The seeds of a banking disaster

The switch to a hard-selling culture helped prime the powder keg of problems now wreaking havoc in the financial sector.

To understand the royal commission report Australians must also understand why it happened.

One of the reasons Australia survived the 2008 global financial crisis was the strength of its banking system. Among the countries of the developed world, only Canada had a system to match Australia’s. A decade later, our banks, their wealth management organisations plus the once great AMP are the subject of hundreds of pages of a royal commission report.

The royal commission did not look at what caused this tragic transformation of our banking and wealth management systems but to understand the royal commission report Australians must also understand why it happened. Then it becomes clear that those same forces that caused the banks to stumble now also endanger non-banks.

So, let’s look at the seeds of disaster that were planted before the 2008 GFC, how they germinated to create the disaster that followed. I emphasise that in explaining why the events took place I am not excusing the bank management and boards.

When Paul Keating made superannuation compulsory around 1992, he triggered intense competition between the retail funds and against the new industry funds. Banks were a big part of their portfolios and they wanted better performance

The institutions began putting intense pressure on bank boards to deliver greater earnings per share. Bank boards succumbed and salary packages of senior bankers began to change so rewards were much more closely aligned to earnings per share and sometimes even the share price. A new breed of top bank management emerged. Gradually the banking pendulum moved, and banks changed from being customer-orientated low risk organisations to ones where higher risk short-term shareholder returns dominated board and executive strategies. Lending became more liberal and costs were slashed.

But it took a long while and a fundamental mistake for those seeds to germinate into disaster. Around the turn of the century the banks concluded that if they entered the wealth management and life businesses there would be incredible synergies and big profits.

The banks did not realise that their basic skill was to evaluate credit. The key life office skills were based on hard selling and high commissions — a very different culture. The life offices had extended into wealth management and based the new industry on their skill base — high commissions and hard selling. Wealth and investment management did not fit the life office culture but that was not discovered until much later. In 2000 CBA bought Colonial and NAB bought MLC and later NAB tried hard to buy AMP. Two years Westpac bought a then troubled BT business and ANZ partnered with ING in wealth management. Neither Westpac nor the ANZ moves were of the size of CBA and NAB.

But all four banks had acquired businesses they did not understand and which had entirely different cultures and ways of doing business. As the institutions turned the performance screw on the banks the mixture was disastrous. The life office culture of high commission and pressure selling permeated banking operations.

If a bank did not perform its shares were slashed and sometimes the CEO’s job was in jeopardy. The media usually embraced the institutional view of a company, multiplying its power.

In this environment, making mistakes meant a possible job loss and that fear permeated down into middle managers who had mortgages and school fees to pay. If you concealed your mistakes and you could keep your job and standard of living.

Most of the mistakes revealed by the Royal Commission had been concealed as part of this process. Charging dead people fees, charging fees for no service, the hideous duplication of superannuation funds, the misstatement of the true financial positions of borrowers and many other sins were not faced when they small. They then got bigger and bigger. The concealment was massive, and the problems became too big to reveal. Meanwhile these financial firms just kept doing what they always had done and didn’t recognise the difference between wealth management/financial planning and insurance selling and the lack of proper disclosure was building up a powder keg of problems.

These companies became entrenched in concealment and protecting management. The regulators did not realise the cultures had changed and did not do their job. In 2018-19, in reversing that mistake, the regulators (and the Royal Commission) have created a dangerous credit squeeze. APRA and ASIC now threaten Australia’s economy.

As crunch day approached, both CBA and NAB each had a chance to face their problem but they baulked at the consequences.

One of the first times the deep problems began to surface was with the exposure of CBA’s so-called Storm wealth management financial scandal. At CBA, hubris had taken over, and the messenger (journalist Adele Ferguson) was bagged for revealing the facts. But eventually, the evidence became too great and the company was forced to set up a structure to look after damaged customers. But no one at CBA would admit error. So, what should have been a huge customer rectification bill became relatively minor. The bank didn’t recognise that the fundamental flaw that had been exposed in its organisation was actually only the tip of the iceberg.

NAB’s chance came differently. Since 2000, Sydney-based MLC was kept totally separate from NAB and the MLC continued to bank with its Sydney mate Westpac rather than NAB. Eventually NAB decided that it shouldn’t leave MLC to operate completely separately. It sent one of its top bankers, Andrew Hagger, into to MLC to discover what was really happening there. He found what appeated to be a cesspool of problems and concealment but thought he could overcome them over time. He took dangerous steps to “buy time” with the unsuspecting regulators.

He should have immediately faced up to the problem and required the board to make the big provisions necessary to restore the fortunes of badly treated customers. But bloodthirsty institutions obsessed with short-term profit, would have slashed NAB’s share price, many believe Hagger was a victim of the conflict between facing up to the mistakes immediately and the imperatives of maximising short-term share prices and profits.

Bill Shorten pressed hard for a Royal Commission and finally Prime Minister Malcolm Turnbull agreed, and it all came out.