Banking royal commission: expect long-term political fallout from the Hayne report

Kenneth Hayne and Josh Frydenberg with the report. Picture: Kym Smith

The Hayne royal commission is a landmark in documenting the moral and financial betrayal of the public by financial and bank elites, raising the pivotal issue of whether genuine reform is possible and the price tag it may involve.

This report will reverberate within politics for many years. The premature claim early last week was that the banks were escaping untouched. That’s wrong. This report shows the public has been robbed and exploited by “the big end of town” but there is one potent retaliatory power the people do possess — votes at the ballot box.

No political party can afford to be seen as a proxy for the banks. No bank chief executive or chair was able to survive explicit criticism from commissioner Kenneth Hayne, hence the demise of NAB’s chiefs Ken Henry and Andrew Thorburn. The Hayne report is not the end of the matter. Unless the banks can prove their behaviour has changed, more punitive action will follow from the political class.

The Morrison government in its fast and effective response had to show its fidelity to Hayne’s recommendations given its diminished position from resisting the royal commission for so long. Bill Shorten, predictably, gave licence to his populism and sense of vindication, declaring on Friday the public would be justified in calling a “cover-up” if “no one out of the banks goes to jail, if no one gets prosecuted or charged”.

“The Liberal Party of Australia is the political arm of the big banks; they ran the protection racket,” Shorten said. His slogan is dual purpose — it keeps Labor as the political winner on the banks and it recruits the Hayne report to validate Labor’s central narrative of the past term — that the economic system is rigged against the ordinary person and has been run on the basis of misconduct, ripping off customers and prospering the elites. Hence Shorten’s killer line: only Labor can be trusted to fix the banks and restore justice to the economy.

The conundrum, however, is that keeping an effective banking system and credit flow is an absolute necessity to avoid recession and even more damage to the public — a reality reflected in Hayne’s quest to avoid too much disruption in his recommendations.

Hayne has done an impressive job. But there are two unanswerable questions that overhang his work. Are his recommendations to restore integrity sufficient given the sheer scale of misconduct and exploitation and, second, has the financial system been instrumental in fuelling household debt to heights that make Australia’s economy dangerously vulnerable to an adverse turn in the global economy?

Paul Keating, the architect of financial deregulation from the 1980s, is a critic of Hayne’s report. Keating tells Inquirer: “The royal commission process was very competent and the report reflects that competence. But the process made as clear as day the interminable conflict between product and advice by institutions promoting their own product.

“The royal commissioner should have recommended these arrangements — this conflict between product and advice — be prohibited. This he monumentally failed to do. He should have acted upon the examination and the evidence of these serious conflicts of interest.”

A similar point was made in this newspaper last week by Alan Kohler. It goes to structural separation. Hayne’s report wrestles with this issue: how far should there be a separation between providing financial advice and manufacture or sale of such products? He concludes the separation options involve “significant disruption”. It was opposed by the Australian Securities & Investments Commission and the four major banks.

The report notes that three of the four banks are exiting their wealth creation arms, in a major change in the industry. Hayne suggests significant change is already under way: “The industry itself will very probably look very different in five years’ time.”

The other pivotal structural issue he refused to endorse was the prohibition of retail-for-profit funds from the superannuation sector, a sacred goal of the ACTU and sections of the ALP. Calling this step “radical”, Hayne said it would eliminate a group of participants and weaken competition, and he branded as “undesirable” the insulation of the industry funds this proposal involved, saying this alone was “probably enough reason to reject the idea”.

Shorten and opposition Treasury spokesman Chris Bowen are furiously championing the Hayne recommendations and are seeking to embarrass the government on this front, a tactic they will pursue to election day.

The Hayne report, however, almost certainly draws a line in the sand for a future Shorten government, making structural separation in banking and the banning of retail super funds (in effect, bank funds) untenable options despite the demands for these steps from the union movement.

But Labor’s zealotry has left it with a political problem. The government was smart enough to stop short of implementing Hayne’s full crackdown on the 16,000-strong mortgage broker industry in terms of moving to a borrower pays remuneration structure. This is a significant small industry that settles 57 per cent of home loans, with the Productivity Commission recommending reforms but arguing mortgage brokers were decisive in providing competition in the home loan market.

With Labor pledged to full implementation, the industry is in uproar. Talkback radio has taken up the cause and the mantra is established — the Hayne report let the banks off and punished the mortgage brokers, a mantra that hurts Labor. Nine out of 10 consumers report satisfaction with brokers. The PC found that, on average, each smaller lender would have needed to open 118 new branches to generate the equivalent market share achieved through the use of brokers.

Don’t assume bank executives won’t be prosecuted. Shorten may get his test met. The Hayne commission has transformed the debate over fees without service. Hayne says the total amount to be paid by entities, the AMP and the banks as compensation for fees charged for no service is estimated at $850 million and may yet reach a billion dollars.

Hayne savages bank leaders, notably Thorburn, who portrayed this in the hearings as “just professional negligence”, but also Australian Prudential Regulation Authority chief Wayne Byres, who said it was largely a legacy of poor IT systems.

Hayne said: “I cannot and do not accept this. Charging for what you do not get is wrong. It is necessary to recognise that the conduct ran through the whole industry. The conduct was so widespread that seeing it as no more than careless must be challenged.”

Hayne has recommended 24 referrals for prosecution, including the Commonwealth Bank, ANZ, NAB and AMP. In his report he offers a sustained legal opinion on section 1041G of the Corporations Act and is putting pressure on ASIC to address these issues. In the report he refers to two other entities that may have contravened this section (penalties include imprisonment or fines).

“I invited ASIC to consider whether criminal or other legal proceedings should be instituted in respect of that conduct,” Hayne said of these entities. He takes time to explain his legal reasoning and says “it is open to a jury to conclude, beyond reasonable doubt, that, in either of the cases described, the taker” in the course of its business engaged in conduct “that was dishonest according to the standards of ordinary people”.

Finally, Hayne says it would be up to the prosecuting authorities to “determine how the charges would be framed”.

There are no prizes for guessing how Josh Frydenberg would respond. Leading the government’s response, the Treasurer said the system had “broken businesses” and “broken lives”. He said Hayne found conduct “driven by greed” and behaviour that broke the law and defied community standards.

The government has imposed a bank levy, implemented a remuneration accountability regime and Hayne has now drafted, in effect, new missions for the two regulators by which they will be judged.

Addressing the broader economic implications, Industry Super Australia chief economist and former head of the Macroeconomics consultancy Stephen Anthony says the upshot is a high degree of financial risk for the nation.

Anthony tells Inquirer: “Bank executives have apparently revelled in raising short-term shareholder value while maximising their own compensation. They became oblivious to any notion of stewardship to their frontline employees, much less the community. Senior public servants were complicit as they joined “the party” on their retirement.

“An incentive-driven frenzy has taken household debt-to-GDP to global highs — financial dynamite strapped to the side of the Australian economy just waiting for an adverse shock to light the fuse.”

The full consequences of the era condemned by Hayne are not yet apparent. In the same week as the Hayne report came, the Reserve Bank conceded a slowing in the economic outlook. The mix of falling home prices, weaker income and consumption growth overlaid by heavy debt and a reduced flow of lending constitutes a dangerous cocktail.

Referring to the “big picture”, Keating rejects any suggestion the solution is to re-regulate the financial system. In truth, there is no return to the early 1980s, where banks rationed credit before the era of deregulation that made them huge creators of credit. The idea that financial re-regulation will make ordinary Australians better off is a fantasy.

The equal truth, however, is that governments have failed in the era of deregulation to prevent conflicts of interest and have failed to put in place policies that would have limited housing prices and household debt and would have advanced home ownership.

Anthony says: “Historically, the business model of Australian banks was very different. It was to prioritise the efficient intermediation of capital to business, prioritise first-home ownership and assist macroeconomic management via reaching liquidity objectives in times of crisis.

“When financial deregulation finally came in 1983, the priority changed. It became banks and global capital markets rather than the interests of Australian families and getting them into affordable houses. The social price tag of this Faustian bargain is now there for all to see.

“You could be forgiven for thinking the goal of government housing subsidies became the ­acquisition by mum-and-dad investors of multiple existing investment properties via debt. By contrast, the goal a generation earlier had been to enable a family to get established on their quarter-acre block. Those dwellings were the foundation of our lives, our families, our social equity and our community stability.

“Vertical integration became a deliberate bank strategy to move oligopolistic competition in loans up and down the house value stream. That is, into the payments system (credit cards), risk (life insurance and consumer credit insurance) and funds management (super and trading).”

Hayne has rewritten the tests for the banks. He has given the public, the politicians, the regulators and the financial institutions a new set of guidelines by which to live, to be assessed and to be punished again if they fail those tests.

Alert to the difficulty of changing culture he knows the ultimate responsibility rests with the institutions — the boards and senior management. He does seem to overlook the pivotal influence of the shareholders in the focus on short-term returns.

Hayne, however, fingers the power reality of the process. The relationship between the bank and customer is a classic in the asymmetry of power: “Consumers often had little detailed knowledge or understanding of the transaction and consumers had next to no power to negotiate the terms.”

How will this change? How can it change?

The report adds moral weight and policy legitimacy to the urgent need to reform rorts eroding the integrity of the superannuation system. Hayne gives full support to the recommendation of the Productivity Commission that the default system — where workers do not nominate their own fund and are defaulted to one — be reformed.

The main beneficiaries of this process are the industry funds via default arrangements in industrial awards and agreements. While Labor says it supports the Hayne recommendations “in principle”, it is improbable to think Labor will accept the recommendations from either the Productivity Commission or Hayne without making protective provisions for the industry funds.

Setting out his framework on superannuation, Hayne says: “Superannuation can no longer be seen only as a compact between employees and one or more employers or only as a compact between organised labour and capital. There are two reasons. First, superannuation is important to the whole nation. Superannuation arrangements are more than private bargains.

“Second, the central principles governing superannuation ­arrangements are, and must remain, the best interests of members and the sole purpose test. Neither of those principles refers to the interests of those behind the establishment of the fund or those who continue to stand behind it.”

This should be writ large over the door of the Australian parliament. It warns the industry and the political class. It raises serious questions about the nexus between the super system and the industrial relations system and it constitutes a warning to government and parliament to think about super in terms of members, not funds.

Finally, Labor’s demand that parliament spend an extra two weeks legislating the Hayne report is an obvious stunt. The legislation would not be ready. Frydenberg is right to say: if you want to legislate, then start with the superannuation reforms ­already before the parliament.