Banks and the moral dimension

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Lynton Freeman says that it " possible for banks to operate efficiently and ethically within the statutes for the benefit of society, without the need for institutional investors demanding the 'right' return on equity."

Mortgage is a French law term meaning ‘death pledge’ or ‘death contract’. Many of us can identify with this.

The World Financial Crisis has brought home to Australians the problems associated with untrustworthy bankers.

There are about two million mortgage holders in Australia. By breaking down these processes to establishing a mortgage and combining some of these processes to one entity (person or persons) there is a group of about ten people associated with each mortgage.

This equates to around 20,000 million individual relationships or persons.

It shows the mortgagor as one entity and the depositor to the ADI as one entity and does not consider any problems concerning interest updates and/or renegotiation.
One such problem for depositors is covered bank bonds.

These bonds should to be covered by the bank's assets. This calls into play the Reserve Bank's guarantee of depositors’ accounts with a competing, proposed capital guaranteed product.

Under Taxation Ruling TR2002/15 and judgment St George Bank v Federal Commissioner of Taxation[2009] FCAFC 62; St George Bank and the National Australia Bank were prosecuted over previous bond issues, which involved swapping funds to equity.

Further taxation problems for the industry ensued when six of Australia’s biggest banks were caught in a Taxation scheme to deceive the New Zealand Taxation authorities with Westpac’s liability close to $1 billion [Westpac Banking Corporation v The Commissioner for Inland Revenue HC AK CIV 2005-404-2843 [2009] and BNZ Investments Limited and Ors v The Commissioner of Inland Revenue [2007] NZCA 356 921].

In Ireland in a High Court Judgment, the National Irish Bank & Anor v Companies Act [2007] IEHC 102 the National Australia Bank subsidiary was found to be proffering inappropriate practices and fined.

These inappropriate practices included:

  • Bogus non-resident accounts, which were opened and maintained in the branches, to enable customers to evade tax through the concealment of funds from the Revenue Commissioners.

  • Fictitiously named accounts were opened and maintained in the branches, enabling customers to evade tax through the concealment of funds from the Revenue Commissioners.

  • CMI (Clerical Medical insurance) policies were promoted as a secure investment for funds undisclosed to the Revenue Commissioners.

  • Special savings accounts had D.I.R.T (deposit interest retention tax) deducted at the reduced rate, notwithstanding that the applicable statutory conditions were observed.

  • There was improper charging of interest and fees to customers.


The judgment found that:

  • The chief executive of the Irish Bank managed the Bank as a core asset of the National Australia Bank.

  • Kept in regular contact with Senior National Australia Bank management in other jurisdictions.

  • Attended meetings of National Australia Group Management in London, Australia and other locations.

  • Maintained contact with external regulators and agencies, including the central bank; and

  • Managed the implementation of National Australia Bank Group initiatives in the Bank.

A senior executive of the NIB stated he was entitled to rely on the bank’s internal systems and procedures, and controls of the internal audit function, to detect and report accurately and comprehensively on the implementation and operation of appropriate procedures, controls and practices of the Bank and on departures therefrom. A further judgment was made in 2011 by the IEHC (Irish High Court), which did not change its rulings but strengthened the sanctions.

In Australia NAB admitted similar situations to its NIB activities, including debit tax, default interest, fees and charges, stamp duty and settlement fees.

In the last fortnight, Independent Australia, exposed how the National Australia Bank had redacted its website to hide customer refunds.

This exposé was followed up by a three part series by Professor Evan Jones on the Commonwealth Bank and its customer practices and the role of valuations (Independent Australia 2-5 April, 2012):

ANZ Bank also is not immune from having accounting and customer account troubles, admitting to a corporate culture culminating in incorrect account keeping and being involved in share market collapses when using that company’s customer accounts as security for lending to the collapsed entity.

Why do Australian Banks have such a bad reputation for looking after other entities funds?

Do Australians trust their banks to be honest with their funds?

When will banks be compelled to be responsible for their conduct and delinquent situations?

In Australia and England, banks are responsible for the accuracy of the customer’s accounts and statements.

With all the regulatory admissions and refunds in the past ten years and given all the taxation anomalies, why did the NAB and other banks’ inaccurate account keeping remain undetected for so long?

Two obvious reasons are:

  1. internal audits; and

  2. varying fees and charges between branches.

The fact is, in some cases they were detected, but detailed questions and insufficient answers have failed to adequately address the issues.

The question is how did the NAB remain undetected by regulatory bodies of unlawfully collecting debit tax from customer accounts? Internal audit, that's how!

An estimated fifty thousand customer accounts where the default interest had been wrongfully collected since 1992 were identified on the 10th of November 2005 at the NAB's Annual Shareholders Meeting.

These fixed rate interest-only business and investment loan accounts were then refunded on the 28th of September 2006.  The interest rate paid by the NAB on the refunds was only 4.5 per cent and reimbursement only went back six years to 1999, despite the fact that the actual problem arose seven years earlier in 1992. The initial default interest would certainly have exceeded the 4.5 per cent interest refund.

How did this happen? Because customers for a variety of reasons did not recognise the incorrect debits to their accounts!

This is not like the situation in Ireland, where NIB customers were permitted to launder funds and it appears NIB obtained extra fees and interest on some accounts.

Customers do not notice small account deductions over a long period of time, but these deductions become large volumes of income for NAB, over a group of accounts.

The connection between the Irish accounts and the Australian accounts is NAB management policy, which uses the same processes of customer accounting.

In both countries, the Bank employees acted in the interests of bank profit.

In August 2000 and reporting in October 2000 the Joint Parliamentary Committee into Corporations and Securities conducted an inquiry into “Shadow Ledgers” and bank statement practices in Australia.

They found that for value bank statements were stopped by Commonwealth Bank of Australia (CBA), NAB and ANZ at the banks’ will, but transactions then proceeded on a not for value statement.

This statement was not delivered to the customer until the Affidavit of Debt was presented to the court at trial.

Litigant customers, therefore, had no opportunity to identify if the statements were correct and, even in the Court, the bank could use incorrect entries without the customer being able to correct them.

The practice was found as being not in the public interest, and banks were ordered to advertise and correct statement practices, as well as to supply correct statements to customers and mediate the circumstances.

For some customers already in the Courts, this correction and mediation did not happen — and now NAB and ANZ corporate culture inspired refund activities are seriously affecting judgments.

Many other corporations trading in the 1950 to 1970 period have the same problem; that is when corporate governance emerged during and from the 1962 Australian credit squeeze, the philosophy amongst the banks was 'the bank is always right'.

Current corporate culture themes emerged from there, with all of them revolving around the ‘right’ result for the corporation.

Policy in Australian Banks for accounting responsibility and the process of maintaining for value bank statements, until moving an account in recovery to a not for value account, is now seen as incorrect because the customer is not liable until the account is legally sworn.

Earlier, in accordance with the judgment in Dobbs v National Bank of Australia Limited HCA [1935 53 CLR, 643] banks then issue a certificate of debt. Some of the other findings in Dobbs were:

  • The contract authorising the certificate of debt, as evidence of the debt could not take away the right to court examination of the debt.

  • The certificate was conclusive only of the debt, not of liability.

  • The officer completing the certificate must be familiar with the account.

  • The certificate was conclusive upon the parties of the amount and existence of the principal debtor’s existence.


However, at that time, banking was much simpler with education limited, bankers trusted and amortisation loans relatively undeveloped.

The current array of products and charges for service were not envisaged. The seriousness of the Bank having the responsibility for the accuracy of the account was an automatic non-contention.

How did Australian Banks go from such a lofty position in society, to be distrusted users of customers and depositors funds?

When computerisation commenced in banking. Failed services were common. But internal            accounting practices changed again and the use of the unaudited account entry for customers’ accounts grew with the proliferation of fees.

This included originating circulars from 3 sources – head office, state management and regional management – creating a situation of fees and charge out policies and deposit policies, to obtain what is ‘right’ for the bank.

These all occurred in unaudited originating entries in customers’ accounts. This culminated in National Australia Bank and Australia and New Zealand Bank admitting corporate cultures and incorrect entries in accounts and refunds.

In 1974, the Trade Practices Act (Cth) was set up. In 2001, the Australian Securities and Investment Commission (ASIC) was established to oversee corporations and Australian Consumer and Competition Commission (ACCC) to oversee consumer problems and competition in industry. Later, in 1998, the Australian Prudential and Regulatory Authority (APRA) was formed to oversee prudential policy and maintain good corporate governance in the financial industry.

Recently, ASIC has voiced its approval of representative or class actions as part of the democratic process and this is being resisted by the NAB trying to control litigation in a current Melbourne class action.

In Dobbs v National Bank of Australia Limited HCA [1935 53 CLR, 643], perhaps NAB has an extraordinarily good reason to do so.

The Judgment in Dobbs now means that the NAB may have admitted incorrect debt certificates, sometimes in Court, through the NAB's refund activities both past and present.

Banks have a privileged place in society because of their relationship with government, community, customers, shareholders and stakeholders.

Whilst in most industries, the DuPont analysis, Return on Equity (ROE), and other business analysis applies, this does not really fit banking.

The bank deals with other entities money — except for its earnings, outgoings and tier 1 equity, which is statutorily overseen in accordance with the Basel Committee recommendations.

It does not fit banking, because return on equity is controlled at will, by levying captured customers through the borrower and lender contract, with the bank offering to efficiently use any depositor’s funds.

Why is productivity not used as the measure?

In Australia, in particular, the banks have a contract to efficiently perform those services through the distribution of government services in funds distribution and evidence collection.

Their relationship with society is to efficiently provide banking services and carry out government policy and statutory requirements effectively.

Have banks have lost their previous status because of their failed balance in all these areas? Perhaps, but it is in their relationship as lender of opportunity that can mostly be shown to inefficiently and inequitably make demands on borrowers without accepting any of the risk and vagaries of the market they lend into.

Banks and society have tried the risk spreading of derivatives with catastrophic results, usually caused by the unrecognised risk associated with careless investment practices.

It is time to find a way to investigate spreading the risk in other ways, and to support society with good banking practices.

Governments and society need to protect banks from themselves, so they can carry out the efficient distribution of government generated funds and support policies as a Government agent and implementer of Government policy.

This also places a responsibility on banks to act in the public interest.

In Australia there is a proliferation of Commonwealth and State Government schemes to establish housing.

This creates a contract between lenders, borrowers and government to maintain the loan but also for accepting part of the capital risk of loss of value.

The loss of value can be traced to banks inefficient investment of funds, and their effort to capitalise on cash markets by accepting the collective risk from other lenders' inefficient use of credit into the housing markets.

Consequently banks have created the scene for loss of capital value by the owner/occupier — and government/industry investment fund wastage.

It is established that savings through home loans establish the collateral needed to relend for home improvements, home extensions, car purchase, consumer goods and various other uses.

It is also established that the lenders (banks) have now reduced the borrowings through these sources because of the value drop in the capital value of the security, caused by their inefficient use of credit and cash generated through borrowers and government.

Banks, therefore, should carry part of the capital risk associated with market vagaries caused through inefficient use of credit availability by their industry, through inefficient risk spreading derivatives across a wide section of the mortgage industry.

What is the most efficient way to assure the borrowers, lenders and government of the security of their investment in home ownership, lending and building?

There already exist individual contracts that are traded based on the underlying security (home) value.

It is this collective value, that causes inefficient credit use, that is now exposed.

Home owners accept all the costs of ownership, including the mistakes of their financiers on their savings value in the mortgage security. There have been some published methods of establishing equity in capital value of security reduction through spreading the market value risk.

There is a single security market in Chicago that may be duplicated in Australia.

The major risk for lenders is the moral risk of when the value of the security is exceeded by the value of the loan and the mortgage becomes delinquent. In addition, there is loss of income and changes in circumstances of borrowers, prepayment by borrowers, becoming more aware and switched on to investments. It is only recently that Australian borrowers were now able to switch lenders without penalties being imposed.

These new mortgage products include Price Level Adjusted Mortgage (PLAMs), Adjustable Balance Mortgages, (ABM), Continuous Workout Mortgages (CWM) and others.

All have a method of adjusting capital value and avoiding moral risk.

However, in the 1970s, one person developed a process of splitting the repayment schedule, by initialising amortisation in another product and retaining the initial value of the mortgage contract separate to the value of the secured premises using investment assurance products.

The whole of the process was not implemented then because of changed circumstances, cost of capital continuance.

To implement the process now would involve some legislative changes, but may save the cash outlay of first home owner grants by replacement with taxation incentives.

In the 1970s, there was an income taxation deduction to $1,200 for individuals for life assurance. One life assurance group provided a surrender value and loan value close to that sum after two years of premium payment.

An average home was $12,000 - $20,000 in that particular geographical area.

The insurer SGIO Queensland had a building society SGIO Building Society providing housing loan funds on 10 per cent deposit. The existing policy provided the mortgage security required for the loan.

After 2 years, the Life Assurance policy provided an income tax deductible deposit for the home purchase.

The Government eventually removed the 60-40 rule (government capital raising process) for investment in Government Securities for life assurance premium income that provided the tax deductibility.

There are now similar schemes with variable flexible repayments, and interest only loans that split the mortgage into repayment and interest.

These are mainly helping those who can service their loans.

However, establishing a home mortgage deposit scheme involving income tax deductible savings for a loan guarantee product could include three of the requirements for a varying security value home loan, spreading the risk between the borrower, lender and government.

It could be adapted to allow current distressed mortgages to continue with banker support through:

  • Deposit,

  • Assured security value at the end of the contract for the lender.

  • An ability to allow the borrower (home owner) to vary the value of the contract security through the period of the loan in line with market variations avoiding moral risk.

The process involves the splitting of the home mortgage into separate parts:

  • The capped value of the purchase property mortgage.

  • The interest component on the varying value of the security.

  • The amortisation through a separate process on the whole value of the loan.

The current APRA Guidelines at APS 220.1-4 allow for the variation of credit risk and the variation in valuations of impaired assets and reinstatements of accounts.

Consequently, the individual bank is in the position to identify a method of saving customers who are over-extended by varying the interest on their security by using the reduced value of the mortgaged property.

The strategic advantage to a bank to continue a reduced earning capacity account is more efficient than losing control of security to a debt recovery process where capital loss is guaranteed.

Partial write-down allows the continuation of an existing customer’s loans at the reduced values, without contravening current APRA Guidelines, by working within the existing system and aids banking integrity.

A proposal for tax deduction of a home owner deposit scheme may be put to the Government through the Senate inquiry into banking operations now underway.

The Australian banking industry needs to review its systems of security valuation and recovery and that is an appropriate forum.

The whole system is geared to moving to default interest to defeat the existing mortgagor and recover the security.

The bank then writes down the account for non-accrual tax deduction process but uses the default interest as part of the debt for judgment debt purposes.

If the customer pays interest, or his interest is current after the writing down of the account, it could be that thebank has been misleading and deceptive.

This is regarded as a low risk by the banking ombudsman, but may be important in the process of allowing existing customers to retain their secured property.

Legislation could require the bank to divulge written down values for the purpose of refinance and commence to realign the whole process of security recovery — as well as to have the mortgagee accept the banking industry’s responsibility for destruction of asset value, arising out of the banking inefficiencies, associated with derivatives trading and misuse of credit.

On February 8, 2012, Science Daily published a guideline for borrowers stating where if a mortgage is traded the likelihood the mortgagor will be granted relief in delinquency is reduced significantly up to 36 per cent.

Science Daily, on October 20, 2011, also published a summary of a study published the same day in the American Journal of Public Health, identifying the loss of health from mortgage stress caused by mortgagors being involved in unhealthy trade-offs in food and prescription medications to continue payments.

The study found a 19 per cent variation in depression rates, 24 per cent variation in loss of food security, and 27 per cent variation in cost related medication failure, over the two year period of the study between mortgage stressed persons and those not under mortgage stress.

Financial counsellors supported the findings in a separate study.

These findings in the United States are duplicated here but are somewhat hidden by Australia’s’ health schemes — but the individual suffering is still evident.

The philosophy of what is good for the corporation is “right” has been brought to light by Evan Jones in Independent Australia when he describes the BankWest practice of railroading customers into failure as a result of “Return on Equity” concerns, so as to satisfy the Commonwealth Bank's institutional investors’ demands for dividends.

The banks (and BankWest is not alone) have lost the sight of the social contract between the bank and society, depositors, borrowers and government to support the demands of institutional investors for dividends when the efficient use of bank assets would aid the retention of homes and small and medium enterprises in all sectors of the economy.

It is clear that lost opportunity now for changes to mortgagee and mortgagor relationships will lead to further increased personal health problems, loss of individual customer wealth and transfer of that wealth to institutional investors, their bidders and debt collection industries, to the detriment of Australian society.

The Commonwealth Government should no longer tolerate the delinquent and bad banking practices that have such a detrimental social impact upon millions of Australians with mortgages and deposits.

It is possible for banks to operate efficiently and ethically within the statutes for the benefit of society, without the need for institutional investors demanding the 'right' return on equity.  
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