I don't know whether Commissioner Kenneth Hayne has ever had a similar conversation, but he has certainly demonstrated excellent instincts in choosing to begin the banking royal commission by looking at the seedy underside of the country's $1.6 trillion home loan market.

A senior executive from National Australia Bank appeared before the royal commission on Tuesday to answer questions about how banks go about winning business in a world where, as counsel assisting Rowena Orr, QC, noted in her opening remarks, most home buyers now use a mortgage broker to arrange their home loan.

Ms Orr cited figures from the Mortgage and Finance Association of Australia, which showed that in the September quarter of 2017, mortgage brokers were responsible for 55.7 per cent of all residential home loans.

Power dynamics

The growing muscle of the mortgage brokers has completely upended the power dynamics in the home lending industry. We're a long way from from the early 1990s when "Aussie" John Symonds first appeared on our television sets promising to help borrowers get a better deal from the "bastard" banks.

The big question – and one of keen interest to the Hayne inquiry – is just how rife is fraudulent conduct in the home loan industry. Chris Pearce

(Of course, Symonds subsequently sold his Aussie Home Loan mortgage broking empire to the Commonwealth Bank, pocketing hundreds of millions of dollars in the process.)

Nowadays, there's no need for borrowers to put on their best Sunday suit and and polish their shoes in order to go and grovel to their local bank manager. And then spend the next few weeks waiting anxiously to hear whether their home loan application has been approved by head office.


Instead, brokers will come to them, with most touting that they'll have loan approvals within 24 hours of the application. But the brokers don't go directly to the banks. Instead, they increase their bargaining power by working through mortgage aggregators who provide brokers with a range of different bank home loan products offered by a panel of lenders to chose from.

This means it's the banks that now find themselves under pressure as mortgage brokers send droves of their customers – via the aggregators – to those lenders who offer either the cheapest home loan rates, and the most lenient lending conditions.

Counsel assisting Rowena Orr, QC, noted in her opening remarks that most home buyers now used a mortgage broker to arrange their home loan. Supplied

Now, this is not a very satisfactory situation for the country's banking fraternity, because home loans make up roughly 60 per cent of their overall loan books.

What's more, businesses' appetite for bank loans has been incredibly feeble since the financial crisis, which means home lending is one of the few areas where banks have seen buoyant credit growth.

So it's hardly surprising that the banks came up with various strategies for fighting back against the growing power of the mortgage brokers.

On Tuesday, NAB's executive general manager of broker partners, Anthony Waldron, gave evidence about the bank's "introducer" program.

Anthony Waldron testified that some bankers had created relationships that didn't exist with introducers. Royal Commission


Generous commissions

Under this program, various classes of people – such as accountants or financial planners, but not mortgage brokers – received generous commissions equivalent to at least 0.4 per cent of the size of the NAB home loan for introducing new customers to the bank. In turn these "introducers" were required to commit to referring $2 million a year in personal loans to the bank, or $10 million in business loans.

NAB now has 1400 such "introducers", down from 8000 at the peak, and they have been an important source of business.

n Waldron confirmed that between 2013 and 2016, NAB approved 45,960 home loans – with a total value of more than $24 billion – that came to the bank through the introducer program.

The problem was that NAB failed to put in place proper systems for detecting fraud in the introducer program, or for managing the potential conflicts of interest.

David Rowe

Waldron testified that some bankers had created relationships that didn't exist with introducers to make payments to external third parties related to the banker.

There was also fraudulent conduct by NAB bankers and the introducers, with unsuitable loans being made, the dishonest use of customer signatures, and false documentation being provided to support loan applications.


In another case, staff in some NAB branches in greater western Sydney were accepting cash bribes to facilitate loans they knew were based on fraudulent documents in order to exceed their sales targets, and ensure they received incentive payments.

But the big question – and one of keen interest to the Hayne inquiry – is just how rife is this fraudulent conduct in the home loan industry. The answer to this question is of huge concern not only to bank shareholders, but also to the country's top financial regulators.

Overstated incomes

The country's $1.6 trillion home lending business has been plagued by various scandals in recent years, which have usually centred on brokers inflating how much their clients have been able to borrow – and therefore their own commissions – by falsely overstating their incomes.

The highly regarded UBS banking analyst Jonathan Mott has long highlighted the problem that these so-called "liar loans" pose for the banks.

One large survey found that one-third of people who had taken out a mortgage in the past 12 months admitted they had not been completely accurate about their financial position when applying for a mortgage.

"Given the rising level of misstatement over multiple years, we estimate there are now around $500 billion of factually inaccurate mortgages on the banks' books", Mott warned in a note last September.

David Rowe

These "liar loans", he said, posed a risk to the banks' balance sheets. In particular, banks could be hit by a surprise surge in problem loans if economic conditions were to deteriorate, causing a jump in unemployment.

"While household debt levels, elevated house prices and subdued income growth are well known, these findings suggest mortgagors are more stretched than the banks believe, implying losses in a downturn could be larger than the banks anticipate."