Bupa’s nursing home scandal is more evidence of a deep crisis in regulation

British health-care conglomerate Bupa runs more nursing homes in Australia than anyone else. We now know its record in meeting basic standards of care is also worse than any other provider. Via The Conversation.

This is more than a now familiar story of a corporation putting shareholders before customers. It is also about another abysmal design failure in regulation.

Health care is meant to be one of our most regulated sectors. In this case, Bupa’s facilities were inspected and certified by the Aged Care Quality and Safety Commission.

The regulator’s inspectors found 45 of Bupa’s 72 nursing homes failed health and safety standards. In 22 homes the health and safety of residents was deemed at “serious risk”. Thirteen homes were “sanctioned” – with government funding being withheld and the homes banned from taking new residents.

Yet none of this appears to have spurred Bupa’s management into action, according to media reports. Flurries of inspection reports and written warnings over months and years only underlined that the regulatory tiger, even if it had teeth, had a very soft bite.

Responsive regulation

We have seen examples of equally insipid regulation in other areas. In the building sector, for example, a range of regulatory flaws including outsourced building certification have led to shoddily built and dangerous apartment construction.

In the financial sector, the banking royal commission castigated the industry regulators – the Australian Securities and Investments Commission and the Australian Prudential Regulatory Authority – for their unwillingness to enforce rules.

“The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct,” noted royal commissioner Ken Hayne. “The prudential regulator, APRA, never went to court.”

This failure is due to more than individual agency shortcomings. It’s an unintended consequence of the design of “responsive regulation” – the system that has superseded command-and-control regulation over the past three decades.

Responsive regulation was popularised by Australian sociologist John Braithwaite and American law professor Ian Ayres in the early 1990s. It was intended to overcome the pitfalls of the command-and-control model, which involved regulators employing large numbers of inspectors to look for non-compliance.

From about the 1970s it had become increasingly evident this model wasn’t working. It was also very expensive. Consider, for example, the cost of having fire and health and safety inspectors visit every single building site, particularly when most builders were doing the right thing. The cost and intrusiveness of the system fuelled calls to do away with regulation .

Too big to fail

Ayers and Braithwaite saw their model as a way forward. “Responsive regulation is not a clearly defined program or a set of prescriptions concerning the best way to regulate,” they explained. “On the contrary, the best strategy is shown to depend on context, regulatory culture and history.”

Responsive regulation assumes that in most cases the enterprises being regulated are interested in compliance and will respond to light-touch directives. It assumes that often compliance failures are due to ignorance or inadequate procedures. Its approach is to give parties a chance to amend their ways.

But there’s a potentially huge flaw in the responsive regulation model. What happens when an organisation is so large it is deemed too big to fail, or deems itself so?

How Ian Ayres and John Braithwaite conceived the enforcement pyramid in responsive regulation. The problem now seems to be that regulators want to stop halfway. Responsive Regulation: Transcending the Deregulation Debate

This seems to have been the case with a number of financial companies whose misdeeds were exposed by the banking royal commission. It seems it might have been the case with Bupa.

In such cases, because of the timidity of the regulator or the confidence of the enterprise, the warnings might just go on and on. The company continues to book its profits – which may well eclipse any penalty it might have to pay if crunch time does ever come.

Markets have their limits

This design flaw highlights a more fundamental problem with governments positioning themselves as rule makers and leaving the rest to the “market”.

Markets are designed to facilitate exchange on the basis of profits. The profit motive means market participants look for the lowest-cost option. In aged care this means paying the lowest possible wages, possibly to unqualified staff, and cutting corners to cut costs.

Markets are very useful for increasing individual choices and efficiently allocating resources, but they are not suited to every task. They fail when factors other than profit ought to be considered.

We therefore need to think about the design of regulatory systems more holistically, as part of a broader social process.

The pioneers of responsive regulation certainly understood this. They emphasised flexibility, taking into account context, culture and history.

What those three things now tell us, given widespread regulatory failure across industries, is that government should not resist stepping in to provide important public services where the private sector cannot or will not do so at an acceptable level. Nor should it be afraid to act through empowered regulators, with ressources and powers to fulfil their mandates.

Author: Author: Benedict Sheehy, Associate professor, University of Canberra

ECB Introduces Deposit Tiering System

On 12 September, the European Central Bank (ECB) announced that it will introduce a two-tier system for banks’ reserve remuneration, exempting a portion of deposits in excess of the minimum reserve requirement from the negative deposit facility rate and giving that portion a 0% rate instead. The introduction of the tiering system on banks’ excess liquidity placed at the central bank is credit positive, says Moody’s.

This is because it will reduce the cost of holding liquidity at the ECB, providing a partial offset. They expect that the tiering mechanism will be particularly positive for banks with material excess liquidity.

The announcement comes as the ECB’s Governing Council announced that it would maintain its accommodative monetary policy stance given slowing economic conditions in Europe, persistent downside risks of global trade tensions and muted inflationary pressures. As a result, the ECB relaunched its Asset Purchase Programme and lowered the rate on the deposit facility by 10 basis points to negative 0.50% from negative 0.40%.

The tiering system on banks’ excess liquidity will moderate the negative effect of persistent low rates on banks in the euro area.

The two-tier system will exempt from negative interest a maximum volume of six times the banks’ minimum reserve requirement, therefore paid at 0%. The minimum reserve requirement and the non-exempted portion of the excess reserves will be charged 0.5%.

The tiering system will apply to all banks and start at the end of October 2019.

Since the aggregated minimum reserve requirement is currently €132 billion, approximately €786 billion (six times the aggregated minimum requirement) would be exempt from negative rates. The remaining reserves and deposit facility would be subject to the new deposit rate of negative 50 basis points, providing a net annual benefit to the euro area’s banks of about €2 billion relative to the status quo of negative 40 basis points on the full balance of €1.9 trillion liquidity placed at the ECB, equivalent to 0.8% of EU banks’ annual net interest income.

In 2018, Moody’s estimate that banks’ €1.8 trillion of total liquidity placed at the central bank at a rate of negative 0.40% cost around €7 billion. This compares with US banks, whose deposits placed with the US Federal Reserve in 2018, remunerated at a rate of 2.35%, represented a revenue of around €40 billion.

The introduction of a two-tier system for banks’ reserve remuneration will be particularly positive for German and French banks, whose liquidity holdings exceed the most their reserve requirements and account for more than 60% of the total liquidity placed at the ECB. The tiering mechanism that the ECB has introduced is similar to the mechanism implemented by Switzerland’s central bank, which also set exemption thresholds for deposit rates as a multiple of banks’ minimum reserve requirements.

Southern European banks will benefit to a lesser extent because they do not hold large amounts of excess reserves at central banks.

However, they will continue benefiting from the third series of targeted longer-term refinancing operations (TLTRO III). The ECB in June 2019 announced that banks could access two years of funding at 10 basis points above the ECB’s refinancing rate of 0%. On 12 September, the ECB removed the 10-basis-point surcharge and announced that TLTRO funding would extend to maturities of three years instead of two, conditions that will be particularly favourable for banking systems with large outstanding repayments from previous TLTRO programmes, such as those in Italy and Spain.

Pepper launches mortgage offering in NZ

Non-bank lender Pepper Money has launched mortgage lending operations in New Zealand, offering advisers in New Zealand the technology and tools to write its prime, near-prime and specialist loans. Via The Adviser.

Following more than a year of consultation with advisers and intermediaries, lending partners, regulators and borrowers, Pepper Money has today (16 September) opened its business in New Zealand.

This builds on the international reach of the non-bank lending group, which already operates in Australia, the UK, Spain, Ireland and Asia.

New Zealand-born Aaron Milburn, Pepper Money’s director of sales and distribution in Australia, will head up the New Zealand business from today. His new job title will be director of sales and distribution for Australia and New Zealand.

Speaking to The Adviser about the new business, Mr Milburn said that Pepper Money will primarily distribute through the third-party channel, as it does in Australia.

Mr Milburn added that while while the company may look to launch mortgages directly in future, “the initial plan – and for the foreseeable future – is to utilise the adviser network over there”.

He explained: “We will initially distribute through the adviser network in NZ through all of the major aggregators that operate in New Zealand. 

“Pepper’s business is 95 per cent driven through brokers in Australia and in the UK, and we see no need to change that model as we enter NZ.”

He continued: “We think that advisers do a wonderful job in New Zealand, and we would like to continue to support that area of distribution as we enter NZ, as we do in Australia.”

Mr Milburn told The Adviser that his first priority in his expanded role will be to launch the suite of products in New Zealand and “deliver what advisers have been asking for at our various feedback sessions and study tours”.

According to the director of sales and distribution for Australia and New Zealand, this largely focuses around filling a “significant gap in the near-prime space in New Zealand, where families are potentially paying too much or have been in the wrong products due to a lack of choice” and providing advisers with supporting tools to help deliver these products.

He explained: “We had advisers in New Zealand contacting Pepper asking us to go over there and really inject some competition into the market and make it easier for advisers and, ultimately, Kiwi families to realise their goals.”

Pepper Money will therefore also offer advisers the Pepper Product Selector (PPS) tool in New Zealand, which will enable brokers to “get indicative offers for their customers in under two minutes”, as well as a “fully online integrated submission platform for brokers,” the marketing toolkit, the social media toolkit and the Pepper Insights Roadshow.

Pepper Money to pay trail

Notably, while the majority of lenders in New Zealand went through a “no trail” period starting in 2006 (when payments went from 0.65 of a percentage point in upfront commission plus 0.20 of a percentage point in trail commission to an average of 0.85 of a percentage point in upfront only), several lenders have begun returning to trail commission to reduce instances of churn.

According to Mr Milburn, Pepper Money in New Zealand will be offering advisers an upfront and trail commission.

He told The Adviser: “Overwhelmingly, the feedback was that an upfront and trail model was preferred. 

“A number of banks have either re-implemented trail in NZ or are looking to in the near future, so we took the opportunity to put trail back into the New Zealand market with our products.”

Mr Milburn concluded that the new operation in New Zealand would build on the practice and service offerings built in Australia.

He said: “We will continue to deliver the level of service and solutions that we do today and continue to really focus on that technology improvement side of things. 

“We want to make it easier and faster for brokers to provide solutions for their customers and help build their brand out in the community and the focus will continue in the back end of 2019 to 2020.”

Low interest rates could bite smaller banks: APRA

The current low interest rate environment could impact the ability of smaller banks to compete against the major institutions, APRA chair Wayne Byres has cautioned, via InvestorDaily.

In an address to the European Australian Business Council in Melbourne, Mr Byres spoke on financial stability and the challenges ahead for the banking system. 

To briefly recap the different experience: 

The return on equity (RoE) of the Australian major banks has certainly declined but has not fallen below 10 per cent, even during the GFC, and is now in the order of 12 per cent; for large global European banks, RoE was negative at the height of the crisis, and has struggled to get much above 5 per cent since then.

Reflecting this, the price-to-book (PTB) ratio of the Australian majors averages around 1.5x, and capital is readily available; for large European banks, PTB has typically been in the order of 0.5x and new capital is therefore expensive.

In 2018, a decade after the crisis, the four Australian majors were ranked in the top 35 banks in the world by market capitalisation. Europe, despite a much larger banking system and population, only had four banks in the top 35.

All four Australian major banks enjoy AA credit ratings, and ready access to funding; very few European banks (without explicit government support) enjoy similar ratings.

He compared the experience of the Australian market to Europe, noting local banks are having to get used to low interest rates, as opposed to their weathered overseas counterparts.

In Europe, where the continent’s GDP fell more than 5 per cent at the height of the global financial crisis and didn’t make it back to 2008 levels for another five years as well as unemployment rising to 11 per cent and only just recovering, he noted the environment has been tough. 

“For European banks, of course, it is nothing new – Europe has operated with its interest rate on the ECB’s main refinancing operations at 1 per cent or below since late 2011, and zero since early 2016,” Mr Byres said.

“In that regard, the European experience illustrates some of the challenges potentially ahead for Australian banks. A very low interest rate environment will see margins squeezed, adding to the headwinds from slow lending growth.

“Profitability, and therefore capital generation, will come under more pressure. And given their different funding profiles, these trends may well impact smaller banks more forcefully than larger ones, reducing the ability of the former to apply competitive pressure to the latter. But to be clear, neither group will welcome further rate reductions.”

He reflected on the market around 2014-15, when APRA was concerned the banks were not responding prudently to the environment of high house prices, high household debt, low rates and subdued income growth.

“Speculative activity was increasingly prominent,” Mr Byres said. 

“Such an environment would, one might think, see prudent bankers trimming their sails and battening down the hatches. Instead, intense competitive pressures across the industry saw a tendency for standards go by the wayside – for lenders, it was full steam ahead.”

APRA and ASIC worked to drive standards to more prudent levels, while ASIC focused on responsible lending.

“However, it is worth remembering that the original risks we were concerned about in 2014 – high prices, high debt, low interest rates and subdued income growth – have not gone away, and in some cases increased,” Mr Byres said. 

“When it comes to the supply of credit, it would therefore be unwise for lending standards to be allowed to erode again as a means of generating lending growth. And on the demand side, it would be unhelpful if recent (and prospective) interest rate reductions led to a resurgence in speculative activity.”

Auction Results 14 Sep 2019

Domain released their latest preliminary results today.

The trends continue to show low volumes but higher clearances than last year, with lower closed sales.

Canberra listed 51 properties, reported 40, with 31 sold, 2 withdrawn and 9 passed in, giving a Domain clearance of 74%.

Brisbane listed 72, reported 35. with 23 sold, 7 withdrawn and 12 passed giving a Domain result of 55%.

Adelaide listed 45, reported 23 and sold 17, with 7 withdrawn and 6 passed in giving a Domain result of 57%.

Banking In Wonderland – The Property Imperative Weekly 14 Sept 2019

The latest edition of our weekly finance and property news digest with a distinctively Australian flavour.

What I said to Treasury:

Contents:

01:40 US Economy and Markets
07:21 UK Brexit
09:30 Euro Zone Stimulus
13:55 Global Interest Rates
14:37 China

18:12 Australia
18:14 Auction Results
19:25 Property Transaction Volumes
20:27 Price Movements
22:24 Finance Commitments
23:38 Weaker Economic Outlook
27:12 New FTB Scheme
29:24 AFR and The Cash Ban
30:24 Market Summary
32:43 Banking In Wonderland

Upcoming live stream