The financial market's verdict on the Australian Banking Commission's report into misconduct in the sector was a large rally in bank shares.
There was widespread relief that the recommendations will not hit bank profits, beyond the relatively modest costs of client compensation and other remedies already factored into forecast earnings.
But, in truth, this is a missed opportunity for a much-needed root-and-branch reform of Australia's over-concentrated banking sector. The power of over-mighty banks, which exploited customers relentlessly, has been largely left in place. The report offers catharsis to the victims, but it fails to address the underlying issues.
In more than a year of sometimes riveting televised hearings, Commissioner Kenneth Hayne, a former High Court judge, examined predatory lending, poor risk management, commission-driven sales cultures, inadequacies in dealing with customer complaints and regulatory failures.
The report outlines six principles to guide future behavior: obeying the law, avoiding misleading conduct, acting fairly, providing services fit for purpose, delivering services with reasonable care and skill, and acting in the best interests of clients.
But, despite its well-intentioned concern about culture, the report makes little effort to define or measure these terms.
Worse, these proposals ultimately deal with the symptoms of the industry's malaise, not the fundamental causes. The commission's full name gives the game away -- it is the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (my italics). It should simply have been the Royal Commission into the Banking, Superannuation and Financial Services Industry.
The first and biggest problem is that, financial services, especially banking, is large and highly concentrated.
The market capitalization of the four major banks, among the largest Australian listed companies, is approximately 360 billion Australian dollars, a quarter of the stock market's total value. Total assets are A$3.6 trillion, around double gross domestic product. The compensation costs arising from the misconduct scandal -- estimated at A$6 billion -- are just a fifth of annual profits of over A$30 billion.
Australian lenders are among the most profitable banks globally, measured on return on equity. As of 2016, Australian bank profits equaled 2.9% of gross domestic product, the highest among major economies. This compares to 1.2% in the U.S., 1.4% in Japan and 0.9% in the U.K.
The market share of the largest five banks is over 80%; only lenders in Canada, Sweden and the Netherlands are higher. The figure is around 40% in the U.S., Germany and the U.K. and slightly higher in Japan and France.
The oligopolistic structure is not accidental. While deregulation, beginning in the 1980s, was beneficial in removing credit rationing and improving customer choice, it did not increase competition. The authorities allowed consolidation, arguing that larger banks were stronger and easier to regulate, a policy criticized in a recent report by the government's Productivity Commission.
The dominant banks exercise significant market power. This is particularly true for personal finance, as over 60% of loans are residential mortgages, the world's highest proportion. The banking report does not make any recommendations regarding the overconcentration which pave the way for misconduct. It does not address the pricing of financial services.
Next, conflicts of interest result from a vertically-integrated banking model, where firms manufacture, sell and advise on their own products. There is an incentive to promote an institution's own products and services, especially those with high fees and sales commissions.
The industry has long resisted any legal requirement to act in the best interests of clients. Despite specifically identifying conflict of interest and greed as key causes of misconduct, the report does not make any recommendation on separating product sales and advice. Other than proposing bans on some commissions paid to mortgage brokers and financial advisers, there is little that targets remuneration practices with underlying conflicts of interest.
The Commission does little to address pay issues in general. The report adopts the generous recommendations on bankers' pay put forward in a report commissioned by banks themselves via the industry lobby group -- the Australian Bankers' Association. Given the Commission's concern about conflicts of interest, this is puzzling.
Third, the principal regulators are under-resourced and underpaid, making it difficult to attract and retain experts. Political interference, driven by high-level lobbying by donors to political parties, inhibits enforcement. Fearful of unsuccessful high-profile prosecutions, regulators favor negotiated settlements.
The Royal Commission seeks additional powers for existing regulators ignoring its own concerns about enforcement and creates a super regulator to oversee existing bodies. But this will not correct the underlying weaknesses.
Fourth, the regulatory approach emphasizes nonintrusive rules. A caveat emptor (buyer beware) system relies on disclosure to protect consumers. The risks disclosed, usually in lengthy legalese, are often incomprehensible. Customers are left with little choice but to accept the terms dictated to them. The Royal Commission does not address these issues.
Fifth, deregulation underestimates the problems of combining financially illiterate customers needing simple savings accounts, loans and risk management products with incentives for bankers to sell other, high-risk, services. Banks answerable to shareholders seek to maximize profits and employee earnings by subordinating client best interests. The report provides no basis to think this will change.
The Banking Royal Commission failed because its terms of reference were too narrow. The inquiry was led by a judge without specialist knowledge. It was run by and for lawyers, with the legal fees for the Commission and participants totaling several hundred million dollars. While counsel assisting the enquiry gained celebrity status for publicly humiliating senior bankers and forcing resignations, it did little to direct focus to structural issues. The Commission did not hire independent financial experts to assist its deliberations.
With a parliamentary election imminent, government and opposition have accepted the report's recommendations. Neither side wants this to be a campaign issue.
History indicates that lobbying by the financial sector may delay and limit implementation.
The industry's arguments are obvious. Action limiting credit supply will damage an already weak housing market. Extra regulatory oversight will increase costs. Personal liability for senior executives and restricting performance-linked remuneration will make talent difficult to attract and decrease competition.
Given the extreme brevity of financial memories, it would be surprising if misconduct does not again rear its ugly head. The Royal Commission is a missed opportunity to deal with the real issues.
Satyajit Das is a former banker. His latest book is 'A Banquet of Consequences' (published in North America as The Age of Stagnation). He is also the author of Extreme Money and Traders, Guns & Money.