Mortgage brokers: Hayne will kill competition


Australian Financial Review ›

February 12, 2019

The sharemarket gave its verdict of the Hayne recommendations last week. On the Tuesday, the big four banks were up by 6 per cent (or $21 billion) – the biggest one-day increase in a decade. Their performance was only outdone by AMP (up 10 per cent). Meanwhile, the smaller banks had only a small lift in share prices and the listed mortgage brokers took a hammering – with Mortgage Choice and AFG down by more than 25 per cent. You could be forgiven for thinking the royal commission had skipped over problems with the banking and wealth management sectors to focus on the mortgage brokers as the real "villains" in the finance industry.

Of course, movements in share prices must be viewed in the context of changed expectations. The increase in big four valuations might just means that the Hayne recommendations were $21 billion "less bad" than investors feared. So, one might be tempted to conclude that the Hayne recommendations are still "tough on banks", just not as tough as they might have been.

But this conclusion is wrong. If the recommendations on mortgage broking are implemented, then the royal commission will likely end up raising the big banks' profits. Notwithstanding sound economic reasons why most consumers will be unwilling to pay upfront broking fees, the recommendations would make commissions to mortgage brokers illegal and effectively kill the industry. Customers won't commit to an upfront fee before receiving the broking service and, absent such a commitment, there is nothing stopping them identifying the best lender with the mortgage broker and then simply buying directly from the bank. The curtailment of mortgage brokers would severely reduce competition between the banks – raising margins on the $1.7 trillion of home loans.

Mortgage brokers intensify competition between the banks by reducing customer search costs and, critically, providing distribution scale economies to smaller banks and non-bank lenders – making them more competitive with the big banks. Each bank feels compelled to compete via this channel while their competitors do. However, if they could, as a group, click their fingers and make mortgage brokers disappear they would. Imagine the smile on their faces when they saw the Hayne recommendations proposing to perform this magic trick for them.

A 0.1 per cent increase in bank margins will raise mortgage profits by $1.7 billion a year in perpetuity. That's worth around $25 billion in bank valuations at a 7 per cent discount rate. But a 0.1 per cent impact is conservative with plausible estimates suggesting materially higher increases in big bank profits absent mortgage brokers.