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The continued impressive growth achieved by Prospa post last year’s aborted IPO coinciding with the fall out from the Banking Royal Commission highlights just how important non-bank lenders have become for the future of Australian small businesses.
Prospa is the dominant player in the online small business lending sector and the first to IPO. The reputation of this sector rests heavily on its fortunes. In some circles Prospa has been described as an SME lender of last resort, a modern day equivalent of a finance company that takes on high risks in return for high returns.
Such descriptions do Prospa and its customers a disservice. I see Prospa as a user friendly, small business lender (mainly for sums less than $50,000) that provides quick and easy access to finance to businesses that would otherwise find it difficult or even impossible to get support from traditional lenders. It doesn’t require property as security and is prepared to lend to businesses that have a short trading history as well as those with blemished track records. And for this they charge accordingly.
Since its inception in 2013, Prospa has lent over $1b to more than 19,000 small businesses. It has to be doing a lot of things well to have:
– A Net Promoter Score of 77 which compares with the average for the big four banks of -10.
– Over 3,000 Trust Pilot reviews of which 94 per cent were “excellent”.
– Won dozens of awards including fastest growing, best employer, best leaders and a multitude of industry awards &
– 67 per cent of customers already returning to take out another loan.
All this at an average Annualised Percentage Rate (APR) of 36.5 per cent!
The obvious question which flows from this is “how can this be?”
To answer this question, it is first necessary to really understand what APR means. APR is the interest rate, expressed as an annual rate, applied to the reducing balance of the loan. The following example illustrates how borrowers are easily confused:
Georgia applies for a $100,000 loan to expand her online sales business. She is told her monthly repayments would be $10,000 for 12 months based on an interest rate of 20%. This means the total repayment amount would be $120,000 being the sum of the principal of $100,000 plus the interest component of $20,000. She figures she can afford this monthly repayment and that an interest rate of 20 per cent seems not too bad for an unsecured loan so she goes ahead.
What Georgia has overlooked is that a significant part of each $10,000 monthly repayment goes to reducing the principal but each month she still pays interest on the full $100,000 notwithstanding the amount she owes reduces with every payment she makes.
So the rate Georgia pays on the actual amount she owes over the year works out to be 37 per cent per annum. This is the APR.
Returning to the question of “how is it that Prospa is doing so much business when its average APR is 36.5 per cent?” In simple terms, it is doing an outstanding job in delivering on its Value Proposition which is centred on providing:
– Access to finance to small businesses which struggle to get funding from traditional sources
– A seamless process with personalised customer support &
– Speedy decisions, usually within the same day, and access to funds very shortly thereafter.
Many borrowers are just so relieved and pleased to get the money quickly and with the minimum of fuss they don’t bother to look further into what the loan is really costing them. They know what their periodic payment is and that’s the main thing. Besides, they don’t have the time to make their own assessment, they don’t understand how interest rates really work, they are reluctant to seek advice for reasons of cost and also they don’t want to appear to not know what they’re talking about.
It is not surprising that a large number people don’t get APRs. I confess when I first started following online lending some four years ago I made the same mistake and to this day I still receive messages saying my maths is wrong. But its not just the less sophisticated small business owners who are misguided, many accountants, advisors and journalists continue to do the same which only perpetuates the confusion about the real cost of money.
The need for a unified industry approach to quoting of online small business loans was one of the motivators that in 2016 caused me to reach out to some of the major players as well as Kate Carnell, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO). After many months of consultation and collaboration with various parties including the industry association AFIA, the AFIA Online Small Business Lenders Code of Lending Practice (the Code) was developed and in January this year seven lenders Capify, Get Capital, Lumi, Moula, OnDeck, Prospa & Spotcap were admitted as founding members of the Code.
Members committed to eight promises to customers, one of which is:
“We will provide clear and accessible information about our Loan Products, so you can
make an informed decision about whether to enter into a Loan Product with us. We will
disclose interest rates, and fees and charges, in an accessible and clear format. Our
advertising and promotional material will not be misleading or deceptive, or be likely to
mislead or deceive.”
Central to delivering on this promise is the SmartBox report, a standard pricing comparison tool which sets out key information including the Loan Amount, the Disbursement Amount, the Total Repayment Amount, the Average Repayment Amount, the Term, the Total Cost of Credit, and the Annual Percentage Rate. The SmartBox report is a key component of the formal offer documentation and all Code members comply with the Code’s SmartBox requirements.
Some lenders could be more transparent by disclosing APRs at the enquiry stage via website loan calculators and examples. For instance, when a potential borrower looks at the Prospa website they will find an example of a loan as follows:
“Rates for small business loans range from 9.9% to 26.5% p.a. simple interest rate. For example, a $10,300 12 month loan (comprising a $10,000 disbursement and $300 origination fee) with a simple interest rate of 9.9% p.a. would have total repayment amount of $11,320.”
This represents an APR of 25 per cent but there is no mention of this. Of course, in the event the borrower was successful with a formal application, the APR would be prominently disclosed but all this detail is only comes after the completion of the loan application process and the making of a formal offer.
Unfortunately precise SmartBox results cannot be provided at the enquiry stage as the lender has yet to do its credit assessment but in their advertising and promotional material including website loan calculators and loan examples, lenders should ensure that APRs are quoted. It could be argued that failure to do so could be seen as being likely to mislead or deceive.
As an aside, what most don’t know is that the more they shop around, the less likely it is they will be able to get a loan and if they do it will cost more. The reason for this is that the algorithms used in assessing loans penalise applicants for the number of times they apply for credit.
I actually think Prospa can use APR as a means to complement and validate its value proposition. In the space of 3 years, its average APR has fallen from 59 per cent to the current 36.5 per cent and with expected lower funding costs arising from improved performance, government initiatives like the Australian Business Securitisation Fund as well as the savings that scale brings, their average APR should continue to decline.
And if the borrower cannot get quick and unsecured money from anywhere else, who is to say 36.5 per cent is expensive? Expensive compared with what? For potential borrowers who might think an APR of 36.5 per cent is excessive, this creates the opportunity to initiate a conversation about how, even at this rate, the loan still represents good value. A further benefit is that it might encourage business owners to think more carefully about whether they are able to generate an acceptable return on the funds borrowed at such rates.
ARE UNFAIR CONTRACT TERMS LAW (UCT) STILL AN ISSUE WITH NON-BANK LENDERS?
Just after Prospa’s aborted IPO I wrote a newsletter Prospa, ASIC & the conundrum of Unfair Contract Terms law which identified several areas in which Prospa’s standard form contracts could potentially be in breach of UCT. Since that time a great deal of work has been undertaken by the seven lenders each of the Code members including obtaining independent legal advice confirming compliance. This culminated in the Code Compliance Committee (CCC) confirming that the standard form contracts used by these lenders are compliant with UCT. On this basis, any business which borrows from a Code member is entitled to assume that lender is UCT compliant.
However, the same independent assurance cannot be given in relation to the standard form contracts used by other non-bank SME lenders and this should be of concern to all stakeholders.
WHERE TO FROM HERE FOR PROSPA?
Whether the IPO valuation of Prospa at $610m is reasonable is for the markets to judge. The prospectus tells a good story of past performance and future prospects. It has a happy, growing and loyal customer base, it is extending its product offerings and expanding into New Zealand. It has a majority independent board and a stable and committed management team.
Prospa’s future value will depend not just on financial performance but also on its conduct. And the standing of other online SME lenders and indeed all non-bank SME lenders will be influenced by its performance and conduct. So for the sake of SMEs hopefully Prospa continues to deliver on its value proposition whilst leading the way in being fully transparent with customers.
The big unknown is how it and other relatively new non-bank SME lenders will fare in the event of a sudden or sustained downturn in economic conditions.
WHERE TO FROM HERE FOR THE NON-BANK SME LENDING SECTOR?
Post the Banking Royal Commission the small business lending market has been ripe for the pickings by non-bank lenders, not just the online lenders. But there are literally dozens of lenders in this largely un-regulated market and not all of them will survive. There is a risk that some will cut corners in order to remain afloat or get ahead.
Industry self-regulation is key to minimising reputational damage that could restrict much needed access to funding for SMEs. The seven members of the AFIA Code deserve credit for developing and implementing their own code. They are role models for the entire non-bank SME lending sector. At the same time, it should also be noted that signing a code is really only one step in the continuous journey of self-regulation.
The CCC must hold members to account and also be transparent in its reporting. Customers need to be aware that they are able to lodge a complaint with the CCC in addition to their right to take a grievance to the lender’s internal dispute resolution department as well as the new Australian Financial Complaints Authority (AFCA).
Other non-bank small business lenders should follow the lead of the Code members in self-regulation. Organisations like AFIA and ASBFEO will support lenders that want to self-regulate. This is a preferred option to the regulators coming in over the top and unilaterally telling them what has to be done.
As the non-bank SME lending sector moves beyond the challenge of increasing awareness to the next challenge of increasing understanding of their offerings, the role of advisors, industry associations, media, bureaucrats and regulators in educating small business owners becomes even more critical.
Introducers must be able to demonstrate that they have acted in the best interests of their SME clients. One outcome from the Banking Royal Commission is that mortgage brokers will be legally obliged to act in the best interests of their clients. Is there any reason why this shouldn’t apply to finance brokers and any other parties who introduce a small business owner to a lender? This would certainly encourage introducers to ensure they have a good understanding of all the available options.
Prospa’s impressive growth story is proof that Australia’s small businesses want and need the funding support non-bank lenders offer. Lenders, advisors, industry associations, media, bureaucrats and regulators all have a role to play making this happen in a fair and transparent manner. At the same time, small business owners cannot simply rely on everyone else to look after their interests, they must prioritise the need to educate themselves. There are many resources available to help them proactively deal with the challenges of financing their business.
theBankDoctor will continue working with all stakeholders to improve access to fair, competitive and transparent funding for small business owners.
In the two weeks since the release of the final report into Misconduct in the Banking, Superannuation & Financial Services Industry, rather bizarrely the most contentious recommendation deals not with bank misconduct but mortgage broker remuneration.
This was primarily a Royal Commission into misconduct by the big four banks and they were lambasted by Kenneth Hayne for the pursuit of short term profit at the expense of basic standards of honesty. Yet despite all the horror stories, Hayne basically concluded that existing laws and regulations are generally adequate to protect borrowers it’s just that the banks have not always obeyed them and the regulators have not done a good enough job in enforcing them.
Meanwhile, Hayne pilloried mortgage brokers for having a conflict of interest because they act for the borrower but get paid by the lender. But unlike the banks, Hayne found little, if any, evidence of systemic misconduct yet his recommendation to replace commissions with a user pays fee for service has significant implications for borrowers, brokers, banks and the broader economy.
The banks had to be brought kicking and screaming to the Royal Commission, although they would say it was their recommendation to the then Treasurer Scott Morrison that led to its establishment in December 2017. Up until then, they stuck to the “it’s just a few bad apples” defence that the Government willingly bought.
Meanwhile mortgage brokers have been proactive in industry self-regulation. Following on from the April 2017 Sedgwick Report, bank and non-bank lenders, aggregators and brokers and consumer groups established the Combined Industry Forum (CIF) to drive better customer outcomes through improved governance and remuneration practices. Whilst the CIF was on this journey, the Productivity Commission and ASIC were conducting their own reviews and tellingly neither called for the scrapping of broker commissions.
Other recommendations re mortgage brokers:
In addition to the recommendation relating to brokerage remuneration, Hayne made two further recommendations:
1. A duty to always act in the best interests of customers. This is a lift in brokers current obligation which is simply to procure a loan which is “not unsuitable”. This change ought to ensure their primary focus is the borrower. No-one should have any issue with this.
The best interests test should be given the opportunity to flush out and punish poor broker conduct before any decision is made on removing lender paid commissions. This is no different to the approach Hayne is taking with the banks i.e. “just obey the law and everything will be all right but if you don’t, this time the regulators will come down hard on you.”
2. Brokers would be subject to stricter future of financial advice (FoFA) laws like those that apply to financial planners. This means brokers will have to render a comprehensive statement of advice every time they suggest a loan and could be sued if the product was inappropriate for the customer in question.
This will add to the compliance burden that someone (the borrower) will have to pay for. Arguably this extra step is unnecessary in light of the new best interests test.
Will this be the end for mortgage brokers?
It is understandable why the recommendation to remove commissions is an emotive issue for mortgage brokers. If implemented as currently proposed, it would fundamentally impact the viability and value of their businesses and put at risk jobs in a sector that employs 50,000 people. Brokers have a strong case and are prosecuting it vigorously. A grass roots industry petition has already gathered 77,000 signatories objecting to the recommendation.
Supporters of Hayne’s recommendation argue that this will not herald the demise of brokers but rather it will lead to an overdue consolidation. Going back to its origins some thirty years ago, mortgage broking was quite a lucrative profession. A booming demand for home loans, significant increases in property values combined with banks losing sight of their customers lead to the current position where 59 per cent of all home loans are written through the broker channel.
In recent times, banks have tightened up on broker remuneration and this, combined with more brokers competing for less business when the demand for, and prices of, housing are falling, has impacted on the profitability of brokers who on average now earn $85,000 pa.
A recent survey showed that over 95 per cent of borrowers would not be prepared to pay for a broker. But really, what other response could be expected? No one is keen to pay for something that is currently free but there are no free lunches and borrowers invariably pay one way or another.
In my experience, brokers almost always deliver better outcomes than the borrower on their own would be capable of achieving. Measures like customer satisfaction rates, net promoter scores and repeat business all suggest brokers are highly valued, certainly more so than bankers. Brokers know the value of what they do for their customers although to date it has not been imperative that they be able to demonstrate this. Regardless of whether we move to a user pays system, brokers need to ensure they are able to clearly convey their value proposition to existing and potential customers.
Brokers who are not convinced their value proposition is sufficiently compelling to retain existing customers and win new ones may well exit the industry. This would not a bad outcome – brokers are not immune the challenges and opportunities change can bring such as open banking.
While some may exit the industry, the bottom line is brokers provide a much needed and valued service. And borrowers who currently say “we wouldn’t pay a fee to a broker for arranging a loan” are likely to change their minds after they try to arrange a loan themselves.
So even if brokers were to be paid by borrowers and not lenders, to the extent they are able to demonstrate value for money, their customers, sooner or later, will come to accept this as part of the cost of getting the loan. However in the meantime there would be substantial disruption.
Laughing all the way to the big banks.
The big banks will clearly be the winners in the event of the demise of mortgage brokers. Competition will be reduced and bank profits will rise with analysts recently estimating the major banks alone could save $1.68 billion a year if commissions were axed. Of course, the banks could pass these savings onto customers in the form of lower rates but would they?
CBA is by far the nation’s biggest home loan lender and so has the most to gain from the demise of mortgage brokers. Its CEO Matt Comyn was advocating the move to a borrower pays system even before Hayne recommended it.
Meanwhile, Aussie Home Loans which is owned by CBA has also argued a smaller broking industry would limit consumer choice and access to credit. This shows that CBA believes it has more to gain by the demise of brokers than it has to lose in the value of its investment in Aussie Home Loans.
Smaller banks will be disadvantaged because they simply don’t have the branch network.
But borrowers would be worse off.
It wont just be harder to get a home loan from a bank, it will also take longer. If all or even some of the home loans currently written through broker channels went straight to the banks, they couldn’t cope. They don’t have the people, branches have been shut and although it works for some, online applications invariably necessitate human involvement. This will be a challenge for those customers whose financial literacy and computer skills are not strong.
With implications for the economy.
The recommendation could contribute to a downturn in the economy. To the extent that borrowers find it increasingly difficult to obtain finance, this will put further pressure the construction industry with associated flow on effects and it will put downward pressure on house prices.
Household debt doesn’t decrease in value but house prices can.
The latest research from Martin North at DFA Analytics reveals that over one million households representing 31 per cent of owner occupied borrowing households are under mortgage stress ie when net income (cash flow) does not cover ongoing costs. Meanwhile, there are in excess of 600,000 home loan borrowers on interest only loans, many of whom will struggle if/when those loans are rolled into principal and interest.
It could get even worse under a Shorten Government.
Labour, which appears to be as close to a “shoe-in” as you could ever get in federal politics, has said it will implement all of the RC’s recommendations. It’s ironic that Labour which is philosophically opposed to the big banks, is actually supporting measures that would only increase their powers and profits. Assuming Labour wins the election and proceeds with their commitment to adopt all of the RC’s recommendations this, on top of their policies on negative gearing and capital gains tax, poses a material threat to Australia’s economy.
WHERE TO FROM HERE?
The risks associated with replacement of commissions paid by lenders with a user pays system outweigh the benefits that might arise from removing the issue of conflicted remuneration.
Introduction of the best interests test together with the establishment of AFCA, the new national body that deals with consumer complaints, will better protect the interests of borrowers. Meanwhile, the momentum for self-regulation is being maintained by the Combined Industry Forum which provides updates on progress in achieving agreed reforms to Government, Treasury and ASIC on a semi-annual basis.
The recommendation to fundamentally change mortgage broker remuneration is more likely to hinder than help customers. It is economically risky and potentially unnecessary. The best interests test combined with self-regulation initiatives should be given the opportunity to work before steps are taken to overhaul the way brokers are remunerated.
The extensive media coverage of the Royal Commission’s findings contain very few references to the SME sector. This is possibly because the report contains only six recommendations, four of which relate solely to the farming sector.
We briefly discuss these recommendations then explain why for the foreseeable future SMEs can expect continued pain before exploring what needs to happen to achieve the longer term gains the RC offers.
The recommendations relating to SMEs.
The first recommendation is a non-recommendation i.e. the National Consumer Credit Protection Act (NCCP) should not be amended to extend its operation to lending to small businesses.
I believe small business borrowers should be afforded the same level of protection as consumers who borrow. It is illogical to assume that anyone who operates a business is somehow automatically more financially literate than a consumer who chooses to earn income by being an employee.
The second recommendation is that the Australian Bankers Association (ABA) should amend the definition of “small business” in the Banking Code of Practice so that the Code applies to any business or group employing fewer than 100 full-time equivalent employees, where the applied for is less than $5 million.
It would certainly be helpful if all stakeholders agreed on what constitutes a small business but this is hardly an issue that is going to make life any easier.
The remaining four recommendations relate solely to the farm sector:
1. A national scheme of farm debt mediation should be enacted.
2. Inject greater independence into the valuation of agricultural properties.
3. Prohibition of charging default interest rates on loans secured by agricultural land in an area declared to be affected by drought or other natural disaster.
4. Improved processes when dealing with distressed agricultural loans.
No-one would dispute the need for the farm sector to be dealt with more fairly by banks, but why stop at farm businesses? For instance, why should distressed non-farm small business borrowers not be able to benefit from “greater independence into the valuation of properties” and “improved processes”?
Commissioner Hayne’s approach is best summarised by his statement that “With some exceptions, I generally do not favour altering the rules that govern lending to SMEs” adding that “the chief protection for small business borrowers has for some time been, and remains, the Banking Code.” If banks breach the Code this could constitute a breach of the law.
Where does this leave SMEs?
All parties have been concerned that the RC could lead to a credit crunch but the fact is that since the RC hearings began just over nine months ago, it has already become harder for SMEs to access credit from banks and it is taking longer to get decisions.
It has become particularly difficult for those SMEs who pledge residential property as security for their business loans because banks now delve into personal financial spending patterns as as well as assessing the capacity of the business to services and repay debt.
For the short team at least, whilst the banks are adjusting to life after the RC, SMEs are not going to find it any easier to access bank credit nor will decision making times improve.
Do the banks want to lend or not?
The banks say they are open for business and the reason why lending is flat is that businesses just aren’t applying to borrow. Both these statements are true but it’s important to delve into why this is the case.
Banking is a high fixed cost business and making loans is central to bank profitability. Banks have to lend to be profitable, they can’t shrink to greatness so they must remain open for business.
So if the banks do want to lend, why is demand for bank credit flat?
Rather than there being an absence of demand for bank credit, an alternative proposition is that some SMEs are no longer bothering to approach banks. This could be due to the belief that the process is too onerous and elongated. These businesses often use trade creditors and the ATO to fund their working capital needs or alternatively turn to family and friends. Others are prepared to pay more to borrow from alternative lenders because they are easier and quicker to deal with.
According to a recent survey commissioned by SME challenger bank Judo Capital and conducted by East & Partners, the unmet demand for SME credit is estimated to be in excess of $80b. This provides the incentive for the establishment and growth of a myriad of non-bank lenders who aim to fill this lending gap.
The challenge for non-bank SME lenders.
The non-bank SME lending sector has the opportunity to learn from the mistakes of the big banks. This sector is highly fragmented and less regulated than the big banks. To date, it has not been exposed to the same level of scrutiny but this is changing and rightly so because not all these lenders are “squeaky clean.”
Industry self-regulation and engagement with regulators, SME associations and other stakeholders is a preferable approach to what we have seen over the years from the banks and the ABA. In this respect, the proactive efforts of a number of fintech balance sheet lenders to develop their own Code of Lending Practice is to be applauded. Hopefully, under the auspices of Australian Financial Industry Association, this industry self-regulation can be expanded to include other non-bank SME lenders.
Will more regulation and enforcement help SMEs?
Commissioner Hayne found the problem was not the laws but that the laws had neither been obeyed by the banks nor adequately enforced by the regulators.
The banks don’t want more regulation and maintain that the revised Banking Code of Practice, which was signed off by ASIC last year and will come into effect in July this year, will provide adequate protection for bank customers. In my view the new code still does not go far enough but the bigger issue is “will they actually comply with it?”
In a newsletter published in March 2018 “Will the new Banking Code of Practice make any difference to SMEs?” I concluded that the code will make a difference if:
1. Banks abide by it.
2. Regulators enforce it and
3. Customers are prepared to hold the banks to account for breaches.
Left to their own devices the banks have placed the interests of their executives and shareholders ahead of their customers. Whilst they say this will change and customers will now come first, can they be relied upon to mend their ways?
The survival imperative alone should be sufficient incentive for the banks to change. If they fail to heed the lessons from the RC they could render themselves irrelevant within ten years. Compliance and enforcement costs will continue to erode profits in what is already a challenging market for the banks. In the past year, $75b has been wiped off the combined market values of the big four banks representing an average share price fall of 17 per cent.
And from now onwards, there will no more arrangements with the regulators culminating in enforceable undertakings, which are a “corporate slap on the wrist”.
So there should be no shortage of motivation for the banks to lift their game and comply with the Code and there will be no shortage of incentive for the beefed up regulators to do their jobs.
The importance of customers holding banks to account.
The RC has shown that the banks failed in their duty of care to customers. We can now expect the regulators to make a better fist of holding the banks to account but bank customers need to do the same. One of the many positives from the RC is that customers can see that they are no longer powerless against the big four bank homogenous oligopoly. To date, aggrieved customers have been reluctant to hold banks to account because of the view that making a complaint is time consuming and besides “nothing is going to change anyway” but now they have recourse via the new Australian Financial Complaints Authority (AFCA) which has the ability to award SMEs damages of up to $1m for bank misconduct.
It is going to be really important that aggrieved customers take advantage of all the avenues of redress available including internal bank dispute resolution options and AFCA.
COMPETITION & EDUCATION.
Regulation and enforcement are not enough on their own to improve SME access to finance and to protect them from bank misconduct. The two other critical components are:
1. Encouraging competition.
Government has finally got the message that the best way to enhance competition is not to try to force the big four banks to change but rather to encourage the establishment and growth of new entrants such as fintechs, challenger banks and neo banks and then allowing market forces to do the rest.
Recent government initiatives that will inject more competition into the SME lending market include:
The $2b Government Securitisation Fund.
Open banking reforms.
Comprehensive Credit Reporting.
The Australian Business Growth Fund.
Technology and innovation are rapidly changing the way SMEs access debt finance. It is an enormous challenge for time poor and often financially unsophisticated SMEs to keep abreast of all the developments in this area. Trusted advisors including accountants, finance brokers and lawyers owe it to their clients to understand what is happening in the ever changing SME finance market place.
Recently, in conjunction with the Australian Small Business & family Enterprise Ombudsman (ASBFEO), we published a guide “Borrowing from fintech lenders” and the ASBFEO will also shortly release a guide to financial products available and what stage of the business cycle each product is designed to fit.
A final comment on Brokers.
The shift to a borrower pays system has huge implications for a sector which is already in turmoil. Without getting into the merits of either side, banks and borrowers need each other and most critically SMEs need brokers because the banks are just not equiped to provide the service that SMEs want and need but to date have not had to pay for.
The nation owes Commissioner Hayne and his team a debt of gratitude for providing the blueprint that gives the banks the opportunity to begin the long task of restoring lost trust. Tellingly, he identified six norms of conduct being:
1. Obey the law.
2. Do not mislead or deceive.
3. Act fairly.
4. Provide services that are fit for purpose.
5. Deliver services with reasonable care and skill and
6. When acting for another, act in the best interests of that other.
If all bank employees, be they a director, CEO or a teller, live by these norms then we will get the banking system we need and deserve.
This fourth and final article reviews the tumultuous last six months and looks to the future as we await Commissioner Hayne’s final report. But first a quick re-cap.
When the hearings began, most of us had little idea of lay ahead. Not so for Commissioner Kenneth Hayne and his team, lead by loyal lieutenants Rowena Orr and Matthew Hodge. They knew exactly what they wanted to achieve and the inquiry was planned to perfection.
Instead of working out what evidence they might need and then subpoenaing it, they simply told the banks “Come clean and give us everything you have on any conduct that may have fallen below “Community standards and expectations.” This elicited tens of thousands of documents in which they found all the incriminating evidence needed to formulate and prosecute their strategy.
The hearings progressed through seven stages – Consumer Lending, Financial Advice, SMEs, Regional & Remote Access, Superannuation, Insurance culminating in the the final stage which delved into the causes of the conduct uncovered in earlier hearings.
Webcast viewing was compulsive, much like a reality TV show, except with this show there was never any doubt who would win. The inquiry opened strongly as we heard heartbreaking and mind boggling stories of just how badly some customers had been treated and banks had behaved. A number of bank witnesses were put up by their bosses likes lambs to the slaughter, powerless against the meticulously prepared and executed probing by counsel assisting.
But it was not until the last round of hearings, when bank CEOs and Chairmen took the stand, that we finally were able to understand what happened and why. In simple terms bank executives, to varying degrees, lost the plot and neither their boards nor the regulators put a halt to it.
I will not endeavour to preempt the recommendations, all will be revealed soon enough. The report must be submitted to the Governor General by February 1st 2019 and the government will then review it before deciding when it will be released.
What is most significant about the timing is that by February we will, officially or unofficially, be in election mode. Whilst it is never over until it is over, the Coalition appears to be heading for one of the biggest defeats in Australia’s political history. The ALP has no shortage of issues to campaign on but high on the list will be the Coalition’s massive political blunder in stubbornly resisting the establishment of a RC.
ALP adverts featuring then Treasurer Morrison saying that the call for a RC “is nothing but a populist whinge from Bill Shorten that could undermine the banking and financial industry’s confidence” are no doubt already in the can.
On the reasonable assumption there will be a change of government, life will get even tougher for the banks. A Shorten Government will not have the same cosy relationship as Coalition governments have had. Nothing like a “Hey ScoMo, thanks for your support mate but this isn’t going to go away so we reckon you may as well just call a Royal Commission now.”
The ALP is ideologically opposed to big banks and as they are likely to have at least two terms in office, the banks should prepare for a long and testy relationship. Here are some of the likely banking initiatives on a Shorten government agenda:
– The possible extension or renewal of the RC.
– Review of the Government guarantee on deposits.
– Increased funding for regulators with a demand for greater accountability.
– Mechanisms (an independent board?) to regularly monitor banks’ progress in implementing APRA and RC recommendations.
– More incentives and encouragement for new competitors as a means of reducing the power of the big banks.
– And they will want to see “heads roll”.
In the most improbable event the Coalition is returned, they would be politically obliged to adopt a similar approach anyway.
So whilst Commissioner Hayne and his team are busy writing up their final report, what are the other stakeholders likely to be up to?
What about the banks?
The banks will appreciate a reprieve from the intense media attention but with the AGM season starting next week this will be short lived. On December 12th Westpac holds its AGM in Perth whilst ANZ and NAB will face their shareholders on 19th December in Perth and Melbourne respectively.
No doubt they are all working furiously on their presentations. One concern will be if shareholders use the AGMs and in particular their voting rights on remuneration reports as a means of expressing their displeasure.
At the same time, directors and executives are engaging in serious collective and individual self-reflection hopefully addressing basic questions like:
– What share of the responsibility do I need to take?
– What personal learnings have I gained from this experience?
– Do I have the professional and technical skills to do the job that is now required?
– Am I up for the challenge i.e. do I have the “fire in the belly?”
– Perhaps the most difficult challenge for the remuneration committees of bank boards is “where will we find the right new people prepared to take on these roles?”
Will they change?
The big question is “will the banks change?” There have been many mea culpas and some contrite acknowledgments at and outside the confines of the RC. CBA and NAB have promised to implement a series of recommendations and actions arising from APRA’s Prudential Inquiry but so far we have seen and heard more defences than substantive changes.
Behaviourists tell us that past behaviour is the best predictor of future behaviour and on this basis it is difficult to be optimistic about the capacity and resolve for change by existing bank boards and CEOs.
The number of times at the RC that bank chairmen and CEOs blamed others was cringeworthy. Yet to date, there have been no high profile casualties aside from AMP’s Chairman Catherine Brenner and CEO Craig Meller and NAB’s wealth management boss, Andrew Hagger. Perhaps the banks are waiting for their AGMs to announce outcomes of any board and management renewal programs. This will be a litmus test.
Bank leaders have talked about the pressure from shareholders and analysts to produce short term results. The ACCC Chairman Rod Sims rightly dismissed this as a cop out. And Ken Henry’s long-winded dissertation about the state of capitalism and the need to consider modifying the law so that director’s responsibilities to customers and other stakeholders were clarified was a lame attempt to divert attention from his board’s failings.
The “it was just a few bad apples” defence seems now to have been permanently discarded with the reluctant acknowledgement that the problems have not been caused by isolated instances but cultural and systemic failures.
Another defence is the “Risk of a recession argument” that says the RC could lead to a recession because it could make it harder for banks to operate. This is a definitely a risk although it should not be allowed to be used as an excuse for inaction. Commissioner Hayne and the government appear to be mindful of the balancing act that needs to be played.
My view is the risk of a recession induced by a tightening of bank credit is less of a concern than the risk of the collapse of the Australian banking system which, in time, may well have happened had this RC not been called.
Imagine the predicament a government, particularly an ALP government, would face if it was confronted with the decision as to whether to bail out one or more of the big banks because a crisis had caused a run on deposits or the withdrawal of wholesale funding?
This explains why, to paraphrase former PM Paul Keating,“this is the Royal Commission we had to have.”
What about the regulators?
The rightly chastised regulators will be less conciliatory and more litigious. Under a Shorten government, regulators will be better resourced but more accountable. Poor bank conduct will be met with heavier fines and consequences. This more formal approach will also be slow, expensive and public.
The regulators also should engage in self-reflection on their own roles and capacity to change. And those who appoint the regulators, like those who appoint bank boards and CEOs, need to ask the question “are the people who got us to where we are today, the best to take us forward?”
What about institutional bank shareholders?
For years, superannuation funds and managed investment funds have backed the big banks. We heard very few public adverse comments as the RC’s revelations unfolded.
Interestingly, at CBA’s AGM last month, institutional support saw approval of the remuneration report at a whopping 92.5 per cent. One institutional shareholder voted for the report because, “We believe the remuneration committee has responded well to shareholder concerns and the board has demonstrated that it will use its discretion where necessary.” Readers can draw their own conclusion.
These days there are a number of “ethical” funds which will not invest in companies, for instance, that mine coal. How many of these funds have said or now might say “we will not invest our clients’ funds in big banks?”
The big banks need brokers and brokers need the big banks. The issues of flat versus variable commissions and fees for service are complicated but a way needs to be found to enable banks and brokers to work together to ensure customers’ interests are protected and optimised. A starting point would be the codification of the duty of the broker to act in the best interest of the customer.
LESSONS FOR BANKS & ALL BUSINESSES
Australia owes a huge debt of gratitude to Commissioner Hayne and his team. Without this inquiry we can only guess what the end result might have been.
So here are five clear and simple lessons that the banks and all businesses can learn from this experience.
1. Put customers first.
In 2015 Ken Henry said, “A bank that truly puts the customer at the centre of everything it does should not need regulation.” The average Net Promoter Score of the big four banks of -10 confirms that the banks are failing miserably on this measure. At least the banks have now acknowledged they have lost sight of the customer. A problem cannot be fixed until first it is acknowledged.
2. Leaders need to lead.
Shareholders, customers and staff want leaders who are trustworthy, ethical, authentic, courageous, loyal, visionary and accountable. They will support those who exhibit these attributes and they will disengage with those who don’t.
3. Good times don’t last forever.
ANZ’s Shayne Elliott made a valid point when he talked about what it means not to have had a recession in nearly three decades. This has contributed to our leaders displaying traits including complacency, over confidence, arrogance and, at the extreme, hubris. Based largely on escalating house prices, we supposedly now have the highest net wealth per capita in the world. Warren Buffett once said, “You only find out who is swimming naked when the tide goes out.” Don’t get caught naked, be prepared.
4. It shouldn’t be all about the pay.
For years, bankers have been living in “La la land” when it comes to pay. I wrote about this two years ago “Bank execs should take a pay cut.” ”
Banking was not always a highly paid profession but bankers did feel privileged to serve and the reward for this came from knowing they were valued, respected and trusted by their customers and communities. There is still much to be said for these “traditional values.”
5. Diversity is good for business.
The big banks have been slow to move on diversity and their failure to fully embrace all its aspects in this rapidly changing environment has been a contributing factor to losing touch as well as opportunities.
2018 has been an “annus horribilus” for the big banks. 2019 is shaping up as being at least as challenging. The RC has identified the problems and their causes and we will soon learn of its recommendations to fix them. We all hope this will give the banks, the incoming government and its agencies a clear blueprint to enable them to begin the long task of restoring lost trust in the banks.
To finish, my four word summary from the RC is simply this…. “Just do what’s right.
Part III in this four part series the “Wash up from the Royal Commission” looks at how the CBA, ANZ, Westpac and Macquarie fared at the RC and identifies five lessons which the big four banks can learn from Macquarie.
In October 2017, two months before the Royal Commission was announced, APRA commissioned an independent inquiry into governance, culture and accountability at CBA. This followed a number of incidents that damaged its reputation and public standing including the AUSTRAC anti-money laundering proceedings.
The overarching conclusion in the APRA report was that “CBA’s continued financial success dulled the senses of the institution”, particularly in relation to the management of non-financial risks. It also identified a number of cultural themes such as a widespread sense of complacency, a reactive stance in dealing with risks, being insular and not learning from experiences and mistakes, and an overly collegial and collaborative working environment which lessened the opportunity for constructive criticism, timely decision-making and a focus on outcomes.
In May this year CBA said it would accept and implement all 35 of the report’s recommendations.
At the RC, CBA was represented by its Chairman Catherine Livingstone and CEO Matt Comyn. Ms Livingstone was appointed to the board in March 2016 and has been chairman since the beginning of 2017 and Mr Comyn was appointed in April this year.
Being new in a role avoids or at least minimises liability for past bank misconduct and makes it easier to apportion responsibility to predecessors. Mr Comyn praised Ms Livingstone whilst taking a shot at her predecessor David Turner. “Without wanting to cast aspersions on any former directors, I think the chairman is very different,” he said.
He told the RC that CBA has not had the right leaders in the past and his response to the question “Does CBA have the right leaders now?” was an equivocal, “We will see.”
Mr Comyn explained how he took the high moral ground in wanting to stop the sale of insurance policies that were of little or no value to customers only to be told by his boss at the time Mr Narev, to “temper your sense of justice.” Mr Comyn declined to go above Mr Narev’s head to the board believing it would have deferred to Mr Narev’s judgment.
Mr Comyn’s soft choice is a prime example of what APRA meant with the report recommendation “An injection into CBA’s DNA of the “should we” question in relation to all dealings with and decisions on customers.”
Ms Livingstone, who served under Mr Turner, threw her predecessor and fellow board members under the bus when she told the RC, “The previous board was too trusting of management and too willing to hand out bonuses despite scandals.”
Neither Ms Livingstone nor Mr Comyn enhanced their reputations at the RC. The “new kid on the block” defence can only hold for so long. The APRA recommendations provide the framework for what now needs to be done. Mr Comyn’s leadership team under the watchful eye of Ms Livingstone’s board, is now solely responsible and accountable for implementing the plan to redeem CBA’s reputation.
Shayne Elliott, who was appointed CEO nearly two years ago, was the least unimpressive of the big four CEO witnesses. He was relatively considered, measured and contrite. For instance, he offered a credible case for retaining some financial incentives for frontline sales staff.
He told the RC how he and his leadership team proactively reduced executive variable remuneration by around 22 per cent. For Mr Elliott what this meant in $ terms is that this year he received $5.25m which was a reduction of $950k from last year. Whilst ANZ executives might regard this as an important acknowledgement of their collective responsibility for poor outcomes, others would see it as confirmation that they are out of touch.
The fixed remuneration of Chairman, David Gonski and his board has been cut by 20 per cent. Mr Gonski was appointed to the board in February 2014 and assumed the chair three months later. Unlike his counterparts at CBA and NAB, he was not required to appear before the RC.
ANZ did not attract the attention of the RC to the extent CBA and NAB did but we still heard of a number of cases where ANZ’s conduct fell below “Community standards and expectations.” One example is the “Fees for no service” scandal which ANZ estimates could cost shareholders $421m.
A recent ASIC report dealing with how banks repay customers for misconduct such as poor financial advice or administrative errors named ANZ as the slowest bank taking an average of four years to identify a breach and an average of a further 213 days to report it to ASIC. ANZ has missed multiple deadlines for compensating thousands of customers who were wrongly charged fees. Mr Elliott blamed this on “technology.”
NAB and CBA were the main focus of the RC’s attention so maybe it had formed the view that any deep dive into Westpac would not elicit any conduct falling below community standards and expectations that had not already been identified at CBA and NAB?
But for Mr Gonski’s board and Mr Elliott’s leadership team it is more a matter of “There by the grace of God go I.”
Over at Westpac, things appear to be relatively benign – if you believe their leaders. At the RC, CEO Brian Hartzer claimed Westpac hasn’t had the large and significant issues that CBA has had. ‘We haven’t had that, we have issues and we’re dealing with them,” he said.
The Chairman, Lindsay Maxsted, has been around a long time having been appointed to the board in 2008 and assuming the chair in 2011. One is entitled to expect that he would have a pretty good handle on what was going on. Back in May 2016 he told AFR’s Joanne Gray, “There’s no culture problems in banks.” Instead, he backed the “Few bad apples” theory.
In light of these statements, it was surprising Mr Maxsted was spared the scrutiny of Commissioner Hayne’s counsel assisting.
Notwithstanding this, Westpac has a history of litigation against ASIC and back in 2015 ASIC declared that of the big four banks Westpac “appears most resistant to ASIC and the laws we administer.”
The previous comment about Westpac escaping the level of scrutiny applied to CBA and NAB holds for ANZ So too does the “There by the grace of God go I” conclusion.
As an aside, last week Gail Kelly, Westpac’s CEO from 2008 to 2015 expressed the view, “I wish I’d done more personally to identify some elements of poor practice,” she said. Ms Kelly’s involvement brings attention to the issue of clawback of long term incentives for senior leaders. Ms Kelly amassed 1.8m shares as part of Westpac’s executive bonus scheme. When she left, these shares were worth more than $60m. That is a lot of money in anyone’s language. Since then the share price has fallen by 30 per cent. Ms Kelly has lost $18m but shareholders have lost a lot more.
In his brief appearance, CEO Nicholas Moore provided some of the most insightful and significant evidence in the entire proceedings. He revealed how Macquarie Bank addressed the same kind of challenges as faced by the big four but in a very different way and with very different outcomes.
In 2012, ASIC identified some misconduct and cultural problems within Macquarie’s private wealth division. An internal investigation was immediately commenced and as a result a number of people were fired including senior executives advisers, managers and people in the compliance function. Reporting was beefed up, new systems, processes and procedures were introduced and clients who had suffered were promptly compensated.
Unlike the big four banks, when Macquarie became aware that customers had been disadvantaged they fessed up, corrected the problem and paid compensation.
Macquarie is not part of the big bank homogeneous oligopoly. Three particular matters attracted my attention:
CEO Nicholas Moore is about to retire after ten years as CEO. During this period, no big four CEO has survived more than five years. Why is this so? I would say simply because he has delivered for his shareholders and customers.
Secondly, Macquarie has a planned succession for Mr Moore. What is most informative about Shemara Wikramanayake’s appointment is not her gender or cultural background but the fact that she has worked for Macquarie for 31 years. What are the chances of a big four bank appointing a 31 year “one team player” as its next CEO?
The third area that stands out at Macquarie is executive remuneration. Mr Moore made $18.9m this year, up from $18.1m last year. The bonus pool for executives this year was a staggering $100m. No wonder it is called the “Millionaire’s factory!” All this, yet no customer or public outcry. It is understandable that shareholders have not objected as the share price has increased 360 per cent in the last ten years. During this time, the best of the big four has been CBA with a 180 per cent increase with NAB coming in fourth at 35 per cent.
Five learnings for the big four banks from Macquarie
1. If you make a mistake, own it.
2. There is no conflict between the interests of customers and shareholders.
3. Paying big bonuses does not automatically lead to poor behaviour.
4. CEOs don’t need to be turned over every five years if you select the right person.
5. Often the best new CEO comes from within.
The phrase “homogenous oligopoly” has appeared regularly in this series. The RC has shown all big four banks face the same challenges in governance, culture and accountability. At the same time, Macquarie has shown them how it can be done. If the big four continue on the current path, it will be a race to the bottom.
I am reminded of a wonderful piece of advice from a mentor at NAB – “There is no point in being the best dressed corpse in the cemetery.” (thanks Errol!)
Part II in this four part series is based on my 25 years in NAB’s frontline business, corporate and retail banking network as well as conversations with current and former customers and staff. I left NAB in 2008 so I am unable to rely on personal experience to opine on events after this time. This article is offered as a constructive contribution to the debate which is a critical component in rebuilding trust in Australia’s big banks.
The saying “Know from whence you came. If you know whence you came, there are no limitations to where you can go” is applicable to a bank as it is to an individual. A few brief historical observations about NAB’s culture re customers and sales provide some context.
After the recession of the early 1990’s, ANZ and especially Westpac which was bailed out by Kerry Packer, were in disarray and the recently privatised CBA was only just sorting itself out. Customers flocked to NAB whose “can do” approach to winning new business saw it dramatically increase market share in core segments of business and retail banking.
The appointment of the American sales training firm Cohen Brown, who later worked for CBA, super charged this growth momentum with mantras like “Born on Monday, die on Friday.” Bankers were required to make public sales commitments on a Monday morning and front the team on Fridays with actual results. Branch and individual sales league ladders recognised top performers and shamed those on the bottom.
Jack Welch, the legendary CEO of General Electric, was the business guru of the time and NAB subscribed to his 20/70/10 theory where the bottom 10 per cent of performers were constantly managed out.
For those at the top of the ladder, life was good with bonuses and trips to luxurious holiday destinations. Leaders all the way to the top drove this culture and it benefited them greatly. In comparison to their leaders, bonuses for high performing frontline staff were nominal and for those further down the ladder, the primary motivation to hit their numbers was simply job retention. The old sporting adage of “you’re only as good as your last game” applied and targets would increase each year.
The sales and growth focus continued into the early 2000’s but change was adrift and the GFC in 2008 was a turning point. With that as background, I have identified ten causes of NAB’s malaise. I stress these issues are not new and are largely inter-connected.
1. CEO Leadership Void.
There has not been a CEO able to unite the entire group since Don Argus who retired in 1999 after 8 years at the helm. The characteristics that set Mr Argus apart were his vision, passion, clarity of purpose, deep understanding of the business, decisiveness, accessibility and authenticity. None of Argus’s successors – Frank Cicutto, John Stewart, Cameron Clyne and Andrew Thorburn had the full package. The average term of the last three CEOs is four years and Andrew Thorburn is into his fifth year.
I don’t intend to delve into the how NAB’s boards or senior management teams have contributed to its current position, that’s for another time.
2. Lost connection with customer.
It would be inaccurate to conclude that the sales culture and associated remuneration structures alone caused NAB to become internally rather than customer focused. They were major factors but there were many others.
There has been much talk about losing “sight” of the customer. I prefer to use the word “connection” as it has a deeper meaning. “Connection” implies a personal relationship and building relationships takes time and requires both parties working together through tough as well as good times. Going back, bankers visited their clients, they “walked the floor” and “kicked the tyres” followed perhaps by a lunch. They exercised personal judgment based on character, reputation and past conduct. They did their own credit assessment and had authority to approve loans. They went into bat for their clients and this loyalty was appreciated and reciprocated.
This changed over time driven by regular restructures which usually involved centralisation of functions in order to reduce labour count. Bankers lost their approval authorities, they had more clients to look after but with less support. Staff turnover increased which meant customers had less stability in their connection with the bank.
Bankers now spend a significant amount of time, as much as one day per week, on compliance. Previously much of this time would have been able to be spent with customers.
For the big banks, the traditional business banking relationship model is no longer viable and there is no turning back but it interesting that former NAB and ANZ EGM Joseph Healey has established Judo Capital, a challenger bank premised on bringing back the “craft of relationship banking” exercised by experienced career bankers.
3. Loss of NAB identity.
NAB had a unique culture as did the other banks. This has changed largely due to the significant numbers of people who move from one bank to another. Once it was a badge of honour to be a one team player but nowadays, if you have not worked for more than one bank the inferred question is “Is there something wrong with you?” This has been a major factor in the big four banks becoming a homogeneous oligopoly.
4. The fun has gone out of banking.
There are many factors, some mentioned above, that have caused staff to feel less engaged but the bottom line is that the fun seems to have largely gone from banking. Fear of being made redundant is commonplace so it’s understandable that loyalty and commitment levels have fallen.
5. Expansion into areas outside of core competencies.
NAB’s failed expansion into banking in the UK and USA has been costly to its balance sheet and brand. And vertical integration including wealth management, insurance, private equity and stockbroking has been similarly unsuccessful.
6. It became too big to control.
With a diverse group businesses which once spanned three continents and employed over 40,000 people, NAB was, and still is, a huge business. This poses challenges for both management and the board and it is clear now that it has not handled all these challenges as well as it could have. It hasn’t had the right resources and processes to manage it.
With the exit from the overseas banks and the current simplification strategy already underway, NAB should be an easier organisation to manage. There is a strange irony that one of former CEO John Stewart’s favourite pieces of advice to customers was “I’ve never seen an organisation shrink to greatness” but this is precisely what NAB is now seeking to do.
7. Hard to get things done and it takes too long.
Feedback from staff is that in recent years it has become harder to get things done. This ranges from credit approvals, development and implementation of new technology platforms, new products and processes.
ASIC recently named NAB as the worst offender when it came to identifying problems relating to bank errors impacting on customers, taking an average of more than four years to recognise there was a problem to begin with.
8. A culture of fear.
People are concerned about speaking up for fear of the consequences. There has been a view that leaders wouldn’t listen anyway based on perceived or actual lack of engagement with senior leaders.
9. Slow to understand & embrace diversity.
Over the journey, banks and NAB in particular have been laggards in gender diversity. One wonders if NAB’s plight might have been different if more women held board and senior management positions earlier.
Staff and customers from different ethnic and religious backgrounds were not always treated respectfully. I recall one senior credit manager advising a young banker “don’t lend to anyone whose name ends in a vowel.” It may have been a joke, but even so…
Many staff in their 50’s leave NAB when they still have much to give. The bank hasn’t always got the best from its older employees and in hindsight more could have been done to help older male bankers in particular deal with their social norms on issues like personal conduct, political correctness and affirmative action.
Corporate memory and a culture of mentorship were amongst NAB’s most valuable intangible assets and brand differentiators. Technology is powerful but a CRM or online training modules cannot replace the experience and wisdom which comes from long serving team players who themselves were mentored from the time they joined.
In all areas of diversity NAB has progressed enormously but it has come from so far back that damage has been done and opportunities missed.
10. Combative approach to potential conflict situations.
Customers and other stakeholders have said NAB is hard work to deal with. Descriptions used to describe how NAB has engaged particularly on contentious issues like loan defaults include “defensive, bureaucratic, arrogant, avoidance, litigious and stalling.”
A conflux of factors over a long period of time have lead NAB to where it is today. They are self-inflicted and can only be resolved by NAB. This is the challenge for Andrew Thorburn and his leadership team under the stewardship of Ken Henry and his board.
Like the boy with the wheelbarrow, they have the job ahead of them. Dr Henry has been a director since 2011 and Chairman since 2015 whilst Mr Thorburn was appointed in 2014. So how time they have remains to be seen.
Coincidentally, last Friday NAB released a document NAB Self-Assessment on governance, accountability and culture. This follows APRA’s request to NAB to provide a response to the same questions posed to CBA as part of APRA’s prudential inquiry into that bank.
This 56 page report contains 26 specific actions this first of which is “The Board will require and oversee a significant lift in the importance given to the voice of the customer and a more intense focus on customer outcomes.”
NAB is to be applauded for making this document public, it didn’t have to. That said, it appears no engagement took place with customers and engagement with staff consisted of 23 focus groups comprising only 150 employees.
Very few saw the Royal Commission steam train coming. Australia is indebted to Commissioner Kenneth Hayne and his team for bringing into the open how and why Australia’s banks have lost their way. We can only speculate what would have happened without this inquiry.
As former career banker I have been mesmerised by the goings on at the RC and, like many others, I’ve pondered the question “how and why did we get to this point?”
This is an extensive topic which cannot be covered in one newsletter so I will break this down into a four part series, the first of which addresses the question of how much responsibility NAB’s Chairman Dr Ken Henry and his CEO Andrew Thorburn should bear for their bank’s plight.
The second newsletter will address “How and why NAB went off the rails.”
The third will look at how the other big banks have fared.
And the final newsletter outlines what recommendations we can expect from the RC and what issues banks are and need to be considering in the meantime.
The focus of the first two newsletters is NAB. This is not motivated by any desire denigrate NAB, in fact it is exactly the opposite. I have abiding gratitude and respect for an institution which gave me the best years of my working life. Spending twenty five years there has given me insights that I don’t have with other banks which is why I feel equipped to make more detailed comments. I suspect though the themes in other banks are similar. I should disclose that I have not worked for NAB for ten years and this has been a period of significant change.
These insights are offered as a contribution to the debate, initiated by the RC, which needs to continue in order for all our banks to begin to rebuild lost trust.
PART I – HOW MUCH RESPONSIBILITY SHOULD NAB’S CHAIRMAN & CEO BEAR FOR NAB’S PLIGHT?
From the middle 1990’s to the middle 2000’s NAB was widely regarded as Australia’s best bank but in more recent times it has slipped. It’s share price has been the worst of the four banks over the past 10 years whilst several scandals have brought to the fore the nebulous issue of culture.
Dr Henry suggested this week that it could take up to ten years to fix NAB’s culture. This is a damning self-assessment from someone who has been a director for seven years and chairman for the last three. It also doesn’t reflect well on CEO Andrew Thorburn who has now been in this role for in excess of four years. So what level of responsibility do NAB’s key leaders bear for its current plight?
Comments made by the pair this week at the RC offer an insight into this. It could not have been easy for any witness to be grilled for hours on end in such an intense environment with so much public scrutiny so its understandable there were moments of frustration. Nevertheless, I was genuinely taken aback by some of their comments.
Dr Henry is a former senior public servant, he is not from the “top end of town” and was regarded as the “new broom” which NAB needed. During his somewhat churlish and combative responses to probing from counsel assisting, he made a number of rather surprising and disconcerting observations.
In relation to the role of the board Dr Henry said that expecting APRA’s requirement that boards ”ensure” they have formed a view of the risk culture is ”a step too far.”
The natural response to Dr Henry’s questioning of the board’s role re risk culture is that if boards are not responsible for ensuring they have a view the risk culture of a bank then who is? It is the board that sets the tone for ethical and responsible decision-making throughout the organisation and central to this, especially for a bank, must surely be risk culture.
In a rambling dissertation on corporate governance, Dr Henry seemed to suggest there may be some incompatibility or perhaps lack of clarity between the role of a director in maximising shareholder value and in serving customers. He also suggested directors’ duties could be extended to protecting “the community.”
It is surprising that a bank director might still be unclear about their responsibilities to shareholders and customers. Shortly after becoming Chairman, Dr Henry said, “A bank that truly puts the customer at the centre of everything it does should not need regulation.” At that time he also said, “When something goes wrong, the finger is going to be pointed at the board so it’s a responsibility we can’t escape. My view is that we should embrace the responsibility.”
Dr Henry also suggested APRA could take a stronger stance on bank culture. When Commissioner Hayne asked whether APRA’s ‘‘suggesting and nudging’’ was enough or whether it need to go beyond that Dr Henry said, “Beyond that, indeed.”
Banks should not wait for or need regulators and governments to take “a stronger stance on bank culture.” Isn’t this the job of the board? Chairmen and directors of bank boards are all well paid for part time positions – around $800k and $400k pa respectively. As highly credentialed professionals they must know what their role as a director of a bank is and how to do it. And if they feel they’re no longer up to it, have too many other directorships or it’s just not worth the risk, then perhaps it would be a good time to step down.
It’s hard to say what motivated Dr Henry to say the cultural fix at NAB could take up to ten years but this does not reflect well on his board who allowed the bank to bumble along until the RC brought these issues to the public’s attention. Either the board was ignorant of the extent of the problems or it was negligent in failing to hold management to account for fixing them. My sense though is that it’s probably both.
Mr Thorburn started the week well, he said all the right things about the primacy of the customer, what it was like when he started out at NAB but how, like a fishing boat, the bank drifted off course. But when the hard questions were asked, he faltered.
A big test came when he was questioned about charging fees for services not delivered and then NAB taking more than three years trying to minimise the extent of refunds. Mr Thorburn said this was in hindsight the wrong approach although he thought it was understandable in the heat of the moment. When he insisted it was not a dishonest act, Commissioner Kenneth Hayne intervened with “well, let me put that proposition in other words that this money fell into the pocket of NAB accidentally?” And Mr Thorburn’s response was, “Well, I can’t disagree with that.”
Mr Thorburn was also asked if he thought the actions of his executives were unethical, to which he replied, “It depends what you mean by unethical.”
Given that NAB has developed a reputation as combative and stalling in dealing with customer disputes it was somewhat ironic therefore to then hear him talk about the new Customer Remediation Centre of Excellence which sounds a bit like the “Crown Casino Centre for Problem Gambling”.
I have not met Mr Thorburn although insiders say he is a very decent man. The proper course of action, as we would all tell our kids, is when you make a mistake, which we all do from time to time, we promptly fess up, fix the problem and compensate those who have been wronged. Why should it be any more complicated than that?
The phrase “thrown under the bus” has had a good workout at the RC. Witnesses have generally tried not to incriminate their colleagues but under intense questioning Mr Thorburn singled out Mr Hagger. It’s right that Mr Hagger was held accountable but who is holding Mr Thorburn to account?
One of Mr Thorburn’s biggest challenges has been how to reduce staff numbers whilst trying to maintain, more or less build, morale. Last year he announced that 6,000 existing roles would be made redundant but 2,000 new ones would be created. At the RC he noted that there had been up to 12 layers between himself and the front line but that is being reduced to around seven. He said, “That’s taking a lot of middle management who are like, observing things. They’re not bad people. They’re just there to comply, not to change things.”
This is not easy, but the CEO is ultimately responsible for ensuring the right people are in the right jobs and that they are well trained, supported and lead. Staff morale, particularly in middle management, remains a significant problem.
Overall, the final week’s appearances at the RC by Dr Henry or Mr Thorburn did little to enhance their reputations or prospects for job longevity. They are unlikely to be looking forward to the AGM which will be held in Melbourne on December 19th.
So the “chickens at NAB have come home to roost.” Its problems did not just arise after Dr Henry and Mr Thorburn were appointed but as the leaders of the board and management they are ultimately responsible and should be held accountable for failing to properly identify and address them in a timely manner.
It is for the shareholders to form their own views as to how much responsibility Dr Henry and Mr Thorburn should carry and whether they are the best people to take NAB forward. Personally, I believe it is time for a fresh approach.
The truth is that NAB’s cultural decline has been in the making for twenty years. This will be addressed in Part II, “How and why did NAB go off the rails.” to be published shortly.
The ABA has just released its new and improved Code of Banking Practice, the fourth version since 1993. But bank behaviour has not improved over this time which lends weight to the view these codes are not worth the paper they are written on. So it would be understandable, but unfortunate, if SMEs thought this new code wont make any difference to them
Its important to note the new code is not in response to the goings on at the Royal Commission. In fact, in 2016 the Australian Bankers Association commissioned an independent expert, Philip Khoury, to undertake a review of the 2013 code. In his February 2017 report, Mr Khoury made 99 recommendations and since that time, the ABA has been engaged in protracted negotiations with various stakeholders including ASIC in order to agree on the contents of the new code.
One of the most contentious issues has been the definition of a small business. ASIC and Kate Carnell, the Australian Small Business & Family Enterprise Ombudsman, have argued that the threshold should be $5m in total borrowings but ASIC eventually rolled over on this and has agreed with the banks preferred threshold of $3m.
I don’t think the definition of a small business is a huge issue as ASIC did say that the $3m level would cover between 92 and 97 per cent of SMEs. ASIC also said it would collect quarterly data from the banks to ensure this is the case and its approval of the new code is conditional on an independent review in 2020 of how a small business should be defined.
It has taken 18 months to get the code launched and it will still not come into force until July 2019. The time it has taken get to this stage is at least as big a concern as the definition of a small business but the main thing is that banks can now work on delivering on their commitments and customers are now in a better position to hold them to account.
The code sets standards of good banking practice when dealing with individual and SME customers and their guarantors. It covers obligations for banks in areas including the offer of banking services, information and disclosure, complaints handling, customers with special needs and customers experiencing financial difficulty. The 60 page document includes 215 specific commitments which all 26 ABA member banks will be required to commit to and the code will form part of the banks’ contractual relationships with their customers.
The new code incorporates a number of specific commitments to SMEs which, if implemented, will certainly help redress the massive power imbalance which currently exists between the banks and their small business borrowers. Here are just some examples of these new commitments:
1. Banks will tell SMEs the information they require and after they have received all the information they will advise how long it will be before they are likely to make a decision. The lack of certainty as to when a decision might be forthcoming is one of the biggest bugbears of small business owners.
2. If the bank does not approve a small business loan it will, if appropriate, give the general reason why the loan was not approved. Whilst “appropriateness” is at the discretion of the bank, if this information was provided in a timely and accurate manner it would be helpful in assisting the borrower obtain finance elsewhere.
3. If a borrower is in default, the bank will give 30 days’ notice before they either require repayment of the loan in full or take enforcement proceedings and if the default is remedied during this period the bank will cease enforcement action. There are exclusions where banks may give a shorter notice period such as if in the bank’s reasonable opinion, it is necessary to act to manage an immediate risk. And if the loan is by way of an overdraft or on demand facility, the bank may not be required to give any notice about when they require repayment.
4. If a borrower has met all loan payment terms, banks will not take action based on non-monetary defaults unless the situation falls within twelve exclusions such as the loan is used for a purpose not approved by the bank or financial information is not provided as required under the agreement.
5. Banks will not include a general material adverse change clause as an event of default in any standard form small business lending contract. But for some kinds of standard form loans eg loans for property development and margin lending, banks may include financial indicator covenants or special covenants tailored to the particular nature of these loans as a trigger for default based action.
6. If a borrower is not in default, and the principal owing on a loan is not due to be fully repaid at the end of its scheduled term by regular periodic repayments, banks will give notice of their decision not to extend the loan at least 3 months before it is due to be repaid in full.
7. Banks will provide copies of property valuations and instructions except when enforcement action has already commenced. The code is silent as to whether SMEs will receive a copy of any Investigating Accountants report they pay for.
Whilst the ABA and the banks are to be commended for making many commitments to small business borrowers, consumers still seem to be afforded a higher level of protection. For example, commitment #113 says banks will not enforce any mortgage or other security provided in connection with a guarantee unless the lender has first enforced any mortgage or other security provided. However this commitment does not apply if the borrower is a small business. As an aside, in consumer situations this commitment also will not apply if the bank “reasonably expects that proceeds of enforcement against the borrower will not be sufficient to repay a substantial portion of the guaranteed liability”.
It is apparent from the above that a number of the commitments afford the banks substantial “wriggle room”. This would not come as a surprise to the cynics although I am optimistic that this time the banks will be more likely to walk the talk and there are a number of factors that support this view:
1. The banks have copped a battering at the Royal Commission and it’s not over yet. At some stage, bank CEOs will be in the witness box to answer questions about culture and accountability. If the banks did obfuscate in the past, it’s not going to look good for their leaders to do so in front of Kenneth Hayne. The Royal Commission has brought the standing of the banks to a cross road. They simply cannot afford to fall further.
2. Even though many small businesses owners are mistrustful of banks, in the past there was little they could actually do about it but the banks no longer have the SME market all to themselves. There are dozens of alternative sources of finance for SMEs these days including challenger banks, fintechs, specialist asset financiers and merchant cash advance lenders. Not only do SMEs now have options, their awareness of these options is improving all the time. This is not lost on the banks.
3. This is the first time an industry code has been approved by ASIC which noted that the ABA had “made additional significant changes in order to satisfy ASIC that the code meets it’s criteria for approval”. Westpac’s CEO Brian Hartzer noted the industry had worked with the regulator to ‘‘completely rewrite’’ the industry’s commitments. It has taken a long time to get to this stage and in the meantime ASIC itself has faced some tough questioning at the Royal Commission with inferences that, at best, it has been soft on the banks and, at worst, it has been asleep at the wheel. ASIC is heavily invested in this code and accordingly we can expect it will play a hands on role in enforcing it.
4.When the previous banking code was launched in 2013, Kate Carnell’s role as ASBFEO did not exist. Since she was appointed in 2016, small business owners have had a powerful and determined advocate who has and will continue to strongly prosecute the interests of her constituency. Other SME advocates including Peter Strong from the Council of Small Business Organisations Australia and hopefully theBankDoctor have been vocal in their support for SMEs. The voice and influence of small business advocates will only continue to grow.
WHERE TO FROM HERE?
To date, the banks have not done a good enough job in walking the talk of their codes of practice and they simply have to do better. Bank CEOs are telling us they are totally committed to making the code work. Training of staff is critical and retention of employment and remuneration needs to be tied more to performing as per the code than financial metrics.
Meanwhile SMEs have to stop believing they are powerless when it come to engaging with their bank. As busy as they are, if SMEs want to be treated better by the banks they need to invest time to understand their rights and remedies. It can’t just be left to the Royal Commission, regulators, advocates and investigative journalists to call out poor behaviour by the banks. If individual small business owners are unhappy with how a bank has conducted itself, they need to take action.
So before SMEs have their next significant encounter with their bank, they should read the code so they know what to expect. And if they believe the bank has not acted in accordance with the code, they should do something about it. SMEs now have enshrined rights and avenues of redress.
All banks have internal dispute resolution people SMEs can talk to. And if they’re not happy with this, they are able to go to the ABA’s external dispute resolution service which is run by relatively independent experts. From November this year SMEs will also have access to the new Australian Financial Complaints Authority and Kate Carnell and other advocates are also there to support small business owners.
The new code of practice represents an opportunity neither SMEs or the banks should overlook. It will make a positive difference to SMEs if they are prepared to hold the banks to account. And if bank conduct is genuinely guided by the code then they may begin to regain lost trust.
Fintech lenders Capify, GetCapital, Moula, OnDeck, Prospa and Spotcap have collaborated with the Australian Finance Industry Association, the Australian Small Business and Family Enterprise Ombudsman, theBankDoctor.org and FinTech Australia to produce a Code that will improve transparency and disclosure in this important alternative source of debt funding for Australian SMEs.
The Code will inform SMEs what they can expect when they engage with lender signatories and it will also include a pricing comparison tool which will show borrowers the true total cost of borrowing.
By signing the Code these lenders are enshrining their commitment to engage with small business owners in a transparent and responsible manner. The six signatories have committed to being fully compliant by the end of December this year. Further work needs to be done in areas like implementation of the pricing comparison tool. An independent and suitably qualified Code Compliance Committee will be appointed to determine whether a lender is compliant. The CCC will also be tasked with the responsibility of ensuring ongoing compliance with and enforcement of the Code. Borrowers and other stakeholders will be able to make complaints to the CCC which will have the power to impose penalties on lenders that breach the Code.
Other fintech SME lenders will be encouraged to apply to become signatories to the Code and this template could also be used by non-bank SME lenders that aren’t fintechs.
SME borrowers who look to borrow from code compliant lenders will be much better placed to answer three important questions being:
“Is this the right product for my needs?”
“Do I know exactly what it is going to cost?” and
“Do I know that I can’t get a better deal elsewhere?”
Whilst there is still work to be done, this is a significant step forward in ensuring fintech lenders engage with SME borrowers in a transparent and responsible manner. You can read the full Code document here.