Although financial institutions generally have high customer satisfaction levels, customer loyalty is often unrewarded with existing customers kept on high margin products that boost institution profits. For this to persist, channels for provision of information and advice (such as mortgage brokers) must be failing.

Scope for price rivalry in principal loan products is constrained by a number of external factors: price setting by the Reserve Bank facilitating price coordination by banks; expectations of ratings agencies that large banks are too big to fail; and some prudential regulation (particularly in risk weighting) that favours large institutions over smaller ones.

The growth in mortgage brokers and other advisers does not appear to have increased price competition. The revolution is now part of the establishment. Non-transparent fees and trailing commissions, and clear conflicts of interest created by ownership are inherent. Lender-owned aggregators and brokers working under them should have a clear best interest duty to their clients.

There is also variation between larger and smaller institutions in funding costs (with a large regulatory-determined component). Not all ADIs face the same regulatory arrangements and regulatory effects on their pricing capacity. A source of differential funding costs to banks is a series of regulatory measures and levies that apply (both positively and negatively) to the major Australian-owned banks but not to smaller Australian-owned ADIs or foreign banks operating in Australia.

The net result of these regulatory measures is a funding advantage for the major banks over smaller Australian banks that rises in times of heightened instability. RBA estimated this advantage to have averaged around 20 to 40 basis points from 2000 to 2013 (worth around $1.9 billion annually to the major banks). More recently, the funding cost advantage of major banks has been estimated to have declined to about 10 basis points, due in part to prudential reforms. But it nevertheless persists, and ratings agencies are unlikely to rate institutions’ fund raising such that there is no effective differential between Australia’s major and smaller banks.

Australia’s major banks have delivered substantial profits to their shareholders  — over and above many other sectors in the economy and in excess of banks in most other developed countries post GFC. In recent times, regulatory changes have put pressure on bank funding costs, but by passing on cost increases to borrowers, Australia’s large banks in particular have been able to maintain high returns on equity (ROEs).
The ROE on interest-only investor loans doubled, for example, to reach over 40% after APRA’s 2017 intervention to stem the flow of new interest-only lending to 30% of new residential mortgage lending (reported by Morgan Stanley). This ROE was possible largely due to an increase by banks in the interest rate applicable to all interest-only loans on their books, even though the regulator’s primary objective was apparently to slow the growth rate in new loans. Competing smaller banks were unable to pick up dissatisfied customers from this re-pricing of their loan book because of the application of the same lending benchmark to them.

Regulators have focused on a quest for financial stability prudential stability since the Global Financial Crisis, promoting the concept of an unquestionably strong financial system.

The institutional responsibility in the financial system for supporting competition is loosely shared across APRA, the RBA, ASIC and the ACCC. In a system where all are somewhat responsible, it is inevitable that (at important times) none are. Someone should.

The Council of Financial Regulators should be more transparent and publish minutes of their deliberations. Under the current regulatory architecture, promoting competition requires a serious rethink about how the RBA, APRA and ASIC consider competition and whether the Australian Competition and Consumer Commission (ACCC) is well-placed to do more than it currently can for competition in the financial system.

Some of APRA’s interventions in the market — while undertaken in a way that is perceived by the regulators to reflect competitive neutrality — have been excessively blunt and have either ignored or harmed competition. Such consequences for competition were neither stated nor transparently assessed in advance. APRA’s interpretation of Basel guidelines on risk weightings that non-IRB banks use for determining the amount of regulatory capital to hold, puts it among the most conservative countries internationally.

  • For home loans, the main area in which Australia’s risk weights vary from international risk weightings is for (lower risk) home loans that have a loan to value ratio below 80%.Australian non-IRB lenders are required to use a risk weight of a flat 35%, compared with Basel-proposed guidelines of 25% to 35% for such loans.
  • For small and medium enterprise (SME) loans, the main area of difference is lending that is not secured by a residence. A single risk weight (of 100%) applies to all SME lendingnot secured by a residence, with no delineation allowed for the size of borrowing, the form of borrowing (term loan, line of credit or overdraft) or the risk profile of the SMEborrowing the funds. In contrast, Basel proposed risk weights for SME lending vary from75% for SME retail lending up to €1 million, to 150% for lending for land acquisition, development and constructions.

The RBA should establish a formal access regime for the new payments platform (NPP). As part of this regime, the RBA should review the fees set by participants of the NPP and transaction fees set by NPPA; and require all transacting participant entities that use an overlay service to share de-identified transaction-level data with the overlay service provider.

Measures that should be prioritised to help consumers become a competitive force in the longer term include:

  • consumer rights to have their financial data transferred directly from one service provider to another, either facilitated through Open Banking arrangements or as part of a more broadly-based consumer data right
  • automatic reimbursement of the ‘unused’ portion of lenders mortgage insurance when a consumer terminates the loan
  • payment system reforms that help detach consumers from their financial providers
  • provision of information on median home loan interest rates provided in the market over the previous month
  • inclusion on insurance premium notices, of the previous year’s premium and percentage change.

More Suggestions Of Poor Mortgage Underwriting Standards

As reported in the AFR, UBS has continued their analysis of the Australian mortgage market, with a focus on disclosed incomes of applicants.

UBS said its work suggested 42 per cent of all households with income of more than $500,000, and 27 per cent of all households with income between $200,000 and $500,000, had taken out a mortgage in 2017, which Mr Mott said “did not appear logical and [is] highly improbable”. Borrowers could be “materially overstating their household income to secure a mortgage”, or the population could be consistently understating income across the census, ATO tax returns and ABS surveys, he suggested.

The extension of the terms of reference for the financial services royal commission to include mortgage brokers and intermediaries provides “a clear indication” it will focus on mortgage mis-selling, Mr Mott added.

“We believe that it is imperative that the Australian banks continue to focus on improving underwriting standards,” he said.

We have to agree with their analysis, as our surveys lead us to the same conclusion.  Here is a plot of income bands and number of mortgaged households. On this data, around 15% of households would reside in the $200-500k zone, compared with the 27% from bank data.

We have been calling for tighter underwriting standards for some time. As UBS concludes:

We believe that responsible lending and mortgage mis-selling are material risks for the banks.

ClearView refunds $1.5 million for poor life insurance sales practices

ASIC says ClearView Life Assurance Limited (Clearview) will refund approximately $1.5 million to 16,000 consumers after ASIC raised concerns about its life insurance sales practices. It has also stopped selling life insurance direct to consumers.

An ASIC review of ClearView’s sales calls found it used unfair and high pressure sales practices when selling consumers life insurance policies by phone. These sales were made directly to consumers, without personal financial advice.

ASIC’s review raised concerns that between 1 January 2014 and 30 June 2017, when selling over 32,000 life insurance policies direct to consumers, 1,166 of which were to consumers residing in high Indigenous populated areas who were unlikely to have English as their first language, ClearView sales staff:

  • made misleading statements about the cover, the premiums, and the effect of any of the consumer’s pre-existing medical conditions
  • did not clearly obtain consumer consent to purchase the cover before processing the premium payments, and
  • used pressure sales tactics to sell the policies.

In response to ASIC’s concerns, ClearView will:

  • refund full premiums, all bank fees and interest to customers with high initial lapse rates
  • refund 50 per cent of premiums and interest to customers with high ongoing lapse rates
  • offer a sales call review to other eligible consumers and remediate if there is evidence of poor conduct
  • engage an independent expert (EY) to provide independent assurance over the consumer remediation program; and
  • cease selling life insurance directly to consumers (that is, without personal financial advice).

ASIC Deputy Chair Peter Kell said that pressure sales tactics are unacceptable.

‘Purchasing life insurance is a key financial decision for consumers, and all the information provided to them must be clear and balanced. Insurers should properly supervise their sales staff and ensure that no misconduct is occurring’, he said.

ClearView will contact eligible consumers.

 

ASIC is currently conducting an industry review of direct life insurance to identify whether there are concerns with sales practices and product design that may be driving poor consumer outcomes in this market.  Where similar conduct is identified, insurers will need to undertake appropriate remediation. ASIC will publish the findings of this review in mid-2018.

Background

ClearView sales staff were selling ‘direct life insurance’ which is sold to individual consumers without personal advice. It can include cover for events including death, accidental death, specific injuries, serious illness, total and permanent disability, unemployment and funeral cover.

This outcome is the result of work by ASIC’s Indigenous Outreach Program (IOP), which is staffed by lawyers and analysts, the majority of whom are Indigenous.

ASIC bans mortgage broker from credit for three years

ASIC has banned Michael Wilkins, of Watanobbi, NSW, from engaging in credit activities for three years.

Mr Wilkins was a mortgage broker and helped clients to arrange finance to purchase properties. ASIC found that on five occasions in June and July 2010, Mr Wilkins submitted loan applications on behalf of clients in which he deliberately overstated their savings by between about $130,000 and $179,000.

By submitting these loan applications, ASIC found that Mr Wilkins gave to the bank information or a document that was false or misleading.

Mr Wilkins has the right to appeal to the Administrative Appeals Tribunal for a review of ASIC’s decision.

Federal Reserve restricts Wells’ growth

Responding to recent and widespread consumer abuses and other compliance breakdowns by Wells Fargo, the Federal Reserve Board on Friday announced that it would restrict the growth of the firm until it sufficiently improves its governance and controls. Concurrently with the Board’s action, Wells Fargo will replace three current board members by April and a fourth board member by the end of the year.

In addition to the growth restriction, the Board’s consent cease and desist order with Wells Fargo requires the firm to improve its governance and risk management processes, including strengthening the effectiveness of oversight by its board of directors. Until the firm makes sufficient improvements, it will be restricted from growing any larger than its total asset size as of the end of 2017. The Board required each current director to sign the cease and desist order.

“We cannot tolerate pervasive and persistent misconduct at any bank and the consumers harmed by Wells Fargo expect that robust and comprehensive reforms will be put in place to make certain that the abuses do not occur again,” Chair Janet L. Yellen said. “The enforcement action we are taking today will ensure that Wells Fargo will not expand until it is able to do so safely and with the protections needed to manage all of its risks and protect its customers.”

In recent years, Wells Fargo pursued a business strategy that prioritized its overall growth without ensuring appropriate management of all key risks. The firm did not have an effective firm-wide risk management framework in place that covered all key risks. This prevented the proper escalation of serious compliance breakdowns to the board of directors.

The Board’s action will restrict Wells Fargo’s growth until its governance and risk management sufficiently improves but will not require the firm to cease current activities, including accepting customer deposits or making consumer loans.

Emphasizing the need for improved director oversight of the firm, the Board has sent letters to each current Wells Fargo board member confirming that the firm’s board of directors, during the period of compliance breakdowns, did not meet supervisory expectations. Letters were also sent to former Chairman and Chief Executive Officer John Stumpf and past lead independent director Stephen Sanger stating that their performance in those roles, in particular, did not meet the Federal Reserve’s expectations.

There’s no evidence behind the strategies banks are using to police behaviour and pay

From The Conversation.

APRA’s investigation into the Commonwealth Bank’s culture is starting to look at how it compensates employees, and whether that incentivises bad behaviour. In fact, my research has shown that cash bonuses are at least partly responsible for the scandals plaguing the financial services industry.

But there isn’t good evidence either to support the banks’ alternative – balanced scorecards. This is a system organisations use to set and track their goals. Companies first set out a series of strategies to achieve their objectives, then create criteria (linked to individual team members) to track progress and give feedback.

If anything, research suggests that balanced scorecards don’t work. Many of the criteria are subjective and therefore can be gamed. And the few objective metrics that are included in the scorecard often face the same issues as cash bonuses – incentivising employees to increase short-term profits.

Financial institutions previously gave employees incentives by linking their bonuses to profits and sales. This created an unhealthy fixation on short-term profits and a lack of concern for the longer-term consequences.

Under these schemes, an employee is incentivised to increase short-term profits, even if this may mean selling products that are unsuitable for customers. In the short term this leads to higher profits (and bonuses), but eventually customers figure out they’ve been mistreated. The result is often a loss of reputation and customers, legal costs, customer remediation programs and fines.

To counter this problem, many financial institutions have introduced the balanced scorecard as a method for measuring staff performance and, ultimately, deciding who receives a bonus.

The idea is that by considering a range of performance criteria, not just profits and sales, employees will become less focused on these short-term financial measures. This will, in turn, reduce misconduct.

Implementing balanced scorecards was one of the key recommendations of last year’s Sedgwick Report. The Australian Bankers’ Association sponsored the report.

But even though the balanced scorecard is considered best practice by many in the industry, there is little research to support its adoption.

The research on balanced scorecards

A recent study by Danish researchers reviewed 117 empirical papers on the balanced scorecard that were published in leading academic journals. They found that much of the research has been done on small and medium-sized firms, and that there were design problems in many of the other papers. Therefore, there is too little evidence to conclude whether the balanced scorecards are successful or not.

When balanced scorecards are implemented in financial institutions, they typically include subjective criteria. For example, one criterion could be that an employee’s “behaviour is consistent with organisational values”. A manager would be required to apply a rating to this criterion.

But there is a lot of doubt as to how credible and consistent these ratings really are.

There’s also nothing to definitely discourage bad behaviour (especially in the short term) when criteria include subjective ratings. Due to the large amount of discretion in applying them, managers may give a high rating to staff who are top performers in sales/profits despite poor behaviour.

When scorecards include both subjective and objective measures (which often include sales and profits), staff will tend to focus on the objective criteria. In other words, the balance in the balanced scorecard goes out the window.

The last thing to consider is that behaviour is influenced not just by bonuses, but also the possibility of promotion. If staff see that those who produce high profits are promoted, regardless of the short-term incentive structure applied, they will draw their own conclusions about how best to climb the corporate ladder.

That is why the promotion of Matt Comyn to CEO of the Commonwealth Bank sends a dangerous message.

Author: Elizabeth Sheedy, Associate Professor – Financial Risk Management, Macquarie University

ANZ responds to fiduciary duty breach claims

From Investor Daily.

Last week, ASIC issued a report confirming in-house product bias within institutionally-aligned licensees between 2015 and 2017, finding that 68 per cent of all client funds across these businesses had been invested in products owned and operated by related entities.

A review of sample files where advice to switch products to an in-house product was provided also found that as many as 75 per cent did not meet the FOFA fiduciary duty in ASIC’s opinion.

Responding to questions from InvestorDaily, a spokesperson for ANZ said its internal review of in-house versus external product distribution had yielded different results to those of the regulator, but noted the bank was unaware how ASIC gauged the numbers.

“Our assessment of the split between ANZ Financial Planning customers’ investments in ANZ products and those in external products is closer to 47/53 respectively, but we do not know what methodology ASIC have used,” the spokesperson said.

The bank said it also permits advisers to apply to recommend products not included on their APLs, and last year received 1,200 of these requests – an “overwhelming majority” of which the spokesperson said were approved.

The spokesperson added that the bank “will continue to work with ASIC and all the other regulators to help them with the important work they do to keep our industry secure and accountable”.

ANZ’s comments follow the release of an internal letter written by the bank’s chief executive, Shayne Elliott, addressing the royal commission into banking, superannuation and financial services.

In the letter, Mr Elliott said seeing all the bank’s instances of misconduct over the last decade laid out in a single document was “confronting”.

“It’s completely unacceptable that we have caused some of our customers financial harm and emotional stress. I’m ultimately accountable for this and once again apologise,” Mr Elliott said.

“Of course, it would be easy to lay the blame on a few bad apples or to say that these are largely historical technical glitches resulting from large complex IT systems. That would be wrong.”

Spokespeople for AMP and Westpac both referred InvestorDaily to the FSC, which has also challenged the investigative approach used by the regulator.

APRA releases CBA Prudential Inquiry Progress Report

The Australian Prudential Regulation Authority (APRA) today released the Progress Report by the Panel appointed by APRA to conduct a Prudential Inquiry into the Commonwealth Bank of Australia (CBA).

In August last year, APRA established the Prudential Inquiry to examine the frameworks and practices in relation to the governance, culture and accountability within the CBA group, in light of a number of incidents which damaged the reputation and public standing of CBA. The Panel was subsequently appointed in September and the Inquiry began work in October.

The Progress Report provides an update on the status of the Inquiry and outlines the methodology that the Panel has adopted to address the Terms of Reference.

The Panel notes in its report that: ‘issues of governance, culture and accountability in a large financial institution are complex and interwoven, and the Panel does not consider it appropriate to draw conclusions, even preliminary ones, before this work is completed and all relevant evidence collected and carefully evaluated. Accordingly, the Panel will reserve its substantive findings and recommendations for inclusion in the Final Report, which will be provided to APRA by 30 April 2018.’

APRA Chairman Wayne Byres welcomed the update provided by the Panel on the extensive investigations currently underway.

“As the Panel has noted, issues of governance, culture and accountability in large organisations are complex to assess. APRA is pleased the Panel is taking a thorough and considered approach to the important task it has been given,” Mr Byres said.

The Panel comprises Dr John Laker AO, Professor Graeme Samuel AC and Jillian Broadbent AO.

The Panel is due to provide a final report to APRA by 30 April 2018.

The Progress Report is available here: CBA Prudential Inquiry Progress Report (PDF)

APRA’s 2018 Priorities

APRA released their Policy Agenda 2018 today which sets their priorities and agenda.

Looking at banking, they outlined the following:

  • Capital adequacy tweaking will likely continue for the next 2-3 years, plus  revisions to the prudential standards for operational risk, interest rate risk in the banking book and market risk, and associated changes to reporting and public disclosure requirements. APRA is considering changes to its overall approach to capital requirements in a number of areas where APRA’s methodology is more conservative than minimum international requirements.
  • APRA does not anticipate the need to incorporate BEAR expectations into the prudential standards or prudential practice guides in 2018 but will provide guidance where appropriate, potentially in the form of published Frequently Asked Questions.
  • They will finalise arrangements to licensing some new ADIs through a phased approach.
  • Expect more changes to APG 223 Residential Mortgage Lending, revising underwriting standards and the development of a prudential practice guide for commercial property lending.

 

 

What Does CBA And The BBSW Case Mean?

Just 24 hours after the announcement of a new CEO, when we were assured that CBA were well on the way to addressing their known issues; ASIC lobbed a bombshell in the shape of the BBSW case.

CBA said today:

Commonwealth Bank has fully co-operated with ASIC’s investigation over the last two years.

Commonwealth Bank disputes the allegations made by ASIC. As this matter is before the courts, it is not appropriate to comment further at this time.

Put to one side whether CBA was part of the group of banks that fixed the pricing of BBSW, and the knock-on effect on product pricing; surely this issue was on the “risk” list in the bank, and should have been disclosed.

If it was not, it should have been. This may once again speak to cultural issues in the organisation.  There is clearly much to fix.  What else is on the risk list?

We discussed the implications on 2GB with Ross Greenwood.

More broadly, we have to consider whether the sheer complexity of the organisation is part of the problem. Perhaps CBA should be split into a series of small entities, for example, separated into its retail division, corporate, wealth, insurance and trading divisions. The question of whether CBA is simply too big and complex to manage, is in our view the underlying and most critical question to be addressed.