Time we lifted the lid on these sheltered workshops

The Australian 12:00am April 23, 2018

Adam Creighton

And that was only week three. If the royal commission into misconduct in finance continues to throw up evidence like last week’s, what looks like an increasingly ironically named “financial services” industry should brace for major change.

Let’s hope Kenneth Hayne’s recommendations, due in February, don’t include another layer of complex, box-ticking regulations, which benefit regulators and the compliance industry. What’s needed are a few simple rules that limit financial institutions to banking or insurance or funds management.

So-called vertical integration — allowing banking behemoths to Hoover up other financial firms — has been a disaster here as it has been around the world. The benefits of one-stop shops seem meagre in light of the sorts of disastrous shopping sprees customers have been unwittingly taken on, and the market and political power such huge firms necessarily amass.

In the rush to condemn firms for lying to regulators and charging fees to dead people for no ser­vices — following a litany of more run-of-the-mill rip-offs — it’s ­important to remember government is ultimately to blame. It’s the naivety of politicians and regu­lators that has permitted fund managers, insurance companies and banks to morph into highly tuned cross-selling machines.

It’s the direction of at least 9.5 per cent of most people’s wages and salaries into stocks and bonds, by compulsory superannuation, that has created the multi-trillion-dollar honey pot for financial ­adviser and fund managers.

Calls for greater levels of training for financial advisers appear to overlook that if financial advisers were trained in financial economics, they’d advise clients not to take their advice, the bulk of which, as billionaire Warren Buffet observed recently, leads to worse returns for most people than if they had simply invested in a basic index fund.

It’s the misplaced belief that “more powers” for regulators will change the underlying incentives of the industry, which feature a raft of hidden privileges and moral hazards. Giving ASIC more powers won’t matter much without the will to use them. The commission has highlighted the limits of APRA and ASIC, whose incentives, like regulators everywhere, are primarily to not rock the boat. The contrast with the lawyers assisting Hayne — Rowena “shock and” Orr and Michael Hodge — is stark. They probably aren’t seeking higher paid jobs with financial firms later in their careers, which has given them greater scope to be tough.

It is also the naive belief that competition in financial services will produce good outcomes for customers, much as the butcher, baker and candlestick maker do for their customers.

Such cookie-cutter arguments ignore a sad fact: we can all compare meat and bread, but financial literacy is woeful, creating the perfect environment for exploitation. In their 2015 book Phishing for Phools: The Economics of Manipulation and Deception, Nobel prize­winners Robert Shiller and George Akerlof argue financial services are particularly prone to “phishing”, or taking advantage of people with services they don’t need. “Unregulated free markets rarely reward … the heroism of those who restrain themselves from taking advantage of customers’ psychological or informational weaknesses. If there is an opportunity to phish, even firms guided by those with real moral integrity will usually have to do so in order to compete and survive,” they wrote.

Financial services have, in any case, few of the characteristics of a genuinely free market. For a start, participants are licensed and scope for rival currencies to develop outside the banking and payment system are pretty much ruled out by law. Given their privileged ability to create loans and deposits, their unique access to the Reserve Bank, and the fact all their liabilities are guaranteed, the bigger banks are more like government departments with free scope to set their own pay than shining examples of free enterprise. The structure of their lending decisions hinges on risk-weights and prudential rules more than their own agency.

Together these arrangements create awesome rents, which are reflected in the cost base of the ­institutions themselves. Recall former National Australia Bank “chief of staff”, Rosemary “sweet­est wicket” Rogers, who had amassed multiple homes worth $6 million and suddenly resigned last year, as recently reported by my colleague Will Glasgow. Colleagues wondered, “How much is Rosemary on?”, Glasgow wrote. But the deeper question is “What on Earth did Rosemary do?” That’s just one recent example of the finance sector’s extraordinary capacity to ­create highly paid BS jobs.

The ­armies of thought leaders, chiefs of staff and deputy group heads of innovation suggest a sector still falling short of the peak efficiency competition was meant to foster. Each of the major banks has more media advisers and managers than the entire roll call of business journalists at The Australian.

Despite all the chatter, banks appear anything but agile. No one wakes up and thinks “Gosh, I can’t wait to consume some financial services”, so it’s worth asking how this sector has roughly tripled since the 1970s and become the biggest sector by far: ­double the size of retail trade, 25 per cent bigger than either construction or health.

Part of the answer is the growth of vertical integration, which has sharpened the sector’s ability to sell products and services that a better informed customer might not buy. I just discovered I was paying for disability insurance I didn’t know I had (through my superannuation). I promptly cancelled it, but this is a common problem. Few Australians, for instance, realise they are spending far more on funds management services each year than electricity or gas (again through their superannuation).

It’s not financial services workers’ or customers’ fault that successive governments have made decisions that have led to the dominance of our economy by a few large and questionably efficient firms in a sector where customer understanding is shockingly low.

The best that might come out of the commission is a recommendation for banks to stick to banking, insurers to stick to insurance, asset managers to stick to asset management, and financial advisers to be independent of all of them. Regulation needs to be set with human nature in mind; not everyone goes into financial ser­vices to serve.