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Tier 3 Banking in Australia Financial Services TIER 3 BANKING IN AUSTRALIA WILL THE REAL CUSTOMER CHAMPIONS PLEASE STAND UP? Sustaining competitiveness will be dependent upon developing successful management strategies, but also upon dispelling any public sense that the mutual building societies are weaker in corporate structure or governance than the societies that have converted to public limited company status. The identity, confidence and integrity of mutuality has to be re- established. Reconceptualising its mission will be a vital part of any mutual society’s survival strategy. David Robinson of the Scottish Provident put the fundamental questions every mutual society is now confronting: Its attitude to mutuality will be crucial. Is it comfortable with its constitution, or does it feel itself to be an anachronism in the contemporary commercial environment? Does it believe that its special relationship with its members gives it an advantage, or is it simply making the best of what it sees as an outmoded and limiting corporate structure? In short, is it happy with what it is? Extract from “In defence of mutuality”, Thomas Clarke, DBM Professor of Corporate Governance at Leeds Business School (2008). While written about the mutual sector in the UK, the messages are equally as important and true for Australia today. CONTENTS INTRODUCTION 4 1. OUR PERFORMANCE ASSESSMENT: ARE MEMBERS BENEFITTING? 6 1.1. Assessing performance 6 1.2. Valuing mutual returns 10 2. ARE MANDATES WORKING? 14 2.1. Are mutuals delivering on their original purpose? 14 2.2. Is the value proposition as articulated today sustainably differentiated? 16 2.3. How effectively are existing mandates implemented? 18 3. FUTURE SCENARIOS 20 3.1. The path to greater cooperation and consolidation 21 3.2. Moving along the ownership scale 22 4. CONCLUSION 25 5. APPENDICES 26 6. BIBLIOGRAPHY 30 Copyright © 2012 Oliver Wyman 3 INTRODUCTION Created as much to solve a social as a financial issue, in a world where banks limited credit and membership was local, Australia’s mutual organisations were built on, and still enjoy, a reputation as the friendly banking alternative. But after a century since mutuals came into existence, do they still provide a better deal for their members than banks? If so, can they maintain their relevance, and should management, boards and regulators be held more accountable for ensuring they deliver on their mandates? Mutuals possess the distinguishing characteristic of being owned by, and run for the benefit of their members. They vary radically in size, geographic and sometimes industry focus, but their constitutions are tied by a common purpose centred around member and community benefit; each member who satisfies the voting member criteria1 holds one vote, regardless of investment level. This common legal ownership structure and socially-based value proposition enable the mutuals – comprising building societies, credit unions and mutual banks – to collectively present themselves as a “sector” (Tier 3) in their own right. But how material a player are they in the Australian market? Tier 3 today accounts for just 3% market share of assets. Despite efforts to enhance competition, and a general reduction in public trust in major financial institutions, the relative shares of the four major banks (Tier 1), regionals and direct players (Tier 2), and the mutual sector have not materially changed. Indeed the mutuals share of assets has declined over time, suggesting that the sector’s value proposition is not as attractive as one might expect, especially given the ‘anti- major bank’ mood of the post-crisis world. The sector does however remain a significant part of the retail banking landscape; with 11% of Australian household deposits, across more than one hundred institutions, it claims aggregate membership of approximately 4.5 million people2. Without the profit margins demanded by shareholders, mutuals should be able to provide better product pricing for their members, which ought to be a powerful platform for competition. Indeed in Australia, as in other countries with a vibrant mutual sector, Tier 3 institutions advertise among the most competitive mortgage and deposit prices on the market. However, this deal is not always as good as it might appear, nor convincing enough to drive significant change in consumer behaviour. Why then have the mutuals not gained new business market share in an environment of emotive public and governmental backlash against major financial institutions, when their published3 pricing is so apparently competitive? A key observation is that advertised rates are just that; online rates are often cheaper, and major banks commonly discount substantially from their advertised rates (indeed many are now advertising these discounts), with the result that the actual differential between discretionary discounted rates from the banks and mutuals are often quite modest and frequently in favour of the major bank customer. Many mutual members can therefore get a better deal elsewhere. 1 Voting membership is typically based on tenure of a few months and investment of at least $250 – $500 2 Abacus “Key Fact Sheet” March 2012 3 See for example the advertised standard variable rates for mortgages. In writing this report, we have attempted to draw on the widest possible range of information, including published reports, academic research and our own primary research. Data is an important constraint on the depth of analysis that can be undertaken. Where possible we have, therefore, supplemented quantitative data with qualitative information obtained from interviews and market experience Copyright © 2012 Oliver Wyman 4 Moreover, the economics are badly skewed; depositor members are in effect subsidising borrowers. Whilst this might suggest that the Tier 3 proposition should attract more borrowers than depositors, the reality is that institutions relying on retail funding must by definition ration credit – and pricing needs to reflect this. The banks, in contrast, also have access to wholesale funding markets – over the longer term this may better position them to attract borrowers meeting their credit criteria. So whilst the 3rd Tier makes an important contribution to banking in Australia, many of the remaining players in the sector (with the notable exception of a handful such as CUA and ME Bank) have arguably stagnated in what should be an era of growth and prosperity. In this report, we examine the deal that members are getting and the reasons for this, and offer a number of potential future scenarios for the sector, drawing observations from other markets. In particular we make reference to the UK mutual sector which, during the 1980s and 1990s, saw some mutual organisations retain but successfully transform their mutual business models, whilst others transformed their operations through loosening the bonds of mutuality. Oliver Wyman’s recommendations for the sector in Australia echo those made in our joint EACB report issued in Europe in 20084: a vibrant mutual sector needs institutions that genuinely champion the customer, address agency issues head on through clarification of membership and simplification of voting rights and control, enhance efficiency in terms of capital retention and cost, and create a compelling proposition evidenced by renewed growth. 4 See bibliography for a link to the report Copyright © 2012 Oliver Wyman 5 1. OUR PERFORMANCE ASSESSMENT: ARE MEMBERS BENEFITTING? We know that the sector has not been substantively growing. But is this a value or communication issue? Our assessment of the sector starts by focusing on whether the sector is providing value, perceived or quantifiable. Before assessing the financial and non-financial benefits of mutuality, it is worth noting that whilst we focus our attention on the outcomes for members as owners, there are several other actors in the mutual sector, including members as customers, mutual management and boards, and regulators. Although historically the interests of these different groups were closely aligned, growth and opening of membership has increased the potential for conflicts of interest, both within and between these groups. 1.1. ASSESSING PERFORMANCE Whilst we acknowledge that for some mutuals membership is seen as a political statement of disapproval of perceived capitalist greed by banks rather than a hard-headed financial choice, many customers do choose a financial service provider based on economics alone – at least before inertia kicks in. Yet even for those who choose based on economics alone, non-financial considerations (including practicalities of customer service and access) do matter over time. Mutual organisations have taken advantage of this by appealing directly to the non-financial objectives of customers, claiming to deliver outstanding service, competitive choice and community benefits, as well as positive returns to members. We assess performance therefore against both financial and non-financial dimensions: • Service: as measured by customer satisfaction data relative to their banking counterparts • Competitive choice: whether the mutuals are providing a genuine alternative to the listed sector with a sufficiently differentiated value proposition • Community benefits: the extent to which communities served by mutuals benefit directly through community outreach, charity and inclusion programmes • Pricing and member equity: how competitive mutual product pricing is, and the extent to which different member groups enjoy an equitable share of the benefit SERVICE
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