THE IMPECCABLE SYSTEM
The top brass at National Australia Bank had the paperwork all ready to go.
It was early September 2018, and a steady stream of embarrassments unveiled by the royal commission over the past six months had kept pressure on the banks to keep their home loan rates as low as possible—for as long as was needed to help repair their reputations.
There was no way they could once again hit the hip pockets of their long-suffering customers at the same time as they were fending off accusations that they had been stealing from the dead. But the sector was feeling the squeeze. The cost of funding on the international money markets was rising and beginning to eat away at their profit margins.
The big Australian banks get much of their lifeblood from tapping into international funding markets. There they are lent money, which in turn allows them to lend money out to local borrowers. Since the ascension of Donald Trump to the White House in late 2016, the cost of sourcing those funds had dramatically increased. Under the strain of a determined march by the US Federal Reserve towards higher official interest rates, the price of money was rising the world over, and Australia was not immune.
In the balancing act of the price NAB paid for money coming into the company versus the cost at which it chose to lend it out, the short straw was going to be drawn by local home-loan borrowers. Customers would have to pay more.
Luckily for NAB, Westpac had already done the hard yards. Just weeks earlier, Westpac boss Brian Hartzer had bitten the bullet and fronted the nightly TV news bulletins to tell borrowers they’d have to pay more for their monthly home loan lest the bank’s profits be impacted. ‘That started going up in February,’ he said, pointing to the bank’s funding costs. ‘We were hoping that it would go back down, but it hasn’t and, after six months at a sustained level, we’ve reluctantly concluded that it’s going to stay at that more elevated rate. Therefore we came to the conclusion that that needed to be reflected in the price of our loans.’
While customers groaned, the rest of the major-bank chief executives sighed with relief. When one institution breaks ranks and foists higher interest rates on customers, it provides cover for the rest to follow. Rod Sims, the chairman of the competition watchdog, calls it ‘synchronised swimming’—behaviour more suited to lemmings than Australia’s most powerful corporations. It’s a pool routine well known to Australian borrowers. For decades the big four have waited for one lender to stick its head out and raise rates, only to then follow in quick succession.
By midday on Thursday 6 September, a week after Westpac had first hiked its rates, ANZ and Commonwealth Bank had announced within hours of one another that they’d be swimming the same stroke. Thus the stage was set for NAB, and instructions had been sent out internally to bring together the paperwork to make a rates announcement of their own.
The Melbourne-based bank, the smallest of the big four, was always going to wait until last. The month before, it had been dragged through a torturous round of public hearings at the royal commission, where it was accused of deliberately misleading regulators over the size of its $100 million fees-for-no-service scandal, and its executives were singled out for acting in contempt of the law. NAB boss Andrew Thorburn had already been forced to publicly apologise for the behaviour of the bank’s most senior executives, whose attempts to run circles around the corporate watchdog had been painfully aired at the public hearings.
With the blame for rising mortgage rates now squarely on the shoulders of Westpac, NAB was readying itself to sneak out its own mortgage hikes and salvage its threatened profitability. However, just hours after the CBA and ANZ rate hike announcements, a Federal Court lawsuit over the fees-for-no-service scandal landed in NAB’s mailbox, sent by ASIC, which was accusing it of having broken the law no fewer than seventy-seven times.
As he digested the statement of claim, which accused the bank of sucking out $35 million and $67 million in differently labelled but inherently useless fees from savers’ retirement nest eggs, Thorburn second-guessed his plans to immediately hike interest rates. The next day, he came into the office and told staff members and executives the bank would not be hiking its rates. They had to repair the damaged brand of the lender.
Deciding not to hit customers with higher fees during a public relations crisis may seem the obvious path to take for a company in search of redemption. But perhaps unsurprisingly, the plan incensed some of Thorburn’s subordinates. Relaying the story, one insider said they were gobsmacked when other bankers lobbied Thorburn to stick with the plan to hike rates. ‘Think of the shareholders!’ one of the bankers said, without a hint of irony.
The chief executive was convinced to go home and use the weekend to think over the plan. Many in the upper ranks were hopeful he would come to his senses and put the bank’s balance sheet ahead of some bleeding-heart plan to put its reputation before its profits.
It was of no use. Come 9 a.m. on Monday, NAB announced it would be holding rates steady. ‘We are listening and acting differently,’ Thorburn announced to the public.
The message was replete with a hastily filmed video of the chief standing in front of a few ATMs explaining why the bank, for once, wasn’t following its rivals: ‘We need to rebuild the trust of our customers, and by holding our NAB standard variable rate longer, we help our customers for longer.’
It may seem like a small moment in the long history of one of the country’s biggest institutions, but the tale is more than a room full of NAB bankers preparing and then scuppering a plan to raise rates when the heat got turned on. Even though the spin doctors had managed to recast the story of a bank cowed into submission into one of a company embarking on a journey towards redemption, the moment marked an important juncture in the behaviour of the most dominant players in the financial system.
The industry had, until now, been used to getting its own way, whenever it wanted, because it went unchallenged in its practice. For so long there had been such little heat applied to the finance sector that it had settled under a permafrost as bankers rode roughshod over customers. Then had come the glare and the blowtorch and the sheer attention, and the old world began to melt before the bankers’ eyes.
The mundane world of interest rate movements may seem incidental to the more salacious scandals perpetrated by the banks over the years. Compared to laundering cash for terrorists, concocting fraudulent reasons to deny insurance claims for heart-attack survivors and stealing money from the dead, the charging of unfavourable mortgage interest rates barely registers on the scandal-Richter scale. But interest rates, and the way banks have acted in open collusion to pass on all of their costs to customers, played a pivotal role in turning public mood against the sector.
While the sizeable few Australians were the victims of shoddy financial advice, callous life insurance claim rejections and ruthless fire sales of intergenerational farming land, the majority were turned against the banks by the slow but systemic heist that is uncompetitive interest rates. Whatever the product was—home loan rates, credit card rates or term deposit rates relied on by retirees—Australians knew they were getting a raw deal. This was served up fresh each time the board of the RBA met and decided to change the country’s official interest rate.
With every cut or hike by the RBA, the focus inevitably turns to which of the nation’s largest banks pass on the higher costs, or the savings from a lower rate, to home loan borrowers.
At any time, one-third of all Australians are paying down a mortgage. Thanks to the great Australian dream of home ownership, interest rate changes are a unique point of tension between the public and the financial sector. Banks are, after all, meant to be just an intermediary for money flowing around the economy. Their job is to be the pipes of the financial system.
But Australia’s banks, playing as if they were the dodgiest plumber A Current Affair could find, decided they would take the biggest cut possible of every dollar that flushed through one of their pipes, and in the process undermined the trust that is paramount to the banking business model.
When customers put money in a bank, they trust that when they want to withdraw money, the bank will have it. In return, the bank pays the customer a small interest payment as a thank-you. The bank is then free to lend the money out to borrowers, and trusts that the money will be repaid. As borrowers repay the bank, they also pay fees in the form of interest rates. Shareholders, who also fund the bank, trust that the company will pay them a return. It’s a money-go-round based on trusting that no one will act in bad faith.
It should be simple. But somewhere along the way, Australia’s biggest banks became powerhouses in turning out supersized profits. Year after year, they would announce another record-high annual profit. Commonwealth Bank, the country’s biggest, in 2018 produced a profit of almost $10 billion—after tax. The big four combined have reached a combined profit of about $30 billion a year.
Senior bankers, regulators and politicians laud the strength of the financial sector and wear it as a badge of pride. It makes sense when you look at the rolling banking crises that European and US taxpayers are beset by.
For a country with a relatively small population, the big four banks are incredibly successful. Their sales, profits, assets and market value have them ranked among the largest 100 companies in the world. But their size is also one of their biggest problems. Mergers and takeovers that were waved through by weak regulators over the past three decades—think Commonwealth Bank’s takeover of Bankwest, or Westpac’s swallowing up of St George—have resulted in a system now dominated by just four companies. With 80 per cent of the housing market under their control, the lenders wield significant pricing power. Rather than competing for customers with lower prices, as more combative industries are forced to do, the major banks engage in a permanent truce where no lender will rock the boat.
The situation got so bad that the competition watchdog was forced to investigate mortgage pricing between the major banks. ‘The pricing behaviour of each of the inquiry banks appears more consistent with “accommodating” a shared interest in avoiding the disruption of mutually beneficial pricing outcomes, rather than consistently vying for market share by offering the lowest interest rates,’ the Australian Competition & Consumer Commission (ACCC) found in 2018 after trawling through thousands of documents and emails at the top ranks of the banks.
As consumers lose out, the cosy situation has made Australia’s banks the most profitable in the world. On the basis of the banks’ return on equity—a key measurement of profitability that shows how much money an investor will get back every year for a dollar invested—Australia is a world-beater. The return on equity for the major Australian banks of roughly 15 per cent a year is 50 per cent higher than that of US or Scandinavian banks and eight times more lucrative than that of the UK banks.
The bankers of Macquarie and Collins streets are not gifted with the touch of Midas. Rather, the penchant for profit comes from the banks’ ‘pricing power’—the ability for the lenders to charge what they like without the threat of a challenger coming along and offering better products at a better price. While it’s great for shareholders, it’s financially bruising for customers. The higher the return on equity, the more money is being charged to borrowers and the less interest is being paid to savers. It also strips money out of the economy that could be spent at local shops or on other projects.
If customers picked up stumps and shopped around it would benefit the economy as much as individuals and force the banks to offer better rates. The problem is that Australians are more likely to divorce their partner than change their bank. From Dollarmites to death, Australians are unflinchingly monogamous with their bank, even when they are treated terribly for their faithfulness.
The Productivity Commission (PC) has found bank customers are penalised by remaining loyal to the tune of $87 a month on the average home loan balance. According to the PC study, the banks offered discounts only to new or angry customers, unbeknown to the loyal borrowers who were taken for granted.
For many financial watchdogs, the most frustrating manifestation of the lack of competition in the banking sector is the lock-step behaviour of the major banks when they set interest rates. Despite having changed the rates on standard variable loans multiple times a year for decades, the rates charged by the lenders track remarkably similar patterns, and always fall within a range of a few percentage points.
Stockbroking industry veteran Brian Johnson, who advises international clients on the Australian banking sector, labels the big four banks a ‘cartel’ in his investment research notes. If you’re an investor, you’ll take it as a compliment for the sector. ‘When you speak to overseas investors, the one thing Australia is known for is for having these real oligopolies,’ Johnson said.
Think of the biggest companies in the department store sector, newspapers, supermarkets, airlines, baby food or beer. Just like the financial sector, Australia’s business sectors are plagued by at best a ‘big four’ oligopoly, and at worst a duopoly. It’s common currency that the banks have been happy with this situation, protecting their profits at the expense of customers and putting the interests of their shareholders before borrowers.
The research backs this up. A 2013 paper from the Journal of International Financial Markets, Institutions & Money found that the three largest Australian banks passed on RBA rate hikes much faster than they did for rate cuts. For every day a bank postponed passing on a 25-basis-point rate cut, they would draw in an extra $6.2 million in profit, according to the research.
After examining the interest rate movements of twenty-three banks over a period of more than a decade through the GFC, Swinburne University business professor Abbas Valadkhani concluded that the banks dropped their standard variable rates like ‘feathers’ but increased them like ‘rockets’ whenever the RBA changed rates. They waited a long time to pass on RBA rate cuts, but acted immediately to hike rates. Up like a rocket, down like a feather.
Banks were also more likely to pass on less of a rate change when the RBA cut rates, lowering their rates by a margin smaller than the official rate cut. Conversely, they would over-egg a rate rise when the central bank hiked rates. On average over the same period, the big four banks gave their customers only 85 per cent of every RBA rate cut but immediately passed on 120 per cent of any rate rise.
Exactly how the banks set their interest rates, who makes these decisions and the excuses deployed to justify them is quite opaque. The Rudd and Gillard governments introduced laws aimed at limiting ‘price signalling’—the sector’s lead-and-follow behaviour—but the plan was met with private and public hostility by the industry.
Politicians were worried because Australians are rather vulnerable to interest-rate gouging, where banks charge fees well above what a reasonable person would expect. The country is a global anomaly in that most home loan borrowers take out a loan with a ‘variable’ rate. This gives the bank the ability to re-price the interest rate at will, with very few rules regarding when, or how often, the rates are changed. Overseas, borrowers are far more likely to have fixed-rate loans, or rates that automatically track changes in the official interest rate with no mark-up or gouging.
According to internal data from the ABA, public perceptions of local banks fell rapidly to their lowest point since the GFC when, in 2012, the lenders stopped passing on the entire reduction in the cash rate announced by the RBA. Prior to the GFC, it took exactly one week for each and every bank to respond to the RBA’s official rate cuts; in the post-GFC world, that average blew out to 2.4 weeks. The failure of banks to pass on these rate cuts stoked disaffection with the sector.
‘The speed and accuracy with which rate cuts and increases are passed on to borrowers, especially among highly indebted households, impacts significantly upon their financial wellbeing,’ Valadkhani said. Since the year 2000, there had been nineteen occasions on which bank rates changed when the RBA did not do anything, as lenders responded to higher or lower funding costs or changes in financial markets. As luck would have it, on eighteen of those nineteen occasions the rate changes were to the detriment of the consumer and left borrowers with rates around 2 per cent higher than they would have otherwise been if variable rates simply tracked changes in the RBA cash rate.
According to former ASIC chairman Greg Medcraft, it was these out-of-cycle rate changes that chipped away trust in the banking oligopoly. As borrowers became increasingly frustrated with their treatment by lenders, they were unable to get a better deal elsewhere as the entire industry was in cahoots. ‘International investors used to say to me with incredulity: “The banks can just charge whatever they want?” Yep, that’s the way it works in Australia,’ Medcraft said.
It was this behaviour that slowly fermented in the minds of consumers, making them question what little trust in the big end of town they had left. And locked away in their corner offices, the bankers believed themselves shielded from the turning tide of public opinion, safe in the knowledge that they, not the central bank, would control the price of money in the economy.
When the longest federal election campaign in Australian history ended in early July 2016, it did so with a near-defeat for Prime Minister Malcolm Turnbull.
Voters gifted Turnbull a hostile Senate that had the numbers to set up an expensive and lengthy royal commission into the banking sector. Labor was intent on casting Turnbull as the protector of the scandal-prone corporations and had campaigned relentlessly in favour of setting up the banking inquiry.
It was in this eggshell environment, over the months in the lead-up to election day, that Australia’s big four banks were on their best behaviour.
In May, just two months before the election, the RBA had cut the official interest rate by 25 basis points to 1.75 per cent. Conscious of the growing tide of public resentment, all the chief executives of the big four banks raced to announce within hours that they would be passing on the entire 25-basis-point RBA rate cut to customers.
Just a few months later, in August, and with Turnbull back in the prime minister’s office, the banks were faced with another RBA rate cut, this time to a record-low 1.5 per cent. This time, however, the big four banks did not pass the savings onto customers.
CBA was first out of the gate, announcing it would reduce rates by 13 basis points—half the RBA rate cut. NAB moved second, moments later promising to reduce mortgage rates by just 10 basis points. Westpac announced a 14-basis-points cut, and ANZ said it would lower its rates by just 12 basis points.
Like clockwork, the near-identical rate cuts left the big four oligopoly all sitting with near-identical standard rates. The decision not to pass on the entire RBA rate cut would reap the banks about $2 billion in extra revenue over a year. It was the same old song from the banks, but they didn’t realise the government was starting to sing a remarkably different tune.
A furious Turnbull called a press conference and announced he would be dragging the chief executives of the major banks before parliament to face a twice-yearly public grilling. ‘The banks should have passed on the full rate cut,’ the prime minister said. ‘There is no basis for them, no commercial basis for them other than to improve their profitability … they must provide a full account of why they have not done so.’
Publicly, the banks could do nothing but agree, lest they be subjected to a more rigorous and time-consuming royal commission.
While detractors labelled the parliamentary hearings a show trial, Liberal MP David Coleman worked methodically within the constraints of the inquiry and took care to diagnose the problems with the sector. He found that since 2000 NAB had made no interest rate changes to the benefit of consumers. ANZ and Westpac had both made only two changes that benefited consumers, and CBA had made just one.
‘The major banks also tend to follow each other’s price increases rather than compete to gain market share,’ Coleman said. Since 2000, in the majority of cases where a bank made an out-of-cycle interest rate change, all the major banks followed their rival within a month.
Many of Coleman’s proposed remedies, such as a public register for badly behaved bankers, were to be taken up by the government in its next federal budget, but at the time the banks had no inkling of the severity of the crackdown.
Hours before handing down the 2017 federal budget, Treasurer Scott Morrison was confidently cruising around the budget lock-up. He was there to give the banks a valuable lesson in politics. The centrepiece of the night was an onslaught of policies targeting the biggest banks, including a $6.2 billion levy focused solely at the largest lenders. It was known as the major bank levy.
Morrison’s response when it was suggested the banks might be a bit unhappy about this? ‘Cry me a river.’
The government had laid down the law, pledging to give financial regulators more teeth and tasking the competition watchdog with an investigation to prevent lock-step movement in mortgage-rate pricing. Fines for the big banks would be raised significantly to $200 million per offence.
Speaking at the National Press Club the next day, Morrison told the banks to suck it up. The public ‘already don’t like you very much’, he said. Radio 3AW host Neil Mitchell was more blunt, saying to NAB chief Andrew Thorburn, ‘You know people think you’re a bunch of bastards. There won’t be a lot of sympathy for you.’
The banks, it seemed, had used up all their goodwill with Canberra’s politicians.
Fast-forward to mid-2018, during a break between bruising public hearing rounds of the royal commission. Westpac boss Brian Hartzer was hosting a lunch in Sydney. There, he would announce some cultural changes the bank was making in light of the inquiry’s early findings.
Seeing and being seen with various businesspeople before he gave his address, Hartzer settled briefly at a table of journalists to shake hands and do the rounds. During the small talk, he mentioned a recent meeting of company representatives at the ABA. When bank executives gather at such roundtables they must bring lawyers with them to ensure no one breaches ‘price signalling’ laws—the ones introduced by the Rudd and Gillard governments—or engages in cartel behaviour.
I expressed surprise at the fact that the bankers needed to have lawyers with them at all times, but the US-bred Hartzer was never good at seeing the humour in anything. ‘It’s not funny,’ he told the journalists. ‘It’s very serious. We could go to jail.’
The price-signalling laws, introduced by then Labor Treasurer Wayne Swan, had made it unlawful for banks to disclose price-related information in a number of situations and had evolved from a string of legal defeats suffered by the competition watchdog in high-profile petrol price fixing cases. However, they were crafted by Swan to target just the big four banks. If two or more competitors privately disclosed pricing information, even if there was no proof that competition had been harmed in any way, executives could face hefty penalties. Swan’s laws were designed to crack down on ‘nod and a wink’ pricing manoeuvres that allowed banks to hike interest rates and leave the door open for other banks to follow, but despite the best intentions, they failed to prevent price-following behaviour in the market and the oligopoly remained as it ever was.
Speaking to me about the proposals years after they were introduced, Swan said the behind-closed-doors campaign against the laws, led by the big four banks’ chief executives, was vitriolic. ‘We tried bloody hard with that package and they were just a culture of arseholes,’ Swan said. ‘The reason they went apeshit about it was that we targeted them for personal responsibility. The only place you can ever really affect results from the high and mighty—who are basically overpaid and overpowered corporate elite—is when you actually target them. They’re really good at hiding behind their corporate veil, but whenever anyone tries to actually hold them to be responsible for one of their actions is when the shit hits the fan.’
Swan said the laws were introduced because the banks were never transparent in their reasoning for changing their variable rates. They could ‘just make up a whole lot of stuff about their margins’ that was at odds with the financial information published by the RBA. ‘If you went back through it all, it was all just bullshit,’ Swan said. ‘They were taking every figure and bending it all the time. It’s just a gigantic spin machine to camouflage the fact that they were gouging drastically.’
Despite spending tens of millions each year on marketing to convince punters of the inherent differences between bank brands, the major banks have shown themselves to be terrible at going it alone. ANZ under chief executive Mike Smith, who was the bank’s boss from 2007 to 2015, attempted to delink—in the minds of customers at least—the association of changes in the lender’s standard variable rate from changes in the RBA cash rate. By nominating a day each month on which rates would be reviewed, separate from the first Tuesday of every month when the RBA board meets, ANZ tried to make its rate changes appear less reactive to RBA decisions and more related to the lender’s overall cost of funds.
But it was spoiled after the other three big banks exploited the plan, waiting until after ANZ announced rate changes to follow with rate hikes or cuts of their own. As the leading bank, ANZ ended up copping most of the flak for moving rates between 2011 and 2014, when the experiment ran.
Starting around the same time in 2011, NAB spent millions telling Australians it was ‘breaking up’ with the other major banks and pledging to do things differently. Realising that people already hated the bank, NAB decided it would scrap the fees it charged to customers coming on board and would pay rival bank exit fees charged to customers who were jumping ship. True to its word, it also followed through with a promise to charge borrowers the lowest interest rate of the major banks—but, rather pathetically, its rates were the lowest by just 0.02 percentage points.
So it was little surprise that politicians had had enough of the behaviour.
After slapping the $6.2 billion major bank levy on the lenders, the government tasked the ACCC to investigate the interest rate decisions of the big four banks to make sure they didn’t just hike rates and pass on the cost of the tax to borrowers. In its report following the investigation, the ACCC remarked that ‘one bank considered whether the costs could be passed on to customers and suppliers at a range of different time periods, including after the end of the ACCC inquiry’, which finished at the end of June 2018. Hartzer, whose bank was first off the mark with the August 2018 rate hike, was forced to admit before parliament later that the unnamed bank was indeed Westpac.
Time and again, the banks used any excuse to increase the cost of clipping the ticket throughout the financial system. While claiming to be dynamos of innovation at the forefront of technological adaptation, they are in reality in a bread-and-butter business of charging hefty fees for otherwise basic services. With a collective profit before tax of around $30 billion a year, the cost is borne by everyday Australians.
The ‘Australian Banks Belong to You’ campaign, launched by the ABA during the royal commission, was an odd attempt to soothe public anger at a testing time. Telling Australians that 80 per cent of these profits were paid out to shareholders only served to remind people of the immense windfalls banks were making off the backs of ordinary borrowers every time interest rates were changed. After perhaps considering the fact that about 25 per cent of bank shareholders were overseas institutions and that the average superannuation member held very few bank shares anyway, the ABA pulled the campaign after a few months.
The banks were never interested in changing their ways. Lowering profits would result in lower share prices, which would then feed into lower levels of executive remuneration. It would be better for customers if the banks were barely there, charging minimal fees for basic financial products. But the incentives to make larger profits at the expense of customers proved too great.
The heat applied during the royal commission was the only thing that could make the banks reconsider the way they treated their customers.