Banking royal commission: no gain without a scathing Hayne

The royal commissioner has outlined problems that won’t be solved by timid final recommendations.

Kenneth Hayne’s 1000-page report is mercifully ­bereft of the waffle that usually clutters financial services writing.

Investors cannot have read the ­interim report of the royal commission into financial services very closely, given bank share ­prices jumped 3 per cent soon after it appeared on the internet yesterday.

The report by Kenneth Hayne is scathing, depicting a bloated, arrogant industry overseen by regulators too timid to ­enforce a rule book stuffed with feckless regulations few people understand. While the commission has months to go — and Labor has called for an extension — it’s clear its final recommendations will need to be far-reaching, and probably damaging to banks’ revenues, if they are to have any hope of cauterising the problems Hayne has outlined. Long-term, the big four banks are a “sell”.

“The banks have gone to the edge of what is permitted, and too often beyond that limit (as a ­result of) greed — the pursuit of short-term profit at the expense of basic standards of honesty,” the former High Court justice writes, adding that “pursuit of profit has trumped consideration of how the profit is made”.

His clearly written, nearly 1000-page report, mercifully ­bereft of the waffle that usually clutters financial services writing, devotes a chapter to problems with the corporate regulator, the Australian Securities & Investments Commission, which he says exhibited a “deeply entrenched culture of negotiating outcomes rather than insisting upon public ­denunciation and punishment for wrongdoing”.

Indeed, for all the sins highlighted in the royal commission — from charging fees to the dead to the more garden-variety rips and obfuscation — over the decade to June 2018, ASIC’s ­infringement notices to the major banks totalled less than $1.3 million.

Bear in mind just one of the big four, Commonwealth Bank, generated a profit last year of $9.9 billion. Over the same period, ASIC permanently banned fewer than 130 financial advisers out of 25,000 in business.

“Too often entities have been treated in ways that would allow them to think that they, not ASIC, not the parliament, not the courts, will decide when and how the law will be obeyed or the consequences of breach remedied,” Hayne writes.

Fixing the problem is much harder than identifying it. Solemn promises by the sector to “do better” won’t do anything.

Hayne wisely shoots down kneejerk calls for “more powers” for regulators. Passing laws is certainly the easy option, one loved by politicians because it creates the impression they have “done something”. But it will only make the problem worse.

“ASIC has had greater enforcement powers than it has used,” Hayne writes, noting “increased penalties for misconduct will have only limited deterrent or punitive effect unless there is greater willingness to seek their application”.

In fact, a lack of powers or so-called insufficient regulation are typically never the problem, either here or in overseas jurisdictions.

Rather it is a lack of will to use the powers that exist, and the stifling complexity of regulation, that allow bankers to contract out their integrity to a vast compliance department more interested in ticking boxes than encouraging more moral behaviour.

As the saying goes, you can’t legislate for morality.

Consider ASIC has to oversee 11 pieces of legislation and its associated regulations. The Corporations Act, the main one, has increased in size 178 per cent since 1981. Does anyone seriously think society is better because of it?

The guide to explain consumer credit law runs to 86 pages, the commissioner writes, for financial advice to 114 pages, and 41 pages for small business lending. ASIC has published more than 450 guides to explain how it interprets these various laws. And that’s ­before we even get to the various toothless “codes” and “oaths” that the financial services firms write themselves.

Adding to all this would be ­insane. Hayne reveals himself to be a good economist, and a better one than those who produce such complex financial regulations, which are ripe for gaming and avoidance.

“Given the existing breadth and complexity of the regulation of financial services, adding any new layer of law or regulation will add a new layer of compliance cost and complexity,” Hayne writes.

He suggests a “radical simplification” might be in order. But this won’t be enough.

Reading the report, it’s inescapable that the banks are too big and powerful to regulate, to the detriment of customers and the broader economy.

No matter how badly they ­behave, because they are so large the authorities could never revoke their banking licence, which begs they question: What is the point of granting a licence to an entity if one can never revoke it?

Breaking up the oligopoly would be difficult, but should be considered. Modern banking is not a free-market business, it’s ­licensed with its borrowing guaranteed by the state and, unlike other businesses, its very product — money — is sanctioned and provided by the government. In this sector, governments have a natural right to meddle.

The incentives faced by individuals will have to change too. The problems observed in the sector aren’t the result of “bad” individuals. They are the result of individuals responding to particular sets of incentives.

Few people in finance, either the regulated or the regulators, have much, if any, of their own “skin in the game”. The prospect of a top bank manager not receiving a bonus on top of a huge salary is hardly a powerful disincentive to avoid questionable behaviour.

Similarly, regulators aren’t ­rewarded for successfully stamping out crime.

Consideration should also be given to providing regulators with financial incentives to take action against banks. If we permit bonuses in ­licensed banks, why not in regulators too?

“Banks only have as much ‘skin in the game’ in their dealings with customers as the bank chooses,” Hayne observes.

This market power has created the vast revenues that have ­become an extraordinary feast for bankers, lawyers, consultants, shareholders and regulators — everyone but customers.

How to return these to the rest of the economy is a global policy challenge that hasn’t been dealt with since the financial crisis. But it’s particularly acute here, where the financial services sector, which is meant to be an intermediary, has swollen to 9 per cent of national ­income, bigger than in Britain or the US. Shrinking it won’t be fixed by higher penalties here or a toughened up oath there.