I caught up with a couple of old friends recently whom I was quite fond of and whom I hadn’t seen for around twenty years. I’ve been doing that a lot recently. When we met it was as if we’d seen each other yesterday. The conversation flowed as it used to. We spoke of the ups and downs of life. Our children and all the highs and lows that entails.
My friends were keen to hear my views on the Royal Commission and we briefly discussed the topic. My views then were in their infancy and had not yet formed or developed properly.
I had sorely missed the intellect of these friends and chastised myself for missing out on twenty years of this. We were the last table left and the staff were keen for us to leave otherwise we could’ve spoken all night. We regretfully parted ways and agreed to catch up again in August.
Now that I’ve had time to think, my views have altered slightly. These days, you can be forgiven for thinking that every financial planner, banker, mortgage broker et al are crooks. Especially if you’ve been reading the sensational headlines about the Royal Commission.
I’ve been a little confused as an industry participant as to what solutions should be suggested and I’m sure my views will continue to develop when the Commission finally winds up. It appears every journalist and politician has already decided what to do before hearing the Commissioner’s recommendations.
While all that has been going on – most of which had been investigated and reported on by ASIC – there have been movements in the force. Here’s a quick summary of what’s been accelerated since the Royal Commission began. Almost all of these were recommendations suggested by one government body or another.
Damage Control
Cast your mind back to 2014 when APRA imposed a speed limit on banks for investor loans. This has now been all but removed. You can read about it here.
At the same time APRA announced that it had instructed banks to develop new internal controls around debt to income. Currently NAB has this in place at 7:1. I wrote an article about this in September last year. Expect other banks to follow.
The most restrictive policy change will come from using real world expenses for potential borrowers rather than a common benchmark across the board. This will only be effective if a long term analysis is used rather than the last 3-6 months.
Potential borrowers are not stupid and they can manipulate their expenditure for a few months prior to submitting an application to maximize their borrowing capacity and they will.
As a result of ASIC’s inquiry into mortgage broker commissions, ASIC recommended commissions be standardised across the industry to stop brokers promoting the highest commission paying institution. A Combined Industry Forum (CIF) was convened to make this (and other recommendations) happen. Last week, Bankwest was the latest to fall into line with this recommendation.
Another of ASIC’s recommendations in the above investigation was to look at the vertical integration model of banks particularly those that own mortgage brokers and aggregators. Last week Macquarie Group announced it was selling a significant stake in Yellow Brick Road.
The banks have been quickly responding to the Royal Commission fallout by tweaking their policies. ANZ now requires potential borrowers to visit a branch for ID and account opening purposes and Westpac introducing additional expenditure categories. Details are here.
Back to the Future?
In the film, Back to the Future the key character, Marty McFly, must go back in time to ensure his parents meet. In doing so he will ensure his own existence.
Those of us with a few grey hairs can remember a better time in the financial services world. A time when there were 4-6 major listed banks, a second tier of mutual organisations (like building societies) and a host of mutual insurers (life, general and health). Sure, mutuals were a little lazy but at least they provided an alternative (competition).
But before we jump into the DeLorean and search for that elusive bolt of lightning…My concern with allowing the banks to divest their planning arms, aggregators, brokers or any other division is that behaviour will not change.
Perhaps we should seriously consider not-for-profit financial institutions again.
Think about it for a while before discounting it out of hand.
A mutual’s profit is distributed to members (customers) by way of a reduced interest rate or a distribution.
AMP was one. That’s what the “M” stands for. It was AAA rated and had zero debt for almost 150 years. It was demutualised around the same time as I met the friends I spoke of in the opening paragraph. This involved raiding the reserves of the organisation which had been contributed by all previous generations and handing it over to members at the time of demutualisation. In my view this was nothing but theft (the process of demutualisation was approved by the NSW Supreme Court, so not technically or legally).
Those aforementioned regional banks that were once mutuals were systematically demutualised from the 1980’s onwards. All those that did were eventually snapped up by the big four banks.
Health insurers were the last bastion of demutualised societies. Some of the large one’s were allowed to demutualise and merge or be taken over.
The official reason for these procession of demutualisations was that they were unable to raise debt or equity (the main reason for this was that any potential debt or equity providers would be subordinated to policy holders or depositors). This meant they couldn’t grow at the same pace as their listed competitors. With the benefit of hindsight this was a good thing. It meant there was ample competition in the market to keep the large players honest.
Investment bankers (who advised the societies to be demutualised) called it value realisation. As if there was no value in a demutualised entity.
AMP was a highly respected mutual for 130 years. One cannot say that it is either a mutual or respected any longer.
I know that this sounds ludicrous but a listed organisation, by law, must serve its shareholders first and foremost. Sometimes this is at the expense of its clients. We’re now seeing that play out at the Royal Commission.
While we can’t go back to the future like Marty McFly that doesn’t mean we can’t learn from recent history to ensure the viable survival of our financial system.
Remuneration of Staff
There was a time when only Institutional bankers received bonuses. Those who dealt with the lucrative institutional end of town.
When our brokerage successfully writes a home loan we’re paid a commission. We are not paid a salary. If our client repays that loan in the first year, for whatever reason, we’re forced to refund 100% of the commission. If the client repays in the 2nd year we refund 50%.
A lender’s employees are paid a salary. Any commissions paid to them as a result of achieving targets should be treated the same way as our commissions are treated.
However, my preference is that their salaries are adjusted (up) and they are not paid an incentive for achieving targets in retail banking. While we’re at it let us please dispose of metrics such as NPS.
I don’t want to be asked to provide another banker, insurer, clerk etc. a score of 9 or 10 because anything less may somehow threaten their jobs. The fact that employees direct you to score them at 9 or above means the outcome of these NPS’ is tainted.
Finally, my view is that the mess we are currently in has to do with people. The banks annihilated their ranks of quality bankers with decades of experience during the GFC. These bankers were replaced with whatever the politically correct demographic du jour was at a lower rate of pay.
Years of experience was displaced with the implementation of standardised risk products and checklists. Any risk decision that required a bespoke solution was no longer bankable.
When systems are standardised across an organisation it makes it easier for people to manipulate. But when systems are standardised industry-wide even stupid people were getting in on it.
The Government
The press would portray this Government and probably the one before it as bumbling fools who know not what they do. That may or may not be true but I have a lot more faith in our public servants particularly those in the Treasury.
There’s an old adage in Government. Never call a Royal Commission unless you first know the outcome.
I’m of the view that the reason this Royal Commission took so long to materialise was because the Government was busy finding out what the outcome would be either via ASIC investigations or Productivity Commission Reports.
ASIC recommended that the vertical integration model should be considered given a range of factors affecting customer outcomes. More and more, this is the direction the media is taking. ASIC’s words:
“Our review identified that competition in the home loan market is affected by ownership relationships between lenders and aggregators and the inability of smaller lenders to access or remunerate brokers in the same way as larger lenders.”
Nuff said.