John Durie: The small businesses that now control the source of the big banks’ profits

The big banks will walk on eggs shells between now and the election as they potentially raise rates and release multi-billion-dollar profits in the middle of a campaign focused on costs of living.

But the real story for the banking industry is how it let small business in the shape of mortgage brokers get control of a key part of its operations.

Politically, it is obviously a nightmare for the big banks, with the Reserve Bank widely tipped to increase rates in the middle of an election campaign for the first time since 2007, at a time when wholesale rates are increasingly hitting bank margins.

If the RBA moves today, the banks will follow and if they have any sense they will also lift deposit rates.

This will keep the politicians off their backs in the short term, but in time, commercial reality says the banks will lift rates above the RBA increases, because wholesale rates are now running hard thanks to inflationary expectations in Australia and the US.

Banks like rate rises in the early days because they can increase mortgage prices more than deposit rates, but it all depends on whether prices can rise more than cost. 

Banks won’t want to be looking greedy in an election campaign because politicians like nothing better than to be seen to be kicking the banks.

The rise of the mortgage brokers

The real story on bank profits is how these giant financial institutions have let mortgage brokers take control of their biggest profit driver: home loans.

Mortgage brokers are sometimes aggregated under bigger houses, like AFG and the Loan Market Group, but Mortgage and Financial Association of Australia chief Mike Felton says 61% of brokers are one- or two-person businesses.

As of December, they accounted for 67% of all home loans initiated, up from 47.3% in 2013.

CBA is the only major bank to initiate more home loans in-house than outsourcing and even then, as of December, brokers accounted for 46% of its loans.

More telling is the fact 49% of new loans came to CBA from brokers.

The reality is the home mortgage market, and its profits, starts with brokers who are, more often than not, sole traders.

These folk are better than the banks at selling their products and this means the banks have lost control of a key part of their business. If someone is borrowing $1 million all they care about is getting the best rate, and as mortgage rates move higher, this becomes even more the case.

The banks write the final product but the person delivering the business comes from outside the bank and is driven by different issues.

This is where the banks’ problems lie and doesn’t help their drive to sell more products to the one customer.  

In the good old days, the customer came to the bank or the bank came to her, and the bank had full control. While in an age of cost cutting it is sometimes cheaper to outsource business, that’s not the case when it means losing control. 

As Felton explained to SmartCompany: “The mortgage broker value proposition has always been based on experience, choice and convenience, but since January 1, 2021 consumers have also benefited from a best interests duty.”

“This has provided yet another compelling reason to utilise the services of a mortgage broker and one that has driven an increase in consumer trust and confidence, as evidenced by the surge in mortgage brokers market share from 59.4% to 66.5% in the past year.

“Obviously as mortgage broker market share increases the number of consumers that have a broker acting in their best interests increases, which naturally drives increased competition and more competitive pricing in the industry,” he adds.

Best interests

Felton argues the best interests rule — which requires brokers to find the best deal for their clients — was a boon because it gave them increased credibility.

Complaints against brokers now account for just 0.38% of all consumer financial complaints.

In 2019, the industry faced a potential hit when Royal Commissioner Ken Hayne recommended broker clients pay commissions, reversing the present rule where the host bank pays the broker’s commission.

The federal government rejected his recommendation, arguing it was best to promote competition in home loans through the brokers and banks. The conflicts were best managed, it decided, and the best interests duty was a key decision.

The fact brokers’ market share is steadily rising suggests the government was correct.

None of which will make bank bosses life any easier between now and the election, as the focus turns to interest rates and increased costs of living.