The Financial System Inquiry released its interim report in July, and is now seeking a second round of submissions.
The interim report asks: “Is vertical integration of mortgage brokers distorting the way in which mortgage brokers direct borrowers to lenders?”
Perhaps it is the way in which the question is phrased, but the significance of the question is unclear.
Presumably, the interim report is attempting to address concerns around market control, lack of competitiveness and consumer disadvantage.
However, it is the wrong question to ask.
If the question is intended to address issues of lack of competitiveness in the mortgage lending space, the answer to that question is clear and simple. No. The market is not a competitive one.
This ‘competitive’ claim can only be made when all market participants enjoy the same market conditions. However this market neutrality does not exist. The big four plus Macquarie, also known as the too-big-to-fail banks, enjoy a substantially significant advantage over both securitised funders as well as even other smaller banks.
The funding cost advantage that the too-big-to-fail banks receive over their smaller counterparts for providing a government guarantee is in the order of 25 basis points according to the IMF – all subsidised by the taxpayer. This allows them to provide cheaper loans, which reduces the profitability of smaller banks not able to enjoy the same advantage provided by government. These banks become less profitable, which makes them targets for the too-big-to-fail banks to purchase – as CBA did with Bankwest. Too-big-to-fail banks also qualify for the internal ratings-based approach of regulatory capital management, which essentially allows them to enjoy less onerous capital allocation requirements than their competitors – with many estimates being less than half.
However, given the interim report states that it believes the banking system is competitive (despite the above facts), and that the market concentration is the result of market competition and efficiency, it is likely the real question is something else.
According to the MFAA, the big four have held an 80 per cent share of the home loan market since the GFC. This dominance is largely a result of the combination of government-subsidised and natural advantages that their operating abilities permit.
Banks are product providers. They own aggregation networks. They own broker groups (CBA ownership of Aussie Home Loans). They own wholesale product providers (NAB ownership of Advantedge). Big four banks totally or substantially own 40 per cent of all broker distribution networks. Even more alarmingly, they also own 70 per cent of the non-bank origination market.
The too-big-to-fail banks control the mortgage industry for these reasons. But more than any other reason, they control the industry mainly because they pay brokers’ commissions.
The question the interim report should have asked is whether there is a disadvantage to consumers as a result of this lessening competition and market control. And once again, the answer is yes.
How is it good for consumers when banks own aggregation networks? Banks can then control which lenders are permitted on the aggregation panel, the commissions paid to the broker, and gain an advantage over its competitors by way of permitting a legal way of gathering what would otherwise be highly protected market intelligence (such as product success, pricing initiatives, sales training and so on).
When banks own wholesale funders, they control the profit margin, allowing them to push up delivery rates and ensuring their own bank-priced products are cheaper and thus more in demand. That particular market threat is thus removed.
For borrowers, and for brokers, the answer to ensuring real continued competition lies in the establishment of a broker-owned union.
This union would be both an aggregator, as well as a white-labeled funder, raising its own funds via securitisation. As aggregator, it would offer 100 per cent commission pass-through; as a securitised funder, it would offer the cheapest white-labeled loans. But more than this, it would hand back control to the brokers, with banks being forced to negotiate with the union due to its sheer size and reliance on broker distribution networks for continued profitability. (This will be discussed in detail in my next blog.)
In the absence of a pragmatic broker representative body such as this, the only real solution is the introduction of a fee-for-service model. Brokers would collect their own fees, making aggregators redundant (and thus bank-ownership redundant), as well as allowing 100 per cent fee retention. All lenders and banks would be open to the broker and borrower, including the discounted online platforms. Brokers would likely need to evolve into offering a broader range of services and micro-manage their clients. However, the inefficiency and poor staff levels at banks are not difficult to compete with.
The future lies in the hands of the broker.