Australian Banks' U-Turn on Conduct Probe Is Bid to Cut Risk

(Bloomberg) -- If you can't beat 'em, join 'em. That's the calculation Australia's biggest banks and the government have made in deciding to cave in to pressure for a public inquiry into alleged misconduct in the financial industry.

After months of denouncing the idea of a Royal Commission as an expensive waste of time, the big four banks staged a backflip Thursday and called on the government to end the damaging political fight and establish an inquiry. That gave Prime Minister Malcolm Turnbull the cover he needed to carry out his own abrupt U-turn of government policy minutes later.

By taking control of the process, rather than risking defeat to opposition lawmakers and rebel members of his own government, Turnbull has been able to set tight limits on the scope of the probe. It excludes a grab-bag of other issues pursued by opposition lawmakers -- such as pay, excess profitability or the government's implicit guarantee of banks -- that could potentially have had far-reaching implications for the industry.

“The major banks acted in the national interest to minimize more serious risk to the banking sector,” Anna Bligh, head of the Australian Bankers' Association, said in a statement. “The possibility that terms of reference on something this important could be the subject of political horse trading should worry every Australian.”

Read more: How outrage over Australia's banks sparked the inquiry

By asking for the commission to be established now, the banks have potentially headed off a far more wide-reaching inquiry if the main opposition Labor party was to win government. The draft terms of reference task the commission to investigate “any conduct, practices, behavior or business activity by a financial services entity that falls below community standards and expectations.”

The tight deadline should also ensure the probe doesn't veer off into unwanted territory. Previous Royal Commissions have run much longer: a probe into police corruption in New South Wales in the 1990s took almost three years to report and the inquiry into child sex abuse, particularly in churches and schools, is still in train almost five years after being established.

“This is relatively benign compared to what could have happened,” said David Walker, portfolio manager at Clime Asset Management which holds shares in the big banks among the A$750 million ($570 million) it oversees. “There has been a knee-jerk reaction in the market today, but I think this has been overdone.”

Read more: Why there's no need to fear a banking inquiry -- Gadfly

More than A$8 billion was initially wiped off the market value of the big four lenders in early Sydney trading Thursday. By midday Friday, most of the lenders had recovered ground. At 12:38 p.m. in Sydney, National Australia Bank Ltd. and Westpac Banking Corp. were up 0.5 percent, Commonwealth Bank of Australia gained 0.3 percent and Australia & New Zealand Banking Group Ltd. rose 1.1 percent.

Royal Commissions in Australia have extensive powers, and are able to compel the production of documents and summon witnesses to testify under oath. The risk for the banks is that a public inquiry uncovers fresh allegations of misconduct, further tarnishing an already battered reputation. The banks have been damaged by a string of scandals over the provision of misleading financial advice, attempted rate rigging and the alleged improper refusal of insurance claims.

In May, the government capitalized on this public anger to slap a A$6.2 billion levy on the big four banks and Macquarie Group Ltd., catching the lenders by surprise. Today's coordinated action by the banks in calling for the inquiry suggests they didn't want to again be caught flat-footed.

The outcome “is less damaging than having the opposition and minor parties dictate the terms of a commission of inquiry,” Deutsche Bank AG banking analyst Anthony Hoo wrote in a note to clients. “However, it is still a negative development given the risk of further conduct issues arising via the inquiry and is likely to weigh on sector valuations.”

Calls for a Royal Commission gained renewed impetus in August when Commonwealth Bank, was sued by the financial crime agency for allegedly repeatedly breaching anti-money laundering regulations. It is defending the case.

While the inquiry offers the banks the long-term opportunity to move on from a period of intense scrutiny, more immediately it will pile further pressure on executives already forced to contend with a slowing revenue outlook.

“The royal commission is likely to be expensive and distracting,” with estimated costs of between A$50 and A$100 million each, UBS Group AG banking analyst Jonathan Mott said in a note to clients. “The banks are battered and bruised, unlikely to improve any time soon.”

Read more: What banking analysts are saying about the inquiry

There was a sting in the tail also for union-backed industry superannuation funds, which have been vocally critical of the banks' attempts to increase their share of the pensions market. The inquiry will explicitly look at whether members' money is put to any purpose that is “not in the best use of members.”

“It is disappointing that the government is seeking to deflect from the real and systemic problems plaguing the big four banks, by including the superannuation system in this inquiry,” Eva Scheerlinck, chief executive officer of the Australian Institute of Superannuation Trustees said. “There is no evidence of gouging, fraud or unethical behavior to warrant a Royal Commission into the industry.”

To contact the reporter on this story: Emily Cadman in Sydney at ecadman2@bloomberg.net.

To contact the editors responsible for this story: Marcus Wright at mwright115@bloomberg.net, Edward Johnson

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