What are the key takeaways from the banking Royal Commission?
In November of 2017, the Government finally announced that a Royal Commission headed up by former High Court Judge, The Honourable Kenneth Hayne will investigate the alleged misconduct of Australia’s banking and financial services industry. So, what does this mean for Australians? We’ll put it into perspective.
Parliament has been debating a Royal Commission for 18 months
Its been on the cards since first recommended in 2014 by a Senate Committee investigation into the Commonwealth Bank financial planning scandal. Immediately following the announcement, the Prime Minister’s office stated that while Australia has a strong and stable banking, superannuation and financial services industry, the speculation regarding a banking inquiry or royal commission was creating unnecessary disruption and uncertainty. This uncertainty has been an overhang on bank share prices, may have diminished their reputations internationally, and has undermined customer trust in the banks.
There’s a lot of detail to get through in a short period of time
When considering both the wide scope of the inquiry and the limited timeframe (the final report is expected to be delivered by 1 February 2019), Kenneth Hayne will have his work cut out for him. The draft scope encompasses banks, insurers and all other types of financial services providers and super funds (excluding self managed super funds). Importantly, it does not have the ability to inquire into a matter that may duplicate an existing inquiry.
Australian taxpayers will foot the bill but won’t receive compensation
At an estimated taxpayer cost of $75 million, the Royal Commission will consider witness testimony and evidence from victims to ultimately provide a series of recommendations, which may include changing laws or regulations that govern the banking sector. But for those Australian consumers affected, it will not have the power to order any form of compensation nor can it change the outcome of cases that have already been heard before courts, including bankruptcy hearings.
We do not expect it to have a direct material impact on banking operations
The profitability and ongoing operations of the banks should remain stable during the investigation; however, it will provide another layer of uncertainty to an already beleaguered sector. Historically a market darling, the Australian banking sector is now under pressure having faced numerous scandals since the global financial crisis that have cast the sector in a negative light and caused increased levels of regulatory oversight and reputational damage. The Royal Commission is likely to add to that pressure, which could result in reduced margins and credit ratings, and extensions to both domestic and international brand damage.
Various actions have already been taken to address issues under investigation
These include increased power and resources for the Australian Securities and Investment Commission (ASIC), significant levels of new legislation and compliance requirements, an improved customer complaint resolution system, and new legislation proposed to increase accountability for executives. Banks themselves have also taken significant action by reviewing codes of conducts, changing remuneration structures and increasing the focus on customer’s needs within their service models.
It will be a costly affair for the sector in more ways than money
Estimates in the range of $50 million per institution are being discussed to cover the raft of lawyers and advisors required to manage the inquiry on behalf of the banks. An undoubted cost to the banking sector will likely not be monetary, but rather come in the form of distraction. At a time when banks would prefer to rebuild investor, customer and public trust, focus on continued earnings growth, and stay ahead of the innovation curve, they will be collecting information and providing evidence to the Royal Commission.
External economic factors are likely to impact the banks more than the Royal Commission
The Australian Prudential Regulation Authority (APRA) is closely monitoring the actions of the banks, warning them against using loose lending practices when determining the loan serviceability of borrowers. ASIC joined APRA in reminding banks of their expectations regarding responsible lending practices, particularly around interest-only and investor loans. Changes in prudential regulations also prompted banks to increase Tier 1 capital ratios, however, balance sheet resilience remains untested when considering current levels of indebtedness and their residential mortgage exposure. A combination of record low wage growth, decreased savings and growing underemployment means any pull-back in the housing market could lead to rising default rates and place pressure on balance sheets.
Overall, we remain cautious on the domestic banking sector
The ongoing uncertainty around the banking sector and the unknown outcomes of the Royal Commission, combined with the banks’ significant exposure to the residential property market, continue to give us cause for concern. We suggest that investors review and consider reducing exposure to the sector and reallocating to investments where the risk return trade-off is more appealing.
This insight may contain general financial advice and was prepared without taking into account your objectives, financial situation or needs. Before acting on any advice, you should consider whether the advice is appropriate to you. Seeking professional personal advice is always highly recommended. Any forward looking statements are based on current expectations at the time of writing. No assurance can be given that such expectations will prove to be correct.