Imagine what might be found by two royal commissioners looking into banks with
a passion for looking into banks.
They make enormous profit and rip customers off – banks need to clean up their act
David Richardson
Imagine what might be found by a royal commissioner looking into banks with the passion Dyson Heydon had for looking into unions ‘
15 April 2016
Australia’s big banks, particularly the “four pillars”, control so much of the nation’s economy, yet the banks have been pushing people into buying wealth products that do not suit them, overselling home mortgages and other debt. Their insurance arms are rejecting legitimate claims while their traders have been accused of manipulating the benchmark interest rate for business loans. Instead of sacking dodgy staff, the whistleblowers are sacrificed.
Meanwhile banks are extremely profitable. Before tax, the banks made $55.3bn – or 3.4% of Australia’s national income – in the year to December 2015. That is, for every dollar spent in Australia 3.4 cents become underlying profit of the banks. Which might leave you asking: why would they feel the need to resort to that sort of behaviour? Perhaps because a good part of the profit comes from the practices which are now under investigation.
Ken Henry, formerly head of Treasury now chair of the National Australia Bank, has been calling for Australian companies to take more responsibility for misdeeds and said “Corporate leaders have responsibility for the culture of organisations and they all kind of know it, but they’re struggling with how to do it and how to be effective”. Australian Securities and Investments Commission head, Greg Medcraft, was also reported as wanting to make boards criminally responsible for bad conduct.
On Thursday the Australian Financial Review’s lead story was “PM puts huge pressure on banks to end scandals”. That “huge pressure” was further described: “Prime Minister Malcolm Turnbull slammed what he said was the banks’ culture of greed”.
The prime minister, with all of his authority to make laws and regulations, elected to tell the banks to fix themselves, pretty please.
All this is fairly mild compared with the message from the American Finance Association president, Luigi Zingales, who said “I fear that in the financial sector fraud has become a feature and not a bug.” Part of the responsibility, in his view, was the instruction in universities where finance faculties “teach our students how to maximise the tax advantage of debt and how to exploit any arbitrage opportunity. Customers are often not seen as people to respect, but as counterparties to take to the cleaners.”
Zingales continues: “If the most profitable line of business is to dupe investors with complex financial products, competitive pressure will induce financial firms to innovate along that dimension.”
These sorts of comments could apply equally to Australia. Staff in the big banks have been turned into sales staff. Every interaction with the bank is seen as an opportunity to try to sell other products. Incentives are provided to staff who make sales and, at the same time, there is disapproval of those staff that do not make their quotas.
Staff who sell “wealth products” have an incentive to sell a lot as well as directing the customers towards the banks’ own products and/or those paying the staff some sort of commission. Probably staff that “play fair” can make a reasonable living selling those products. But those who are willing to cut corners and sell products with the biggest commissions are going to do very well.
Loan managers are similarly likely to be “incentivised” to maximise their loans and, as a result, the Australian Prudential Regulation Authority has voiced concerns about some of the loan contracts to risky customers. APRA claims to have worked hard with banks over the last year to improve lending standards.
Along with the incentive to sell unsuited products, the banks themselves have developed ways of presenting their loan and deposit offers that are difficult to understand let alone compare against their competition.
The Commonwealth Bank’s insurance arm has been in the news for knocking back reasonable claims or trying to hold out until the death of the claimant. What is a claims manager supposed to do? We can imagine how an insurance company (or a branch of a bank) would feel about a claims manager who willingly agreed to all the claims that came in. There is no incentive structure that guarantees an outcome will be fair.
We expect to see banks as solid, staid and very conservative institutions who are motivated by much more lofty concerns than making money. But the banks have allowed, or encouraged, the development of an incentive structure that now lures those who see a banking career as selling wealth management products, rather than serving customers and as Zingales says “fraud is a feature, not a bug”.
So how do we clean up this industry?
Imagine what might be found by a royal commissioner who brought the passion and drive Dyson Heydon had for looking critically into unions to looking into the banks.
No wonder the banks are now threatening a mining-tax style campaign and the Financial System Inquiry head and former Commonwealth Bank CEO David Murray has strenuously objected to proposals to prescribe bank culture.
But somehow, a bad culture has to be addressed by changing the incentive structure, not least by stronger sanctions against those who rip us off.