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Treasury finds flaws in upfront, flat fee commission models

  • Treasury finds flaws in upfront, flat fee commission models

    In a report to the royal commission, it warns that these models could be "commercially inefficient"

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    In a detailed response to the royal commission, the Treasury has warned that adopting a broker remuneration model that is “too prescriptive” could prove detrimental to competition in the mortgage market.

    “The standard commission structure represents a balancing of commercial interests and responsibilities between lenders, aggregators and brokers, as well as the interests of consumers. Too prescriptive and fixed a model risks being commercially inefficient,” Treasury wrote in a background paper released last week.

    Models that have been adopted in the Netherlands and the UK, and that could be applied here, include a move away from remuneration set by loan size to a fixed dollar amount; ending trail commissions; or requiring the consumer to pay the broker, not the lender. However in its analysis of these models, Treasury identified several downsides.

    Fixed dollar model
    While moving away from remuneration set by loan size would disincentivise brokers from encouraging consumers to take out larger loans than needed, it might also incentivise the splitting of loans into multiple accounts to generate additional broker fees, Treasury wrote.

    A fixed rate might also discourage brokers from taking on complex deals.

    Removing trail model
    Treasury said the advantage of removing trail means less incentive to inappropriately recommend larger loans that take the consumer longer to pay back and greater incentive to help customers refinance.

    However, in the UK, where trail doesn’t exist, there has been concern over churn, which is one of the main arguments the Australian industry bodies have brought up. This has led UK lenders to pay retention fees to brokers to encourage consumers to stay with lenders but at a different rate.

    Flat fee model
    The third model examined— requiring consumers rather than lenders to pay the broker— “would be the most radical”, Treasury wrote.

    While eliminating payment from lenders would likely make brokers’ recommendations more closely aligned with the consumers’ best interests, the risk is that consumers would bypass brokers and go directly to lenders, “threatening the viability of the mortgage broker distribution channel”.

    According to Treasury, estimates show most consumers would be willing to pay brokers no more than $1,000, which is well below the average commission they receive from lenders.

    “If mortgage broking activity contracted, this could have a significant detrimental impact on competition in the mortgage market,” Treasury said.

    In the Netherlands, where the fee-for-service model has been adopted, lenders must charge a mortgage arrangement fee in an attempt to maintain competitive neutrality between brokers and lenders.

    The Treasury warned the commission that if further changes to broker remuneration are adopted, they could “have the potential to be disruptive to an industry already facing significant change in light of the CIF proposals and tighter lending standards, and involve significant costs in transitioning to and bedding down any changes”.

    With all of this said, the Treasury urged the royal commission to consider “flexible and less prescriptive approaches”.

    But what about the Productivity Commission?

    However, according to an article published in The Australian in early July, the Productivity Commission has other ideas.

    The newspaper reported that the PC had “provided a policy solution to eliminate the perverse incentives” of trail in its unreleased final report on Competition in the Australian Financial System, which is currently being reviewed by the government.

    Related stories:
    "The consumer does not have a confidence deficit in the broker channel"
    Productivity Commission proposes slashing trail: report

    Original Article