Wealth management arms the root of all banks’ image problems

Former CBA chief David Murray has raised the spectre of Labor’s historic opposition to the banking system.

Former Commonwealth Bank chief executive David Murray raised the spectre of the Labor Party’s historic opposition to the banking system yesterday.

In interviews with journalists after speaking at the Actuaries Institute, Murray harked back to the days when Ben Chifley’s membership of the banking royal commission of the 1930s led to his moves as Labor prime minister in the late 1940s to nationalise the banks.

But Murray, who headed up the last inquiry into the financial system and is one of the few ­people prepared to speak up for the banks these days, introduced a new element into the debate.

These days, he said, Labor was also motivated by its opposition to banks being in the wealth management business as a result of its support for the industry superannuation fund movement.

The industry super funds are not “union funds” but are based on specific industry sectors with directorships shared equally between unions and employers. They are now snapping at the heels of the banks’ wealth management businesses.

Murray, of course, knows all about the banks’ move into the wealth management business.

He was CEO of the Commonwealth Bank in early 2000 when it made its ambitious $8 billion takeover of the Colonial Mutual life ­office, then the biggest takeover in Australian history.

At the time, the industry superannuation funds were much smaller players in the Australian financial system with assets of only about $36 billion.

Now the industry funds have grown to having assets of between $400bn and $500bn, challenging the amount held by the traditional retail sector including the bank-owned wealth management arms.

The industry fund movement loves to point the finger at the retail sector, pointing out — as it did yesterday — its long history of higher investment returns, partly due to its lower cost base and partly due to an ability to invest in longer-term assets such as infrastructure.

The banks, in turn, believe that the industry funds have an in-built advantage as they are often named as default funds for workers under enterprise bargaining deals.

More critical for the banks, in the highly sensitive political situation, is the internal issue of how they are handling their wealth management businesses.

Expanding into wealth management was a logical step for the banks. (The rise of compulsory super was draining funds from the bank sector. And if they didn’t do it, other players would come into the market and eat their lunch.)

But it is fair to say the move by the banks into the bank assurance model has not quite worked out the way they would have hoped.

Banks and their management arms will be the subject of a royal commission if Labor gets it way.

The latest Reserve Bank Bulletin released last week had a thoughtful paper on banks’ wealth management arms.

(By wealth management it means superannuation, managed funds, life insurance as well as ­financial advisory services.)

The paper, by Reserve Bank economist Theodore Golat, points out that the profitability of the banks’ wealth management businesses — at least when considered by income — has not been as strong as in other sectors of the banks’ activities, particularly since 2007. “A key reason for this has been that the margins on these businesses (measured by revenue as a proportion of assets under management) have fallen by around 20 per cent over the same period,” Golat says.

A graph of the major banks’ income growth rates from 2007 to 2015 shows that wealth management income has grown much slower than non-wealth management income for all big four banks.

Golat argues that the main source of pressure on the bank wealth arms has been rising competition from industry super funds, “which have consistently delivered higher returns to their customers after fees than retail funds”.

“Returns on equity from the major banks’ wealth management operations also appear to have been lower than average than those from their traditional banking activities,” he notes.

The other key point is that the culture of banking is different to the wealth management business, which is much more sales orientated. This and the pressure on bank staff to cross-sell their wealth management products has led to complaints by some customers who find themselves confronted with sales proposals when they go to their branch for traditional banking services.

Murray argues that every business sells products and banks are just as entitled to offer a range of products to their customers as any other business.

But how much of the different culture in banking and wealth management has been responsible for some of the image problems the banks have had?

Have bank chief executives put pressure on wealth management sectors to boost their returns?

And how much cross-selling of wealth products has led to discomfort among bank customers?

Golat notes that “banks’ ownership of wealth management businesses also exposes them to ­financial and reputational damage in the event of misconduct within these businesses”.

“A number of instances of ­misconduct have occurred in bank-owned wealth management businesses over the past couple of years,” Golat says.

“Banks could expose themselves to potentially significant legal, regulatory and reputational risk as a result of their ownership of wealth management businesses, which could be especially concerning at a time when the bank was under pressure more generally. The major banks’ wealth management activities have not lived up to initial expectations for income growth and cross-selling opportunities.”

But he does point out that the businesses do provide a source of income diversification and are generating returns, in most cases, above the banks’ cost of capital.

Golat is not saying anything that would surprise bank analysts. But it is an authoritative and frank paper outlining some of the forces underlying the politically sensitive situation where the banks have found themselves today.