Analysis: Will Murray change mortgage lending?

After two rounds of submissions and an interim report, the financial services universe eagerly anticipates the final recommendations of the FSI.

Putting the Murray Inquiry in context, Deborah Ralston, executive director of the Australian Centre for Financial Studies says she doesn’t know that any inquiry has had such wide-ranging opportunity for input.

“With this inquiry they have listened very fully and very widely across the sector,” Ms Ralston said.

“Over time there have been some very heated disputes,” she said.

In the mortgage space, issues have been raised about the systemic risk of housing, bank capital, vertical integration in mortgage broking and, as a result, the role of broker commissions.

Vertical integration

One of the most relevant issues that transpired from the interim report was the issue of vertical integration in mortgage broking.

Up until that point, the vertical integration discussion had largely been confined to the wealth management space.

But when the Murray Inquiry found vertical integration in mortgage broking can create conflicts of interest, a second round of submissions polarised the industry.

The MFAA, CBA and Westpac were quick to defend bank ownership of mortgage brokerages and aggregators.

In its second submission, the MFAA argued that there is no evidence that bank ownership of some mortgage broking groups is influencing individual brokers to act anti-competitively and not in the consumers’ interest.

CBA, which owns 80 per cent of Aussie Home Loans, argued that the higher percentage of loans directed to smaller lenders by brokers compared to the percentage of loans sourced directly by smaller lenders is indicative that integration had made no impact on competition, nor does it distort the way brokers direct borrowers to lenders.

Westpac, owner of mortgage manager RAMS, similarly argued that “there is no cogent evidence” that vertical integration in mortgage broking has distorted competition.

The lender said vertical integration structures have actually generated pro-competitive outcomes for consumers.

Meanwhile, on the other side of the fence, the regionals claimed that while they have “no firm evidence” that vertical integration is distorting the way brokers’ direct borrowers to lenders, there may be some means of increasing a broker’s remuneration without having to disclose it to mortgage customers.

“For example, where a broker has to pay a fee, or the aggregator retains part of the commission for utilising aggregator platform infrastructure, such as a computer system, this fee could be reduced or the full commission passed through to the broker if the broker originated a loan supplied by the broker’s bank owner,” the submission said.

“This fee discount would not need to be disclosed to the mortgage loan customer, but stands as a clear conflict,” it said.

Further, the regionals argued that the majors’ dominance of the third-party channel will negatively impact the role of brokers in driving innovation and consumer welfare.

“The mortgage broker channel drove much of the competition and innovation in the lending market in the period leading up to the GFC,” the submission said.

“The broking industry emerged in the 1990s partly in response to the widespread closure of bank branches,” it said.

“It assisted smaller banks in achieving a nationwide footprint and was a key player in the period of mortgage finance competition and innovation.

“The extent to which this industry is now becoming captured by large product providers will undermine its potential role in driving competition, innovation and consumer welfare.”

The regionals took issue with the fact that, while calling for further information, the FSI has not outlined options to address concerns over ownership of mortgage brokers by the major banks.

Broker commissions

The role of broker commissions was brought up in the second round of submissions, perhaps most controversially by professional services firm EY.

The group recommended the introduction of a fee-for-service requirement to mitigate conflicted remuneration in mortgage broking.

Outsource Financial chief executive Tanya Sale believes ASIC is currently looking into broker disclosure and any potential conflicts of interest with brokers of bank-owned aggregators.

“It is all about disclosure,” Ms Sale told Mortgage Business.

“I honestly think ASIC should and will look at the disclosure documents of the bank-owned aggregators,” she said. “I think that will come.”

While the old mantra that ‘anything goes as long as you disclose’ has been questioned by ASIC, disclosure relies on financial literacy, Deloitte’s James Hickey says.

“That relies on a degree of financial literacy across the general borrowing public; it is hard to have everyone on the same level of knowledge and expectation,” he says.

“So therefore disclosure may mean more to some people than others.

“Therefore it is missing the purpose if it doesn’t help people who aren’t as financially well informed as others.”

Capital requirements

As the regulators look to ensure Australian banks have adequate capital levels in a global context, the smaller lenders have been calling for equal risk weights so that they can compete on a level playing field with the majors.

Part of the current problem is that smaller lenders are being forced to write riskier loans as the capital disadvantage prevents them from competing on price with the majors, according to Digital Finance Analytics (DFA) founding principal Martin North.

“The current disparity between the majors and the regional and smaller banks mean that some of those smaller banks have to look to write higher risk loans because they cannot compete on price or standalones because their capital is higher and therefore their costs are higher,” Mr North said.

“So essentially the way that the capital structures currently work, it actually pushes some smaller banks particularly perhaps away from where you would like to see them lending,” he said.

If the FSI recommends that the big banks hold additional capital, it would be a considerable headwind to the improved funding conditions they have lately enjoyed, J.P. Morgan banking analyst Scott Manning said.

“Measures proposed under the FSI could lead to potential costs for Australia’s major banks of up to $2 billion,” Mr Manning said, adding that recent price discounting would also be impacted.

Ms Ralston is confident that calls for a ‘level playing field’ by the non-majors will be answered.

“I suspect that something will be done between competitive neutrality between the big banks and second-tier banks,” Ms Ralston said.

“I think the second-tier banks might be a winner,” she said.

The FSI’s final report is due out in November.