“Too often, the answer seems to be greed – the pursuit of short term profit at
the expense of basic standards of honesty.”
Justice Kenneth Hayne justifying banking reform

A lot of the media scrutiny of the Banking Royal Commission report has focused on the lack of criminal prosecutions of bank executives. Hayne reported 24 instances of potentially criminal conduct to ASIC for investigation, but apart from sounding like inadequate in numbers, it is also likely to be a lawyer fest taking many years, and unlikely to change behaviour beyond those persecuted. And it is not banking reform!

Nobody is suggesting that soon to be former NAB Chairman Ken Henry is a criminal, he fell on his own sword of arrogant behaviour at the Royal Commission hearings. It is sad to see how a merited and respected public servant became the unintended face of bank executives behaving badly. But at least he had the guts to front Leigh Sales on the ABC 7:30 report and show some genuine contrition – a rare occurrence among entitled captains of industry.

Ken Henry deserves to be remembered more for the ‘Henry Review’ – an aspirational document containing well thought out recommendations for proper and long-term tax reform. It was commissioned by then PM Kevin Rudd and published in 2010. Rudd used it as a pretext for the ill fated mining ‘super profit’ tax which ended up costing him his job. Since then, as is customary for such documents, the Henry Review was consigned to the too hard basket – sucked up in the ‘longevity vacuum‘ – the absence of long term policy planning that has beset Australian Governments for decades.

And although the Government (and Labor) have pledged their support for all 76 recommendations in the report, many of those recommendations are aspirational in nature, calling for more reviews, more oversight, even a new regulator to oversee the regulators!

As mentioned in part 1 of the analysis, the report deals in detail with remuneration of front-line staff and commissions paid to financial advisers and mortgage brokers. It is silent on the excesses of executive and board salaries, but recommends that bonus structures focus more on compliance, risk mediation, accountability and culture.

To suggest that executive bonuses should be partially based on compliance is to pander to the notion that compliance is a necessary evil to aspire to rather than what it should be: the minimum standard of performance. Nobody should be paid extra for following the rules!

Nor should anyone be paid extra for being accountable.

Currently, executive bonuses in the banks are based mainly on shareholder returns and (often nebulous) measures of customer satisfaction – typically seen as service in relation to competitors rather than absolute measures of good service. I doubt if many big bank customers would suggest any of them are champions of service excellence.

Hayne does not mention the phrase ‘customer service’ once in the report.

banking reform

Culture is mentioned 282 times, so clearly that this is where Hayne and his colleagues see the problems. But they offer no real solutions except for mandatory reviews and more supervision and oversight (recommendations 5.1 through 5.7).

There are, of course, no quick fixes to changing the culture of any business, let alone businesses with tens of thousand of employees. Even less so in a business sector that operates as a virtual oligopoly, protected by that most sacred cow – the ‘four pillars policy’.

Paul Keating originally instituted it in 1990 as a deterrent against merging the big four banks (and then, the two main insurance companies). The Wallis Inquiry – the closest we’ve come to true banking reform for decades – recommended its removal in 1997, a recommendation only partially followed by then treasurer Peter Costello, removing the insurance companies from the policy.

Four pillars (and our banking regulations in general) is credited with everything that is good about the Australian banking system, including how Australia avoided the worst effects of the Global Financial Crisis (GFC).

And while there is truth in that, and our big four banks have rock solid balance sheets, it ignores the issues around vertical integration of banking and retail financial services. Not being allowed to merge didn’t mean that the big four weren’t allowed to acquire smaller competitors and ‘downstream’ retail operators such as financial services firms (e.g. ANZ buying Lend Lease) and so called wealth managers (e.g. Westpac buying BT Financial Group) as well as insurance companies (e.g. CBA acquiring Colonial Mutual, incidentally a source of many of its particular woes ever since).

Hayne dedicates a whole chapter (1.3) to issues arising from such vertical integration, but doesn’t recommend any changes to existing policies.

Vertical integration is supposed to be of benefit to customers through one-stop shop, economies of scale and other euphemisms for getting a bigger share of customers’ wallets. Nothing inherently wrong with that, except that the Royal Commission uncovered a number of issues related to lack of transparency and independency of financial advice.

The report also does not talk much about product complexity, a source of much customer frustration. Banks used to be quite simple businesses – taking customer deposits and lending money. It remains their primary function, but financial engineering, vertical integration and the over-riding focus on shareholder returns has led to banks offering more complicated products and diversified beyond their core competencies.

Financial engineering enabled by deregulation of the finance system world-wide caused the GFC, and it appears that we have learnt very little from that.

It is solid prudential regulation and the sound foundation of the Reserve Bank of Australia (RBA) that underpins our banking system. The four pillars policy is well past it’s used-by-date – as the Wallis inquiry concluded over twenty years ago. It has allowed the major banks to grow fat and complacent as Hayne’s report demonstrates. And as Wallis noted back then, there is no reason that merger regulations as overseen by the ACCC cannot be applied to the banks, too.

I am not suggesting that bank mergers is a panacea. But removing it will diminish some of the complacency and force more real competition by removing the cosy collegial nature of inter-bank relations.

Relations that see them invariably offer the same deposit rates, the same mortgage rates and change them in lock-step. (And serve up the same cringe-worthy TV ads that tries to make them look like community-minded puppy-dogs that will take care of you and your first-born from cradle to grave.)

Another omission from the Hayne report is any mention of the so called ‘Fintech’ sector. Fintechs cover a vast array of companies that offer various kinds of financial services, including car leasing, business equipment lending, business and even consumer finance, including the rather dubious practice of payday lending.

They currently fly under the radar, but it is a fast growing sector that source funds in ways that allow them to operate on the fringes of the prudential regulatory regime. It was only when they wanted to list on the ASX that ASIC started to take a keen interest in the practices of one of the better known firms – Latitude Financial – last year.

Another quiet achiever in this market is global payment giant PayPal – offering business lending to online businesses on the strength only of their incoming cash-flow. Dutch ING Group is yet another, offering online only banking services direct to consumers.

Global or local – innovative and nimble – Fintech is the future of banking, but we need to ensure that they are covered by the strong, prudential regulations that have served us relatively well. Otherwise the next royal commission will paint an even bleaker picture of an industry out of control.

Hayne was at pains to get the report out as soon as possible, and he and his team should be commended for that. But the work has only just begun. The report is woefully inadequate (partly because of its limited terms of reference) in addressing the deep rooted structural and cultural issues of our finance market operators.

It does recognise problems related to executive remuneration, it even recognises the root cause as greed. But cultural reviews and changes to reporting and remuneration systems that address only the mix but not the magnitude of excess won’t fix the problem.

The report alludes to the causes of the GFC and recognises that not much has changed to prevent it from happening again. Remarkably, there is no mention whatsoever of the role of the auditors failing to hold the banks accountable, nor of the many representatives of accounting firms that sit on bank boards and the potential conflict of interest that this poses.

There is no mention of how bank boards are made up entirely of people with financial, legal, accounting and business background with the odd ex politician thrown in for good (lobbying) measure. No consumer advocates, no employee representation, hardly an academic in sight (One to be exact – at the CBA board which is also the only gender balanced board.)

These are the people that ultimately should be held accountable for the damning Royal Commission report. But with the exception (so far) of Ken Henry and Andrew Thorburn at NAB they don’t seem to see themselves as part of the problem.

And that, is the real problem.

Banking reform

The next Federal Government must abandon the old policies set for a different time (including ‘four pillars’). It must recognise that vertical integration is not working well for customers, that being accountable only to shareholders leaves the customers stranded, and understand that tomorrow’s competitive landscape is very different. It must be open to consider drastic measures, including:

  • Public and transparent scrutiny of all mergers and acquisitions that relates to companies that handle people’s money – at least over a certain (small) size.
  • Extend and broaden the Financial Adviser licensing regime to all bank and finance company executives and mandate reporting of compliance failures.
  • Mandate rules for license suspension and loss due to non-compliance and mis-behaviour.
  • Make failure to report compliance issues detected in critical areas in a timely manner an indictable crime of not just the perpetrator(s), but also of their superiors.
  • Regulate for a broader representation on bank boards that reflect community values and expectations, not just shareholder value.
  • Regulate for financial product and product disclosure in a manner that serves the consumer not just the black letter law obfuscation of the current PDS system.
  • Comprehensively review all aspects of the existing and fragmented regulatory regime with an aim to simplify, mandate and make transparent.
  • Review ways to mandate board and executive remuneration to better align with a broader set of objectives and better meet community expectations.

Bank boards and executives will, of course, cry foul at much of this – decrying excessive regulation in a free market economy. And in principle, they may be right.

But decades of mismanagement, mistreating customers and free-wheeling greed proves that those same bankers don’t deserve to operate in that market. And if we can’t change the people, as a free society, we have to change the rules.

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