Banking Reform

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GUEST OBSERVATION
The government is acting on all 76 of Justice Hayne’s recommendations.
Treasurer Josh Frydenberg was glossing over history when he said the <a href="https://financialservices.royalcommission.gov.au/Pages/reports.aspx" target="_blank">final report of the banking royal commission</a> “endorsed many of the themes and individual reforms the government is currently pursuing”.
In fact, on coming to office in late 2013, his government – through Finance Minister Mathias Cormann - <a href="https://www.smh.com.au/business/banking-and-finance/how-the-coalition-ran-interference-for-the-banks-20180425-p4zbjz" target="_blank">did the opposite</a>.
Instead of extending provisions in the law that financial service providers act in the “best interests” of their clients, it tried to remove them, pressing Senate independents to have them excised from the at-the-time unimplemented Future of Financial Advice Act.
It argued there would be greater certainty if advisers were merely required to fulfill a number of specific requirements rather than to act in the overall best interests of their clients.
It’s a checklist approach <a href="https://financialservices.royalcommission.gov.au/Pages/default.aspx" target="_blank">Justice Kenneth Hayne dismisses</a>, saying it has encouraged advisers to pursue a “good enough” outcome “instead of the best interests of the relevant clients or members”.
“The more complicated the law, the harder it is to see unifying and informing principles and purposes,” the report says. “Exceptions and limitations encourage literal application and focusing on boundary‑marking and categorisation.”
What’s important is that the intent of the law is met, “rather than merely its terms complied with”.
Hayne wants laws rewritten to draw explicit connections between their requirements and what they are trying to achieve.
Such rewriting will make it clear that “exceptions and carve outs like grandfathered commissions constitute a departure from applying the relevant fundamental norm”.
The Coalition fought hard to allow financial advisers to continue to receive some grandfathered commissions – commissions their customers were signed up to before laws outlawing commissions came into place.
Hayne wants all grandfathering to go “as soon as is reasonably practicable”.
Frydenberg <a href="https://treasury.gov.au/publication/p2019-fsrc-response/" target="_blank">has agreed</a>. From January 1, 2021 all grandfathering will go, and any previously grandfathered payments to advisers from clients accounts will be handed back to clients where they can reasonably be identified.
Ongoing fees taken from clients accounts will need to be specifically reauthorised each year, a proposal neither the Coalition nor Labor put forward in negotiations over the Future of Financial Advice Act, settling on reauthorisation every two years in order to avoid paperwork.
Frydenberg has accepted the recommendation, without a start date.
Hayne wants all commissions to mortgage brokers banned so that the borrower, not the lender, pays the broker a fee.
The Royal Commissioner wants the changes made over a period of two or three years, first by banning so-called annual trailing commissions that last the length of the loans, and then by banning upfront commissions.
Frydenberg will ban trailing commissions from July 1, 2020 and will ask the Council of Financial Regulators and the Australian Competition and Consumer Commission to review in three years’ time the implications of moving to full consumer-pays.
Hayne’s point is that buyers of financial products of all types often assume the person standing between them and the provider is acting in their interests. They need not be when they are being paid by the provider.
<blockquote>
1. The interests of client, intermediary and provider of a product or service are not only different, they are opposed.
2. An intermediary who seeks to stand in “more than one canoe” cannot. Duty (to client) and (self) interest pull in opposite directions.
</blockquote>
Hayne’s three key themes are now government policy:
<ul>
<li>
no conflicted remuneration
</li>
<li>
no exemptions, including grandfathered arrangements
</li>
<li>
explicit consent for payments.
</li>
</ul>
Financial industry laws and regulations will apply more broadly than they have. Funeral insurance will no longer be exempted. Car dealers will face a limit on the fee they can get for selling add-on insurance.
And retailers won’t be able to sell add-on insurance at the same time as the products themselves. Frydenberg said that people buying mobile phones were being sold screen insurance that cost more than the replacement of the screens.
“Hawking”, unsolicited phone calls and pitches for superannuation and insurance and other products, will be prohibited. Lenders to farmers won’t be able to charge high default interest rates during droughts or when there is no realistic prospect of recovering the money.
Banks won’t be able to offer overdrafts on basic accounts without the formal approval of the accounts’ owners, they won’t be able to charge dishonour fees on basic accounts, they will have to value agricultural land used as security for loans independently of the people who decide whether to grant the loans.
Superannuation fund trustees won’t be able to work for other parts of the conglomerate that owns the fund giving them a conflict of interest, and trustees and directors will be subject to civil penalties if they fail to act in the fund members’ best interests.
Each Australian will be defaulted into (“stapled” onto) only one superannuation account once at the beginning of their working life instead of into several as they change jobs as is required by awards and industrial agreements. The <a href="https://www.pc.gov.au/inquiries/completed/superannuation" target="_blank">Productivity Commission estimated</a> these multiple accounts cost super fund members A$10 billion per year in unnecessary fees.
Australia’s much-criticised “twin peaks” model of regulation shared between the Australian Securities and Investments Commission and the Australian Prudential Regulation Authority, will stay, although they will be subject to a new independent oversight body that will report on their performance every two years. They will also need to prepare and maintain a joint co-operation memorandum.
In any investigation ASIC will have to have as a starting point the question of whether a case should be taken to court. Infringement notices should mainly be reserved for administrative rather than deliberate failings.
Hayne says too often, banks and other financial services entities that broke the law were not properly held to account.
<blockquote>
Misconduct will be deterred only if entities believe that misconduct will be detected, denounced and justly punished.
Misconduct, especially misconduct that yields profit, is not deterred by requiring those who are found to have done wrong to do no more than pay compensation. And wrongdoing is not denounced by issuing a media release.
</blockquote>
He says in almost every case, bad conduct was driven not only by the firm’s pursuit of profit but also by individuals’ pursuit of gain.
<blockquote>
Providing a service to customers was relegated to second place. Sales became all important. Those who dealt with customers became sellers. And the confusion of roles extended well beyond front line service staff. Advisers became sellers and sellers became advisers.
Rewarding misconduct is wrong. Yet incentive, bonus and commission schemes throughout the financial services industry have measured sales and profit, but not compliance with the law and proper standards. Rewards have been paid regardless of whether the person rewarded should have done what they did.
</blockquote>
Frydenberg says he is taking action on all 76 recommendations.
He’ll set up an industry-funded compensation scheme able to payout over misconduct over the past ten years.
And 24 specific acts of misconduct have been referred to authorities, covering every big financial firm other than Westpac.
<a href="https://theconversation.com/au/team#peter-martin" target="_blank">Peter Martin</a>, Section Editor, Business and Economy, <a href="http://www.theconversation.com/" target="_blank">The Conversation</a>
This article is republished from <a href="http://theconversation.com" target="_blank">The Conversation</a> under a Creative Commons license. Read the <a href="https://theconversation.com/banking-royal-commission-no-commissions-no-exemptions-no-fees-without-permission-hayne-gets-the-government-to-do-a-u-turn-110974" target="_blank">original article</a>.
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j.ballantyne1990-6AQqhLzZaK

Banking Royal Commission: no commissions, no exemptions, no fees without permission, Hayne gets the government to do a U-turn

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EXPERT OBSERVATION
Last week was all about interest rates – even though the RBA and the US Fed kept both of their official rates unchanged at their most recent meetings.
But as usual, what’s likely to happen in the future is the interesting question.
In Australia, all eyes will be on how ASIC and APRA respond to the findings of the banking royal commission. Will they be defensive about past mistakes, or move forward with tighter regulations on banks and financial planning? What will the RBA do in this context?
On interest rates the answer is probably “nothing soon”.
<a href="https://www.rba.gov.au/media-releases/2018/mr-18-11" target="_blank">The official statement</a> by RBA Governor Philip Lowe makes one almost physically feel the contortions.
“The Bank’s central forecast for the Australian economy remains for growth to pick up, to average a bit above 3 per cent in 2018 and 2019. This should see some reduction in spare capacity in the economy.”
OK, growth is about to move up strongly.
“Household income has been growing slowly and debt levels are high.”
Well, that sounds concerning, since <a href="https://tradingeconomics.com/australia/household-final-consumption-expenditure-etc-percent-of-gdp-wb-data" target="_blank">household consumption accounts for nearly 60% of GDP</a>.
Unemployment was getting better, but that’s stopped happening.
“Inflation remains low…with both CPI and underlying inflation running marginally below 2 per cent. Inflation is likely to remain low for some time…A gradual pick-up in inflation is, however, expected as the economy strengthens.”
So inflation has been outside the target band of 2-3% for a very long time, but if that courageous GDP growth forecast pans out then we might end up back in the band.
And on, and on. No wonder US President Harry Truman once lamented “Give me a one-handed economist. All my economists say ‘on one hand…’, then ‘but on the other…’”
In any case, for the foreseeable future it is not what the RBA does, but what the big four banks do that will have the biggest impact on the interest rates Australian borrowers face.
Wholesale funding costs have been ticking up, cutting net interest spreads for the banks. And the wash-up of the Royal Commission is likely to lead to a further tightening of underwriting standards. As ANZ CEO Shayne Elliot put it:
“People are still going to buy a home, so it doesn’t change fundamental demand, but it will change the process and will probably make it harder for people to be successful in their applications.”
Those two factors taken together could easily see a 15-20 basis point increase in rates for home loan borrowers. That might be tempered by potential outrage from the public – banks behave badly and then put their prices up – but the banks have a lot of market power, as history has shown in these matters.
Across the pond, the US Federal Reserve left official rates unchanged from March at 1.5% to 1.75%. That ended, for now, a string of six rate hikes since December 2015.
In a <a href="https://www.federalreserve.gov/newsevents/pressreleases/monetary20180502a.htm" target="_blank">relatively brief statement</a> the Fed noted;
“the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Recent data suggest that growth of household spending moderated from its strong fourth-quarter pace, while business fixed investment continued to grow strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent.”
The leading interpretation of this is that the Fed thinks inflation is ticking up and will likely raise rates another 25 basis points at the next meeting if nothing material changes in the economy.
All this is a reminder that monetary policy is as much art as it is science.
It is also worth remembering that the other key function of central banks is prudential regulation. That is where the real changes could be interesting. Fed Chair Jay Powell is known to be much more amenable to deregulation of the financial sector than his predecessor Janet Yellen. It may not be too long before we see those instincts put into action.
<img src="https://counter.theconversation.com/content/96006/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1">Perhaps the regulatory front will be more interesting than interest rates for the remainder of 2018.
Richard Holden, Professor of Economics and PLuS Alliance Fellow, UNSW
This article was originally published on <a href="http://theconversation.com" target="_blank">The Conversation</a>. Read the <a href="https://theconversation.com/vital-signs-fallout-from-banking-crackdown-could-be-worse-than-interest-rate-rises-96006" target="_blank">original article</a>.
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The fallout from banking crackdown could be worse than interest rate rises: Richard Holden

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<img src="https://counter.theconversation.edu.au/content/57114/count.gif" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
The idea of separating out the arms of the “Big Four” banks like insurance and superannuation from their core banking business is gaining traction in Australia.
It featured in the Greens' banking and finance election policy. However this is not a new idea; Australia is just catching up to banking reforms already made by the UK.
The proposals by the Greens are, in international terms, actually quite tame. The Greens talk about “looking at breaking up the banks,” rather than actually breaking them up. They also suggest applying a “tax deductible levy of 0.20% on the asset base of institutions worth greater than $100 billion” on the “too big to fail” Big Four.
Other jurisdictions have gone much further than the Green’s proposals. For example, following the recommendations of the Vickers’ Inquiry into the UK banking system, banks with assets over £25 billion, will be required from 2017 to split off their retail banking activities into separately managed entities that can be floated off, if the holding company goes belly up. Similar rules are also to be enacted throughout the European Union.
Far from local banks being well-regulated, the latest research on managing systemic risk by the Bank of England shows that Australian banks are simultaneously extreme outliers, in regards to size relative to GDP, yet among the lowest of their peers as regards capital requirements. This is extremely risky, especially given the banks’ exposure to the Australian housing market.
The Australian taxpayer is providing a guarantee for such risky behaviour which the Reserve Bank estimates to be worth some $3.5 billion per year to the big four banks.
One of the Green’s proposed considerations is to investigate:
“The nature of vertically integrated business models, including: i. the integration of everyday banking, financial planning, wealth management and insurance within a single entity; ii. whether the incentives provided encourage illegal or unethical conduct; and iii. whether the incentives provided are aligned with the duty of care to customers.”
This term “vertical integration” is a classic illustration of the problems that arise in so-called Universal Banking. The concept of Universal Banking, sometimes called a “financial supermarket”, in which many financial services are sold under the one roof, goes back to the 19th century in Germany.
This is where German banks not only took deposits and made loans, but also funded and even made equity investments in companies. This one-stop shop was credited with helping to make Germany an industrial superpower in the late 19th century.
On the other hand in the UK and USA, there was strict separation of retail banks and so-called investment (or merchant) banks. In the USA, this separation was enshrined in the famous/infamous Glass Steagall Act of 1933 which was an outcome of the Pecora Commission into the Wall Street Crash of 1929.
In the UK, a strict separation lasted until 1984, when the Thatcher government implemented the so-called Big Bang, which broke down the barriers between commercial and merchant banks. Subsequently, there was a massive consolidation of banks, merchant banks and eventually building societies.
US banks, such as Citicorp and JPMorgan, joined in the takeovers of UK firms even though technically it was still forbidden in the USA. However in 1999, after pressure in the industry and with almost unanimous congressional support, the Glass Steagall Act was repealed and the concept of a one-stop shop for financial products became the accepted business model around the world.
In Australia in the year 2000, NAB acquired MLC Life Limited, which was the insurance and investment arm of Lend Lease. Soon afterwards the other big three Australian banks followed suit, acquiring investment firms and insurance companies. For example, Colonial Mutual insurance was acquired by the Commonwealth Bank to become its scandal-ridden CommInsure subsidiary.
The prevailing model of Universal Banking in Australia is barely 15 years old.
<h2>Why did Universal Banking become the accepted model around the world?</h2>
There are two arguments usually put forward for Universal Banking: economies of “scale” and economies of “scope.” The argument for scale is, the bigger a bank is, the better it can leverage its resources, especially expensive technology. The more depositors a bank has the more money it can lend and in a sort of virtuous circle, the more depositors the bank can attract, always provided that the banks treat their depositors fairly, of course.
Scale is important. For comparison, the largest retail bank in the world by market capitalisation is the US based Wells Fargo bank which has some 70 million customers worldwide, mainly in the USA. That is about three times the population of Australia.
Last financial year, Wells declared net income of around A$30 billion (US$ 22.9 billion) which is almost identical to the total declared by the Big Four banks. On a per customer basis then, Wells appears not to be as efficient as Australian banks, or just possibly Australian customers may be getting a very raw dea<a href="https://www.smh.com.au/business/banking-and-finance/banks-fail-to-pass-on-rba-cuts-to-credit-card-customers-20160603-gpb18z">l</a> from their banks.
Economies of scope means that a bank, using its presence in the market, can expand the products it sells to existing and new customers. This so-called cross-selling is infuriatingly obvious in Australian banks.
An example of this is a consumer, when attempting merely to pay in a cheque, can be bombarded with questions about whether they would like insurance with that. It is a form of diversification, expanding and hopefully stabilising sources of income.
In pursuit of scope, the largest Australian banks have all acquired investment management and insurance companies, bundling these acquisitions up into fashionable “Wealth Management” units. According to KPMG, these units provided a 25 percent of the Big Four’s profits in 2015. The problem is that the Big Four banks have proved to be not very good at “wealth management.”
The original reason for diving into the wealth management business was the pot of gold that is Australian superannuation, which is growing year on year through mandatory contributions and today sits at just over A$2 trillion – who could lose? Certainly not the superannuation funds managers.
But could they outperform others? Unfortunately not, as the largest bank-owned retail funds consistently underperform not-for profit industry funds - not really surprising as industry funds operate on a not-for-profit basis.
And all the while, people are deserting the retail sector in droves to run their own Self-Managed Superannuation Funds (SMSFs). In 2016, self-managed assets total some A$592 billion or 30% of the total super pot of just over A$2 trillion, exceeding the retail sector and growing each month.
If the prospect was only ever little more than a pipe-dream, it became a nightmare as pensioners lost their savings in the GFC, created incidentally by banks. And today the prospect of even the middle class living in poverty in retirement has become a reality. In Australia, with the average super balance for men at retirement being just less than $300,000 (much less for women), ASFA, the industry body for super funds, concludes that” many recent retirees will need to substantially rely on the Age Pension in their retirement”.
<h2>Is the rationale for seeking economies of scope still valid?</h2>
Technology has changed everything. In the 20th century, people still went into banks to withdraw or deposit money, to make payments, to ask for a mortgage or to talk about investments.
It was quite possible then for the banks to catch customers at the counter and sell them something they may not want or need but nonetheless may be good for them, like an insurance policy.
But a lot of people don’t go to banks much anymore. They get cash when they check out at the supermarket.
They visit websites or mortgage brokers when they are looking for a mortgage. They search websites that compare deposit and investments offers, and there are a myriad of ways that people can pay bills or make payments for online goods.
People are deserting bank branches for the internet and the importance of face-to face contact and opportunities to cross-sell have diminished.
If there is no pot of gold at the end of the Wealth Management rainbow for banks nor their customers, then the boards of Australian banks must look to strategies other than Universal Banking.
Unfortunately, the subject of banking reform was not addressed fully by the Financial Systems Inquiry, headed as it was by the architect of CommBank’s vertical integration strategy, and the subject has since become a political football.
The Green’s policy would be seen as a minimum and meek in most other jurisdictions, while the industry’s response is shortsighted and defensive. The subject is too important to be trapped in this stalemate.
Pat McConnell is honorary fellow, Macquarie University Applied Finance Centre, Macquarie University and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/pat-mcconnell-13137" target="_blank">here</a>.
 
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