Today’s guest post comes from Lex Graber from Direct Investor and talks about the simplification of the banking system.

Like the Henry report and other government initiatives many people in the Finance Industry believe it’s time to revisit the entire Banking and Loan Origination System given the large commentary on this subject lately. Part of the reason for the review has been the GFC and the poor credit management it has alerted us too. We thought it was time to take a look at why it has become so complex and how we can move to rebuild and reform the industry by examining some of these issues.

Most people are familiar with the KISS principle, that is, we should seek to simplify where possible. If we take a Bank/Lender product as an example, there was a time not so very long ago when Bank service was better and people formed relationships with their Banker. This meant Bank customers were reluctant to move and seek a competitors offerings.

With the arrival of the Internet and several economic downturns later Bank customers became more price conscious and shopped around. Some Banks gained ground as their products were clearly cheaper while others lost ground. Service was discounted by their customers in order to continue to put food on the table whilst Banks looked to trim their service and increase their margins.

Banks made use of the Internet too. Online transactions, EFT and ATM usage became the norm which resulted in reduced Bank employee branch requirements, removal of much of the Cheque processing overheads and easier access to funds. Their overheads rose temporarily whilst implementing all these changes and then dropped due to the cheaper transaction costs. The cost of a transaction using the new cheaper channels was less than 0.01% of the manual costs as you could run 20 transactions through the Internet for just 1 cent.

Suddenly Bank profits exceeded the profit of the then title holder on the ASX (BHP) and people sat up and took notice. My NAB shares went from a humble $5 to $35 in just the 8 years I was working for them. The rest of the big Banks did just as well and the Banking Industry became the new darling, a favourite with Super funds and other large corporations. Service and loyalty faded from living memory and with the massive downsizing in Bank staff eventually created the broker secondary market channel. As Banks loans became commodities and were essentially a standardised product there was little need for brokers initially. There was little or no competition as people were used to dealing with the big four. The fact that people had become more and more disloyal and fickle made Bank providers pay more attention to their product/pricing policy. To the customer, product comparisons became harder and harder to do online. Other financial parties saw an opportunity to differentiate between products. The lack of good service and quality options (Banks were still very conservative and non-innovative back then) produced a fertile environment for 2nd and 3rd Tier product providers and offshore Banks to enter the market and brokers provided a ready made channel for them without the expense of a branch network.

The golden time for brokers and competition in Australia had begun and names like Aussie Home Loans, Rams and St. George hit our TV screens. Others like Credit Unions and Co-ops filled the void left by lower margin areas the Banks had abandoned in seeking higher return on equity.

We all stood by and allowed the complexities to gradually build up until no two loan products could be directly compared based on their merits and costs. This is because if clients knew exactly what they were getting they could just find and use the cheapest product or the one with the features they were prepared to pay for. This would be a disaster for those that had poor and non-competitive offerings (relying on handcuffed channels and slick advertising). It also created the perfect environment for the masses of out of work ex-Bank staff prepared to wade through the paperwork to offer a service previously not required. Finding people a better loan product than they could themselves!

With more and more products and higher levels of complexity and compliance even the best brokers would be hard pressed to know all about every product and how it compares. The choice of product is now often from a short list of favorites and brokers resist straying outside these as the cost of learning new ones may mean forgetting and losing the advantage of the ones they have managed to get their heads around.

So that’s sort of how we think we got to this point … but what would happen if we opted for a return to a simpler and easier model? The market would quickly sort out the efficient and effective with the client the ultimate winner. This is the ‘stated’ goal of all parties in the industry and our government. But is it really? Who would lose in this equation?

Whilst there is still so much choice and brokers are prepared to do the work to find alternatives then they will always have a service and a place as customers are often unwilling to do hard and boring work themselves (just ask your cleaner how busy they are).

Banks and Aggregators would lose out as they would not be required ‘to the same extent’ unless they could get better products or provide volume discounts and funnel product updates to us in a timely manner. With products themselves being simpler you would not need as much ongoing re-education, just a good PC solution and metrics tool, and of course your CRM for managing appointments and reminders. You could wade through more products and find better matching solutions as a broker too, making your job more secure and satisfying. The market would force Banks, other lenders and aggregators to keep competitive. Sounds like a win for most of us and both the government and our clients. We just need to break the ties that bind us to allow the market to reset to a more competitive standard i.e. DEF fees binding clients, exclusive agreements binding brokers to aggregators and volume targets binding brokers to lenders. These all interfere with our ability to adjust to changing markets and remain competitive.

So how do we go about it? We all need to contribute ideas and several websites have been set up to gather input (and I’m sure more will as time goes on).

We at Direct Investor put on our thinking caps and thought about what the finance system might look like if we’d designed it from scratch today. Here are some ideas about the way it might look.

1. 1. All products have a minimum 3 year shelf life during which non-legal or legislative terms are unable to change (level of certainty for all concerned - stop moving the goal posts mid-way). If something new comes in that was not in the original policy it can be added but no changes to existing terms (e.g. Max loan limit or LVR e.t.c unless it is driven from the LMI back end over which lenders have no control).
2. LMI providers under tight government control to prevent them being Bank owned and profiteering, or offer a Government LMI provider as an option on equal terms to the private option.
3. All products advertised at wholesale cost as a ‘base’ product regardless of the channel (then brokers and Banks have to disclose fully their fees to set up and manage the loans and comparisons could be fairly made). Any bundling discounts could be disclosed as such (i.e. take a credit card and we throw it in for no annual fees saving you $n p.a.) and the channel ‘cost of service’ could be compared based on the cost this added to the loan.
4. All break and DEF costs dropped as they hide the real potential cost of the loan and replaced with loyalty ‘returns of fees’ (i.e. if you stay with us for 12 months we give you a bonus). This would remove clawbacks and other penalties passed to the broker that are beyond their control. You don’t return a faulty TV to the store and expect the salesman who sold it to you to return their sales commission, why should finance be any different?
5. Extra features costs are separately available as add ons (e.g. early repayments add 0.1% to the rate) so like with like comparisons can be made easily and clients can pay for the features they really want and not bundled ones they are forced to accept and may never use. This would make lenders more price and market conscious, thus pricing and offering features the market tells them is wanted/needed.
6. Any policy changes must be announced 30 days before they can take effect, no telling brokers they must now do it this way and the written notice will be out soon, that’s just unacceptable.
7. All loans, including the Banks internal ones, lodged through a third party (i.e. no hiding their own data entry standards in their own systems) system with any ‘specialty fields’ required by their products/policies being attached to a separate addendum form. With products being directly comparable, most data entry should be the same regardless of the Lender offering the product (this would simplify loan submission and improve quality of submissions). All submissions to be electronic using PDF or similar tamper-proof format with password authentication.
8. Penalties imposed on both lenders and brokers for non-compliance set by a government regulated body and funded by a small transaction tax on each loan, with the proceeds used to improve the efficiency and effectiveness of the industry and its standards.
9. Open ability for all to rate each others service and offerings.
10. A universal commission structure that applies to all products, removing the requirement to disclose commission on a lender and product-by-product basis.

These attributes would lessen the need for aggregators to do so much just to stay in the game, they could go back to just aggregation and funneling product changes back to brokers. Lenders could deal more directly with Brokers in a more cost-effective manner, and industry bodies such as the MFAA could provide value-added services such as group EDR (COSL) coverage to their members and ensuring standards and legislation are fair and consistent for the good of the Industry and its customers.

We hope that these idea have at the very least got you thinking about how else this industry might operate to the greater benefit of all participants.