Conduct risk in the banking industry is in the limelight, especially with the recent set up of the Royal Commission to study misconduct in the banking, superannuation and financial services industry. From mis- selling of financial products to wrong treatment of customers, misconduct by banks can give rise to extremely high misconduct costs. Comprehensive secondary research in this field has been performed on the historical cases of banking misconduct and this has yielded two major outputs: one, the drivers or causes of each misconduct case and two, the financial and qualitative impact of each case (for example, the fines banks had to shell out due to each misconduct or the level of customer dissatisfaction banks have to face due to a scandal). Based on a comprehensive five step methodology developed, it was concluded with justification that the five areas where a future misconduct might occur in the banking industry are: Mortgage lending, Credit Card financing, FX trading, Financial Advisory and Deposit accounts.
Poor internal culture: A common theme in banking misconduct cases?
Through the entire process of performing secondary research and developing a methodology for prediction of future misconduct areas, the most important insight that stemmed was the role of internal company culture in causing banking misconduct. It was discovered that the internal governance, procedures and controls in a bank seemed to play a major role in either preventing misconduct or causing misconduct. Out of the seven major drivers of banking misconduct, as many as four major drivers are related to a banks’ poor internal culture. Poor company culture includes lack of ethical and professional standards in a bank, or lack of employee training in those standards even if they exist and many of the times, adherence or non-adherence to an ethical culture is influenced by how serious the banks’ top management is with regards to maintaining an ethical culture. Lack of accountability and transparency
and weak internal monitoring and surveillance breeds misconduct. Research shows that Banking customers are finding it more and more difficult to restore their faith in the banking industry due to the corrupt internal culture of banks. Banks are selling financial products unsuitable for customer’s needs or they are giving out loans based on inaccurate or unreliable customer information (called ‘liar loans’). This is directly related to a banks’ culture of rewarding excessive risk taking with little accountability. If the internal culture in a bank promotes “growth at all cost” business model and creates an imbalance between customer’s best interests and profitability, it is prone to one or the other misconduct happening in the future. Lack of a strong ethical culture amongst the bank employees makes the bank more prone to misconduct. It is seen from historical research that most of the misconduct cases, especially in mortgage lending, car loans and credit card financing have happened because of the banks’ inability to strike a balance between sales driven front office culture and the overall risk culture. A lot of cases of misconduct involving poor financial advice or breach of laws have happened due to either the absence or non-adherence of professional standards in a bank. Poor internal culture leads to conflict of interest wherein financial advisors and bankers are recommending unsatisfactory products. Moreover, the bonus based incentive structures of bank employees have created a culture of increased lending and aggressive selling tactics are deployed and based on the research performed, it was observed that many of these loans were issued on the basis of inaccurate or incomplete customer information, thus compromising due diligence. Moreover, poor internal culture is not just restricted to one or two banks. With the revelation of top three Australian banks charged guilty of swap rate rigging, it is safe to say that the problem is pervasive.
Internal Culture Review and Overhaul: A Step in the Right Direction
Overhauling the banks’ internal culture and remuneration policies is a step to prevent misconduct from happening in the industry in the future. When bank employees act in tune with their individual ethics, when
employees are rewarded for doing the right thing and when they are encouraged to report breaches of ethical standards, misconduct will be discouraged. Enforcing a culture of customer centricity from top management to bottom and encouraging whistle-blowers is the need of the hour. Rewarding compliant and ethical conduct will impel employees to take their fiduciary and regulatory responsibilities more seriously and will prevent misconduct from happening in the future. Overall structural and organisational culture overhaul, and giving more weightage to moral implications of misconduct are the key to a healthy banking sector. Regulating an invisible force such as organisational culture is extremely difficult but new legislations including BEAR (Banking Executive Accountability Regime) are the step in the right direction and will surely motivate banks to bring about cultural change.
A holistic solution to tackle misconduct would combine conduct, culture and improved customer experience as its highest goal. Conduct standards need to be driven from the bottom-up; The solution is formulating a training plan which could be tweaked from bank to bank. This would protect the client, and inform and educate staff. Personal development of staff coupled with institutional protection for the bank is a win-win scenario. Cultural improvement could be driven through seminars and one to one sessions with experts, driving C-level employees to take ownership of staff conduct, and impel subordinates to take their fiduciary and regulatory responsibilities more seriously, especially in light of BEAR and FEAR legislation.
Finally, moving on to customer experience, the banking industry is becoming increasingly transparent, not just internally but with the client also. Implementation of strong internal safeguards regarding customer information, as well as increased disclosure to the client is the need of the hour.