The Royal Commission into misconduct in the Banking, Superannuation and Financial Services Industry has been dominating media headlines in Australia and has sent the share prices of the four major banks plummeting.  This blog is a brief look at the Royal Commission and its likely impact on the Australian economy and the major banks – ANZ, CBA, NAB and Westpac.

What is a Royal Commission?

A Royal Commission is an independent public inquiry typically instigated by a state or federal government.  They usually investigate an illegal activity, matter of gross administrative incompetence, impropriety or the handling of a natural disaster.

A Royal Commission has the power to summon witnesses under oath to give evidence and ask parties to produce documents.  Its powers are underpinned by the criminal code; failing to comply with a Royal Commission request can result in a jail term.  But the Royal Commission has no powers to pass regulations or create law.  This responsibility lies with the Government and industry regulators who may act on recommendations from the Royal Commission.

The current Royal Commission was called by the Federal Government to examine misconduct into the banking, superannuation and financial services industry.  It has four rounds of public hearings spanning March to July and will produce an interim report by the end of September.

What has happened so far?

Three of the four public hearings are complete.  The allegations against the banks – and the public outcry –  have been more severe than anticipated.  These allegations include giving bad financial advice, poor lending practices, rewarding staff for channelling customers’ money into their own products, denying legitimate insurance claims, forging documents and bribery.

What are the likely repercussions?

Some of the conduct we’ve heard about is appalling.  We will certainly see an improvement in banking industry standards and compliance to prevent some of the poor cases we have heard about from happening in the future.

From an economic viewpoint, perhaps the most significant issue is the allegation of poor lending practices.  The banks have been accused of not properly verifying borrowers’ living expenses and consequently approving loans that are too large.  In response to the Royal Commission spotlight, the banks are improving their lending due diligence processes.  It is feared that this will reduce the supply of credit to the housing market and cause property prices to fall.

The economic fallout

Anecdotal feedback we have collected suggests there has been a tightening of credit available to some borrowers.  This is supported by official data which shows that housing credit growth has slowed from around 7% last year to 5.8% in May this year – the slowest since mid-20141.  This is being felt in the housing market where Sydney prices have fallen 3.5% from their peak and national price growth has stalled.

Source:  ABS, APRA

However, we think the risks of a major housing or economic downturn are limited.  Credit growth in housing will probably contract a bit further but remain at a reasonable level as the banking regulator loosens credit restrictions in some areas.  This should prevent a serious housing market downturn.

The wider Australian economy will lose the tailwind of a booming housing market, but a recovering resources sector and surge in infrastructure expenditure should continue to underpin economic growth.

The main risk to the Australian economy is a significant increase in interest rates.  We do not expect this to occur over the next 12 to 18 months so are not too concerned about this at the moment.  But this is a critical issue we will monitor closely.

The share prices of the major banks fell between 8% and 15% from the beginning of this year to their lows in mid-June.  It is likely that their earnings growth will slow as credit growth slows and they lose some market share to other lenders.  But their attractive imputed dividend yields of around 10% for Australian investors should see their share prices find support around these levels.