A new era for Australian banks

A watershed moment for Australian banking and financial services emerged this evening with the publication of the Hayne Royal Commission into misconduct in financial services. As the sun rises on a new era for the financial services industry, we ask what this means for the companies, the industry and your portfolios.

The report was released after the cash market close, but ASX 200 futures jumped around 0.3% moments after the release. This was a fairly accurate representation of the overarching fact that the recommendations outlined in the report are nowhere near as stringent as some were expecting. However, while shareholders and bank executives may breathe a sigh of relief the general public will not be doing so as the trust deficit is still wide-open and it seems little will been done to recover it.

While there is no doubt the outcome of the enquiry will be a more heavy-handed regulatory body, increased compliance costs and a crackdown on overinflated remuneration policies. The commission stopped short of recommending structural separation of product and advice, a win for the banks. It is, however, without doubt that the current regime of loose financial sector governance and the acceptance of our banking system as somewhat of a black box, with ASIC turning a blind eye, is over. 

There are many other sectors and sub-components that were affected, to name a few mortgage brokers are in the firing line along with insurance sellers and to some extent superannuation services. 

Another key concern was the impact to the supply of credit in the aftermath of the royal commission. These fears have been put to rest as the report deems current laws sufficient and does not outline any further tightening in lending standards, other than practices that have already been adopted since the inquiry emerged. Lending standards have already tightened significantly since the inception of the inquiry and tougher credit checks and verification of borrower income and expenses are already in full swing, which will continue to quell credit growth. 

Now the fears of an overly rigourous set of recommendations has been removed we should see a relief rally in the bank shares. But investors should take a relief rally with a pinch of salt as it could fade quickly. The Royal Commission is just a side show for the events unfolding in the real economy. The housing market will continue to slide in 2019 with Sydney and Melbourne seeing accelerated falls. Sydney property prices are already down 12% from their July 2017 peak and with banks' continued credit constriction and the economy decelerating, these falls are likely to intensify. 

As we have previously outlined this will have a knock-on effect to the real economy, generating a deterioration in growth and rise in unemployment throughout the year ahead. 

Over the next few years, the below major recommendations by Hayne, notwithstanding the governance that ASIC need to enforce in its institution, are to be implemented into the industry;

• “Fees for no service” will be abolished
• Annual reviews of ongoing fees to be approved by the client
• Funeral insurance will no longer be exempted from Financial Industry Laws. 
• Car dealers will be limited on fees they can get for selling add-on insurance.
• Retailers won’t be able to sell add-on insurance at the same time as the products.
• “Hawking” for superannuation and insurance and other products prohibited. 
• The borrower, not the lender, will pay mortgage broker fees
• APRA will supervise remuneration structures and banks to review pay systems of front office staff annually 
• Lenders to farmers won’t be able to charge high default interest rates during droughts or when there is no realistic prospect of recovering.
• Banks can’t offer overdrafts on basic accounts without the formal approval and can’t charge dishonour fees on basic accounts.
• Superannuation fund trustees won’t be able to work for other parts of the conglomerate that owns the fund removing conflict of interest. 
• Each Australian will be defaulted into only one superannuation account once at the beginning of their working life instead of into several saving an estimated of A$10 billion per year in unnecessary fees.
• A new independent oversight body will report on ASIC and APRA performance every two years. 
• In any investigation ASIC will have to answer the question of whether a case should be taken to court. Infringement notices should mainly be reserved for administrative rather than deliberate failings.
• It will set up an industry-funded compensation scheme able to payout over misconduct over the past 10 years.

All of these recommendations will significantly impact and change this industry. Increased regulation, compliance frameworks, watchdog expansion, remuneration caps and commission restructures will all affect the long term yield and performance of the industry as a whole.