In its first few weeks, the Royal Commission into Misconduct in the Financial Services industry has opened the floodgates, and a torrent of misconduct, maladministration, technical incompetence and downright fraudulent activity has poured out. And it is not just one bank that has admitted some wrongdoing, but all of the Big Four. Nor is it one product but, so far, a raft of bad lending, from mortgages to overdrafts and car loans, and more to come.
[Note An edited version of this article appeared in Australian Banking and Finance on 24th March 2018. Many thanks to editor Elizabeth Fry.]
The redoubtable counsel assisting the Commission, Rowena Orr QC, has gently, but firmly, invited several banking executives to admit to wrongdoing, which they duly have done. An iron fist in a very velvet glove which will undoubtedly poleaxe more executives over the next few months.
So how have we got to the situation where as Commissioner Hayne has mused more than once, the bankers in front of him appear to be more interested in ‘administrative convenience’ rather than ‘obeying the law’? And if the banks have skirted the edge of the law they have positively ignored regulators, by failing to report wrongdoing or providing prompt remediation for customers.
The important point to note that this rampant misconduct is personal, as individuals at all levels have pushed the boundaries of illegality, and in several cases strayed over the line into fraudulent activity. And no amount of belated apologies will absolve the perpetrators and the leaders of banks for their parts in these misdemeanors.
However, a deeper question is WHY has such this misconduct occurred at the same time, in all major banks and also why has such misbehaviour been allowed to proliferate and pollute all aspects of Australian banking?
The evidence to date shows that there is a systemic dimension to this widespread misconduct. It is not only individuals and institutions that are at fault, it is also the Australian banking system itself that has been debased. Underlying the unbridled misconduct, there is a much deeper malaise that must be fixed before trust in the banking systems can be restored.
Some have argued that there is too little competition in the Australian banking market. But the truth is that there is too much competition. Not the ‘good’ competition that drives down prices and creates innovative products for consumers, but the ’bad’ competition that drives firms to sell profitable products using whatever dodgy methods work. In such cut-throat situations, firms compete in a race to the bottom, cutting corners and ignoring the laws of the land and basic decency to achieve business targets that emphasize growth rather than sustainability. Evidence to the Commission has shown this to be the case with the largest Australian banks, and as the inquiry continues, more evidence will show that the misconduct is so wide-spread and endemic that the system needs to be reformed. The misconduct revealed is merely the outward symptom of a much deeper problem.
The business models of the largest Australian banks are broken.
Having, in recent years, given up their international ambitions, and in some cases deciding to exit wealth management and insurance markets altogether, the banks are all frantically chasing the same few borrowers who are desperately trying to get onto the property ladder at auctions around the country, every weekend.
Australian banks make the bulk of their profits (over 73%) from lending in the Australian/New Zealand consumer and small business markets, and this concentration is likely to increase as fee-earning wealth business are jettisoned. The author’s research shows that, by comparison, the largest Canadian banks earn only 57% of their profits from lending and earn over 50% more than comparable Australian banks from international activities. The largest Australian banks appear to have abandoned the sound principle of diversification and are all making a one-way bet on rising house prices and borrowers’ ability to repay larger and larger mortgages.
Australia is also massively overbanked. Statistics from the Productivity Commission shows that, in 2016, there were roughly 5,300 bank branches in Australia, or roughly one full-service branch for every 1,820 families. Not only is this physical presence overkill, but these families are using physical banking facilities less with, for example, a drop in the use of cheques by some 56% and an increase in use of card payments by over 70% in the last five years.
The costs of the bloated branch networks of, in particular, the largest banks cannot be sustained, as technology changes the profit/loss equation. But the change necessary will not be easy as the already battered reputations of the banks will be damaged even further whenever massive programs of branch closures need to be undertaken.
An efficient and fair banking system is essential to a modern economy. After the Royal Commission is completed and the last pillory is dismantled, the Australian banking system will have to be rebuilt based on a fairer, more sustainable architecture.
And now is the time to start thinking about how to fix the underlying causes of misconduct, and what the better Australian banking system of the future should look like.