The Royal Commission

The Royal Commission has handed down its report. It’s certainly put a blowtorch on the practices of some of our banks but that was hardly a revelation. In 1991 Peter Burke wrote You can Bank on the Wails, a series of anecdotes about bad behaviour by banks, and in 2001 Graeme Hand wrote Naked Among Cannibals, which explored “ how Australian banks have lost the trust and respect of their customers”. In my own book 25 years of Whitt and Wisdom there is a 97 page section “Enemies of Wealth.” The sub-section on the banks is entitled “Banks Forever Gouging”.

For years I have been campaigning against the shameful practice of increasing the interest rate the moment a loan gets in arrears, but I can’t see where that gets a mention in the commission’s report.

But what does concern me is the proposal to ban trailing fees for mortgage brokers. While this has been welcomed in certain sectors, there is a general ignorance of the purpose of trailing fees and how they work. It’s a quirk of human nature that most people have no problem with expenses that are deducted but hate to receive a separate invoice. The classic case is the group certificate. Nobody seems to worry when $20,000 is deducted in tax, but they will scream to high heaven if they are asked to write a cheque for $500 to the tax man.

When the financial services industry was in its infancy the main remuneration was by an upfront commission. The problem with this was that the business had no recurring income and was solely dependent on chasing new business just to stay afloat. This created the problem of how to charge a person who wanted ongoing advice from time to time.

It was unsustainable and eventually upfront commissions were slashed, and a trail fee introduced in lieu. This gave the business a basic income to rely on, while enabling it to provide ongoing service to their clients without issuing a new invoice. This is a different model to say a law office who I am reliably told will charge $49 just to open an email.

I received a great insight into the mortgage broking business last month when I was researching borrowing for the family home. The options were overwhelming, the criteria for loan eligibility was inconsistent and confusing, the loan rate varied from lender to lender and the most suitable lender often turned on whether the borrower could meet certain eligibility criteria. My conclusion was to get a mortgage broker – it’s too hard to do on your own.

A mortgage broker tells me that on a $400,000 loan he would receive an upfront commission of .6%, $2400 paid for by the bank and which could be clawed back if the loan was paid out within three years from establishment. The lender would pay the broker a trail fee of .15%, $600, as compensation for providing advice to the borrower as needed.

This could include advice about moving to a fixed rate, the situation if there was a change of employment, what could happen to the loan if the borrower moved interstate, negotiating a better rate with their existing lender instead of changing banks, and what would be the best way to finance a change in residence, or the acquisition of an investment property.

The Royal Commission has recommended that this system be scrapped, and applicants who wish to use a mortgage broker will have to pay an upfront fee – and if they can’t pay, it could be added to the loan!

Well, you know what’s going to happen. No young couple looking for a loan will be prepared to fork out over $2000 to a mortgage broker to research the market and find out the best deal. Instead, they will go on-line to look for what appears to be the best deal and jump in.

The banks will have a field day. Without a mortgage broker as an intermediary to keep them honest the hapless borrower will be at their mercy. Expect a return to establishment fees, and even more complex products.

When the Royal Commission was taking place the values of bank shares were slashed. It speaks volumes that as soon as the market opened last Tuesday morning bank shares were up around 5%. I rest my case.