The mortgage broking industry has gone into damage control after the interim report of the royal commission launched a broadside on the upfront and trailing commissions that underpin the economics of the industry, suggesting its final report could eradicate the payments on the basis they create conflicts of interest.
The CEO of the Mortgage & Finance Association of Australia, Mike Felton, said the limited terms of reference for the inquiry meant implementing any recommendation to limit broker commissions would have “unintended consequences” by reducing competition in the $1.6 trillion home loan market.
“The royal commission’s terms of reference did not include a competition remit, which is appropriate,” Mr Felton said. “However, ignoring competition when considering further changes to the financial system could lead to unintended consequences, and risks driving customers back to bank branches.”
Brokers sent 30 per cent of loans to non-major banks, he said, up from 21 per cent five years ago.
The executive director of the Finance Brokers Association of Australia, Peter White, said “on first glance, it appears the commission does not fully understand the finance broking sector” and he encouraged members to keep the faith.
“We expected an interim report like this and we will work through the points, but nowhere is there any suggestion that the broking sector is systemically broken,” he said.
But the report did suggest commission payments could put banks in breach of legal obligations. In its second volume examining Commonwealth Bank’s relationships with Aussie Home Loan brokers, the interim report said, “continuing to pay intermediaries a value based upfront and trail commission after these deleterious consequences had been identified might raise an issue about satisfaction of the lender’s general obligation under Section 47(1)(b) of the NCCP Act.” That section requires banks to ensure customers aren’t endangered by policies that create conflict of interest.
Commissioner Kenneth Hayne also questioned work of the Combined Industry Forum, including changes to upfront and trailing commissions so they are only levied on drawn-down amounts, removing incentives for brokers to procure loans larger than a borrower will use. But the interim report said this “does not deal with the more basic problem of borrowers being encouraged to borrow more than they need”.
“As noted elsewhere in this report, value-based remuneration conflicts directly with customers’ interests.”
The head of Elders Home Loans, John Rolfe, said removing trail commissions could result in more borrowers being churned into new loans, as brokers sought to generate new income. “Those motivated by maximising their commission will look to refinance customers more often,” he said.
“Whilst they may be able to justify on basis of rate, when you take into account the customer’s time and effort, it may not be entirely in their best interests. It will also lead to banks and other lenders increasing rates and fees across the board as a short term clients will not be profitable.”
Susan Mitchell, the CEO of ASX-listed Mortgage Choice, said trail commission “ensures positive customer outcomes, as trail incentivises the broker to maintain contact with their customers, review their loan status and ensure their needs are being met by their current loan product”.
She said she hoped the final report, due in February, “will recognise the important contribution that mortgage brokers provide to everyday Australians and finds the current mortgage broker remuneration structure leads to positive customer outcomes”.
Yet the interim report found much confusion about who mortgage brokers actually work for. It said the relationship between broker and would-be borrower was “obscure”, and while brokers are considered to be acting on their behalf “the broker owes the borrower no duty larger than not to negotiate an unsuitable loan”.
“There is no doubt that in the eyes of at least some lenders, the broker’s task is to sell that lender’s products,” Commissioner Hayne said.
Mr Rolfe said: “Whilst we don’t deny there are a couple of rogues in the industry that may be motivated to maximise their position, the majority of brokers know that doing the right thing by the customer is their major motivator.”
The Productivity Commission, in its report on competition in the financial system earlier this year, called for trailing commissions to be removed but also noted this could have adverse impacts on competition, which is said it is important to encourage.
“Fixed fees paid by customers rather than commission structures have been proposed, and would eliminate conflicts, but the cost to competition would be high,” the PC said. “Consumers would desert brokers, and smaller lenders … would suffer much more than larger lenders.”