* Confidential CBA letter disclosed in inquiry
* Incentives could encourage brokers to write bigger loans
* CBA chose to do nothing in order to protect "volume" - exec
SYDNEY, March 15 (Reuters) - Commonwealth Bank of Australia Chief Executive Ian Narev knew that a system of financial incentives to reward mortgage brokers could hurt customers but failed to act, an inquiry into Australia's financial sector heard on Thursday.
A confidential letter penned by Narev in 2017 and disclosed on the third day of the financial sector Royal Commission criticised the practice of paying brokers more for bigger loans, an incentive still widely in place including at CBA.
But instead of ordering changes to remuneration practices to protect customers from taking out loans they could never pay off, CBA chose to protect "volume" in the bank's highly lucrative mortgage business, a CBA executive said.
"We agree ... that while brokers provide a service that many potential mortgagees value, the use of loan size linked with up-front and trailing commissions for third parties can potentially lead to poor customer outcomes," wrote Narev, who is stepping down as CEO next month after a series of scandals at the bank.
Under questioning, CBA's executive general manager home buying, Daniel Huggins, said that although Narev supported changes to incentives, nothing was done to unwind the broker commission system because the bank would "likely lose a lot of volume" if it was the first of its peers to do so.
Broker payments, particularly trailing commissions paid over the life of a loan, are a sensitive topic for Australian financial institutions as the four biggest banks derived A$51.77 billion ($40.8 billion) from mortgage agents in the September quarter of 2017, according to the inquiry.
As the country's biggest lender, CBA attracts about 40 percent of new home loans from brokers.
The year-long Royal Commission has extensive powers to subpoena documents and can recommend criminal or civil prosecutions and legislative changes, potentially forcing changes to broker incentives.
The Royal Commission was ordered by the government after years of scandals in Australia's financial sector, which included poor financial advice, interest-rate rigging, and accusations of money-laundering.
CBA is the second bank to be scrutinized after National Australia Bank, which conceded on the opening days of the inquiry that its system of bonuses and incentives encouraged bankers to engage in fraudulent lending practices to boost their incomes. ($1 = 1.2697 Australian dollars) (Reporting by Jonathan Barrett and Paulina Duran in SYDNEY; Editing by Stephen Coates)