Mortgage brokers struggle to make case for trailing commissions that Hayne wants gone
As recently as the 1990s, banks employed bank managers who knew their communities so well they not only greeted the locals by name, they were intimately familiar with their work, family and financial history.
When it came to assessing their capacity to borrow and repay money, it was a fairly straightforward calculation. Loans were applied for, not sold, and these bank staff received wages, not commissions.
In the three decades since then, the banks have moved to the sales-driven culture identified and criticised by Kenneth Hayne in the final report of his royal commission. What we used to understand as the role of an old-style bank manager has been subverted.
The banks’ own staff, as well as third-party mortgage brokers, are being paid incentives and bonuses, often based on how many loans are written and how big they are rather than what’s in the best interests of customers.
Among his four general observations, Mr Hayne stated that clients might assume that the person standing between them and the entity providing the financial service or product was acting for them, and in their best interests.
“But in many cases the intermediary is paid by, and may act in, the interests of the provider of the service or product,” he observes.
“If the intermediary (bank staff or broker) does not act for the provider, the intermediary may act only in the interests of the intermediary.
“The interests of client, intermediary and provider of a product or service are not only different, they are opposed.”
Mortgage brokers replace bank staff
Over recent years, the big four banks have shed thousands of jobs as they scramble to cut costs. At the same time, mortgage brokers have replaced bank staff as the biggest writers of home loans.
In almost 60 per cent of cases, the banks now outsource the time and effort involved in arranging a home loan to a mortgage broker, who does much of the leg-work for them. In return, the banks pay mortgage brokers an upfront fee (usually a percentage of the loan amount) and an ongoing “trailing” commission, also based on how much is borrowed.
But the royal commission has recommended that the borrower, not the lender, should pay the mortgage broker a fee for arranging a loan, to ensure the broker is working for the customer and not the bank.
Trailing commissions are ‘money for nothing’
It’s that trailing commission that royal commissioner Kenneth Hayne has dubbed “money for nothing”.
Among the 76 recommendations in his final report, Mr Hayne suggested trail commissions be banned.
On Twitter, Ian Armstrong — who spent 36 years working at a couple of the major banks, for much of that time as a relationship manager helping clients with loans — said he concurred with the royal commission findings.
“I left the industry early under the stress of the unrelenting sales culture. It was unethical and targets unsustainable. Experience meant little. If you could push product, you were a star.”
That model extends to mortgage brokers, through the commission system.
Mr Hayne concluded that “the present system of remunerating mortgage brokers is conflicted remuneration”. The payment, he said, is one that “could reasonably be expected to influence the choice of financial product recommended to clients”.
In that system, loans are sold for commission rather than as part of the daily job of the old-style bank managers, who were paid a salary and were keen to please their loyal customers by looking out for their best interests.
The royal commission report found that, “providing a service to customers was relegated to second place. Sales became all important. Those who dealt with customers became sellers.”
This change in banking culture that’s emerged over recent decades might help explain why household debt in Australia as a percentage of household disposable income has jumped from about 60 per cent in the late 1980s to about 200 per cent today.
According to the Bank for International Settlements, Australia’s household debt is now the second highest in the world behind Switzerland.
Brokers fight back with major ad campaign
The Mortgage and Finance Association of Australia (MFAA), which represents more than 13,500 brokers, has launched an advertising campaign claiming that upending the mortgage broking industry will limit competition in the home loan market, restrict customer access to credit and lead to higher interest rates.
Tagged “Don’t Kill Competition” the ad tells viewers that fewer mortgage brokers mean less competition, which translates to fewer options for customers and higher costs.
A submission by the Commonwealth Treasury in response to the royal commission’s interim report also warned that removing broker commissions could see fewer brokers in the market, which might then threaten competition.
Among its responses to the royal commission’s recommendations, the Customer-Owned Banking Association emphasised the importance of the broking channel for many small lenders.
COBA expressed concern about the idea of shifting the burden of paying mortgage brokers away from banks to customers.
“We are keen to proceed with caution to ensure that there is no adverse impact on consumers’ access to lenders and that competition in the home lending market isn’t eroded,” it said.
Would the recommendations lead to less competition?
For all the competition mortgage brokers say they help foster, the big four banks still dominate the $1.7 trillion mortgage market. Westpac, the Commonwealth Bank, ANZ and NAB control more than 80 per cent of all owner-occupied loans and 85 per cent of investment home loans.
Given our homes are our single biggest financial commitment, taking a day or so to shop around and compare all the various lenders against our individual circumstances doesn’t feel so onerous.
Seven months before Kenneth Hayne gave his verdict on the financial services industry, the Productivity Commission had released its own report into competition in the Australian Financial System.
In home loan markets, it found that “mortgage brokers who once revitalised price competition and revolutionised product delivery have become part of the banking establishment”.
Like the Hayne report, it too recommended banning trail commissions.
“Fees and trail commissions have no evident link to customer best interests.”
And, like Kenneth Hayne, it wanted a best interests duty — but not just for brokers, also for bank staff who sell loans.
“All brokers, advisers and lender employees who deliver home loans to customers should have a clear legally backed best interest obligation to their clients,” the commission report said.
Would the royal commission recommendations lead to tighter credit?
Since Mr Hayne began scrutinising the financial services industry more than 12 months ago, banks have systematically begun exercising more caution.
The royal commission coincided with a regulatory crackdown on lending standards by APRA, as well as enforcement of responsible lending rules by ASIC, including an ongoing court case against Westpac.
These tighter credit conditions have coincided with a slump in house prices, notably in Sydney and Melbourne.
The Council of Financial Regulators recently reaffirmed its view that stricter lending standards had “strengthened the resilience of the system”.
Better justifying a customer’s capacity to repay a loan and moving away from a commission-driven sales culture is part of the cultural change Kenneth Hayne wants to see at the banks.
The royal commission’s repeated calls for more “responsible lending” will inevitably mean less access to credit, far beyond the effects of any new approach to the way mortgage brokers are paid.
In its ad campaign, the MFAA asks, “What would a world without mortgage brokers look like?”
Perhaps it would look a bit like the 1980s, when retail banking was more about service than sales.