Brokers v branches: The competitive utility of the broker channel

The report revealed that brokers, who settled 55.7 per cent of mortgages over the September quarter, lodged 28 per cent of their deals to lenders other than the big four banks and their affiliates. When looking at loans sent to banks other than the big four (excluding their affiliates), figures from Comparator suggest that 49.3 per cent of loans were set to these institutions.

Deloitte pointed to the Productivity Commission’s (PC) draft report into competition in the Australian financial system, which outlined that mortgage brokers have increased the market share of smaller lenders by 1.55 per cent, and that these banks would need to open 118 new branches to generate the equivalent market share.

The findings of the DAE report are timely, given the recent decision by Bankwest to close 29 of its branches. In fact, Bankwest’s managing director, Rowan Munchenberg, claimed that the lender knew it “[could not] match the major banks’ nationwide footprint and also deliver world-class digital services”, so it would therefore “prioritise digital channels and broker relationships”.

Mr Munchenberg said at the time: “Many people still value face-to-face interactions, but customers increasingly expect seamless self-service options that allow them to do their banking when and where they choose.

“We’re seeing a consistent trend of customers choosing mobile banking over in-branch options for their transaction needs, with an 88 per cent rise in app logins over the past three years.

“So, we’re transforming our organisation to respond more rapidly to these changing customer needs by adopting new ways of working and embracing new technologies.

“But we know we can’t match the major banks’ nationwide footprint and also deliver world-class digital services, so we will prioritise digital channels and broker relationships.”

Broker channel costs vs branch channel costs

But just how much does it cost to open and run a branch? It’s a question that many have been asking recently.

In its draft report, the PC sought evidence concerning the comparative costs of distributing home loans through the broker channel, against the costs incurred through the propriety channel. It revealed that it was unable to gather sufficient evidence from lenders and the third-party channel when pulling the report together.

“Whether brokers are an efficient, lower-cost distribution channel for lenders depends in large part on the way lender branch costs are apportioned between different activities,” the PC said.

“That the providers of half of Australia’s home loans were unable to give evidence on how they assess the costs and benefits of using brokers rather than branches to source home loans is surprising.”

However, appearing before the PC during its public hearings, executive director of the Finance Brokers Association of Australia (FBAA) Peter White suggested that the cost of using brokers was around half of the cost of the proprietary channel.

Mr White told the PC: “The use of brokers evolved from a clear recognition that the value proposition of using a broker was more attractive than branches and staff.

“The proliferation of brokers has occurred because of the benefit derived by product issuers from an expanding broker network, and, implicitly, product issuers know that a broker distribution model is cheaper and more effective than staff and branches, which is why it continues to thrive.”

This estimation has been given additional weight by DAE, which noted in its recent report that while “transaction costs are higher in the broker channel due to commission payments”, and that “processing costs are similar for both broking and banks’ direct channels”, lenders can make “significant savings” through the use of the third-party channel.

The report stated that the distribution of mortgages through branch networks incurs higher overhead and infrastructure costs, which it claimed make up 40 to 60 per cent of such lenders’ operating expenditure.

“Branches have fixed costs, in the sense that they are incurred even if no new loans are settled. These costs include premises lease and rentals; electricity; computer equipment and software; advertising and marketing costs; and staff employment, compliance and training costs,” the authors noted.

But, on compliance costs, DAE observed that the third-party channel absorbs much of the financial burden, highlighting data provided by mortgage aggregator Connective.

“The costs associated with staff compliance and training costs can be significant on a per-loan basis. Aggregators train and mentor their mortgage brokers and enforce compliance,” the report read.

“Connective, for example, estimated it spent around $2.7 million on educational events for brokers in 2017, on top of providing mentoring and business structure planning.”

Wider distribution channel

Moreover, Deloitte reported that mortgage brokers provide lenders with a “distribution channel that complements existing branch networks or stands in for them where none exist”, through:

• Broader consumer reach – Brokers are more geographically dispersed and have access to a wider range of consumer markets than the direct lender channel.
• Market sensing – In those areas where a lender has a relatively limited physical presence, lenders can use feedback from brokers to inform future decisions around product and service offerings. Deloitte made reference to comments from Liberty Financial CEO James Boyle, who said: “We value feedback from brokers and they are reliable in letting us know which group of customers are in need of help or require different solutions.”
• Lender segments – Mortgage brokers are the main distribution channel for smaller lenders, including regional banks and non-ADIs with limited branch networks. Without mortgage brokers, smaller lenders would have to incur the cost of establishing additional branches to distribute their products outside their local market or face the prospect of withdrawing from the market.

In summary of its insight into the benefits of using the broker channel for lenders, Deloitte pointed to a comment from head of broker distribution at Heritage Bank Michael Trencher.

“The key benefits of the mortgage broker channel [to lenders] are scale, distribution, broadening service and providing access to other areas of key banking services,” Mr Trencher said.

With new light shed by the Deloitte report, one could argue that any attempt to undermine the current broker channel would be a net loss for all stakeholders.

However, based on the available evidence, it seems clear that the average consumer would stand to lose the most.  

Ultimately, one could conclude that limited choice, higher operating costs offset by lenders with sharper pricing, and the reduced presence of grass-roots, community-based credit providers, would be a thorn in the side of the average consumer, struggling to make sense of a complex mortgage market.

[Related: ‘Brokers make mortgage markets work better’: Deloitte]