April 6, 2018 / 6:33 AM / a year ago

As Australia regulators target broker fees, banks' mortgage business face risk

SYDNEY (Reuters) - Australia’s regulators criticized compensation methods used by lenders to win mortgage business in submissions to a powerful inquiry into financial sector misconduct, potentially leading to changes that could disrupt a major revenue source for the banks.

FILE PHOTO: A man walks past a branch of the Commonwealth Bank of Australia in central Sydney, Australia, February 7, 2018. REUTERS/Daniel Munoz/File Photo

In documents lodged with the judicial inquiry on Thursday, Australia’s banking and corporate regulators said remuneration structures used to reward mortgage brokers for recommending bank products are inherently risky and weaken lending standards.

They took aim at the commissions banks use to reward brokers who recommend their products. So-called trailing commissions rise in line with the size of the loan and are paid over the life of the product, which can be decades.

Any change to the commission structure, which the inquiry may ultimately recommend, would upend how banks attract customers through their vast financial planning and broker networks, potentially disrupting one of their best performing businesses - mortgages.

“A ban on commissions is likely to have a serious impact on the mortgage broker market,” said Azib Khan, a Morgans banking analyst. If the mortgage broker market suffers, the banks, who rely on these networks to source about half of their loans, would instead have to invest in growing their own proprietary networks, Khan added.

The four biggest banks - Commonwealth Bank of Australia (CBA.AX), Westpac Banking Corp (WBC.AX), National Australia Bank (NAB.AX) and Australia and New Zealand Banking Group (ANZ.AX) - derived revenues of A$51.77 billion ($39.8 billion) from mortgage agents in the September quarter of 2017, according to the inquiry.

The Australian Securities and Investments Commission (ASIC) said in its submission a flat fee would help avoid conflicts of interest for the brokers because they would no longer have an incentive to recommend a bigger loan than the customer needed. It would also make it easier to compare fees, it said.

The Australian Prudential Regulation Authority (APRA) said the banks’ reluctance to voluntarily improve lending standards and change their sales incentives had “all led to APRA needing to be more interventionist in its approach to supervision of mortgage lending than it would ordinarily be”.

The submissions were made in response to the first set of findings of a year-long inquiry that found trailing fees created an incentive for brokers to recommend larger loans for longer periods of time.

Trailing commissions have been prevalent in financial sector products of some countries, though their potential for conflicts of interest has been recognized.

In the Netherlands, where the banking system is similar to Australia’s albeit with some differences in the way home loans are sold, broker commissions were banned in the aftermath of the global financial crisis. There, flat fees are paid directly to the brokers by the consumer.

Under questioning by the Royal Commission, as the Australian inquiry is called, CBA and NAB executives conceded that despite the known conflicts, nothing had been done to unwind the broker commission system because the banks would lose market share to rivals if they changed practices first.

NAB and Westpac argued in submissions on Thursday that the upfront and trailing commissions don’t lead to “poor customer outcomes”. CBA said there was “merit” in banning volume-based commissions.

The Royal Commission has extensive powers to subpoena documents and can recommend criminal or civil prosecutions and legislative changes.

Reporting by Paulina Duran in SYDNEY; Editing by Muralikumar Anantharaman

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