The Banks Consider The True Cost Of Financial Advice

24 May 2016

“Have the institutions tackled the business model that has the product areas subsiding the advice businesses? When they do, will we see the rise of the independent again?”

While most voters are not paying much attention to the election campaign, the financial services industry is on high alert. That’s not just because of the tightening in the polls suggesting Labor has a reasonable chance of winning. It is clear that whichever party wins, big changes are coming in wealth management.

The Coalition’s plans to change the rules on superannuation are only the most obvious – especially noticeable given they are creating most outrage among their own loyal Liberal supporters.

But this shouldn’t obscure a much wider shift in thinking about the whole business model for financial advice and the notion of vertical integration. That’s where banks’ own wealth-management businesses distribute bank products as well as provide financial advice to customers.

Labor’s support for a royal commission into the banking industry, for example, is designed to feed off community grievance that banks make too much money out of all this.

In fact, the reverse is more the case. Most are actually not making enough revenue to justify the reputational risk, added complexity, and embarrassment of scandals and accusations of conflicts of interest.

It’s why any future findings from a possible royal commission will be more like belated recognition of a more complicated commercial reality already facing banks and investment banks.

Wealth management ‘love affair’ waning

The latest edition of Financial Standard, a specialist finance industry journal, features an article entitled “Bank love affair with wealth management waning”.

It suggests pressure for return on equity following the regulators’ demands to hold more capital only makes it harder for banks when ROE on wealth management arms is usually lower than traditional banking activities.

John Brogden, former head of the Financial Services Council, has made similar points. He told a recent conference vertical integration and flawed remuneration policies were plaguing the banking and financial services industry and that bank directors should be considering selling their wealth management arms.

Not that most banks concede any such thing. They argue providing financial advice an important part of serving their customers’ needs –  as opposed to the  less appealing image of being an avenue to distribute bank products.

But they are definitely trying to simplify how these businesses operate and to change the way they are funded –  effectively subsidised by the higher returns from other banking operations.

The original idea was that “cross-selling” of wealth products to bank customers would create a cycle of self re-enforcing financial benefits. As a commercial strategy, those results have continued to be a disappointment, despite the conflicts of interest that have been so rife. Yet most bank-owned or aligned dealer groups and licensees, for example, don’t make enough profit to be cost-effective in their own right.

NAB has just sold off 80 per cent of its life insurance business to Nippon Life, for example. It said this would allow it to provide insurance solutions for customers “while improving wealth returns for shareholders”.

ANZ has just had a major restructure of its wealth management business to re-incorporate it back into its retail operations. Wealth was responsible for just  8 per cent of earnings in the first half result.  Chief executive Shayne Elliott argues it is necessary to avoid the problems that come with too much complexity.

Fundamental problems of incentives structure

But plenty of others still suggest none of this still goes far enough to deal with the fundamental problems of the incentives structure still in place in the banks.

Exactly a decade ago this month, Steve Tucker, then chief executive  of NAB’s wealth business, MLC, gave a groundbreaking speech and interview to The Australian Financial Review demanding an end to the traditional system of commission payments.

At the time, his alarmed peers argued this would simply damage MLC by causing it to lose market share because no others would follow. They said this approach would harm institutions because customers wouldn’t be willing to pay up front rather than have the real price hidden in “trailing commissions” tacked onto policies indefinitely.

That speech was just ahead of the global financial crisis that demonstrated so dramatically how much harm those conflicts of interest could do to consumers of financial products sold under the guise of independent advice.

It eventually took several years of scandals and the reforms of a Labor government to try to end commission payments, at least for new clients. The alternative of a “fee for service” payment is now accepted as the best model, even if there’s less agreement on what the acceptable cost to clients should be, how much advisers should be paid and how to manage it all more efficiently.

But  10 years on, Tucker still wonders how much progress has been made and says there’s more work to be done. Tucker is now chairman of a new independent advice business, Koda Capital, which operates as a professional partnership. Given the changes to super, there’s unlikely to be any shortage of clients seeking assistance.

“There’s nothing wrong with vertical integration as long as those conflicts are carefully managed,” he says. “But we need to restructure the remuneration system so there is not such a bias towards certain outcomes.”

“Have the institutions tackled the business model that has the product areas subsiding the advice businesses? When they do, will we see the rise of the independent again?” Banks deny any bias, of course, citing the fiduciary duty that now exists for advisers to act in the clients’ best interests.  It’s also true that plenty of “independent” financial advisers have their own conflicts of interest yet take far less responsibility for redress when things go wrong.

Trust and competence are never guaranteed in financial advice or wealth management.  But banks are held to a higher standard as Malcolm Turnbull reminded them recently. They are still trying to figure out the true cost of meeting that.



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