Category: Economics and Banking

ING DIRECT to launch new upfront commission model

ING DIRECT has announced a new upfront commission model that will come into effect from 1 January 2016.

The simplified commission model will be structured around individual accounts as opposed to the current model’s focus on aggregator volumes and conversion rates, ensuring transparency for brokers and alignment with the bank’s primary bank strategy.

Mark Woolnough, Head of Third Party Distribution, commented: “We reward our customers for their loyalty and for supporting our business strategy to be the main bank for Australians. It made sense to do the same for brokers, resulting in our new, simplified commission model which will reward the type of business that best supports our primary bank strategy – lower LVR, Orange Advantage home loans.”

The minimum upfront commission will remain unchanged at 50bps (+GST) with the maximum increasing to 80bps (+GST) until 30 June 2016.

ING DIRECT’s new commission model was finalised following consultation sessions with aggregators and will apply on new residential loans with new to ING DIRECT security property settled from 1 January 2016.

HBOS report does little to tackle systemic problems

From The Conversation.

Remember the 2007-08 banking crash? In the build up to it, UK bankers made vast profits and their executives collected big bonuses. After the crash, they were bailed out by taxpayers, which led to increased government borrowing. We have all been suffering a never ending programme of austerity ever since.

One of the biggest banks to fall was HBOS, which traded under the brands Halifax and Bank of Scotland. No ordinary bank, it had a market capitalisation of over £40 billion at its peak in 2007 and was the UK’s largest lender. But the financial crisis exposed the bank. It had to be bailed out to the tune of £30 billion and almost 50,000 employees have lost their jobs.

The official investigation into what happened has taken seven years. Two reports, at a cost of £7m, have now been published by the Bank of England. The first is a 407-page report on the demise of HBOS. The second is a 144-page assessment by Andrew Green QC on whether the decisions taken on enforcement by the former regulator, the Financial Services Authority (FSA), were reasonable.

The first report paints a picture of reckless risk-taking by the HBOS board, which despite warnings continued with its growth strategy. The report said that the HBOS board had a “flawed and unbalanced strategy and a business model with inherent vulnerabilities arising from an excessive focus on market share, asset growth and short-term profitability”. And the FSA’s supervisory approach is described as “highly unsatisfactory”.

The UK’s approach to punishing the bad behaviour in its banking industry that led to the financial crisis has been lacklustre at best. While Iceland has sent 26 financiers to prison for their misdemeanours, not one senior banker in the UK has gone on trial over the failure of a bank.

The Bank of England’s reports into HBOS took seven years to complete and cost £7m. shutterstock.com

The reports call for investigations into as many as ten senior executives and possibly the barring of them from working for a financial company, though it may be too late to impose any fines. Any attempt to impose retribution after such a long delay is bound to be contested by HBOS executives. So expect long legal battles.

Overall, the reports are disappointing. They are more noticeable for their silence and lack of attention to systemic problems.

A system-wide problem

A major regulatory problem in the UK is the revolving door through which industry grandees become regulators and vice-versa. Are they defenders and promoters of industries or umpires and prosecutors? For example, James Crosby, HBOS’ chief executive until 2006 became a non-executive director of the FSA in 2005, and from 2007-2009 was also its deputy chairman. The report is silent on such relationships.

The HBOS report cites regulatory failures but fails to note that the UK has a fragmented and ineffective regulatory structure. The report does not address how HBOS was audited, despite the bank’s auditors being the most important group of independent professionals to regularly examine the performance and accounts of HBOS.

Instead it defers to the accounting regulator, the Financial Reporting Council (FRC) which has indicated it will look into the report. But those of us hoping for a swift conclusion will likely be disappointed. As a recent example, car manufacturer MG Rover’s collapse in 2005 amid allegations of accounting misdemeanours, was not concluded until 2015.

The report notes that HBOS had a remuneration committee consisting of non-executive directors, mostly directors of other companies. Executive pay was linked to profit targets. This encouraged excessive risk-taking. It draws attention to sharp accounting practices which boosted balance sheets and profits. At the same time, risks were poorly monitored by an audit committee consisting of non-executives. Despite the huge corporate governance failures, the report makes no recommendations about board structures or reward systems.

So despite the HBOS debacle and the banking crash little has changed. Banks remain devoted to maximising shareholder wealth even if that means taking excessive risks. Shareholders have only a short-term interest in banks as they constantly buy or sell shares to make short-term profits, and can’t invigilate mega corporations. HBOS employees and other stakeholders suffered, but there is no place for them on company boards.

Nothing has been done to protect and empower whistleblowers such as Paul Moore, HBOS’s chief regulatory risk officer, who was fired in 2004 after he warned the board of the bank’s risky sales strategy. Auditor files are still secret and they still don’t owe a “duty of care” to any individual stakeholder, or even the regulator.

The publication of the HBOS report may enable politicians and regulators to draw a line under the affair, but the banking industry still needs major reform.

Authors: Atul Sha, Senior Lecturer – Accounting & Finance, University Campus Suffolk;  Prem Sikk, Professor of Accounting, Essex Business School, University of Essex

 

New Bank Operational Risk Method May Boost Comparability

Operational risks will rise as banks increasingly rely on technology, heightening exposure to systems failure and cyber attacks. Banks also face growing compliance and regulatory risks and the overhang of unresolved litigation is still considerable in some markets.

According to Fitch Ratings, the Basel Committee’s proposed overhaul of the way banks calculate how much capital they need to cover operational risk should result in simpler, more standardised charges, allowing for greater comparability.

Banks have been calculating operational risk capital requirements for over 10 years since the implementation of Basel II, but in many cases capital set aside proved inadequate to cover substantial losses arising from misconduct fines, controls failure or fraud, for example.

The Basel Committee’s update on post-crisis reforms, presented to the G20 leaders at the recent Antalya summit, confirms that it is considering eliminating the use of internal models to calculate operational risk capital charges. Basel II introduced several methods for calculating operational risks to reflect particular risk profiles across banks, variations in operating environment and management practices. But we believe flexibility has confused market participants and contributed to a lack of transparency.

The Basel Committee is considering replacing all current approaches with a single new standardised measurement approach (SMA), and will open a one-year consultation period by end-2015. SMA will borrow from the current advanced measurement approach (AMA) by incorporating a requirement for banks to continue to collect operational risk loss data, but internal modelling will not be used to determine appropriate capital levels. Comparing operational risk capital charges currently set aside by banks using AMA has proved difficult, largely because internal models are highly complex, methodologies vary from bank to bank and calculation outputs lack transparency.

Some Basel II methods for calculating operational risk charges are predetermined by regulators, such as the basic indicator and standardised approaches, both of which link capital charges to gross income (the standardised approach allows banks to vary multipliers across business lines and units). But operational risk capital charges can also be calculated using an internal measurement approach where banks draw on data from their internal operational loss experiences. The Basel Committee, which is already driving a trend to reduce reliance on complex models in other areas, says it will consult on removing the AMA. The AMA gave banks the greatest amount of freedom to set operational risk charges, as flexibility on the modelling approach meant risk charges would differ even when applied to the same base data.

Why HBOS Failed

The UK Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA) has published the Review into the failure of HBOS Group. The Review concludes that ultimate responsibility for the failure of HBOS rests with the Board and senior management. They failed to set an appropriate strategy for the firm’s business and failed to challenge a flawed business model which placed inappropriate reliance on continuous growth without due regard to risks involved. In addition, flaws in the FSA’s supervisory approach meant it did not appreciate the full extent of the risks HBOS was running and was not in a position to intervene before it was too late.

This review was originally started by the former regulator, the Financial Services Authority (FSA). Its purpose is to analyse the causes of the firm’s failure, and to draw out lessons for the future, for both the industry and the regulatory system as a whole.

On 1 October 2008 HBOS was approaching a point at which it was no longer able to meet its liabilities as they fell due and so sought Emergency Liquidity Assistance from the Bank of England. This report seeks to explain why HBOS failed, the role that HBOS Board and senior management played in the failure and the FSA’s supervision of HBOS.

The main period covered by the FCA/PRA Report (the Review Period) is from January 2005 to the point of failure, though it draws on earlier materials going back to the creation of HBOS in 2001, and some materials from after the point of failure where these provide useful context to help the explanation of failure. The Report draws on the records of the firm, the FSA as supervisor of HBOS, interviews with the main individuals involved, and other relevant outside sources. Documentary evidence has been combined with interviews, so that individuals could give theirown account of events, and supplemented by representations received from a number of parties.

The paradox of the story is that at the time, and indeed up until quite near to its failure, HBOS was widely regarded as a success story. The 2001 merger of Halifax and Bank of Scotland had yielded double-digit profit growth in all but one of the years up to end-2006 and analysts’ and brokers’ views were positive at least until early 2007. But, by this time, the seeds of the firm’s destruction had already been sown as a flawed strategy led to a business model that was excessively vulnerable to an economic downturn and a dislocation in wholesale funding markets.

The failure of HBOS can ultimately be explained by a combination of factors:

  • Its Board failed to instil a culture within the firm that balanced risk and return appropriately,and lacked sufficient experience and knowledge of banking.
  • The result was a flawed and unbalanced strategy and a business model with inherent vulnerabilities arising from an excessive focus on market share, asset growth and short-term profitability.
  • This approach permitted the firm’s executive management to pursue rapid and uncontrolled growth of the Group’s balance sheet, and led to an over-exposure to highly cyclical commercial real estate (CRE) at the peak of the economic cycle, lower quality lending, sizable exposures to entrepreneurs, increased leverage, and high and increasing reliance on wholesale funding. The risks involved were either not identified or, where identified, not fully understood by the firm.
  • There was a failure by the Board and control functions to challenge effectively executive management in pursuing this course or to ensure adequate mitigating actions.
  • HBOS’s underlying balance sheet weaknesses made the Group extremely vulnerable to market shocks and ultimately failure as the crisis of the financial system intensified.
  • There was an extended period of inflows of capital to developed economies, resulting in low yields, declining awareness of risk and asset price bubbles, in which market discipline – investors, analysts, rating agencies and other third parties – failed to constrain firms from undertaking risky strategies.
  • An overall systemic crisis in which the banks in worse relative positions were extremely vulnerable to failure. HBOS was one such bank.

Ultimate responsibility for the failure of HBOS rests with its Board. However, another striking feature of HBOS’s failure is how the FSA did not appreciate the full extent of the risks HBOS was running and did not take sufficient steps to intervene before it was too late.

The FSA Board and executive management failed to ensure that adequate resources were devoted to the supervision of large systemically important firms such as HBOS. This gave rise to:

  • a risk assessment process that was too reactive, with inadequate consideration of strategic
  • insufficient focus on the core prudential risk areas of asset quality and liquidity in a benign economic outlook; and
  • too much trust being placed in the competence and capabilities of firms’ senior management and control functions, with insufficient testing and challenge by the FSA.

Andrew Bailey, Deputy Governor of the Bank of England, CEO of the PRA and Accountable Executive for the HBOS Review said “The story of the failure of HBOS is important both to provide a record of an event which required a major contribution by the public purse, and because it is a story of the failure of a bank that did not undertake complicated activity or so-called racy investment banking. HBOS was at root a simple bank that nonetheless managed to create a big problem.”

Sir Brian Pomeroy, Senior Independent Director at the Financial Conduct Authority and Chairman of the HBOS Review Steering Committee said:

“The review into HBOS has involved a dedicated team sourcing and considering a huge amount of material including reviewing around a quarter of a million documents and interviews with 80 key individuals. I am hugely thankful for the painstaking work the team have done to compile a comprehensive report. While much has already been written about the failure of HBOS, I believe this to be the definitive account and to be a thorough, fair and balanced view of what occurred.”

As part of the Review, Andrew Green QC was asked to provide an independent assessment of whether the decisions taken on enforcement by the former regulator, the FSA, were reasonable. The PRA and FCA are therefore also today publishing Andrew Green QC’s report into the FSA’s enforcement actions following the failure of HBOS

In his report, Andrew Green QC recommends that the PRA and FCA should now consider whether any former senior managers of HBOS should be the subject of an enforcement investigation with a view to prohibition proceedings.

The PRA and FCA will conclude a review as to whether further enforcement action should be taken as early as possible next year.

Proposed Basel Market Risk Framework Will Demand More Capital

Trading banks will find their capital requirements rising by more than 2%, according to the Basel Committee on Banking Supervision who has today published the results of its interim impact analysis of its fundamental review of the trading book. The report assesses the impact of proposed revisions to the market risk framework set out in two consultative documents published in October 2013 and December 2014. Further revisions to the market risk rules have since been made, and the Committee expects to finalise the standard around year-end.

The analysis was based on a sample of 44 banks (including 2 from Australia) that provided usable data for the study and assumed that the proposed market risk framework was fully in force as of 31 December 2014. It shows that the change in market risk capital charges would produce a 4.7% increase in the overall Basel III minimum capital requirement. When the bank with the largest value of market risk-weighted assets is excluded from the sample, the change in total market risk capital charges leads to a 2.3% increase in overall Basel III minimum regulatory capital.

Compared with the current market risk framework, the proposed standard would result in a weighted average increase of 74% in aggregate market risk capital. When measured as a simple average, the increase in the total market risk capital requirement is 41%. For the median bank in the same sample, the capital increase is 18%.

Compared with the current internally modelled approaches for market risk, the capital requirement under the proposed internally modelled approaches would result in an increase of 54%. For the median bank, the capital requirement under the proposed internally modelled approaches is 13% higher.

Compared with the current standardised approach for market risk, the capital requirement under the proposed standardised approach is 128% higher. For the median bank, the capital requirement under the proposed standardised approach is 51% higher.

Can We Trust The BBSW?

RBA’s Guy Debelle, Assistant Governor (Financial Markets) has been speaking about benchmark currency and interest rates. Benchmarks only work if they are trusted, and transparent. Of note are his comments on the local market, where the primary interest rate benchmark is the bank bill swap rate (BBSW).

As you may be aware, a few weeks ago, the Council of Financial Regulators issued a consultation paper on possible reforms to BBSW. I will run through the motivation for doing so as well as the possible options we canvassed in the consultation paper.

Given its wide usage, BBSW has been identified by ASIC as a financial benchmark of systemic importance in our market. Hence it is important there is ongoing confidence in it.

As you may know, BBSW was calculated for a number of years by, each day, asking a panel of banks to submit their assessment of where the market was trading in Prime Bank paper at a particular time of the day. While it was a submission-based process, it was different from LIBOR in that it was the assessment of the borrowing cost of a notional Prime Bank, informed by observable transactions, rather than an assessment of a submitting bank’s own borrowing costs.

In response to the prospect of a large number of the banks on the submission panel no longer being willing to provide submissions, the calculation of BBSW was reformed in 2013 in line with the International Organization of Securities Commissions’ (IOSCO) Principles for Financial Benchmarks, which were issued in July 2013.

Since 2013, the Australian Financial Markets Association (AFMA) calculates BBSW benchmark rates as the midpoint of the nationally observed best bid and best offer (NBBO) for Prime Bank Eligible Securities, which are bank accepted bills and negotiable certificates of deposit (NCDs). Currently, the prime banks are the four major Australian banks. The rate set process uses live and executable bid and offer prices sourced from interbank trading venues approved by AFMA, which are currently ICAP, Tullett Prebon and Yieldbroker. The bids and offers are sourced from three times around 10am each day.

While the outstanding stock of bills and NCDs issued by the Prime Banks has increased since 2013 to around $140 billion, trading activity during the daily BBSW rate set has declined over recent years. The consultation paper illustrates how low the turnover currently is. There are quite a number of days were there is no turnover at all at the rate set. The low turnover in the interbank market raises the risk that market participants may at some point be less willing to use BBSW.

This is the motivation for the CFR’s consultation to ensure that BBSW remains a trusted, reliable and robust financial benchmark.

Some preliminary data collected from the four major Australian banks indicate that there is substantially more activity in the NCD market than is being measured at the rate set, with the activity mainly occurring outside the interbank market. At least $100 million in NCDs were bought or sold on almost all business days, with activity almost entirely at the 1-, 3- and 6- month tenors. However, the non-bank participants that buy and sell NCDs tend to transact bilaterally with the issuing bank, with the price struck at the (yet to be determined) BBSW ahead of the actual rate set, rather than at a directly negotiated rate. If these participants could be encouraged to buy and sell NCDs at outright yields, then these transactions may have the potential to underpin the BBSW benchmark.

Hence the consultation paper proposes one option for reform which would be to continue with the current NBBO calculation methodology, but to underpin the executable prices with a broader set of NCD market transactions contracted up to the time of the rate set. By more firmly anchoring the BBSW benchmark to observable transactions entered into at arm’s length between buyers and sellers in the market, this may ensure that the benchmark remains a credible indicator of rates in the market.

For this option to be feasible, it would be necessary for the banks to directly negotiate the interest rates on their NCDs with third parties, rather than linking the rate to BBSW. This would require a change to the existing market practice. (In this regard this option has some similarities with the FX benchmark reforms where prior to the reforms, participants also agreed to transact at a yet to be determined price and at the midpoint of the fix.)

Another option for reform, akin to the proposed methodology for LIBOR, would be for the banks to submit to the benchmark administrator their assessment of their aggregate cost of wholesale funding, based on their transactions in a particular window. That is, the banks would do the aggregation and the administrator would only need to average the (currently) four submissions. An alternative option would be for the banks to submit all their transactional data to the benchmark administrator who would then itself do the aggregation. Both of these options would need to provide for circumstances in which the Prime Banks had not executed any transactions in the relevant window.

The final option would be to accept the current system as it is, notwithstanding the very low turnover at the rate set.

The consultation is open until 3 December.

 

RBA Minutes – Still Accommodative

The RBA minutes for November do not tell us much that is new, other than confirming again the categorisation of loans by the banks is likely to continue, and monetary settings are considered to be accommodative, despite recent mortgage rate hikes.

The major banks in Australia continued to raise equity to meet the changes to minimum capital requirements announced by APRA around mid year, which would take effect from July 2016. Equity as a source of funding for banks had increased by around ½ percentage point to 8 per cent of total funding. The largest banks had increased standard variable housing rates in October by 15–20 basis points. Members noted that widening margins on mortgage lending were in part offsetting lower margins on lending to larger businesses, for which lending rates had continued to decline in the face of strong competition. Deposit rates had been lowered and funding costs more generally had declined.

Over the course of 2015 to date, Australian financial institutions had made substantial revisions to the data used to categorise housing, business and personal credit. The revisions were particularly large for the split of housing credit between owner-occupation and investment, with the share of housing credit extended to investors revised from 35 to 40 per cent. More recently, as a result of the increase in lending rates to investors in housing, a significant amount of housing lending had been reclassified from investment to owner-occupation. Further switching was expected in coming months. The revisions had resulted in discrete breaks in the level of the two components of housing credit, complicating the assessment of the rate of growth in these two components. Members noted that the stock of total lending for housing as well as its growth rate were not materially affected by the revisions.

At the time of the meeting, pricing in financial markets reflected around a 50–50 expectation of a reduction in the cash rate at the present meeting.

Considerations for Monetary Policy

In considering the stance of monetary policy in Australia, members noted that the global economy was expanding at a moderate pace, with some further softening in conditions in the Asian region, continuing growth in the United States and a recovery in Europe. The slowdown in Asia had been more persistent than earlier anticipated and had contributed to lower commodity prices, along with increased supply of commodities, including from Australia. The terms of trade for Australia had declined further. Monetary policy was accommodative in many economies and the low level of oil prices was expected to support growth in Australia’s major trading partners over the next few years. Inflation rates remained low and below central banks’ targets.

Members noted that recent data on economic activity in Australia suggested that the moderate economic expansion had continued. The very low level of interest rates was supporting growth in household consumption and dwelling investment. In addition, the Australian dollar was adjusting to the significant declines in key commodity prices and boosting demand for domestic production. This had been most evident in the services sector, which had experienced strong employment growth over the past year. While measures of non-mining investment intentions had remained subdued, surveys of business conditions had strengthened to above-average levels. These factors suggested that the prospects for an improvement in economic conditions had firmed a little over recent months.

Overall, the forecast for the Australian economy remained for growth to strengthen gradually over the next two years as the drag on GDP growth from falling mining investment waned and activity progressively shifted to non-mining sectors of the economy. However, members recognised that there was still evidence of spare capacity, including the relatively high unemployment rate, low wage growth and the lower-than-expected inflation outcome in the September quarter. The gradual nature of the pick-up in domestic growth suggested that spare capacity would persist for some time. Inflation was forecast to be consistent with the target over the next one to two years, but somewhat lower than earlier expected.

In these circumstances, members judged that monetary policy needed to be accommodative. While the recent changes to some lending rates for housing would reduce the support to demand from low interest rates slightly, overall conditions were still accommodative. Credit growth had increased a little over recent months and housing prices had risen further in Melbourne and Sydney, though the pace of growth had moderated and housing prices were steady in other cities. Members noted that supervisory measures were helping to contain risks that may arise from the housing market.

Taking the above information into consideration, members decided that leaving the cash rate unchanged at this meeting was appropriate. They judged that the inflation outlook may afford some scope for further easing of monetary policy, should that be appropriate to lend support to demand. The Board would continue to assess the outlook, and whether the current stance of policy would most effectively foster sustainable growth and inflation consistent with the target.

The Risks In Broker Originated Loans

From Mortgage Professional Australia.

You may recall the stir caused among brokers when APRA chairman Wayne Byres warned lenders about third-party originated loans at the Australian Business Economists briefing in August.

Byres said, “Third-party originated loans tend to have a materially higher default rate compared to loans originated through proprietary channels.”

The regulator gave MPA an insight into its data on default rates, which it had requested from a number of the largest lenders. Its spokesperson said: “This data showed that the default rate on mortgages originated through third-party channels was typically higher than mortgages originated via proprietary channels. There were differences from lender to lender but, on average, the average default rate for third-party originated loans was around 30% higher.”

But despite highlighting higher default rates on third-party loans, the chairman went on to say at the briefing: “This does not mean third-party channels have lower underwriting standards, but simply that the new business that flows through these channels appears to be of higher risk, and must be managed with appropriate care.”

However, the mention of higher default rates and higher risk associated with third party loans gave brokers cause for concern that their loan-writing abilities and the quality of broker-sourced loans were being negatively portrayed, leading the industry associations to question APRA’s comments.

MFAA CEO Siobhan Hayden was able to meet with APRA and clarify for the industry that Byres’ comments on the riskier nature of third-party loans were not an attack on brokers’ loan-writing abilities.

“It was more around that the type of customers that would present themselves to a teller versus the type of customers that would engage with a finance broker – [they] are different, and inherently I would agree with that,” Hayden told MPA. “The types of structures that finance brokers are asked to support customers on are more detailed, more involved and require more consideration, so I didn’t disagree with that analysis.”

She said APRA did suggest very clearly to her that the overall rate of arrears and defaults was negligible – the lowest it had been in this economic climate. Another positive outcome was that the association was also able to provide more details to the regulator on how APRA’s decisions affect the broker channel directly.

Clearing up areas of confusion such as these is one of the reasons associations are invaluable to brokers and their industry as a whole.

“You need the industry body to be able to be there having that dialogue [with APRA or ASIC], and this is one of the most important things that associations do,” said FBAA chief executive Peter White. “This is where industry associations are at their fore.

“Normally it’s not a regulator that we deal with; they don’t regulate our industry. At the end of the day APRA is looking at the credit and regulatory regime of the lenders and they’re looking at their processes and credit policies – a broker can’t write a loan that isn’t within credit policy.”

MPA took a look at what other statistics had to reveal about third-party originated loans, and what lenders, a risk expert and an aggregator had to say on the quality of broker introduced loans.

The MFAA’s 2015 Ernst & Young report Observations on the Value of Mortgage Broking found there was no difference between thecredit quality of the retail and broker channels. “There has not been any material differences witnessed in the characteristics (ie credit quality, cost of acquisition (post commissions), net interest margin and loyalty) of the broker portfolio to that of proprietary channels,” the report stated.

“With regards to credit quality, lenders noted that the arrears rate in both portfolios is largely similar. It should be noted however, that given the historically low levels of arrears lenders are experiencing this has only been analysed by lenders at a headline level.”

One thing that is certain is the broker market share is only going up. The MFAA’s 2015 report states that broker-originated loans now contribute to 50% of mortgages in the system (both new and refinanced), double the volume since 2003 when around 25% of all new home loans were sourced through brokers, according to the Reserve Bank’s 2004 Financial Stability Review.

Risk management expert Professor Paul Kennedy of Macquarie University said the fact that broker-originated loans involved extra participants gave them a tendency to be riskier.

“Every layer you put in the financial process gives you more challenge in getting the incentives right and making sure everything is aligned to a fair and equitable outcome,” Kennedy said.

‘I think [broker-originated loans] bring their own challenges, and the challenges include they are one step removed from the lender, so you need to ensure that you have strong connection and oversight with them – also, the population of people that they are dealing with may be different from those who come directly to the lender themselves.

“You need different channels to ensure you can service the market. Different channels come with their own particular challenges. Those are not insurmountable challenges; you just need to be aware of them when you are growing that channel.”

WHY AUSSIE BROKERS RANK HIGHLY ON COMPLIANCE ON GLOBAL STAGE

The risk involved in broker introduced loans within Australia compares well with those originated by brokers globally, says Professor Paul Kennedy of Macquarie University. With extensive experience in risk management at top banks in Europe and Australia, among them CBA and NAB, Kennedy says historically Australian brokers have compared quite well.

“Although Australia has suffered incidents of, for instance, poor broker-originated loans, they tend to be restricted to specific firms and regions,” he says.

“I think Australia’s had isolated poor incidents which are intrinsic to the business model, and there will always be the odd bad apple, but so far we have escaped the worst systemic abuse that has been perhaps a bit more obvious particularly in the UK. We actually have a reasonable financial system and I think we’ve been tested quite well through the global financial crisis in comparison – our financial system is pretty sound.”

Brokers’ top priority
That most brokers in the industry want to achieve high compliance and do the best by their clients is probably fair to say.

“I think brokers have a very real concern that they are compliant with the law. I would say it’s probably on the top of mind with just about every broker that I speak to,” said Vow CEO Tim Brown, who explained that their compliance webinars were the best attended of all of Vow’s webinars.

One of Australia’s largest aggregation groups, Vow has a strong presence in compliance training for its brokers and runs a broker survey every six months. “Compliance is our most highly regarded area,” says Brown. “Our compliance area gets a 93% satisfaction rating, which shows they really value the education that we give them through our compliance.”

The aggregator also runs workshops that give brokers the opportunity to bring in their own files and discuss them. “People are able to have an open discussion without feeling threatened that they are going to get caught out. We find, educationally wise, they learn more from that experience than by us going and doing audits.”

While compulsory for those under Vow’s licence, brokers are finding the workshops so useful that those with their own licences are requesting that the aggregator runs similar workshops for a fee.

“They’ve been requesting that they want to attend our workshops, and they want us to do audits on them. It would give us some comfort, too, to know they are being compliant, albeit they’re not under our licence.”

Brown’s background in banking has placed him in a good position to compare the retail and broker channels.

“Most brokers have been in the industry a long time; they tend to have come out of major banks and so they tend to be well trained anyway and they know what not to do. They’ve got integrity and they know that their licence can be put at risk if they put a client into a loan that they can’t afford or that isn’t the right product for them.”

Broker-originated lending stands tall
MPA spoke to three lenders, who explained why the future was looking bright for the broker channel – and said third-party originated loans were ticking all the boxes.

Australia’s largest customer-owned bank, Heritage Bank, sources 50% of its mortgage loans through brokers and 50% from its retail network. The bank has also had an exceedingly strong year in loan origination through its broker partners, head of third party channels David Ure said. “This channel gives us access to markets across Australia,” he said. “Our relationship with the channel is considered very important.”

Ure said the bank’s main risk associated with loans introduced through a third party was in receiving/assessing and approving loan applications. “However, this risk is well mitigated through legislation and compliance requirements within the industry, as well as Heritage’s relationship with our broker partners,” he said.

But for ING Direct head of broker distribution Mark Woolnough, brokers don’t introduce any material risk into the process. “We’ve been working with brokers for a long time, nearing 20 years now, and we’ve always said to brokers and internally, they are essentially an extension of our own sales team. Being a branchless bank we don’t have a face-to-face or mobile sales network. We see our broker partners as the extension of our sales force, and therefore they’re effectively seen as our shopfront.”

He said brokers accounted for more than 20% of ING Direct’s lending business and there was no significant difference regarding approvals, defaults or refinances between direct and broker customers. “For us, there’s no statistical difference because our focus is not on just getting people into their homes but to make sure they stay in their homes longterm, which is reflected in where we pitch our products and our credit policy and our appetite to help customers.”

ME’s general manager brokers Lino Pelaccia said his bank’s experience of working with brokers had been “extremely positive”, with half of ME’s home loan sales originating from brokers in the past year.

“Brokers run professional, risk-averse businesses that are compliant and accredited with industry bodies,” said Pelaccia. “Brokers are also a great source for instant feedback on the state of the market and how our products and services are being received.”

ME plans to expand its broker network and expects it to generate 55% of home loan settlements over the next three years, totalling $3.3bn in FY16 and increasing to $5.3bn in FY18. “Brokers are a valued sales channel for ME, and the broker channel is critical to our growth plans going forward.”

Revisiting Three Intellectual Pillars of Monetary Policy Received Wisdom

A really excellent speech by Claudio Borio, Head of the Monetary and Economic Department of the BIS, at the Cato Institute in which he questions three deeply held beliefs that underpin current monetary policy received wisdom and cites Mark Twain “It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.”

The speech draws two conclusions. First, the well known trend decline in real interest rates is, at least in part, a disequilibrium phenomenon, not consistent with lasting financial, macroeconomic and monetary stability and unusually easy monetary policy spreads globally.

Second there is a need to adjust current monetary policy frameworks so that monetary policy plays a more active role in preventing systemic financial instability and its huge macroeconomic costs. This calls for taking financial booms and busts more systematically into account. Financial booms sap productivity by misallocating resources.

One slide in particular caught my attention. It is Table 1: Early warning indicators for banking distress – risks ahead.

BIS-Nov-2015The three beliefs he questions are worth thinking about:

  1. Is it appropriate to define equilibrium (or natural) rates as those consistent with output at potential and with stable prices (inflation)?
  2. Is it appropriate to think of money (monetary policy) as neutral, ie as having no impact on real outcomes, over medium- to long-term horizons relevant for policy – 10-20 years or so, if not longer?
  3. Is it is appropriate to set policy on the presumption that deflations are always very costly?

He finds that there are good reasons to question these three deeply held beliefs underpinning monetary policy received wisdom.

First, defining equilibrium (or natural) rates purely in terms of the equality of actual and potential output and price stability in any given period is too narrow an approach. An equilibrium rate should also be consistent with sustainable financial and macroeconomic stability – two sides of the same coin. Here, he highlighted the role of financial booms and busts, or financial cycles.

Second, money (monetary policy) is not neutral over medium- to long-term horizons relevant for policy – 10–20 years or so, if not longer. This is precisely because it contributes to financial booms and busts, which give rise to long-lasting, if not permanent, economic costs. Here he highlighted the neglected impact of resource misallocations on productivity growth.

Finally, deflations are not always costly in terms of output. The evidence indicates that the link comes largely from the Great Depression and, even then, it disappears if one controls for asset price declines. Here he highlighted the costs of asset price, especially property price, declines and the distinction between supply-driven and demand-driven deflations.
Therefore, the long-term decline in real interest rates since at least the 1990s may well be, in part, a disequilibrium phenomenon, not consistent with lasting financial, macroeconomic and monetary stability. Here he highlighted the asymmetrical monetary policy response to financial booms and busts, which induces an easing bias over time.

There is a need to adjust monetary policy frameworks to take financial booms and busts systematically into account. This, in turn, would avoid that easing bias and the risk of a debt trap. Here he highlighted that it is imprudent to rely exclusively on macroprudential measures to constrain the buildup of financial imbalances. Macroprudential policy must be part of the answer, but it cannot be the whole answer.

ING Direct Lifts Mortgage Rates

ING DIRECT today announced it will increase interest rates by 0.18% p.a. across its variable owner occupier and investor residential loan portfolio, effective 15 January 2016.

As at 15 January 2016, the variable interest rate on the Orange Advantage offset home loan for residential owner occupier borrowers will be 5.02% p.a. (5.21% p.a. comparison rate).