With an election just weeks away, the Federal Government has backed away from the banking royal commission's recommendation that all commissions in the mortgage broking industry be abolished and consumer groups warn it will leave borrowers worse off.

Key points: When Kenneth Hayne's final report was released, the Government pledged to ban trailing commissions from July 2020

When Kenneth Hayne's final report was released, the Government pledged to ban trailing commissions from July 2020 Trailing commissions are paid to brokers for the duration of a loan, as opposed to upfront commissions

Trailing commissions are paid to brokers for the duration of a loan, as opposed to upfront commissions The mortgage broking industry claimed up to 70 per cent of its members could lose their livelihoods

In his final report, Kenneth Hayne recommended all commissions ultimately be axed and replaced with upfront fees paid by the borrower, rather than the bank.

But the Government has announced brokers will be allowed to keep both upfront and trailing commissions for at least the next three years.

That is despite overwhelming evidence that loans arranged by brokers tend to be larger, take longer to pay down and cost more than loans arranged directly with banks or other providers.

With the bank paying the commission, the incentive is for the broker to direct their clients to the bank with the highest commission.

Because the commission is a percentage of the size of the loan, there is also an incentive to encourage clients to borrow as much as possible.

A 2017 study of the home loan industry by investment bank UBS found up to a third of mortgages are "liar loans" — based on inaccurate information that may have been massaged to help the borrower get a bigger loan than they should have been eligible for.

According to UBS, loans arranged through brokers had a higher rate of misrepresentation.

Industry argued 70pc of brokers would lose livelihoods

On the day the royal commission final report was released in February, the Government announced it would allow upfront commissions to continue but would ban trailing commissions, paid for the duration of the loan, from July 2020.

Amid a concerted campaign from the mortgage broking industry, which claimed up to 70 per cent of its members could lose their livelihoods if commissions were abolished, the Government has now relented on trailing commissions.

It said both upfront and trailing commissions will stay in place for the next three years, at which time there will be a review by the Australian Competition and Consumer Commission and the Council of Australian Financial Regulators (APRA, ASIC, Reserve Bank and Treasury).

Mortgage brokers have welcomed the move, with chief executive of Mortgage Choice Susan Mitchell arguing Mr Hayne's proposal would have reduced competition in the home loan market and favoured the major banks, as many smaller lenders relied on mortgage brokers to sell their loans.

"I think that both parties recognise the research that's been done which would imply that consumers are not willing to pay the level of fee with keeping a viable broker channel," she said.

"Therefore, if you were to move to that smaller fee, you would move to an anti-competitive position."

'Government responding to powerful lobby group'

Associate Professor Michael Rafferty, from the School of Business at RMIT, told the ABC it was an extraordinary decision, but one by which he was not surprised.

"The financial services sector is the most powerful lobby group in Australia and it's heavily ingrained with both major political parties," he said.

The Consumer Action Law Centre's chief executive Gerard Brody said the backflip on banning trailing commissions put industry interests ahead of customers.

"Our laws have a lot of problems in them — creating loopholes, creating exemptions, creating conflicted remuneration — because of lobbying by the industry," he said.

"I think that's what we're seeing again today, a government responding to lobbying by an industry sector."

Professor Rafferty said the backdown over mortgage broker commissions pointed to deeper problems and "the continuing self-destruction of the Liberal Party", which he said he was seeing in other areas, like the debate around coal-fired power stations and climate change.

"There's an inability within the Liberal Party at the moment to navigate obvious reform," he said.

'Critical part of competition'

The Treasurer would disagree with that assessment, offering a more pragmatic view.

"The abolition of trail from July 2020 won't proceed as first announced," Josh Frydenberg told reporters at a press conference.

"The reason is, we're concerned about the impact on competition in the mortgage lending market. Small lenders and mortgage brokers are an absolutely critical part of competition in that market."

In a statement announcing the decision, Mr Frydenberg said almost 60 per cent of home loans were settled by mortgage brokers.

"There are 16,000 mortgage brokers across Australia, many of which are small businesses, employing 27,000 people," the statement said.

"The Government wants to see more mortgage brokers, not less."

Mr Frydenberg said an ASIC review of mortgage broker remuneration in 2017 did not identify trailing commissions as directly leading to poor consumer outcomes.

The Government is adopting Mr Hayne's recommendation for mortgage brokers to be subject to a "best-interest duty", just like financial planners.

Labor has also backed away from implementing Mr Hayne's recommendations about mortgage brokers in full.

The royal commission recommended that, ultimately, borrowers should pay mortgage brokers for their services, not banks.

However, the Opposition is proposing that upfront commissions remain paid by the bank, but be regulated so as to be the same across all lenders, although Labor would ban trailing commissions from July 2020.