There has been great surprise at the revelations of bad behaviour by this country’s biggest financial institutions in recent days, though not everybody was shocked. For two decades, this reporter has fielded complaints about rip-offs and bank victims getting the regulatory cold shoulder. What will come of the Royal Commission? Will AMP be lose its financial services licence like small operators who break the law, or will the systemic corruption which was on display at the Royal Commission this week continue to flourish?

When James Wheeldon was a young lawyer working at the Australian Securities & Investments Commission, he had to report to a senior lawyer, a lawyer who was on secondment from the National Australia Bank.

“My job a a lawyer was to deliver for the banks,” Wheeldon said, in the wake of the dramatic revelations at the Royal Commission this week.

“It didn’t matter what the policy implications were, everything I did was about fees – and ASIC has been a knowing, willing participant, even collaborator, in the banks’ dishonest effort to increase fees. It’s like Roger Rogerson giving the green light to Neddy Smith. We are okay with you doing this.

“ASIC has a deeply ingrained culture of subservience towards the major financial institutions.”

“As a lawyer in the Regulatory Policy Branch, I routinely saw large financial institutions regularly make dishonest representations to ASIC, their lawyers too, and I complained and they did nothing.

“I complained that the banks lied to ASIC, that ASIC tolerated it, that ASIC amended the Corporations Act for the benefit of the banks in order to assist them in ripping off their customers.”

Wheeldon’s complaints fell on deaf ears. In disillusion that he was compelled to do the bidding of the banks and their lobby group, now called the Financial Services Council, he left in disgust. He now works as a barrister specialising in Corporations Act cases.

Revealing look at ASIC’s practices

It was all about fees this week too, week three of the Royal Commission, as testimony emerged of fraud, dishonesty, greed and incompetence by hundreds of bank-aligned financial planners.

At a packed court room in Melbourne’s legal district, the stories flowed of chronic fee gouging, charging for services never provided, misleading regulators, AMP’s board of directors tampering with an “independent expert” report destined for the corporate regulator ASIC. Life savings lost in a litany of law-breaking by the biggest blue-chip institutions in the land.

AMP was first to be questioned in the unfolding fee-for-no-service scandal. The Commonwealth Bank’s stint in the box kicked off too with tales of the bank charging fees to dead people. The other major banks will follow.

“By my count this was the 14th false or misleading statement by AMP to ASIC? … You’re losing count,” said senior counsel assisting the commission Michael Hodge to AMP executive Jack Regan.

“I’m in your hands in that regard, Mr Hodge,” Mr Regan replied.

Later:

“I think that takes us to 17 false or misleading statements by my count, Mr Regan,” said Mr Hodge at one point.

“Were you counting that as one or two?” Mr Regan replied.

“I only counted that as one, do you think I should count it as two?”

“I think in fairness Mr Hodge you should.”

“OK. The 18th false or misleading statement by AMP to ASIC.”

The count was hovering at 20 by end of session. When the year is out, it will have been the tip of the iceberg in the financial advisory sphere alone. No matter credit card shenanigans, mortgage fraud, market rigging, systematic breaches of the Anti-Money Laundering and Counter Terrorism Financing laws and other things.

When governments allow private institutions the cherished status of being too big to fail, risks are taken with the comfort of impunity, risk is not properly priced, and that risk fuels leverage in the financial system and throws up the spectre of a “hard landing”

Corruption is entrenched culture in banking. Nothing has changed for two decades. We can say this with fair authority, having personally fielded complaints about the banks, ASIC and the Financial Ombudsman’s Service (FOS) for two decades.

The Royal Commission will trip from one scandal to the next. Like Donald Trump, people will become inured to it. Stories of corruption and malpractice will flow like a raging torrent. The essential question is, what will come out of it?

After only three weeks it is pretty clear there are deep-seated problems of culture at both Australia’s largest financial institutions and at the financial regulators. Culture is not easily fixed.

“Regulatory capture” is merely part of the picture. It is symptomatic of a more potent, more tricky issue, and that is “moral hazard”.

It is not universally understood by Australians but the banks are underpinned by taxpayers via the Reserve Bank’s Committed Liquidity Facility (CLF), effectivly a bail-out fund which the RBA hates to hear described as a bail-out fund.

Mother of all bailout funds

The bankers might own their profits but, thanks to this CLF, we the taxpayers own their risks. When governments allow private institutions the cherished status of being too big to fail, risks are taken with the comfort of impunity, risk is not properly priced, and that risk fuels leverage in the financial system and throws up the spectre of a “hard landing”, a crash.

Whether to prop up the banks is not a clear-cut issue. Sovereign guarantees and the Four Pillars policy, in many ways, have served Australia well. By Four Pillars, we mean the policy of keeping the four big banks immune from takeover.

It has left us with a powerful oligopoly, and one which is demonstrably failing to look after customers by the thousands; but it has also buttressed the financial system against external shocks.

So it was that, in counterpoint to the ructions which beset other economies, Australia’s financial system sailed through the Global Financial Crisis.

The fact is that successive governments and their regulators have favoured system stability over competition and attentive regulation. The greater fear is not the suffering of customers and corruption in the banks, it is of a gigantic collapse.

A situation has been allowed to develop by political acquiescence and regulatory inertia where the concentration of power and wealth is at dangerous levels.

We are left with one Leviathan institution of sorts, a vertically integrated fee-monster, a lending oligopoly of four institutions with interlocking shareholdings, interlocking interests, and with 80 per cent market share. The Big Four enjoy a lower cost of capital than other lenders, hence a lending advantage over smaller banks and non-bank lenders (NBLs), thanks to sovereign guarantees.

The Global Financial Crisis also delivered them a deposits guarantee, and a capital raising guarantee, both now expired, which enabled them to use the government as a backer to raise money on internatioal bond markets more cheaply.

As they waded into money markets overseas, foreign investors paid pay more for their bonds, that is, they accepted a lower yeild, because they knew that the risk was lower with Aussie banks because the taxpayer stood behind them with a guarantee.

What did they do with all this cheap money? The Big Four mostly lent it to home buyers and investors to buy property. Macquarie went on a spree buying junk bonds and bagged the difference in the interest rates. Thanks to this foreign borrowing, among other factors, the property market is sky-high.

Measures which might have contained it such as negative gearing reform have been neglected, Indeed anti-money laundering and terrorism financing reform (AML-CTF) has been put off for almost a decade because successive governments have been lobbied to do sit on their hands.

Australia on watch-list as China billions pour into property

The flood of money from Chinese investors has spurred the biggest residential property bull-run in the world.  So shielded from collapse, the market is overcooked.

And thanks to the concentration of the banks’ business risk in residential property, there is now a sovereign risk of unnatural proportions.

No matter what emerges from the Royal Commission therefore, the government’s primary interest will still be in maintaining system stability.

Yet all sorts of things are skewed. Young people can’t afford a house, lending to small businesses is relatively low. It is preferable to lend to property speculators than farmers because the banks know the government will pull every string it can to protect the property market, the banks and ultimately taxpayers from collapse.

This is perhaps why the banks are good corporate citizens on the tax front. Unlike many other large corporations, when it comes to paying tax, the Big Four shell out well over $10 billion in income tax each year collectively.

How then can a government reform culture, even with overwhelming evidence of bad behaviour emanating from the Royal Commission, when its overarching interest is in protecting the banks?

This week, the vexing challenges of vertical integration came into view: five big institutions (AMP is the other), too big to fail, mollycoddled by the authorities at the highest level.

As some commentators point out, the banks (CBA confirmed this week it was selling Colonial First State and ANZ has already flagged its exit from wealth management) are moving to offload their financial services divisions. This is market-driven, the returns are too low for the capital allotted, and the shift away from vertical integration may diminish predatory behaviour by the Big Four because the temptation to flog in-house product, regardless of returns, will diminish.

The catharsis and pageantry of the Royal Commission will have a salutary effect on the banking sector, it will restrain poor behaviour for a while and, at the margin, will adjust culture.

But as James Wheeldon puts it, “ASIC takes AFSLs (Australian Financial Services Licences) off financial planners all the time. Are they going to do it to AMP? Not a chance.”

The culture is set. Ultimately regulatory capture and moral hazard will prevail as governments prioritise system stability over prosecuting bankers … and making substantial reforms to the banks and regulatory agencies.

The irony is that the risk they hoped to avoid is the very risk which now looms larger, as mollycoddling the banks can only lead to a system with untenable leverage.

Banks, regulators & a reverse-Nuremberg defence