Banks defend ‘soft dollar’ and volume-based incentives

The much-anticipated final report from Stephen Sedgwick AO has made a number of recommendations for reform in mortgage broking after identifying “significant risks of mis-selling”.

According to Mr Sedgwick, a number of banks told him during the consultation process that 'soft dollar' and volume based incentives were needed to remain competitive in the third-party channel. 

The Retail Banking Remuneration Review, released yesterday, made 21 recommendations to change remuneration and culture within the banking sector. Six recommendations related to third parties, with a major spotlight on mortgage brokers.

“The work of the Review in respect of third parties has been dominated by issues associated with the remuneration of brokers, aggregators and introducers and referrers in the mortgage market,” Mr Sedgwick said.

“This reflects the tenor of the discussions held with banks. However other third-party relationships considered included some franchise arrangements and other arrangements such as commercial equipment finance brokers, commercial and retail brokers and agribusiness lending,” he said.

“Several factors suggest that there are significant risks of mis-selling attached to current arrangements to remunerate mortgage brokers.”

The report found that banks seeking to increase market share through a sales campaign often improve both the terms and conditions they offer the borrower and the commission they pay the mortgage broker.

“Some banks told me during consultations that they believe they need to offer volume-based incentives to mortgage brokers over and above the upfront and trail commissions to remain competitive,” Mr Sedgwick said.

“Many banks said they need to offer significant ‘soft dollar’ payments to mortgage brokers,” he said.

According to Mr Sedgwick, data presented to the Review during the consultation process (and confirmed in the ASIC Report) shows that mortgages arranged through the broker channel are likely to be larger, paid off more slowly, and more likely to be interest-only loans than those provided to equivalent customers who dealt directly with bank staff.

“A few banks reported during consultations that they had changed (or were intending to change) trail commission arrangements because some customers draw down a larger loan amount than they need, with the surplus being deposited in an offset account or a loan account (i.e. as a redraw amount),” Mr Sedgwick said.

During the consultation period following the publication of Sedgwick’s Issues Paper in January, brokers and aggregators denied that these factors imply an excessive risk of mis-selling, noting that checks and balances are in place to address such risks and that the ultimate responsibility to assess the credit worthiness of the borrower and determine whether to provide a mortgage lies with the relevant bank.

“They note also that the banning of mortgage exit fees in 2011 has facilitated switching between lenders, which provides a simple remedy to a customer who, after taking a loan, discovers that another product better meets their needs. In such a case the trail commission ceases, which mortgage brokers believe is an important disincentive to mis-selling,” Mr Sedgwick said.

While neither ASIC nor the Sedgwick Review has found compelling evidence of systemic harm that would warrant the outright banning of such payments, Mr Sedgwick believes changes still need to be made to current broker remuneration models.

The Review has made the following recommendations regarding mortgage brokers:

Recommendation 16

In respect of remuneration of mortgage brokers:
a. Banks cease the practice of providing volume-based incentives that are additional to upfront and trail commissions;
b. Banks cease non-transparent soft dollar payments in favour of more transparent methods to support training etc.; and
c. Banks cease the practice of increasing the incentives payable to brokers when engaging in sales campaigns

Recommendation 17

Banks adopt, through negotiation with their commercial partners, an ‘end to end’ approach to the governance of mortgage brokers that approximates as closely as possible a holistic approach broadly equivalent to that proposed for the performance management of equivalent retail bank staff

Recommendation 18

Banks adopt approaches to the remuneration of aggregators and mortgage brokers that do not directly link payments to loan size and reflects a holistic approach to performance management (see Recommendation 17):
a. To establish in a timely fashion how best to address Recommendations 17 and 18, banks with a significant recourse to the mortgage broker channel, but at least the four major banks, each to report regularly to ASIC on their progress; and
b. With enhanced oversight by ASIC (and other regulators as necessary) to monitor market responses

Recommendation 19

The independent review proposed under Recommendation 15 or, at the latest, any post implementation review of the operations of the proposed product intervention power for ASIC, examine whether the government should legislate to extend ASIC’s intervention powers to address conflicted remuneration in circumstances in which the industry cannot or does not address Recommendations 16, 17 and 18 adequately without such an intervention

Recommendation 20

In respect of introducers and referrers:
a. Banks examine their governance of these arrangements to ensure that existing practices are appropriate; and
b. ASIC, in due course, investigate whether the upfront commission paid to introducers and referrers is justified

Recommendation 21

Banks that provide products or services through franchisees examine their governance and, as appropriate, remuneration arrangements and seek to make changes that are consistent with the recommendations of this Review.

Obviously aware of the number of reviews and inquiries taking place in the banking sector, Mr Sedgwick was quick to ensure that all 21 recommendations be implemented, and quickly. His first recommendation states that “All banks begin to implement the recommendations in this Report as quickly as systems and other changes can be introduced. If transitional arrangements are necessary, full implementation should be achieved by no later than the performance year that begins in 2020.”

Within hours of the report’s release, ANZ confirmed its commitment to implementing Sedgwick’s recommendations.

“The review also acknowledged the important role of the mortgage broker industry in serving customers and promoting competition. ANZ will work with both the broker industry and relevant regulators to implement the recommendations,” the bank said.

Meanwhile, CBA chief executive Ian Narev said the bank will implement many of the recommendations by 1 July and all changes in place by the following financial year.

More to come. 

[Related: Remuneration report exposes 'inconvenient truth']

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