Opinion: General Manager of Wealth, Josh Callaghan
Since the release of the report, on February 4, 2019, the share price of all major banks and many other companies in the sector have jumped up. In fact, by lunchtime the following day the financial sector was up over 4%, in fact, all major banks were up with AMP gaining almost 10% at the time.
This may suggest that the market priced in a heavier blow from the final report and I must admit, I was also expecting more. Although, in my opinion it was an underwhelming result, we can’t overlook the gravity of some of the recommendations and savvy bank investors will likely want to keep an eye on how things progress.
— CanstarInvestorHub (@InvestorHubAUS) February 5, 2019
Here are four recommendations from the report that investors may want to watch.
1. Removing broker commissions – a double edged sword
In an attempt to rid the whole finance system of conflicted remuneration, the report has recommended that the borrowers, not the lenders, should foot the bill for the mortgage broker and that trail commissions should be banned initially, followed by all commissions in the future.
At first, this may sound like a windfall for the banks which pay out over $2 billion annually in broker commissions. However, if fully implemented, the likely collapse of the mortgage broker market and therefore internalisation of those activities may quickly outstrip those commissions.
Brokers currently source potential leads, qualify and nurture them, assist in product selection including discussing options and likelihood of approval, complete the application, coordinate documents and are often a key stakeholder in getting to settlement.
As a result, banks may need to spend much more on marketing to attract leads and convert them. They will likely need to invest in call centres and on-the-road staff to cover the application process and document coordination. They may also face a heavier credit assessment load as more applications come through without any pre-vetting.
In my view, it’s unlikely that this recommendation will be implemented in its entirety. However, even banning trail commissions may lead to a higher level of churn, which may increase the commission costs and reduce the lifetime value of customers as brokers have an outweighed incentive to write new loans rather than leave them where they are.
2. Vertical integration – good news for Westpac
Addressing vertical integration was perhaps one of the most widely anticipated recommendations from the royal commission, and refers to the inherent conflicts that exist when a product provider also owns the distribution channels. Although, the issue is discussed in the report, it seems to have been largely left to other mechanisms to solve the problems arising from vertical integration.
This is good news for banks, in particular Westpac which, unlike its competitors, made the strategic decision to keep their wealth arm, known as BT. It is also good news for AMP whose model largely hinges on the distribution of its own products through its large financial planning network. In fact, AMP shares rose around 10% in the first day after the report was released.
3. ASIC and APRA out to make a point
The regulators were also in the firing line, both ASIC and APRA were called out specifically and a number of recommendations were made about what they do and how they do it. The report still believes that the two pillar approach is right, however recommended a watchdog of the watchdogs be introduced.
The roll up of all of this though, is even more regulatory change and costs, plus the potential for those new regulations to negatively impact the banks’ revenue generating activities.
Related article: The Banking Royal Commission’s Recommendations in a Nutshell
4. Ask me about insurance… please
Commissioner Hayne has recommended to prohibit hawking of superannuation or insurance products to customers. This means that a finance broker or bank staff members can’t proactively offer these products to a customer unless that customer specifically asks about it.
Each bank has a different level of income generated from insurances depending on their model. For example, the revenue generated from CBA’s insurance premiums was over $3 billion according to their FY18 financial statement. While the commissioners’ recommendation won’t stop that revenue, it’s reasonably safe to assume it will make a dent on it, given the opportunity to cross-sell insurance is a key source of generating new policies.
To sum up
While the recommendations from the report are unlikely to shake up the status-quo for the banks, we may start to see reputational damage hampering growth, in the short to medium term, of their own branded offerings, which is generally their most profitable. Let’s not forget that in Australia the ‘Big Four’ banks form the lifeblood of our financial system, so even if people move their lending elsewhere, the Big Four are likely to be benefiting in some way from that.
In short, there are probably bigger headwinds for the banks that may impact their share prices this year, such as a softening in the housing market, a tightening in credit policy and increases in the cost of funds. Like always, investors need to be vigilant in their assessments and keep up-to-date with the changing dynamics.
About Josh Callaghan
Canstar’s General Manager for Wealth, Josh Callaghan,is the former General Manager of Wealth at Canstar and co-founder of Fintech Queensland. In his role at Canstar, Josh was responsible for the strategic direction, operations and commercial outcomes of the Wealth division, which includes Superannuation and Investments. He has over 19 years of experience in product management, strategy, technology and marketing in the financial services industry.