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Royal commission risks missing mark on deeper issuesADAM CREIGHTONFollow @Adam_Creighton

• 12:00AM FEBRUARY 2, 2019
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On the day the draft report of the royal commission into financial services was released last year, banks’ share prices jumped around 3 per cent. “The banks have gone to the edge of what is permitted, and too often beyond that limit (as a result of) greed — the pursuit of short-term profit at the expense of basic standards of honesty,” the former High Court justice Ken Hayne wrote, adding that “pursuit of profit has trumped consideration of how the profit is made”.

The report was rhetorically damning but investors, it seemed, didn’t see anything that would threaten the lush rivers of gold flowing into the financial services sector, which, at 9 per cent of GDP, is growing and the largest sector of the economy by a big margin.

Release of the final report next Monday afternoon will prompt a deluge of solemn press releases as banks, lobby groups, and politicians whirr into action, all earnestly promising to “rebuild trust”. The royal commission has been a bonanza for lawyers and the booming corporate spin sector, but I’m suspicious much ultimately will change.

The fact Labor has promised in advance of the report’s release to back every one of the recommendations suggests there’s nothing too draconian in it.

Dozens of people would have read chunks of the report. It’s possible the substance of the recommendations has been known for weeks among the big end of town.

To be sure, the commission has taken a toll. Since it was announced on November 30, 2017, Australian banks have shed almost $70 billion in market value. AMP and IOOF aside, though, there’s been no rout; the big four remain highly profitable with few challenges on the horizon.

The underlying causes of the problems brought to light in the royal commission — compulsory superannuation that guarantees inefficiency in funds management, shockingly bad financial literacy among the public, and greed — won’t change.

The big banks have survived multiple reports and inquiries before. The political impetus for reform will abate as memories fade.

What specifically might we expect on Tuesday when markets first respond to the final report? I’m betting shares rally. News that a few individuals have been recommended for prosecution will make good copy, and provide the government with some scalps to parade, but won’t affect the underlying economics of the industry.

Banning trailing commissions (which amount to more than $1bn a year nationally), another likely recommendation, would threaten the jobs of thousands of mortgage brokers who will struggle to survive if they have to charge customers a fee into the thousands of dollars upfront.

But these changes won’t change the underlying demand for mortgages or funds management services, and could even help the biggest financial institutions if customers aren’t able to compare options as easily.

The same could be said for a requirement for clients of financial advisers to opt in every one year rather than two, a rule that emerged from the Future of Financial Advice laws, as one senior finance sector insider expects.

From the teller to the boardroom, rules around remuneration are likely to change too. The 1000-page draft report highlighted how financial targets and incentives had undermined the quality of advice and encouraged negligence. But prescriptive rules will have unintended consequences. Banning “bonuses” might simply lead to higher fixed salaries, for instance.

The big question will be whether Hayne mandates structural separation of banks from wealth management or adviser groups. That would have serious implications. Smaller, nimbler, more genuinely competitive financial institutions would be in customers’ interests, but not the industry’s. Regulators are sure to receive another wrap over the knuckles, perhaps alongside a recommendation for more or greater powers.

APRA and especially ASIC rightly came under particular fire in the draft report for their lax approach to enforcing existing laws. Indeed, over the decade to June 2018, ASIC’s infringement notices to the major banks totalled less than $1.3 million. Yet more powers won’t change the incentives of regulators to enforce laws. The cosy relationships between regulators and financial institutions is difficult to unravel. Regulators will still face the threat of missing out on lucrative jobs and board seats if they rock the boat.

Even if the recommendations are tougher than expected, don’t underestimate the ability of the financial sector to resist them. Recall the world suffered a devastating financial crisis a decade ago yet financial services barely changed. Last year the Coalition government failed even to change the composition of boards’ positions on superannuation funds — a minor tweak in the big scheme of things.

Federal Treasurer Josh Frydenberg will come under significant political pressure to adopt all the recommendations, as Labor has done, not least because anything less than effusive endorsement might remind voters the Coalition fought hard not to have a royal commission in the first place.

Whatever happens next week, expect lots of earnest calls to “restore trust”, which, conveniently for the sector and the political class, can’t be measured.

ADAM CREIGHTON

ECONOMICS EDITOR

Adam Creighton is an award-winning economics journalist with a special interest in tax and financial policy. He spent most of 2016 at the Wall Street Journal in Washington DC. He won the Citi Journalism Award f... Read more