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Drain the swamp: Why the banks are facing a potential Royal Commission

Tom Richardson
CBA Mastercard

Senior mangement at Australia’s big 4 banks of National Australia Bank Ltd. (ASX: NAB), Commonwealth Bank of Australia (ASX: CBA), Australia & New Zealand Banking Group (ASX: ANZ) and Westpac Banking Corp (ASX: WBC) will be looking nervously to Canberra given the rising prospects of a political inquisition into their profit-making cultures and treatment of customers.

News reports suggest that a Royal Commission into the big banks is more likely as the political composition of parliament evolves after the Queensland elections.

Unfortunately, Australia’s banks have a long rap sheet of misbehaviour including inappropriately rejecting life insurance claims from Australia’s most needy (CBA), to artificially manipulating their own benchmark lending rate the Bank Bill Swap Rate (BBSW).

ANZ and NAB have settled with ASIC regarding the BBSW allegations, while Westpac has surprisingly decided to fight the allegations in court.

Perhaps the most damaging news of all came when AUSTRAC the anti-money laundering (AML) regulator accused CBA of failing to have reporting systems in place to notify the regulator of suspicious financial transactions.

In shock allegations AUSTRAC has alleged that CBA “did not carry out any assessment of the money laundering and terrorism financing (ML/TF) risk of IDMs before their rollout in 2012.

The IDMs or Intelligent Deposit Machines (ATMs where you can deposit large amounts of OTC cash) are what are potentially used by tax dodgers or criminals to deposit cash in the hope of laundering it through the banking system to disguise its ill-gotten sources.

The more cash banks have on their balance sheets the more they are able to lend it out at highly leveraged and profitable rates of return under the fractional reserve banking system.

In other words it’s being alleged that in ignoring important anti money laundering reporting obligations CBA may have been able to lift its deposits (and consequently profit-making potential) as tax dodgers for example favoured its IDMs to make deposits.

Prior to the GFC it has been estimated that some overseas banks lent out $50 for every $1 they held in reserve (from retail depositors for example) as risk management went out the window in pursuit of profits. This would be the equivalent of buying a $1 million house with just a $20,000 deposit, with some some overseas banks this leveraged prior to the banking system’s credit and liquidity crisis that snowballed into the GFC.

Over this period Australia’s banks were lauded as examples of responsible lending, although the recent stream of bad news around culture has turned the tables on the public’s perception of them.

In response the banks have launched an advertising campaign claiming that the industry’s profits belong to all Australians, although questions remain over internal culture that seemingly puts chasing profits before obligations to customers and society.

Outcomes

A Royal Commission will prove a major distraction for the banks’ senior management teams and result in increased reporting, risk control, legal, and compliance costs.

Cost increases are unlikely to amount to a needle-moving extent however and the banks have multiple levers to pull in response to any costly new obligations.

I wouldn’t sell my bank shares in response to any potential Royal Commission as for defensively-focused blue-chip dividend seekers they remain a reasonable hold in my opinion.

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Motley Fool contributor Tom Richardson has no position in any of the stocks mentioned.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of National Australia Bank Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.