Behind CBA's system failures

I hope this week you will forgive me but it's not often that an investment commentator has a personal debate with a chief executive about his company and it's the CEO who turns out to be wrong rather than the commentator.

A couple of years ago I found myself debating with former Commonwealth Bank CEO Ian Narev about the company's investment in technology and its high dividend rate. My argument was that in a world where systems are going to be more and more important for banking (and many other industries)

Australian banks, and particularly the Commonwealth Bank (CBA), were way out of line with the rest of the world's bankers in paying such a high level of their profits out in dividends. They would need to invest that money in better and better systems or it would affect long-term returns.

I realise this is not a popular view among income poor shareholders.

Ian Narev was very persuasive in putting an alternate view forward, stating that the bank would not have the ability to manage substantially greater amounts of investment in systems while defending the dividend policy.

Unfortunately, on systems I was right and CBA is now in all sorts of bother over its money laundering and terror funding activities which owe their genesis to faulty systems. In that area you can add some bad management as well.

A Commission bombshell

Just how all that turns out in the courts is, of course, yet to be determined. But this week at the Royal Commission, the head of CBA's private bank Marianne Perkovic dropped a complete bombshell on CBA's activities when she was asked if their systems were so hopeless that they had no idea of what was going on in its business.

Her answer, under oath, was a short but devastating: ‘Yes'.

Later she agreed that systems were good at recognising revenue for CBA with the implication that they were useless when it came to anything else including looking after customers. 

CBA raced ahead of the other banks in its systems starting with an investment by David Murray and continuing under Ralph Norris. The bank installed a lot of systems under its own design.

I remember Ian Narev telling me after his appointment, but before he took office, that his job was to take advantage of those systems and use them to enhance the bank's services and profitability to customers.

Unfortunately, a whole lot of new products and services were required, and it wasn't easy for CBA because it was adding on to a system that was unique. But they claimed they were able to add new products and features and that the systems were in good shape and doing their job.

Marianne Perkovic, (and I emphasise under oath), has blown that answer apart. But each of the other banks have a variation on this problem.

In the case of NAB it linked with the computer giant Oracle to develop a completely new system. That system was used to propel Ubank, but when Andrew Thorburn took over as CEO he balked at changing the whole bank, believing that due to new changes in technology, the current systems could be updated.

So far that seems to have worked. Both Westpac and the ANZ have never attempted any base changes and just added on new systems. The other three big banks are now watching CBA get itself into very deep trouble because its basic computer systems are not working as they should. The new CBA chief-executive will need to address shareholder questions, especially after the old executive threw

But one qualification. CBA has thrown its middle ranking executives into the fire and later the new CEO will need to address shareholders on these questions.

System or people at fault?

My mates in the small business accounting software area think the CBA systems are better than the other banks, and they are working perfectly well. It is always possible that CBA staff at the Royal Commission are blaming systems when it is simply management error but we will reserve that judgment for a few months.

At the same time, NAB chairman and former Treasury boss Ken Henry, is suggesting that there has been too much emphasis on shareholder returns and not enough investment in listed businesses.

I know it is not good news for shareholders, but I suspect that out of the Royal Commission will create a much more conservative dividend policy particularly if the commission makes banks properly assess living expenses of property investors prior to lending them the money. 

But, that is only part of what will happen if the commission continues to uncover bad practices in banking, financial planning and insurance. We have already seen several middle to upper ranking executives absolutely trashed by the commission. Their careers have had a major setback and it is even possible that some of the people from AMP may be sent to jail.

This is going to create a very different environment in the banking, financial planning and insurance sector as it diverts money that would otherwise have gone to shareholders, into systems and other activities.

We will see the banking conglomerates split. Not surprisingly, CBA and AMP shares have been the main casualties and CBA shares are very close to $71.50, the price at which the bank issued new shares in 2015 in a $5 billion capital raising.

The problem at Village

Another development this week caught my eye was the decline in revenue for Village Roadshow.

I have been a follower of Village Roadshow as I know the Kirby family, and from time to time visit its various cinemas

It is fascinating that the cinema revenues are now very soft. Village hopes that some block-buster films will rescue the situation in coming months, but I think the problem goes deeper. and again, it is partly about systems. 

When Village was at its prime it didn't spend the money to gather the email and other means of contact for the vast number of people visiting its cinemas. It needed to develop a customer-base where it could promote its films and entertainment experience

Increasingly at the same time the film makers have not fully realised that an increasing chunk of their audience are older people and a large amount of the films that are being produced are aimed at the young audience in a space where everyone feels comfortable.

This is also a problem with a lot of retailers. A really hard look at this business is required and Village cinema softness is not good news for big shopping centers who had hoped cinemas would drive traffic.

Another blow to Village Roadshow was the fact that the Commonwealth Games diverted people from its theme parks. If that is all that has caused the theme park downturn, then it's a short-term blow and there may be a longer-term gain as a result of greater exposure for the Gold Coast.

But behind that decline is the fact that a great many people find the Gold Coast is very expensive and go to Bali or Thailand instead. This is a major challenge for the theme parks on the Gold Coast and like cinemas a more innovative approach to marketing and product development may be required.

Finally, you will have noticed that after a month or so when fear drove investors to US 10-year bonds and pushed rates down, US bonds are back out of favor and yields are rising. If it continues it means Australian rates will rise separately to decisions of the Reserve Bank