Banking royal commission highlights the conflict of interest at heart of mortgage broking
Cash envelopes filled with bribes, problem gamblers getting credit extensions and a bank manager transferring $35,000 direct to foreign scammers.
It is not The Sopranos, but some of the allegations heard in the first public hearings at the banking royal commission.
The framework around billions of dollars of consumer finance — home loans, credit cards and car loans — was examined this past fortnight.
Here are a few things we learnt about the system of incentives and potential conflicts of interests in the mortgage broking business.
How mortgage brokers maximise their income
Half of Australia’s mortgages are written by brokers, who act as a third party between the customer and lender.
But who are they really working for?
Australia’s largest institution, the Commonwealth Bank, admitted there was a conflict of interest created by the commission payments that banks made to mortgage brokers in the $1.5 trillion — yes, with a T — housing finance market.
“The larger the loan, the bigger the commission?” senior counsel assisting Rowena Orr QC asked the bank’s executive general manager of home buying, Daniel Huggins.
“That’s correct,” Mr Huggins replied.
“The longer the loan takes to pay off and the larger it is, then the larger the trailing commission and that can lead to a conflict — that is a conflict — between the customer and the broker,” he added, under sustained questioning.
Ms Orr followed up, making a direct link between how much a broker earns and the size of the loan they write for customers.
“Because it’s in the mortgage broker’s interests to get the largest loan approved possible to extend over the longest period of time, for the customer to repay it?” she asked.
That would “maximise their income”, Mr Huggins agreed.
Bank customers using brokers not getting the best deal
In a previously confidential submission, the Commonwealth Bank’s outgoing CEO Ian Narev agreed the system by which brokers are paid meant customers were not getting the best deal.
He wrote to an Australian Bankers’ Association review into retail banking remuneration:
“The use of loan size linked with upfront and trailing commissions for third parties can potentially lead to poor customer outcomes. We would support… measures on incentives related to mortgages… for example the de-linking of incentives from the value of the loan.”
Customers going through brokers have a higher total loan-to-value ratio, pay more in interest and pay down their loans more slowly.
Despite the bank agreeing flat fees would stop brokers boosting the size of loans and suggesting slower pay-down strategies to increase their trailing commissions to maximise profit, they are not fixing the system.
But no bank wants to be the “first mover”, because it could cost them business.
Mr Huggins said CBA has not taken any steps to move away from the practice of paying commissions to mortgage brokers based on loan size and including trailing commissions.
“I’m not sure I would suggest that the difficulties are surmountable if CBA would act alone,” he said.
‘Shock and Orr’ of Hayne’s commission
But it is not entirely grim. The long hours of hearings have been enlightened by the dry wit of Commissioner Kenneth Hayne AC.
Robert Regan got in the witness box and stated he was 72, implying this was quite a lot.
Commissioner Hayne, also 72, was not having it:
“A man in young middle age,” he told the witness. “Say after me, Mr Regan: a man of young middle age? Yes. That’s all we are.”
There were a few other pointed barbs across the fortnight.
“I put it to you, the expression ‘customer needs’ is a euphemism,” will be going up on the wall at financial counsellors across the nation.
And one more kicker. At the end of a long day, NAB counsel Wendy Harris QC tendered some documents and asked if the Commissioner would like them separately or together.
“I was going to proceed to the exhibits, Commissioner, but we can tender them together if it suits,” she noted.
“A matter of supreme indifference,” he said, not looking up.
The Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry is set to release a draft report by September.
That tight timeframe was evident as counsel tore through their selected case studies, followed by a grilling of the relevant bank executive.
Hearings begin again in mid-April, examining scandals in wealth management and financial planning.
There are billions in the balance, so expect more fireworks.