By Jonathan Barrett and Paulina Duran
SYDNEY (Reuters) - Commonwealth Bank of Australia <CBA.AX> Chief Executive Ian Narev knew that a system of financial incentives to reward mortgage brokers could hurt customers but failed to act, an inquiry into Australia's financial sector heard on Thursday.
A confidential letter penned by Narev in 2017 and disclosed on the third day of the financial sector Royal Commission criticized the practice of paying brokers more for bigger loans, an incentive still widely in place including at CBA.
Instead of ordering changes to remuneration practices to protect customers from taking out loans they could struggle to pay off, CBA chose to protect "volume" in the bank's highly lucrative mortgage business, a CBA executive said.
"We agree ... that while brokers provide a service that many potential mortgagees value, the use of loan size linked with up-front and trailing commissions for third parties can potentially lead to poor customer outcomes," wrote Narev, who is stepping down as CEO next month after a series of scandals at the bank.
Under questioning, CBA's executive general manager home buying, Daniel Huggins, said that although Narev supported changes to incentives, nothing was done to unwind the broker commission system because the bank would lose business to rivals.
"I think we have acknowledged there is a conflict in the commission structure," Huggins said under questioning at the public inquiry in Melbourne.
"There is a first-mover problem, in that the (bank) who moved first would likely lose a lot of volume."
Broker payments, particularly trailing commissions paid over the life of a loan, are a sensitive topic for Australian financial institutions as the four biggest banks derived A$51.77 billion ($40.8 billion) from mortgage agents in the September quarter of 2017, according to the inquiry.
As the country's biggest lender, CBA attracts about 40 percent of new home loans from brokers.
The year-long Royal Commission has extensive powers to subpoena documents and can recommend criminal or civil prosecutions and legislative changes, potentially forcing changes to broker incentives.
The center-right government agreed to call an inquiry after years of scandals in Australia's financial sector, which included poor financial advice, interest-rate rigging, and accusations of money-laundering.
CBA is the second bank to be scrutinized after National Australia Bank <NAB.AX>, which conceded on the opening days of the inquiry that its system of bonuses and incentives encouraged bankers to engage in fraudulent lending practices.
LACK OF COMPETITION
In another blow to the banks, the competition regulator said in a separate report released on Thursday that there was "less-than-vigorous price competition" between Australia's "Big Four" - CBA, NAB, Westpac Banking Corp <WBC.AX> and Australia and New Zealand Banking Group <ANZ.AX>.
"We do not often see the big four banks vying to offer borrowers the lowest interest rates. Their pricing behavior seems more accommodating and consistent with maintaining current positions," Australian Competition and Consumer Commission (ACCC) Chairman Rod Sims said in a statement.
While the Royal Commission has so far focused on poor lending practices, the push for an inquiry was fueled by concerns banks were using out-of-cycle mortgage rate rises to boost profits, to the detriment of consumers.
Out-of-cycle rises refer to increases in mortgage rates even when the central bank has not raised the cash rate. Australia's big banks are often criticized for uniformly opting for out-of-cycle rises, leaving borrowers with little choice but to pay more.
(Reporting by Jonathan Barrett and Paulina Duran in SYDNEY; Editing by Stephen Coates)