Australia’s Royal Commission has brought out into the open a decade’s worth of misconduct in the country’s banking sector. As the industry faces geopolitical pressures and the emergence of challenger banks, Australian banking is set for an overhaul. Kimberley Long reports.
Australia’s Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is being seen as a pivotal moment for the country’s big four banks – ANZ, Commonwealth Bank of Australia (CBA), National Australia Bank, and Westpac – all of which had come through the 2008 financial crisis relatively unscathed.
Following pressure from political parties and consumer groups, the commission began proceedings in early 2018. Overseen by commissioner Kenneth Hayne, it held seven public inquiries throughout the year. While the final report is due for submission on February 1, 2019, reports of misconduct have already emerged.
Chasing profits
Fiona Reynolds, CEO of industry body Principles for Responsible Investment, says there have been numerous case studies revealing unethical behaviour. “The Royal Commission has uncovered some serious misconduct. Clients have been given poor advice, with banks acting [in] their own interests. Clients have been sold inappropriate products, and the banks have denied legitimate insurance claims. The banks have taken years to stop fee payments from being taken from customers, even those who have died,” she says.
Criticism of the banks has been scathing. In the interim report published in September 2018, the commission concluded that “greed” was the key factor in much of the misconduct, while sales had often been the “sole focus of attention” as the banks chased profits.
Mr Hayne said in the report that the findings show the behaviour over the past 10 years goes beyond a few bad apples, while Ms Reynolds adds: “There have been 140 Australian finance professionals tried for misconduct, and 80 of those have been jailed.”
Tighter controls
While the Royal Commission has yet to give its final conclusion and outline what banks can and cannot do in future, the banks have been taking some proactive steps. Three of the big four have pulled out of the wealth management business, with just Westpac still offering the service. Mortgage lending is also undergoing stricter checks into the background of borrowers and their ability to repay.
But as they cease offering these services, banks are concerned about the vacuum that could be created if they pull out of certain businesses and who will fill that space.
“There are concerns around the potential impact of stricter regulations on giving advice,” says David Lindberg chief executive, business bank, at Westpac. “If it becomes more difficult or costly to give [this advice], the real risk is that it becomes the preserve of the affluent, which doesn’t help average people grow their wealth. That is not the outcome that the regulators want.”
Meanwhile, Ms Reynolds says the banks must be held accountable for the recommendations they give, in order to protect the public. “Customers who received bad advice are the ones who actively went looking for the assistance of a finance professional; they wanted to do the right thing,” she says.
A question of trust
From the banks’ perspective there are lessons to be learned, but unlike with the financial crash of 2008, it has not come with a significant financial impact on them.
Alan Huse, head of payments and cash management at ANZ, says: “The Royal Commission has created a challenge, but not because the banks are in financial trouble. [Its] focus is on dealing with community and customer disillusion.”
The potential erosion of trust between banks and consumers is of considerable concern. Mark Whelan, group executive, institutional, at ANZ, says: “The banks want to rebuild trust, but need to work out how to put this into practice. Banks need to clearly demonstrate we are taking an ethical position. We need to start asking ourselves not only can we do [something], but should we do it.
“In terms of the regulatory response, so far it is not known what will happen. But the regulators and the public in general expect banks to do business better and there will be increased scrutiny.”
Despite the criticisms levelled at the banks, Mr Lindberg believes there has to be a sense of proportion to what is being reported. “It is worth noting that the Royal Commission is a review and snapshot of 10 years of issues in the industry. The worst situations have been turned into a number of case studies. What has emerged has, of course, been embarrassing and inexcusable, but what hasn’t been included in this process are stories of millions of customers that are satisfied,” he says.
Ratings affected
Yet even before the commission’s final findings are revealed, rating agencies have been reassessing their outlook on Australian banks. For example, Fitch changed its outlook on CBA in May 2018.
Tim Roche, senior director, head of Australia and New Zealand financial institutions, at Fitch, says: “The outlook on CBA’s long-term issuer default rating was revised to ‘negative’ from ‘stable’ following the release of the Australian Prudential Regulation Authority [APRA] inquiry report into the bank. The report highlighted a number of shortcomings in CBA’s management of non-financial risks and provided a series of recommendations for the bank to remediate these issues. The shortcomings identified by the report in part contributed to some of the issues the Royal Commission highlighted for CBA.”
Mr Roche speculates that there could be sizable financial penalties. “We have seen the banks take on costs relating to customer remediation in the 2018 financial year, but any fines stemming from adverse findings from the Royal Commission will be seen in 2019 and beyond. There is also a risk of class actions, which may lead to further costs,” he says.
Making profits
Banking in Australia remains a highly profitable business, nonetheless. The Banker’s data from the Top 1000 World Banks ranking for 2018 shows the country’s 10 largest banks by Tier 1 capital had combined assets of $3053bn and pre-tax profits of $37bn in 2017; an increase of 25% on the previous year.
In the Fitch Ratings’ ‘Outlook Asia-Pacific developed market banks report’ for 2019, the agency stated the findings of the Royal Commission would not have a huge impact on banks immediately, noting that they have substantial financial buffers in place to withstand any challenges.
Even if the financial cost can be absorbed by the banks, Mr Roche believes they will pay a bigger price in the hours lost to ensuring they meet any recommendations made by the commission. “The pathway to address the shortcomings is somewhat complex and is likely to consume significant management time. This may result in less attention and investment in the core banking business, which could result in sustained damage to the franchise relative to peers,” he says.
The Royal Commission will also decide if banks are required to provide remediation to any customers, adding to their costs. Mr Roche says there is scope for further pressure depending on how customers respond to the final outcomes. “Negative public sentiment could result in a sustained weakening in market shares of the major banks, which may in turn pressure their company profiles and ultimately their ratings,” he says.
The bigger picture
The Fitch report outlined the potential for slower credit growth and pressure off household finances as being other significant pressures. While overall the Australian economy continues to perform well, the influences of political and macro pressures are pushing down.
ANZ’s Mr Huse says: “Australia’s economic growth is holding up at the present time. Unemployment is low and inflation is under control. Areas of concern are the levels of household debt and lack of wage growth. There may be more movement towards using the fiscal benefits from continued economic growth to help households.”
On the business side there is concern around the potential impact of the forthcoming 2019 federal elections and geopolitical influences.
Mr Lindberg says the global theme of distrust towards companies is being experienced in Australia. “There is a lot happening in Australia that could impact banking and business confidence,” he says. “Companies and consumers feel nervous about the forthcoming elections so we’re seeing businesses back off. Before you have policy, you have rhetoric, and the consensus is Labor has a lower pro-business attitude, and Liberals or the Coalition government tend to be more pro-business.”
For companies that depend on Australian banks, this is creating an additional wave of problems. “Businesses are worried about what the future will bring for them,” says Mr Lindberg. “The Australian banks have long had a strong relationship with the country’s small and medium-sized enterprises [SMEs], but this sector is worried about the changes on the horizon.” If the banks find themselves facing tighter controls around lending, it could hit Australia’s 2 million small companies and their ability to access funds.
This is likely to negatively affect an environment that already has downward rates of return. Mr Lindberg says: “Low returns are not a new phenomenon. There has been between 3% and 5% credit growth on the business side over the past five years. But it decreased from about 5% to 2% in 2018, mainly as a result of the election, surrounding political uncertainty, and anti-business sentiment.”
New faces
With Australia’s consumer market dominated by four banks and little presence from overseas banks, there is room for competition. The Royal Commission and its potential to impact consumer trust came just as the digital bank 86 400 was launched. Pronounced ‘eighty-six-thousand four-hundred’, the bank is named after the number of seconds in a day. Its ethos is designed to capture millennial and generation Z consumers, who expect not only to be able to use their mobile phones in every aspect of their life, but to also have an easy banking experience.
Robert Bell, CEO of 86 400, believes the bank provides an alternative in a competitive market. “The Royal Commission has highlighted the poor behaviour by the big four banks, and the need for more consumer choice,” he says.
While Mr Bell acknowledges there is consumer trust in the banks at a basic level, he says there is room for improvement, adding: “Customers trust the banks to keep their money safe, but do not think they are providing a good level of service. With the findings of the Royal Commission emerging, more will be asking if they can trust the banks to do the right thing.”
While currently 86 400 offers just a bank account and debit card, the bank aims to expanded its product suite, according to Mr Bell. “Over time we plan to expand the bank with the addition of more complex financial products such as loans and mortgages. We could team up with other providers and offer these services on a marketplace platform,” he says.
Adapting to emerging technology may also benefit SMEs that face the prospect of tighter lending controls from their key banking partners. After a slow start, the real-time New Payments Platform (NPP) is gaining traction among consumers, with 2 million pay IDs now registered across all banks since the launch in February 2018. But it is NPP’s potential in the business community that bankers believe is underutilised.
ANZ’s Mr Huse says: “SMEs could potentially gain from using NPP. With 24/7 availability and a 280-character payment message feature, SMEs can build customer propositions around this. Despite this, as with consumers, the uptake so far is quite low across the industry but we expect this to increase when some of the other overlay services, such as request to pay and payment with attachment, are made available.”
Regulators under scrutiny
While banks have borne the brunt of the criticism, the Royal Commission has also been vocal on regulatory shortcomings over bank behaviour in the past decade. The regulators have come under fire for a lack of meaningful action that allowed the banks to continue unchecked. The interim report said: “The conduct regulator, ASIC [the Australian Securities and Investments Commission], rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court.”
In answering for their own behaviour, regulators have had to outline how they will tighten up controls in the future. There is consensus among the bankers interviewed that it was unlikely there would be new regulations, but rather greater supervision within the existing rules.
The regulators have hinted at what may come in 2019. John Lonsdale, deputy chair of APRA, said in a speech in November 2018 that a review into the enforcement strategy will be made and presented to APRA members in March 2019.
“Without pre-empting the review, we have acknowledged the need to consider a stronger appetite for formal enforcement action, including giving greater weight to its strategic use as an industry-wide deterrent,” he said at the Financial Services Institute of Australasia event, before adding that the regulator will remain “supervision-led, rather than enforcement-led”.
In its response to the interim report, ASIC said it would be taking a stronger line against misconduct and “accelerate its enforcement activities and its capacity to pursue actions for serious misconduct through greater use of external expertise and resources, and carry out enhanced supervision of financial and corporate actors”.
Hopes remain that once the Royal Commission has announced its requirements and the regulators’ updated policies are established, the outcome will be positive for the banking industry as a whole. Fitch’s Mr Roche says: “The outcome of the Royal Commission should ultimately be positive for the system, requiring it to address conduct-related issues.”
