Tag: Banking Royal Commission

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 FBAAPeter 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 stronglaws 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

The Unknown Unknowns From The Royal Commission

The first round of hearings at the Royal Commission into Financial Services Misconduct closed out after two weeks of frankly amazing evidence. Their live streaming of the hearings was well worth watching.  Of the 2,386 submissions received so far 69% related to banking alone!

The case study approach looked at issues across residential mortgages, car finance, credit cards, add-on insurance products, credit offers and account administration. We discuss the findings so far. Watch the video or read the transcript.

The litany of potential breaches of both the law, company policy and regulatory guides were pretty relentless, with evidence from various bank customers as well as representatives from ANZ, CBA, NAB and Westpac, plus others. It looks to me as if many of these breaches will possibly force the banks to pay sizeable remediation costs and penalties. Weirdly, NAB who was first up, probably came out the least damaged, despite the focus on their Introducer program. Their own whistleblower programme brought the issues of fraud inside the bank and beyond to light.

Some of the other players were clearly caught out trying to avoid scrutiny, and seeking to bend the rules systematically to maximise profitability, despite the severe impact on customers. They also tried to blame systems, or brokers, or executional issues. It was pretty damming. We should expect extra remediation costs and even fines together with a heightened risk of further individual or group actions. It is not over yet.

A number of industry practices will be changed, centred on responsible lending, including a further tightening of lending standards and so credit will be harder to get – this will continue to drive credit growth, especially for housing, lower still.

In the final session, in addition to legal breaches, there was also discussion of what conduct below community standards and expectations might mean. The case study approach brought the issues to the fore.

Specific areas included mortgage broking where we think it is likely remuneration models will change, with a focus on fees rather than commissions, and this will shake up the industry. Insiders are already saying this could reduce competition, but we do not agree. Also take note that the banks tended to blame the brokers and aggregators, but they ALL have responsible lending obligations, and they cannot outsource them.

If there is a move towards meeting customer best interest as opposed to not unsuitable, this could lead to a consolidation of brokers and financial planners, something which makes sense, in that a mortgage, or wealth building is part of the same continuum, and credit is not somehow other – the two regimes are an accident of history because the credit laws evolved separately from individual state laws. They should be merged, in the best interests of customers.

But now to those unknown unknowns. I do not think the poor behaviour resides only in the large players which were examined. Arguably, it is endemic across smaller banks and non-banks too. In fact, many smaller players are very active broker users. This means that the proportion of loans held by customers which are unsuitable is considerable. We must not let this become a big bank, or broker bashing exercise. We need structural and comprehensive reform across the board.

Next we need to remember that half of all loans are originated in the banks themselves, and the same underwriting weaknesses are sure to reside there too – the banks will try to deflect attention beyond their boundaries, but they need to look inside too (and evidence suggests they prefer to look away!). Have no doubt, liar loans are found in loans written by bankers themselves. But the case studies in this sector are harder to find, for obvious reasons.

The same drivers are also apparent in the growing non-bank sector, where regulation is weaker. We need to look there too – including the car loans, and pay day loans, plus the strong growth in interest only mortgages by some players. APRA only now has new powers of oversight, but they are still pretty weak.

At its heart we need to rebalance the cultural norms in finance from profit at all costs, to serving the customer at all costs. The fact is, do that, put the customer first, and profitability follows. We discussed this in our recent Customer Owned Banking post.

Now, recalling the terms of reference of the Royal Commission, they will need to look beyond bank practice to think about completion, access to banking services and even the broader impact on the economy.

As we have argued, credit growth has been the engine of GDP growth, – the RBA has used this growth in credit to drive household consumption to replace mining investment. As lending practices are progressively tightened this has the potential to slow growth significantly at a time when rates are rising. We expect the rate of slowing to speed up ahead. I also think the confused roles of the regulators – ACCC, APRA, ASIC, RBA and The Council of Financial Regulators, where they all sit round the table (minus the ACCC) with The Treasury – are partly to blame. As the recent Productivity Commission review called out there needs to be change here too. But that is probably beyond the Commissions ambit, for now.

The bottom line is this, the economic outfall of the Royal Commission, even based on just round one will be significant. Credit growth may well slow. Bank share valuations will be hit (they have already fallen) and as the size of the costs of remediation emerge, this could get worse. But lending practices will not get fixed anytime soon. There is a long reform journey ahead.

And in three weeks, we are back, this time looking at financial planning and wealth management, the $2 trillion plus sector.

 

Trail commissions may lead to “poor customer outcomes,” – CBA

A senior manager of the Commonwealth Bank (CBA) has admitted that upfront and trailing commissions for mortgage brokers can lead to poor customer outcomes, as reported in the Australian Broker.

During his 15 March testimony before the Royal Commission, executive general manager of home buying Daniel Huggins said the commission structure is linked to the size of the loan. The longer loan takes to pay off, the larger the trailing commission will be. “[T]hat can lead to a conflict – well, there is a conflict between – between the customer, you know, and – and the broker,” he added.

Huggins confirmed to Senior Counsel Assisting Rowena Orr that brokers can maximise their income by getting the largest possible loan approved to extend over the longest period of time for the customer to repay.

The bank knew about this as early as February 2017, according to a confidential letter by outgoing CBA CEO Ian Narev to Stephen Sedgwick, who was the independent reviewer for the Retail Banking Remuneration Review back then. Orr presented the confidential letter during the hearing.

“We agree with the reviewer’s observations that while brokers provide a service that many potential mortgagees value, the use of loan size linked with upfront and trailing commissions for third parties can potentially lead to poor customer outcomes,” said Narev in the letter.

“We would support elevated controls and measures on incentives relates to mortgages that are consistent with their importance and the nature of the guidance that is provided,” Narev added. These initiatives include delinking of incentives from the value of the loan across the industry, and the potential extension of regulations such as future and financial advice to mortgages in retail banking.

Another CBA submission attached to Narev’s letter said that broker loans are reliably associated with higher leverage compared to those applied through proprietary channels. “[E]ven for customers with an identical estimate of ex ante risk, loans through the broker channel have higher leverage… [and] loans written through the broker channel have a higher incidents of interest only repayments,” it added.

Huggins agreed with Orr that CBA’s submission lends some support to the case for discontinuing the practice of volume-based commissions for third parties. But he said there are a range of considerations that the bank would have to make.

“There is a first mover problem, in that the person who moved first would likely lose a lot of volume. The second problem is you create a conflict if one person, or half of the people move, and the other half don’t,” Huggins said.

According to Huggins, CBA has not stopped paying volume based commissions to brokers. He also confirmed the lender has not taken any steps towards ceasing its practice.

Is this the beginning of the end of the mortgage broking industry?

ABC Radio National Breakfast did a segment on Mortgage Brokers, in the light of the Royal Commission, including DFA commentary.

A prominent finance industry expert has warned we’re witnessing the beginning of the end of the mortgage broking industry as new technology makes it easier for consumers to apply for a loan on their own.

But it’s not the only pressure facing these middlemen between lender and borrower.

The mortgage broking industry has faced intense questioning about its practices during the first round of the Banking Royal Commission, with evidence of conflicts of interest and outright fraud being brought to light.

But the sector’s hit back saying critics are seeking to disparage an entire industry made up of predominantly honest small business owners.

 

COBA and the Future Of Banking

I had the opportunity to participate in the Customer Owned Banking Association conference yesterday.  I hold the view the these smaller, but more customer aligned financial services organisation are Australia’s best kept secret.  In fact, often they offer better rates, and a distinctive set of cultural values. But they need to drive a different path to the majors, when the economics of their businesses are stressed.

The current environment with the more than 20 inquiries including the Royal Commission and the higher funding costs as represented by the 20 basis point spread growth in the A$ Bill/OIS raises a whole set of questions. Plus the FED is predicting a further 8 rate hikes in the USA over the next couple of years, taking the US rate well above 3%! That will impact here.

I made a video blog of my visit to Sydney, and included extracts from a live radio interview I did for 6PR on interest rates, and my comments from a panel discussion regarding the future of banking.

 

 

 

Why don’t we read the fine print? Because banks know the pressure points to push

From The Conversation.

The Financial Services Royal Commission has exposed the pressure selling tactics used by the banks. They draw on simple psychological rules to target vulnerabilities among some of their most loyal customers.

One example is the high-pressure selling of add-on insurance for customers when they sign up to a credit card. The Commonwealth Bank of Australia (CBA) acknowledged that upwards of A$13 million of refunds are likely to be paid to consumers who had been pressured into buying these add-on products.

Another witness at the commission, Irene Savidis, relayed what happened when she tried to cancel this insurance:

they just kind of kept pushing it on me saying, you know, “It’s good for you, it will help you.” I just felt pressured or kind of like, you know, no matter what I said, it was the opposite. So I couldn’t – I felt like I couldn’t cancel it.

These techniques are well established in psychological research as ways to manipulate behaviour. In this single example, we can see how the representative of the CBA used trust, repetition (the more something is repeated, the more we are likely to believe that it is true), authority (the salesperson is perceived to be an expert), and scarcity (act now, or you will miss out). All of these factors are part of the marketers’ bag of tricks.

As much as trust can be useful under certain circumstances, at times it can be dangerous. When we are faced with choices or decisions where we don’t feel confident, we have a tendency to give over our decision making to somebody who we believe has those skills and authority and trust them to do the right thing by us.

How we make decisions under situations of stress

As we can see in the examples from the commission, many of these financial decisions are being made by consumers under already significant financial and psychological stress. We also know that under these conditions none of us make the best decisions.

In psychology, we know that people don’t always think through their decision making in a rational and linear way when placed under situations of stress. This becomes more pronounced when – counter intuitively – people are provided with lots of information related to a topic that they don’t have the ability to fully understand, either because it is complex and confusing, or even simply because it is in an area that they don’t have any experience in.

It’s in these situations that they rely on peripheral information to make their choices – things like colours, previous experience with similar situations, even the aesthetic layout of the information, or the way the person giving them the information is dressed.

When we feel we have less resources, we perform worse on tasks requiring high-level cognitive control, like important decision making. Logical reasoning, the kind that should occur when signing up to a loan, extending our credit, or committing to any major financial agreement, is relatively inefficient in these situations.

Responding to pressure selling techniques

So, how do we respond to the types of techniques that we have seen and any others that might be exposed by the commission over the next 12 months?

We need to accept that our decision making is flawed and not judge ourselves, or others, harshly, when they seem to make irrational decisions, or behave in a way that is counter-intuitive. We need to accept that people are complicated, and will make a decision that conforms to their emotional state of mind, at that point in time.

That said, there are some things people can do to avoid some of these manipulative tactics. One thing is to do your best to slow down when it comes to decision-making. If you do want to buy something, that’s fine, but do it outside the heat of the sales process.

Speak to someone you trust about your plans. Recognise that your emotional brain may already have convinced your rational brain that you are making a good decision, so you need to check in with someone who isn’t emotionally engaged in the decision.

And if the person offering something like add-on insurance creates a sense of scarcity, then identify the feeling, and assume you can walk away. A classic technique of traditional sales is to say something along the lines of, “I can only offer you this now”, but the best response is always to take your time. If they are offering you this today, they are more than likely to offer it to you tomorrow.

One thing that has emerged from the royal commission is the somewhat obvious fact that banks are businesses. Indeed, people should not be fooled into thinking that banks are anything other than profit-driven organisations. Banks know exactly what they are doing when it comes to the use of manipulative techniques to get customers to buy their products.

The hope is that this royal commission will be able uncover and act upon some of the practices verging on illegal, while highlighting some of the more unpleasant and unethical practices that have been occurring.

Author: Paul Harrison, Director, Centre for Employee and Consumer Wellbeing; Senior Lecturer, Deakin Business School, Deakin University; Chiara Piancatelli, PhD Candidate

System Alert – Does Not Comply With Responsible Lending!

The Royal Commission looking at Financial Services Misconduct heard today that the Commonwealth Bank’s automated system for approving overdrafts failed and so for four years from 2011 it gave some customers a line of credit they shouldn’t have received.

As a result, the volume of overdrafts rose significantly from 228,000 in 2012 (up 80% from the previous year) to 550,000 in 2014. The bank said its automated system “spat out” wrong approvals and was “doomed to fail” because of bad design.  We discuss this in our latest video blog.

In fact, questions were raised by consumer advocacy groups before the bank released there was an issue. The implementation of serviceability assessments was not made correctly. As a result of changes made to the system, the bank failed its responsible lending obligations.

It was also slow to interact with the regulator on this issue.  Once again, cultural and behavioural issues were in the spotlight.

The object lesson here is that automated credit decision systems can lead you up the garden path.  This is important given the current rush to digital channels and more automation.

Mortgage Expenses In The Spotlight

The Royal Commission into Financial Services Misconduct, yesterday spent time with ANZ, and examined their expenses validation and verification processes, especially when applications were made via the broker channel.

Astonishingly, it appears that the bank may ignore the expense data from the broker as submitted (so the Commission asked why they capture the data at all!). Household Expenditure Measure (HEMs) figured in the discussion, as a test which was used by the bank in the assessment process. It will be interesting to see if the Commission views this approach is compliant with their responsible lending obligations.

It begs the question more broadly, are mortgages held by the banks supported by appropriate expense calculations? Some are saying that up to 40% of loans on book may have issues.

We also note that the “mortgage power” type calculators available on bank web sites to give an indication of a borrowers ability to get a mortgage, on average now gives a mortgage figure some 20% lower than a couple of years back.

So, many borrowers would not now get the mortgage they did then. Think about the implications for existing borrowers seeking to refinance, or to move from interest only loans to principal and interest loans!

There was also more data on lower auction clearance rates. Plus predicted falls in home prices, from Moody’s.

When you overlay the Commission findings, with the sales trends (deep discounts are now a feature of current sales, see above), it seems to me home prices are set for more falls in the months ahead.

We discussed this in our latest video blog.

More broadly, the Commission shows the massive repair job the banks have to do on their reputations and culture. No wonder their share prices are down.  Of more significance are the structural risks to the economy, as households continue to struggle with over-committed budgets thanks to lax lending.  This is unlikely to end well.

The purpose of the Commission was to remove uncertainty from the banking sector, but as it goes about its business, in fact the levels of concern are rising. It has royally back-fired!

But there is a good chance that customer outcomes will be enhanced as the consequences  are digested. This would be an excellent outcome. But not an intended one.