Banking reform - An opportunity missed

The move was widely welcomed by increasingly disgruntled consumers but there are mounting concerns across the broking industry as to how effective the proposed plans will be. While the second tier and the mutuals sectors should benefit from the proposed reforms the non-banks are concerned that they will miss out – and even find themselves in a worse position.

The government was spurred to act in response to major banks’ tightening grip on the mortgage market and the resulting spike in out of cycle rate increases that have hit borrowers.

A proposed ban on exit fees for new mortgages and the prospect of greater portability went down well with consumers. But the broking industry and wider financial services sector appear unconvinced the reform package will deliver increased competition through measures that the government claimed “won’t let the big banks off the hook”.

According to the Treasury, the reforms will empower consumers to get a better deal, help smaller lenders put more competitive pressure on the big banks, and secure our financial system so it can continue to provide a sustainable flow of credit to households and businesses.

In addition to the much publicised ban on exit fees on new home loans from 1 July 2011, a raft of changes included in the reform package would aim to boost consumer flexibility to transfer deposits and mortgages; introduce a mandatory key fact sheet for new home loan customers; and empower the Australian Competition and Consumer Commision to prosecute anti-competitive price signaling.

The reforms would also fast-track legislation around credit cards; launch a national community awareness campaign aimed at banking consumers; and set up a taskforce with the Reserve Bank of Australia to enhance ATM competition reforms.

The main thrust behind the government reforms is to inject greater competition into the mortgage market, which many believe could be achieved by supporting the smaller lenders.

The reforms would “build a new pillar in the banking system based on the combined competitive power of our mutual credit unions and building societies”, the proposal says.

This would allow all banks, credit unions and building societies to issue covered bonds to broaden access to cheaper, more stable and longer-term funding, and harness national superannuation savings.

But this will be of little comfort to the non-bank sector.

All that is on the table for the non-banks is a further $4 billion investment to support the RMBS market and the development of a ‘bullet bond’ structure for RMBS issuance to strengthen and diversify RMBS funding.

WILL THE REFORMS WORK?

So, will the proposals have the effect the Treasurer is claiming? Tony Meredith, Executive Manager, Personal Lending at Suncorp has his doubts: “It’s hard to tell,” he says.

“I don’t think it’s going to result in major changes to the amount of competition. Obviously, there’s a lot in there about making things more visible, with the one-page fact sheet, and so on.

“But customers [already] have a lot of variety out there, through infochoice, RateCity and a number of other background sites that allow them to actually compare rates.

“So, whether these fact sheets and one-pagers really make a difference for customers remains to be seen.”

Lisa Sanders, director of originator Loan Management Services, is adamant that the proposed reforms will not improve lender competition: “In fact, they will likely hamper competition,” she told The Adviser.

“For brokers, it would likely mean reduced commissions and the reforms would reduce the choice of competitive loan options for their clients.”

According to Andrew Mirams, managing director of finance brokerage Intuitive Finance, the reform package represents a government effort “to beat its chest on something it can’t control”.

“If anything, it gives the banks the ability to raise application fees and interest rates as they will not lose out – they are a business and need to produce and return on equity.

Mr Mirams points out that the banks will just increase the ‘other’ fees at exit to claw back some cost. “Give with one hand, take back with the other,” he says.

Mortgage Choice’s chief executive officer, Michael Russell, says while the reforms have both good and bad points, overall they would do little to stimulate competition.

Mr Russell’s concerns centre on the lack of support for the non-banks – something which he believes is essential if real competition is to be injected into the market. And while Mortgage Choice is a brokerage and not an originator, Mr Russell nevertheless feels strongly about the needs of the non-bank lenders as well as the second tier banks.

“Anything that dilutes their ability to compete with the major banks will impact home loan choices and the service available to our customers,” he says.

“While we welcome an inquiry into mortgage market competition, it is apparent some proposals have not been thought through.

“We are deeply concerned that the unintended consequences of some of these proposed reforms look very much like disadvantaging the very people they are designed to assist,” he says

“Those people, of course, are Australian mortgage holders.”

But criticism of the proposed reforms goes much further than the mortgage broking industry. Moody’s Investors Service labelled the reform package as “ineffective”.

Patrick Winsbury, a senior vice president at Moody’s Sydney office, says the various initiatives to increase competition are likely to have an impact only over an extended period – if at all – and therefore create limited near-term pressure on the credit profiles of Australia’s major banks, which are the principal targets of the government’s proposals.

“In fact, the major banks stand to benefit from the ability to issue covered bonds. But the proposals provide only a foundation upon which to tackle the structural dependence of the major banks on offshore wholesale funding.

“This is the most significant negative credit issue that the Australian financial system faces,” Mr Winsbury says.

EXIT FEE DANGERS

But while there are certainly flaws in the proposed boost to competition via funding, of greater concern to Mortgage Choice’s Michael Russell is the intended removal of mortgage exit fees.

Mr Russell points out that non-bank lenders have long been forced to raise funds at a higher cost to their banking counterparts.

This often means that the non-banks need to operate at thinner margins to compete and so in many cases they must impose an exit fee to recover their reasonable costs should a loan be discharged early.

“ASIC recognises this and made it very clear last month in RG220 what it regards as a reasonable exit fee and what it regards as unconscionable. Why is there now a reform package at odds with this recommendation?” Mr Russell asks.

He was quick to stress that Mortgage Choice opposed the intervention of government regulation of the financial services industry; rather, he supported the “continued deregulation that allows market forces to drive competition”.

Steve Sampson, Provident Capital’s head of distribution, lending, agreed that the government was wrong to interfere with exit fees.

According to Mr Sampson, the banning of exit fees will effectively reduce competition because non-bank lenders recoup acquisition costs with the collection of deferred establishment fees (DEFs).

While it is hard to tell what impact any banking reforms would have on brokers until they are formally introduced, the government’s plan to slash mortgage exit fees could force lenders to recoup these costs elsewhere.

“If you take away somebody’s income – i.e the banks’ – where do they recoup those lost costs? They have shareholders. They may look to recoup their costs from mortgage brokers,” In Touch chief executive officer Paul Ryan told The Adviser.

Ms Sanders shares similar concerns around exit fees: “Banning deferred establishment fees will certainly mean that lenders will be looking to recoup those costs elsewhere,” she says.

“While brokers will most likely wear some of the cost through reduced commissions, it will mean that clients will pay more fees and possibly higher interest.

“Cutting broker commissions, providing an incentive to churn, and reducing competition will have a massive impact on borrowers in a very negative way.”

The non-bank market share stood at 13 per cent in 2007, but it now sits at around 5 per cent.

The surge in non-bank lending had a direct impact on bank lending margins as they were forced to compete with the smaller lenders on price. There is growing frustration amongst the non-banks that the impact they have had on the Australia mortgage market has been forgotten.

“The support of mutuals simply ignores the sector that has historically driven down pricing by creating competition with the four pillars,” Mr Sampson says.

“The writing is on the wall and the Australian Bankers Association has already attested to that. Commission reduction and amortisation of up-fronts over a period of the loan must be on the banks’ mind, which is sure to cause cash flow issues for brokers.

“The loan receptacle notion would also mean that brokers could quite easily experience even more channel conflict. That also might play into the hands of the majors too.”

‘NEW’ FUNDING SOURCES

In a world that remains firmly in the grips of the GFC, access to funding remains a major challenge for smaller lenders. While there has been an easing in funding costs over the last couple of years, prices remain high and this continues to favour the majors.

“We’ll have to wait and see whether [the covered bonds component] makes a difference over time,” Suncorp’s Tony Meredith says. “Obviously, it’s going to have some difference for some smaller lenders out there – including us – but whether it’s a new source of funding? Realistically, we’ll have to see how it plays out.”

“Although the injection into RMBS is $4 billion, when you actually look at the monthly numbers in terms of dispersal to the customers, four is a relatively small number.

“So first, there’s the size of it, and second, you’ve got the actual cost to small institutions. Based on those two factors, will it really result in more competition for customers out there?”