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A Banking Regime Steeped in Inefficiency

A Banking Regime Steeped in Inefficiency

“WHEREAS Australia has one of the strongest and most stable banking, superannuation and financial services industries in the world, which performs a critical role in underpinning the Australian economy.

AND Australia's banking system is systemically strong with internationally recognised and world's best prudential regulation and oversight.” 

Preamble to the Letters Patent for the Hayne Royal Commission, 14 December 2017 

By Dr. Evan Jones

The chutzpah behind this absurd characterisation is a scandal, but utterly representative of the dereliction of capacity and of integrity among the political class.

Back in the real world, it all goes on behind the scenes.

A bank lender cynically or fraudulently defaults a borrower (small business, farmer, mortgagor). The loan facilities may have been the result of predatory lending in the first place. It calls in the mercenaries (valuers, lawyers, receivers, etc.) who proceed to destroy the borrower’s business and the borrowers themselves. This is a straightforward if extended process. It is a practice repeated day after day but nobody in authority seeks to know about it.

The resources and energies consumed in dealing with foul play

With their businesses down the tubes, the immediate response of those defaulted is to fight back, to complain to the regulatory authorities, etc. This process begins with hopes for a short duration, but it proceeds indefinitely. In the meantime, the victim will probably have been deprived of their residence and of the bulk of what financial assets remain. They will be surviving on a pittance courtesy of Centrelink/pension and/or relatives.

The foreclosed small business people and farming families are lost to the much-vaunted ‘entrepreneurial class’, for the medium term and probably forever. They are reduced to trying to survive financially and emotionally, fighting their oppressor and its accomplices, breaking up with their families, perhaps killing themselves. There is associated long-term trauma. Their energy and their contribution are hitherto lost to the economy and society. Then comes the ancillary expenses of doctors, psychiatrists and social workers.

The financial regulatory agencies (especially ASIC and APRA) will do nothing in these particular domains, but such agencies are financed at considerable public expense to effect this diversionary non-task.
Some victims will try litigation in the court system, which is already stuffed full of bank litigation. The typical bank victim will face mountainous legal expenses which they can’t afford. The court system is run at enormous public expense.

Banks insure against bad debts and associated expenses, but if the bad debts have been fraudulently created, the insurance payouts are themselves a drain on insurance sector balance sheets. Banks obtain tax write-offs for bad debts, but if the bad debts have been fraudulently created, those write-offs are a fraud on the public purse.

The banks themselves, after considerable external pressure, have established well-staffed ‘customer advocate’ centres which generally devote themselves, in a drawn-out process, to trying to demonstrate to victims that they are responsible for their own demise. Occasionally the odd desultory settlement is granted to the victim. Additional costs to banks’ bottom line.

The banks funded the now replaced Financial Ombudsman Service, and the finance sector funds the amalgamated single ombudsman AFCA. FOS was incompetent at best, complicit with its funders at worse. AFCA, overwhelmed with complaints, may possibly be less openly complicit, but one predicts that the end result will be little better than for FOS. More expense involved in supposedly cleaning up (heading off ) past incompetent and/or corrupt practices.

Parliamentary committee inquiries on the latest scandal are being held on a near-permanent basis, at considerable expense. There was the sector-specific Murray inquiry, of which below. Add the 2018 Hayne Royal Commission itself, at whopping expense. With very marginal enlightenment and change at best – hence my critical response to Hayne’s Final Report. The reality is encased in minute detail in submissions from victims to these inquiries/Commission, but nobody in authority reads them.

Parliaments consume resources in drafting bills and passing legislation oriented to financial sector reforms, with great fanfare. The orientation is mostly to retail banking – even there not much changes in practice. Even when the legislation atypically has formal teeth, it may lie fallow in being ignored (witness ASIC’s post 2001 responsibility for business to business unconscionable conduct in financial services, encased in the ASIC Act s12CB and s12CC – see my submission, Sub #295, attachment 2, to the Senate 2014 ASIC inquiry).

Formally significant, a package of measures passed the Senate in February 2019 to dramatically increase the penalties for white collar crime. “The new regime will increase the maximum prison penalties to 15 years for the most serious corporate offences … The old penalties carried a five-year maximum prison sentence.” But the problem is not the strength of the penalties but whether they will ever be applied. When was a senior bank executive gaoled for five minutes leave alone five years? The legal experts still have to work out how hold individuals responsible for crimes of the corporations over which they preside. I’ve believe it when I see it.

People associated with the finance sector throw regular conferences, at which bigshots attend and make presentations, some mouthing concerns about dysfunctional cultures. Save for the hypersensitive David Murray who takes the ‘liberate market forces’ dictum to its limits and who thinks that dysfunctional bank culture is not something regulators or politicians should concern themselves with – c/f an April 2016 AFR article, ‘David Murray lashes regulators on culture crackdown’. These conferences are dutifully reported in all seriousness by the business media. But nothing substantive happens. Thus a lot of highly-paid bizoids and regulators have wasted previous time – unless, that is, public relations is really what the game is about. But the public interest?

What all this ‘activity’ amounts to is a serious consumption of resources, much of them public, to no ultimate avail. It is almost entirely all window dressing.

What this edifice amounts to is thus a hugely inefficient system – a system staggeringly inefficient. The point? If the banks had done the right thing in the first place, little of this panoply of institutional attempted clean-up would be necessary.

Let us return to the large-scale 2014 Financial System Inquiry to highlight how deeply entrenched is the gap between rhetoric and reality.

The Murray Financial System Inquiry as exemplar of the problem

Enter the late 2013 Abbott/Hockey-initiated Financial System Inquiry, which was supposed to be a ‘root and branch’ investigation into the financial system. It wasn’t. In the government response two years later, ScoMo as Treasurer claimed that his measures would “help to deliver a financial system that is resilient, efficient and fair”. They didn’t help, because fairness was off the agenda.

What could one expect from the installation as head of that inquiry one David Murray who, more than any other individual (in conjunction with Treasurer/Prime Minister Keating’s CBA privatisation), was responsible for dismantling any public interest residual in the CBA and replacing it with the singular profit imperative, creating the base from which rose the CBA’s embedded culture of corruption. On Murray and the CBA see my 2012 The Dark Side of the Commonwealth Bank’.

The Murray review did recommend the banning of ‘unfair terms in standard contracts’ in SME loan contracts – a desirable move (and subsequently legislated). But the recommendation lacks context. A token gesture?

The review displayed no interest in why such unfair terms were in contracts in the first place. Or, with the prospects of an unchanged culture in banking, why banks wouldn’t continue to employ such terms (who will be checking?) or merely find alternative means to unconscionable/fraudulent default (as in discretionary devaluation of customer assets held as security).

In passing, the review notes: ‘The Inquiry also encourages the banking industry to adjust its codes of practice, to require banks to give borrowers sufficient notice of an intention to enforce contract terms and give borrowers time to source alternative financing.’ (Final Report p.283) This has the character of a throwaway line, scandalously indifferent to malicious bank practice, the charade that is the Code of Banking Practice, and the certainty that the banks will continue to employ the non-renewal of facilities to their advantage.

My August 2014 submission to the FSI Interim Report highlighted in detail the problems surrounding bank lenders and SME/farmer borrowers. The content of that submission was ignored in the Final Report, exposing the fact that the Murray cabal purposely and strategically ignored the corruption that is endemic in SME/farmer lending and subsequent default/foreclosure. That is a scandal in itself, but par for the course.

It is telling that Murray was thus quoted (March 2015): ‘There was no need for a royal commission "unless there's criminality … Otherwise there's probably no distinct benefit."’ Unless there’s criminality? Murray, the well-established insider, the man who oversaw the unconscionable refashioning of Commonwealth Development Bank borrower contracts as means to their default in the mid-1990s, professes to know nothing. Then why do the authorities and the media treat this man with respect and continue to seek his (worthless) opinion? They all become part of the problem.

More, if one promises ‘fairness’ but one declines to bother about how it is to be implanted in banking practice, then the much-vaunted prospect of improvements in system ‘efficiency’ flies out the window as well, with all the associated dimensions of inefficiency as outlined above. It is clear that the establishment’s formal concern for sectoral ‘efficiency’ is itself hollow – a charade.

The Productivity Commission

Note that we have an official think tank, the Productivity Commission (PC), whose brief is all-encompassing. There is no other outfit like it in the world, such is its mandate. As its name implies, its central brief is to dig deep, discover inefficiencies wherever they are lurking and provide strong recommendations towards their eradication.

In May 2017, Prime Minister Scott Morrison (under pressure on the banking front) solicited a report from the PC on competition in the Australian Financial System. Its brief was determined as:

The Productivity Commission will look at how to improve consumer outcomes, the productivity and international competitiveness of the financial system and economy more broadly, and support financial system innovation, while balancing financial stability objectives.

The formal intent was to not merely enhance the efficiency of the financial system but, through the centrality of the financial system, the efficiency of the economy in general. A noble idea in principle.

The PC delivered its very fat report in June 2018.

The report desirably highlighted significant failings, with myriad financial products badly designed, opaquely labelled, sold to the wrong people and/or at inflated prices, and so on. But a key means to a solution for these maladies (p.69)?

By allowing more efficient firms to enter financial product markets and gain market share, at the expense of firms that are less efficient or less focused on consumer needs, competition can lead to community-wide improvements.

This claim is utterly puerile, product of a priori textbook learning. In practice, it’s the strongest that survive rather than the most efficient.

At root, it is strange that this PC inquiry should be delving into means of enhancing competition when ‘competition’ was supposed to be the Great White Hope of financial deregulation. The vision of competition (its meaning never articulated)) as the magic potion was central to the 1981 Campbell Report – the bible for subsequent financial deregulation. Liberating the powerful and cleansing forces of competition from the dead weight of Post-World War II regulations and restrictions was supposed to produce the best of all possible worlds.

Strange then that after comprehensive deregulation decades ago, the authorities should still be mulling over ways to enhance competition. The comprehensive tolerance by the competition authority (the Trade Practices Commission, after 1996 the ACCC), under successive Chairmen, of bank takeovers and mergers has been ignored. Ditto the integration of banking and ‘wealth management’ arenas, legitimised by the 1997 Wallis Report, and iconically represented by the CBA purchase of Colonial in 2000 – a move that further consolidated the power of the Big 4 banks.

The problem lies with the PC mindset, which hasn’t evolved since its birth as the Industries Assistance (sic) Commission in 1974. When Labor was elected in 1983, there was pressure from Left Labor and the unions to have the IAC dismantled. Hawke established an inquiry under industrialist John Uhrig. Uhrig caved in in the end, but the report (Review of the Industries Assistance Commission, 1984) documented well the faults in the IAC’s modus operandi. The PC’s self-congratulatory history of itself (From Industry Assistance to Productivity, 2003) naturally distorts the record of this inquiry. I had dinner recently with an ex-student who had worked at the IAC in the mid-1980s. He noted that the ‘line’ was already established before any inquiry was begun and the report issued; any staffer who deviated from the line was marginalised.

The Hawke/Keating government not merely kept the organisation as is but reinforced its ideological purity and extended its brief into government enterprises and public services after refashioning the IAC into the Industry Commission in 1990. Prime Minister Howard gave the beast its present name, while simultaneously dismantling several think thanks that weren’t as ideologically purist.

This PC competition report is further evidence that the PC consults only like-minded groups and individuals – that is, within the establishment loop. It’s an inbred community, socialised to not merely ignore the essence of the problem but, in so doing, to be thus part of the problem.

It is telling that PC staff had the opportunity to open the door. Thus, the report cites the Australian Small Business and Family Enterprise Ombudsman (launched in early 2016 by the Turnbull government under pressure), which is part of officialdom but has unexpectedly toed a relatively independent line. But the report fails to follow ASBFEO’s discordant stance down the track. The Report also acknowledges the 2016 Joint Parliamentary inquiry into ‘The impairment of customer loans’ (p.441), but similarly fails to pursue the implications of the evident bank malpractice exposed in that inquiry.

Following establishment fashion, the PC imagines that bank misdemeanours will be simply rectified with the latest revision to the Code of Banking Practice (joke). Ditto with the recent addition of the ‘unfair contract’ provisions to consumer law (following the Murray FSI) and the monitoring of lending contracts (p.455). Certainly, the attempt to rein in unfair contract provisions is long overdue, but it remains a partial exercise (overdrafts are still repayable at call, providing fundamental leverage for bank malpractice). Fundamentally, one can’t trust the integrity of any monitoring process (is it happening? who is doing it?) while nobody in authority concerns themselves with the entrenched culture conducive to malpractice and the myriad devices which are perennially being devised and employed towards that end. The PC just doesn’t want to know.

The present banking system not fit for purpose

The fundamental problem is that the banking system as is presently structured is not fit for purpose.

The present system is a product of the neoliberal age, leveraged on the neoliberal 1981 Campbell Report. Everyone now in positions of authority, whether in the private banking sector itself or the public arena of politics and regulation, is either a progenitor or a product of that era. No-one wants to think in terms of what financial system we might want from first principles – this in spite of a handful of post-Campbell inquiries (Martin 1991, Wallis 1997, Murray 2014) that were purportedly oriented to ‘the big picture’. Everything is tinkering around the edges, with the Coalition introducing pragmatic measures under pressure, and all pushing for a more resolute application of structures (essentially the existing system of self-regulation) that have already demonstrably failed.

The Campbell Report itself didn’t come from nowhere. The Committee Chair Keith Campbell was then Chairman of Hooker Corporation. In the mid-1970s he was financing market raiders, part of the new ‘restless breed’ who indulged in the unprecedented pursuit of hostile takeovers with reckless borrowing. Campbell’s essential pursuit was in real estate, with no history of concern for the ‘public interest’. Why would such a man be chosen to head such a crucial inquiry? However, the key monetary authorities (Reserve Bank, Treasury) were integral constituents of a synchronised deregulatory cabal.

Trevor Sykes’ magisterial The Bold Riders (1994, updated 1996) outlines in fine detail the craziness that dominated the Australian corporate sector in the 1970s and 1980s, fuelled by financial institution intemperance and, in turn, facilitated by unthinking financial deregulation.

Although not systematic, in the process Sykes highlights a complementary crazy development in the domain of savings banks – long custodians of a narrowly proscribed function and associated probity. The savings bank field was opened to the private trading banks in 1956, no doubt product of the bank lobby that had coagulated under the Australian Banking Association after the trading bank’s successful battle against Chifley’s attempted bank nationalisation in the late 1940s. This development (with the subsequent bank acquisition of hire purchase / finance companies) lay at the beginning of the dismantlement of specialist financial institutions and the ultimate establishment of the Big 4 banks as allfinanz institutions by the 2000s – with all its inbuilt flaws.

Sykes also highlights the important role of State Labor governments (Victoria, South Australia, Western Australia, NSW). They wanted to leverage their hallowed public savings banks for broader purposes in the pursuit of State-based development projects. Post-Campbell financial deregulation provided de facto legitimation for these questionable ambitions. Sykes’ Bold Riders has two masterly chapters on the debacle that ensued with the SBSA (Ch.15) and the SSBV via its merchant bank subsidiary Tricontinental (Ch.14).

It is instructive that in the staged process of the full privatisation of the Commonwealth Bank (and the dismantlement of its small business/farmer subsidiary Commonwealth Development Bank), the political class (National Party members included) pointed to the debacles amongst the State savings banks to claim that one couldn’t have public banking institutions because the field made it intrinsically unsuitable for public authority management. The hundred years plus or minus of previous public savings bank history had been obliterated from the consciousness of those we elect to run the country in the public interest.

The point is that nobody in authority is asking the fundamental questions of what functions we want a finance sector to serve and what institutions will serve those ends – and it gets worse with each passing decade. Market forces rule, should rule, and there is no role for public involvement in the setting of finance sector priorities and in the direction of credit in particular.

The issue is particularly piquant for federal Labor, which is currently far more progressive (at least in promises) than the useless Coalition. It has to confront, when returned to office, that it has to repudiate the sacrosanctness of the ‘holy’ years of Hawke and Keating – a point I made in a letter to some new Labor stars in February 2019.

Back to the Productivity Commission report on competition in financial services

The PC report desirably devotes a chapter to SME finance (Ch.16). This chapter is entirely consistent with the point above – the absence of consideration of the big picture.

The PC does at least emphasise one important failure of the current regulatory regime. APRA has imposed on bank lending to SMEs a higher risk weight than is required under Basel or demanded by other central banks. Thus the APRA imposition further enhances bank distaste for SME lending and further enhances its attraction to home mortgage lending.

Prudential capital requirements in their first phase were neutral across a bank’s lending portfolio. Subsequent Basel stages involved refinements that imposed varying weights on different lending classes, notably favouring home lending. Thus a regulatory vehicle (indeed the only one) to ensure bank system stability was now indirectly heavily influencing lending portfolio decisions. And in the process heavily distorting the housing market (in conjunction with ridiculously low interest rates issuing from the Reserve Bank bereft of intelligent and instrumental capacity to influence the overall level of economic activity).

This is the neoliberal model at work – competition as the universal elixir plus prudential regulation for system stability (i.e. to inhibit the universally admired competitive impulse from having adverse effects – but don’t look for the anomaly in that coupling). Innate in the model is that the private sector will determine lending priorities, but in practice risk-weighted prudential ratios is also contributing an indirect impact.

The PC is desirably recommending that APRA gets with international best practice on SME lending risk weighting. However, it doesn’t question whether bank SME rate pricing is rational or merely exploitative. More, the PC doesn’t question the worth of the basic model itself, in spite of over three decades of failures. On the contrary, the PC and the regulatory and political establishment see the institutions of the post-Campbell era as an outstanding success – supposedly facilitating a robust Australian economy since the early 1990s.

Regarding options, the PC has its prejudices which will not be shaken.

There is the notable issue of the prospect of government-owned banks. The PC sees no need, indeed only dangers (p.94ff). It replicates the Campbell Report dicta, as well as reminding readers of the failures of the State government-owned banks post-deregulation (as per above). It also cites itself in support of its own prejudices.

The PC consulted with New Zealand’s Kiwibank but appears to have found nothing of interest, even though the bank’s ongoing viability (it was established in 2001) evidently has something to offer. The PC has evidently never heard of the KfW bank, established in 1948 to facilitate (West) German economic recovery and possibly the most famous government-owned bank in the world. It is 70 years old and still going strong. Nothing to learn here?

There is also the issue of a possible credit guarantee scheme for SME lending. The PC is predictably opposed to this idea (p.455). In a 2015 inquiry report, Business Set-up, Transfer and Closure, the PC found such schemes “were distortive and inefficient. They transferred risks from private parties to taxpayers and could dissuade lenders from undertaking sufficient monitoring and vetting when making loans …”.

Certainly such an idea is outside of left field for Australia. The 2015 PC report cites academic literature – as ever, ‘rigorous’ in its research. It is interesting that this literature is ambiguous in its findings yet the PC infers a net negative outcome.

The PC goes on and on about the potential ‘distortions and inefficiencies’ from government involvement, citing as authorities the usual suspects (e.g. the OECD), but this ‘reasoning’ derives essentially from a priori abstract principles – private sector good, public sector bad.

More, the PC can’t confront that lenders, driven by private sector imperatives, already systematically refrain ‘from undertaking sufficient monitoring and vetting when making loans’ because they take customer assets as security for the loans – a practice which the PC in turn sees as ‘rational’ because it supposedly enhances self-discipline on the part of the SME borrower.

The 2015 PC report also cites positively the US Small Business Investment Company Program, an investment fund that provides capital to SMEs, albeit it ignores the prospects for an Australian application. More fundamentally, behind the SBIC is the US Small Business Administration, which administers the SBIC and provides guarantees. The US SBA was established in 1953 and is a multi-billion dollar organisation. And this in the heart of the so-called pinnacle of the ‘free enterprise system’! Yet the PC ignores the SBA in its totality.

Why?

The PC commands the heights of official ‘expertise’ in Australia. But because the PC is so purist (even by global standards), governments (rather than abolishing the PC, because they are too cowardly) will often ignore it. As a consequence, government actions are perennially pragmatic because they are deprived of big picture framework necessary to give them substance and coherence. Thus, bizarrely, we have Prime Minister Scott Morrison, on the campaign trail, promising a $100 SME investment fund, comparable to the US SBIC!

Thus the PC, given its dominance of official think tank advice coupled with its pre-ordained agenda, is a major source of nation-wide inefficiency in its own right.

The private sector and the regulators travel down old paths

On the private sector front, the CBA, facing the necessity to do something to atone for its sins (those publicised, only a small proportion of the totality), has decided to retrench 10,000 plus staff from its workforce. To facilitate the process towards a ‘simpler, better bank’, CEO Comyn has decided to call in McKinsey (Glascow & Lacy, ‘McKinsey busy with CBA cuts’, The Australian 13 April 2019; behind paywall). Comyn’s head of retail banking Angus Sullivan is also ex-McKinsey.

The Australian article calls it a ‘transformation project’. Sure. We’ve seen this caper before, and efficiencies gains are far from being guaranteed – on the contrary. No doubt the branch network will again be under threat.

Especially if McKinsey or their ilk are involved, from whom one can expect a destructive project that takes years to clean up – as I have previously documented with the McKinsey experience in bank consultation.

ASIC’s James Shipton has also brought in McKinsey (a tidy $1.1 million expense) to advise on ASIC’s placement of operatives inside the banks (Glascow & Lacy, Margin Call, The Australian, 17 April; behind paywall).

There is no history of McKinsey understanding the means to better customer service. There is definitely no record of McKinsey understanding the banking sector’s tendency to malpractice. Good money down the drain – going through the motions?

As for the post-Hayne adoption by ASIC of the placing of an ASIC operative or two inside the banks, there appears to have been little to no public exposure of any investigation by Australian authorities in the experience of such a practice in the US. The US Office of the Comptroller of the Currency has long had multiple OCC staffers inside the big US banks. To what ultimate effect? What were these staffers doing when the nefarious practices leading to the catastrophic GFC were playing out? We await with interest an audit of this experiment down under down the track.

Two worlds

There is the world of officialdom – the political class, the regulators, the experts – whose personnel listen only to each other. All the players are respectable, the banking system is generally working well and any deficiencies can be readily ameliorated.

There is another world comprising the criminals and the victims. The world of officialdom doesn’t recognise what goes on in this underworld. Ditto the mainstream media, in spite of its disclosures but those disclosures are bounded. The corruption and the problems therein are not being acknowledged and addressed.

The banks, as large-scale enterprises, straddle both worlds. To what extent those two worlds interact inside those institutions is unknown but is of some public significance. The underworld component of the banking sector, with trivial exceptions like rogue financial planners, is well hidden from the public eye.

There is an anomaly in that the ASBFEO straddles both worlds. In operation under Kate Carnell, ASBFEO has proved to be more independent than no doubt the Coalition desired; it has become a positive force for SME support. However, its brief is all-encompassing and its ability to alter the balance of forces in the banking sphere between bank lenders and SME/farmer borrowers is at present limited.

For the world of officialdom, the underworld simply doesn’t exist. It is an omission staggering in its scale, and thus in its duplicity. Which omission of course draws the frustration, despair and fury of bank victims everywhere.

Hence the current role of bank victim groupings and their out-front advocates. They are knocking on doors, being ‘in your face’ – cracking open the self-enclosed world of officialdom. In the post-Hayne environment, senior bankers, senior politicians are being forced to respond in some tangible form.

There is still a very long way to go. But a large-scale exposure of two key props of banking sector malpractice is a necessity. Those two props?

First, the corrupt cabal of law firms/valuers/receivers/etc. This mob should have been included in the Banking Royal Commission’s Terms of Reference. As demanded by the victims, one needs a second Royal Commission to expose (and remedy) their sins.

Second, the complicity of the judiciary itself in favouring bank lenders over borrowers in bank litigation – the issue is elaborated in my recent submission to the ‘Resolution of disputes with financial service providers within the justice system Inquiry’. We’ll be dead before the law of contract, judicial culture and the court system are each reformed so that justice will truly be served. But highlighting the integral role of banking law and the courts in maintaining the current iniquitous system of injustice is an important first step towards confronting this deeply entrenched problem.

Last modified onMonday, 06 May 2019 02:58

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