By Leonie Chapman – LAWYAL Solicitors, and Tim Brown – Chairman of MFAA
First published by LexisNexis Banking and Finance Law Bulletin 2015 Vol 31 No 1
In late 2013 the Treasurer released draft terms of reference for the Financial System Inquiry. After consultation with interested stakeholders, the Treasurer appointed an independent Committee charged with examining how the financial system could be positioned to best meet Australia’s evolving needs and support Australia’s economic growth.[i] The intension of the Financial System Inquiry is to establish a direction for the future of Australia’s financial system, given it has been sixteen years since the last financial system inquiry. In July 2014 the Committee produced its Interim Report (“Interim Report”), which tackled issues relevant to credit advisers such as the substantial regulatory reform agenda, new competitive dynamics in the banking sector and the impact of the global financial crisis (“GFC”). As part of consultation with the banking and finance industry, the Mortgage and Finance Association of Australia (“MFAA”) responded[ii] specifically to express, among other matters, its disagreement with the Interim Report’s observation that the banking sector is competitive, albeit concentrated.
In November 2014 the Financial System Inquiry Final Report[iii] was published (“Final Report”) taking into account industry and expert responses, including from the MFAA[iv]. In this article, we explore the findings in the Financial System Inquiry as they apply to the mortgage broking and lending industry and in particular, hear the views of Tim Brown, Chairman of the MFAA on the Final Report’s findings in relation to competition in the banking sector.
The Interim Report observes that competition can still be strong between players in a concentrated market, stating “market concentration can be a by-product of competition, if more efficient firms grow at the expense of their less efficient competitors.”[v] The Final Report concluded that that competition is generally adequate in the market, although the high concentration and increasing vertical integration in some parts of the financial system has the potential to limit the benefits of competition in the future and should be proactively monitored over time.[vi] Generally, Tim Brown and the MFAA disagree with the Final Report findings that the banking sector is competitive, albeit concentrated, and we provide below a lending market perspective on competition in the Australian financial system, that may be of interest to banking and finance lawyers.
GFC and competition
Firstly, Mr Brown explains how the Interim Report and Final Report both seem to incorrectly and narrowly focus on the ‘banking sector’ rather than reference to the wider ‘lending sector’. In 2007, 85% of the residential lending market was made up of banking sector institutions (including mutual communities), with the remainder of the share going to non-bank and specialist lenders. Up until the GFC the specialist-lending sector successfully competed with the banks and stole significant market share from banks, resulting in overall lower margins in favour of customers.
While to a certain extent the Final Report’s statement that competition can still exist in a concentrated market, may be true, Mr Brown describes how this does not in any way reflect the dynamics of the lending market since 2007. In the MFAA response[vii] to the Interim Report, it submitted that larger banks have grown in market share since 2007 resulting in a more concentrated lending market, not because the larger banks have been ‘more efficient’, as the Interim Report suggests, or as a by-product of competition. Rather, the MFAA believes there are a number of other factors that explain why larger banks have grown, including: (a) the GFC; (b) the allowing mid-tier banks and lenders to be acquired by larger lenders without regulatory intervention; (c) over regulation, including the Government’s ill-considered decision to ban exit fees; (d) Government intervention with wholesale funding and savings guarantees; and (e) the reduction (or elimination) of securitised funding to smaller lenders.
In particular, regarding the influence the government guarantees had on competition, the Final Report noted simply that “perceptions of implicit guarantees in the banking system can distort competition by providing a funding advantage to those banks”[viii], however went on to say that any recommendations that increase resilience of the largest banks, will reduce these perceptions over time and help contribute to restoring a more competitive environment. So far, the perceptions of the MFAA have not changed. It believes that these advantages to the larger banks and lenders throughout the GFC, to the clear disadvantage of the smaller banks and specialist lenders, played a large part in creating the lack of competition in the lending sector we see today. On this basis, Mr Brown and the MFAA continue to contend the Financial System Inquiry’s findings that the current concentration of the lending market is a by-product of competition and that the reason for banks taking a larger share is their efficiency. It is Mr Brown’s view that the lending sector in particular is not as competitive as it should be, and the ultimate disadvantage is to consumers.
Vertical integration of credit advisers and competition
An imbalance of regulatory cost versus share of market, coupled with the GFC, which saw large banks swallow some mortgage aggregators and brokers. The Financial System Inquiry asks whether this vertical integration is distorting the way in which credit advisers direct borrowers to lenders?[ix] Mr Brown explains how the MFAA would be concerned if the response to this question was ‘yes’. While MFAA believes large banks and lenders swallowing smaller banks and lenders has created less competition in the banking sector, it strongly disagrees with the Financial System Inquiry findings that vertical integration of credit advisers into larger aggregators and lenders has had the unintended effect of reducing competition. There is a big difference, according to Mr Brown. There is no evidence that bank ownership of some mortgage broking groups is influencing individual brokers to act anti competitively and against the consumers’ interest. To the contrary, Mr Brown explains that the evidence shows that credit advisers have been influential in diffusing the concentration in the market and has assisted with facilitating competition, in particular in the mortgage lending market.
The heart of the question by the Financial System Inquiry, according to Mr Brown, is the assumption that ownership of a mortgage aggregation or broking group may influence the conduct of an individual credit adviser, being a member of one of those groups, to the disadvantage of consumers. As the conduct of credit advisers is robustly governed by the provisions of the National Consumer Credit Protection Act, 2009 (NCCP Act), MFAA argues against this assumption. Credit advisers are required to be licenced, disclose commissions and the lenders on their panel, conduct responsible lending assessments and in particular, are required to ensure there is no disadvantage to clients as the result of any conflicts of interest that may arise. Of particular interest to banking and finance lawyers like myself, Mr Brown explains how, unlike other legislation such as Corporations Act 2001 (Cth), which requires an AFSL holder to ”have in place adequate arrangements for management of conflicts of interest”[x], credit advisers cannot simply manage a conflict through disclosure. Credit advisers under the NCCP Act are required to take individual responsibility to ensure there is no consumer disadvantage as a result of a conflict.[xi]
Further, MFAA statistics[xii] documented in their response to the Interim Report, demonstrate that currently a consumer is less likely to be recommended a product with one of the big four lenders by a broker (at 74%), than if they sourced the product directly with the big four banks (at 82%). This should be considered in light of the fact that aggregators and broking groups which are now wholly owned by the big four lenders, comprise an estimated 40% of all credit advisers. If credit advisers were directing borrowers to their bank holding companies in conflict with their duties to customers, according to the MFAA it should be expected that the percentage of loans transacted by brokers into the top four banks would be much higher. The MFAA continues to believe that credit advisers play a role in diffusing the concentration in the market, rather than adding to it, by recommending products from smaller lenders and ensuring genuine suitability of loan product for their customers.
Financial System Inquiry did comment that stakeholders provided little evidence of differences in quality of advice from independent, aligned or vertically integrated mortgage broking firms, however it still sees value to the customer in making ownership and alignment more transparent.[xiii] The Financial System Inquiry has recommended that brokers should disclose their ownership structures more broadly than the current Credit Guide rules apply, and disclosure should extend to branded documents and materials.[xiv]We think it is highly doubtful that the benefits to consumers in adding further disclosure requirements on brokers will outweigh the already high transitional costs to the industry of effective branding changes.
Regulation and competition
This brings us to the question of regulation and its impact on competition. In MFAA’s submission[xv] in response to the Interim Report, it stated that regulation must either be competition enhancing or, at least, competitively neutral in its impact on the various players in the lending market. The consumer credit and other regulations introduced to the mortgages industry over the last five years with its many requirements and high compliance cost, apply equally to a small credit adviser as it does to a large bank. Further, banning exit fees may have even had the unintended impact of reducing competition between the larger and smaller lending players. This has resulted in an inequity across the sector, with smaller credit advisers and non-bank lenders struggling to keep up with the regulatory costs that can be better absorbed by the big banks. In our view, this does not mean small credit advisers are less efficient.
Mr Brown and the MFAA submission[xvi] express a desire for any new regulation to enhance competition, rather than decrease. Mr Brown explains the MFAA’s view that, before Treasury considers introducing any further regulatory reform that may impact credit advisers, it should first examine the proposed reforms to ensure that they are competitively neutral across all players in the market. The Final Report addressed this point by suggesting a review of the state of competition should occur every three years, that reporting on how regulators balance competition against their core objectives should be improved, and that competition should be made part of the regulators’ mandate.[xvii] Thankfully, the Financial System Inquiry is very conscious that unnecessary and inappropriate regulation has the potential to reduce the financial system’s efficiency.
As an immediate first step, the Financial System Inquiry states that regulators should examine their rules and procedures to assess whether those that create inappropriate barriers to competition can be modified or removed, or whether alternative and more pro-competitive approaches can be identified. Mr Brown and the MFAA agrees that this would be a good first step. In the absence of change, there is a risk that regulators and policy makers will not place sufficient emphasis on competition when making decisions, and this could have a flow on effect of disrupting innovation. The extent of market concentration in some parts of the system, and its potential to limit competition in the future is a significant issue, according to Mr Brown.
Securitisation and competition
Finally and importantly to the MFAA, is the need for a stronger securitisation market to enhance competition and enable a vibrant and innovative non-bank, specialist and small lender sector. This is something Mr Brown as Head of Sales & Distribution, and I, senior as in-house lawyer, both experienced first hand at Macquarie Bank just as the GFC began. Tim Brown explains his experience at Macquarie Mortgages when Lehman’s Brothers Collapsed, which caused the systematic collapse of the securitisation market and the closure of warehouses facilities that many of the financial institutions were using to fund mortgages growth. The flow on affect was the inability for many smaller institutions, including Macquarie, to fund mortgages. Had Australia had a similar system to Canada at the time, Macquarie may not have had to withdraw from the lending market, St George Bank would not currently be owned by Westpac, Bankwest may not have had to sell to Commonwealth Bank of Australia (“CBA”), and the founder of Aussie Home Loans, John Symond, may not have seen the need to sell to CBA to secure Aussie’s future in the mortgages industry.
The substantial negative effects of having to wind back origination where funding options decreased or were completely eradicated, enabled large balance sheet lenders to regain the market share they had previously forfeited to the innovative lenders. In MFAA’s submission[xviii] in response to the Interim Report it strongly expressed that competition in the lending sector needed to be enhanced by a strong securitisation market, and the importance of Government intervention in the residential mortgage backed securities (“RMBS”) market on an ongoing basis. It argues that Canada has proven that this type of system can be managed without risk to taxpayers and without the creation of ‘moral hazard’. Australian Office of Financial Management (“AOFM”) has also provided this proof in the past few years. MFAA believes the AOFM’s involvement in the market should be re-ignited on an ongoing basis to ensure a more competitive lending market.
There is no doubt that prior to the GFC, the availability of competitively priced securitised funds enabled non-bank lenders to aggressively attack the margins of the major retail banks. It also enabled non-bank lenders to start competing on service levels, and as a result of both improved margins and service to customers, the non-bank lending market share rapidly grew. The fact that the specialist lender market share went from nil to over 15% in a decade is evidence in itself of the inefficiencies and lack of competitiveness in the banking sector since the GFC.
Mr Brown submits that since 2007 the only significant changes to the lending market have been: (1) the pause in the securitisation market; and (2) major government intervention in the form of regulation. The competitive drive from larger banks and financial institutions has not changed; rather “their aggressive and successful smaller competitors have been hamstrung”, says Mr Brown. I most definitely agree, particularly having had an inside perspective on the impact these factors have had on securitised lenders, even the most efficient. It is crucial that non-bank lenders and smaller lenders have access to securitised funding, to enhance competition and innovation in the lending market.
As the Interim Report observes, the RMBS market has started to recover, however the markets still have a long way to go before bouncing back to the pre-GFC level. While the Reserve Bank of Australia does not expect the market will return to pre-GFC levels in the near future[xix], we believe there is still a need to ensure that it is fostered and continues to grow.
Unfortunately, the MFAA’s submissions regarding the successful impact of the Canadian approach in driving the non-bank sector and providing more competition was largely disregarded by the Financial System Inquiry, which according to the MFAA incorrectly grouped the Canadian model with the USA model approach as though they were one and the same. This ignored the reality that the Canadian system has operated since the 1940s and never once has there been a liability for taxpayers, and in each year a profit has been returned to the Canadian consolidated revenue. We believe that the infrastructure should be created in Australia now, not as a crisis strategy, but as a long-term solution. It seems that the Financial System Inquiry would require a “clear market or regulatory failure in the RMBS market”[xx] before it could consider intervening. MFAA, Mr Brown and I (along with many others in the banking and finance industry) believe that this would be too late.
MFAA acknowledges that the Australian Government did move fairly quickly (albeit after the event) by directing AOFM to purchase RMBS securities to support the market. Through the rigour of its operations it caused no liability to the taxpayer and, like the Canadian program, produced a profit for the Government. We believe that had it been operating before the GFC, it would have saved many non-bank lenders from reducing their lending or changing their business models. For these reasons the MFAA believes it is important that the Government intervenes in the RMBS market by reigniting the involvement of AOFM on an ongoing basis to ensure a more competitive lending market.
The MFAA expressed disappointment at many of the findings and recommendations of the Financial System Inquiry specific to the question of competition in the banking sector. In particular and relevant mostly to the lending sector, MFAA does not believe the major banks have been ‘more efficient’ than their smaller counterparts causing a more concentrated and less competitive market. In contrast, Mr Brown and the MFAA maintain that the major banks have received advantage over the smaller lenders since the GFC, including Government bank guarantees, over-regulation causing an imbalance, and lack of steady securitisation funding. While many of the MFAA’s suggestions to the Financial System Inquiry regarding competition were dismissed, we hope that at the very least, some of the recommendations of the Financial System Inquiry, including an assessment of the impact that over-regulation has had on competition, may result in the return of innovation and enhanced competition in the lending market in the future.
Leonie Chapman, Principal Lawyer and Director, LAWYAL Solicitors, firstname.lastname@example.org.
Tim Brown, Chairman of Mortgage Finance Association of Australia (MFAA)
[i] Financial System Inquiry, Interim Report, Treasury, July 2014, at p xi
[ii] Submission by Mortgage Finance Association of Australia in response to Financial System Inquiry, dated March 2014
[iii] Financial System Inquiry, Final Report, Treasury, November 2014
[iv] Above, n 2
[v] Financial System Inquiry, Interim Report, Treasury, July 2014, at page 2 – 3
[vi] Financial System Inquiry, Final Report, Treasury, November 2014, at p xvi
[vii] Interim Report Response by Mortgage Finance Association of Australia, August 2014
[viii] Financial System Inquiry, Final Report, Treasury, November 2014, at p 19
[ix] Financial System Inquiry, Final Report, Treasury, November 2014, at p 255
[x] Corporations Act 2001 (Cth), at s 912(1)(aa)
[xi] National Consumer Credit Protection Act 2009 (Cth), at s 47(1)(b)
[xii] Source: MFAA calculations based on comparator – Broker Market Share statistics, June Qtr 2014; APRA Monthly Banking Statistics – June 2014; ABS Housing Finance 5609.0 – June 2014.
[xiii] Financial System Inquiry, Final Report, Treasury, November 2014, at p 272
[xiv] Financial System Inquiry, Final Report, Treasury, November 2014, Recommendation 40 at p 271
[xv] Above, n 2
[xvi] Above, n 2
[xvii] Financial System Inquiry, Final Report, Treasury, November 2014, Recommendation 40, at p 254
[xviii] Above, n 2
[xix] Financial System Inquiry, Interim Report, Treasury, July 2014, at p xviii
[xx] Financial System Inquiry, Interim Report, Treasury, July 2014, at p 2-15