The Five Systemic Problems Revealed By Hayne's Report

The banks operate as an oligopoly and Kenneth Hayne should consider breaking them up. Supplied

There is no other way to react to the Hayne interim report of the banking royal commission, but to be horrified. Australian financial institutions that we rely on and trust to do the right thing have let down many in the community down in the pursuit of profit, at the expense of those they serve: the customers.

Imagine, for a moment, Kenneth Hayne drawing this conclusion into Australia's medical industry:

"Our hearings … found systemic over-servicing of patients, patients being prescribed drugs for conditions that they had no evidence for, and referrals to specialists and agencies that were not warranted. Complaints from patients about these issues were not sufficiently remedied in a timely manner. As a result, patients' lives were endangered and further jeopardised by both the actions and inactions taken by their doctors. The medical regulator almost never took any of the doctors or medical companies to Court, even where there was clear evidence of wrong-doing. When court proceedings were initiated, the penalties imposed by the medical regulator were so immaterial that the doctors and their medical firms (and their insurers) never experienced the due penalties they should have faced under the Law."

And yet, substantively, these are Hayne's findings about Australian banks thus far.

How could it have come to this? Why have the government and our financial regulators not been able to protect consumers?

There are some significant an systemic problems that need confronting given the interim report's findings.

First, perverse incentives operate between how customers are serviced and how the financial services entities – and employees involved – are remunerated. An economically unfair partnership exists in how a consumer's financial problems are solved. There is a strong misalignment of power between participants

Second, Australian financial services entities appear to not fear the corporate cop. The 1995-97 (Wood) royal commission into the NSW Police Service found that criminals didn't fear the police. The NSW "Police Force" name was duly reinstated soon after. The point is that fearing enforcement should come naturally to everyone. ASIC is financially under-resourced, has the wrong employee skill-set mix regarding lawyer/economist/quant/datascience/IT specialists. It has too many lawyers, and has been overly timid in taking any meaningful legal action over cases of alleged wrong-doing.

Australia would be well served recruiting both US and EU regulators, under a more litigious regime, to show how corporate policing is really done. But only where the current laws enable enforcement.

Lack of data available

Third, there is a deficiency in the quantity and quality of data available to the regulators, on a platform that can be shared between them. The data architecture of the financial system needs major investigation, involving regulators, academics, regulators and industry. The Australian Prudential Regulation Authority should be commended for their past work here. But we are far behind North America and the UK, for example. It would seem, based on the evidence before the royal commission, that there are data (numbers and textual language) and architectural gaps that need to be quickly plugged and shared across all financial regulators.

Fourth, financial consumers are hugely dependent on a financial system that has increasingly required that they look after their own interests – e.g. self-provision for retirement via compulsory superannuation contributions – irrespective of whether they have the expertise to do so. For those that don't – the vast majority – relying on a financial adviser has become critical. But this has fed the beast of the problem further. Uninformed participants have been herded towards our banks and their financial planning arms, where they were channelled into high-fee, low-performing, and conflicted advice platforms.

This has moral hazard concerns for the Australian taxpayer, where the goal of self-provision in retirement is to help alleviate the ageing population problem we face as a nation.

Fifth, despite all the excellent work that has been done over the past few years in reviewing the state of competition policy frameworks in Australia, our banking industry – like many other industries in the country – operates like an oligopoly.

The banks are extremely powerful in that, by their very nature, they are the "grease" in the engine room of the economy, which has spillover effects across the broader economy. The big four banks account for about 80 per cent of market share. Of the ASX 200 companies they contribute 41 per cent of annual corporate tax revenue, almost twice the size of the second ranked industry (metals and mining). Each of the big four banks look almost like a mirror image of each other.

While there are signs of divestment activity, particularly of the banks' wealth arms, a controversial view is that they are, in reality, conglomerates that need to be broken up. That the banks have been shown – so far – to have behaved in a systematically unethical manner that has brought their conduct into such disrepute needs strong action after this royal commission has concluded.

Lastly, the royal commission into the banks should focus policymakers, industry and the community on the dysfunction in political leadership; characterised by short-termism and rushed political fixes to systemic problems in the banking sector. There is a plethora of evidence of major problems having arisen over the past decade where political leadership has been found wanting.


By Professor David R. Gallagher - is the inaugural Malcolm Broomhead chair in finance at The University of Queensland Business School. The views are his own.

Financial Review

1 October 2018


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