The banks are going to buried in compliance

The last thing Australia needs is a financial services industry entirely gummed up by compliance and regulation.

It’s undoubtedly too late to hope for this, but the last thing Australia needs is a financial services industry entirely gummed up by compliance and regulation.

The scorching criticism of both APRA and ASIC in yesterday’s royal commission interim report will light a righteous fire under the regulators as well as result in the government throwing money at them. They will become rich, powerful moral crusaders.

What’s more, while the interim report contained no recommendations for extra regulations, that will definitely not be true of the final report. Kenneth Hayne is a black-letter lawyer; he is going to bury the banks in black letters.

They brought it on themselves, of course, and deserve everything they get. Australia’s financial services industry is the classic case study for the old saying that if you don’t regulate yourself properly, you’ll get regulated by someone far less sympathetic.

But it’s not about regulation. Before the royal commission interim report came out yesterday afternoon, I happened to spend an hour watching a video of the world’s richest man, Jeff Bezos, being interviewed in front of an audience in Washington two weeks ago.

It provided a perfect counterpoint prelude to the royal commission interim report. Bezos explained that Amazon’s success is based on an “obsessive, compulsive focus on customers”, usually at the expense of short-term profit. Others talk about focusing on customers, he said, but they are actually focusing on competitors.

Australia’s banks don’t even have to worry about competitors. As the interim report points out: “Competition within the banking industry is weak. Barriers to entering the industry are high. To participate in the economy, to par­ticipate in everyday life, Aus­tralians need a bank account. But they are reluctant to change banks.”

So what have the banks been focusing on, in the absence of customers and competitors? Profit, that’s what.

“There being little threat of failure of the enterprise, and there being little competitive pressure, pursuit of profit has trumped consideration of how the profit is made. The banks have gone to the edge of what is permitted, and too often beyond that limit, in pursuit of profit.”

Unsurprisingly perhaps, given what’s been exposed in the past six months of public hearings, this is a scorching interim report. Nobody involved in the financial services sector comes out of it well, including APRA and ASIC … especially ASIC.

APRA gets off more lightly because its objective is to promote financial system stability, which it has done. But ASIC’s focus is regulation, and “given the extent of known misconduct, attention must first be directed to whether, and how, ASIC might have better regulated conduct within the industry.”

In answering that question, Hayne rips ASIC a new one: “When deciding what to do in response to misconduct, ASIC’s starting point appears to have been: How can this be resolved by agreement? This cannot be the starting point for a conduct regulator.

“The conduct regulator, ASIC, rarely went to court to seek public denunciation of and punishment for misconduct. The prudential regulator, APRA, never went to court. Much more often than not, when misconduct was revealed, little happened beyond apology from the entity, a drawn out remediation program and protracted negotiation with ASIC of a media release, an infringement notice, or an enforceable undertaking that acknowledged no more than that ASIC had reasonable ‘concerns’ about the entity’s conduct.”

And … “Regulatory responses … focused on the remediation of specific instances of poor advice, rather than seeking to identify root causes within institutions and the industry.”

So it’s likely that one result of the royal commission, possibly the main result, will be a much tougher, more interventionist corporate regulator, better funded and more likely to head straight to court when it finds misconduct — and not just among banks. ASIC will be tougher on everybody.

But the question remains whether the banks can reform themselves beyond the demands of regulation and compliance, that they come out of this process not only sadder and wiser, but “obsessively, compulsively, focused on customers”.

That’s doubtful. They are coming from a long way behind and after this year will be operating under a mountain of new regulation and compliance, and they’ve got plenty. It will take remarkable leadership to produce profound cultural change in that environment.

As Hayne says: “That generally similar conduct occurred in all of the major entities suggests that the conduct cannot be explained as ‘a few bad apples’. That characterisation serves to contain allegations of misconduct and distance the entity from responsibility. It ignores the root causes of conduct, which often lie with the systems, processes and culture cultivated by an entity.”

There is one central challenge for the directors and executives involved in this industry: to somehow get rid of the sales culture in banking and wealth management while still selling. Not easy.

On that subject, one quote in the report stood out: “So long as advisers stand to benefit financially from clients acting on the advice that is given, the adviser’s interests conflict with the client’s interests.” That sums up the fundamental issue, and the reason a royal commission was needed.

When it comes to financial matters, whether it’s borrowing or investing, most people are vulnerable and easy to exploit.

Alan Kohler is publisher of The Constant Investor.