Banking royal commission untangles mortgage broker conflicts

The Hayne royal commission has now arrived at one of the most fiendishly difficult questions in the country's $1.6 trillion home loan industry: exactly whose interests do mortgage brokers represent?

The question arose after ANZ's executive general manager home loans and retail lending William Ranken testified that the bank does not check the accuracy of information provided by brokers about their customers' living expenses, even though the bank's responsible lending obligations require it to verify the financial situation of its customers.

At this point, Commissioner Kenneth Hayne was curious as to why banks would put so much faith in the information provided by mortgage brokers.

"Why is it in the broker's interest to pin the customer down? Why is it in the broker's interest to interrogate the customer when the customer reports living expenses as $X a month?" he asked.

"What's in it for the broker to say, 'Oh, are you sure? Is that right?'"

The ANZ's Ranken replied: "It's up to the individual broker, I suppose They're acting as agent for the customer."

Commissioner Hayne, however, is far too sophisticated an intellect to accept this as a self-evident truth.

"Well, are they?" he queried.

"There's a nice question, about ... who's the agent for who in this transaction, but we can have a debate about that later. But do you agree with me there is no incentive for the broker to interrogate the customer about expenses?"

The ANZ's Ranken wasn't going to concede defeat that easily. He responded that under their own licensing obligations, mortgage brokers are required to ensure that products are suitable for their customers and to understand their customers' positions.

Substituting living expenses

Commissioner Hayne, however, was already a step ahead of him. He is interested in another wrinkle in the home loan system, which allows brokers to shift responsibility on to the banks for ensuring that the home loans they provide are suitable for their customers.

That's because when the living expenses submitted by mortgage brokers are absurdly low, banks routinely substitute a higher spending level, based on the Australian Bureau of Statistics' Household Expenditure Measure (HEM).

Indeed, a KPMG report of ANZ's home lending practices, which was prepared at the request of the Australian Prudential Regulation Authority, found that 73 per cent of the files reviewed had substituted the HEM figure for the customers' stated living expenses.

As Hayne inquired: "There's no incentive because they know banks will default to higher of declared expenses or HEM, is that right?'

"Yes", Ranken agreed.

Hayne teased out the consequences. "And they know that the bank will do that – or at least it would be open to a broker to conclude that the bank defaulting to HEM was seen by the bank as the bank meeting its obligations about responsible lending."

The banking royal commission, of course, isn't the first to raise the issue about whose interests the mortgage broker actually represents.

A draft report "Competition in the Australian Financial System", released by the Productivity Commission in January this year, raised similar concerns.

As the draft report pointed out, the hefty commissions paid by banks to mortgage brokers have the potential to create serious conflicts of interest.

"Unlike in wealth management (a similar advisory business, involving serious financial cost) mortgage brokers are not obliged by law to act in the best interests of the customer," the report noted.

"And an important source of advice subsequent to the transaction is compromised, as trailing commissions encourage broker loyalty to the financial institution, not the customer."

The Productivity Commission even went so far as to query whether those who use mortgage brokers end up ahead financially.

"While enabling ready comparisons between a selection of home loan providers and reducing consumer search costs, mortgage brokers do not consistently get lower home loan interest rates for consumers than would be available to the consumer by going directly to the provider", the report said.

Still, there is huge value in the meticulous examination of the complex inter-relationship between the banks and the mortgage brokers that the Hayne royal commission is undertaking.

It's shedding a spotlight on a range of flawed bank lending practices – and even basic assumptions – that have grown up in tandem with the explosion in the role of the mortgage broking industry since the early 1990s.

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