Bank directors should prepare for a more regulated environment with fewer opportunities for revenue generation. JOEL CARRETT
Bank directors and their executives should be prepared for more ongoing scrutiny internally and externally on non-financial risk and customer wellbeing. The Commissioner has not minced words in prioritising customer benefit over drivers such as financial gains to banks and individuals: "The culture and conduct of the banks was driven by, and was reflected in, their remuneration practices and policies."
The interim report is a series of questions which ask where the balance should be found between customer interest and the profit of institutions and individual remuneration. The call is for greater focus on customer benefit and stronger controls on bank conduct. The Commissioner wonders whether more regulation will make a difference, but highlights the need for regulators to more actively use a greater range of sanctions in enforcement.
After the existential shocks of the GFC, it is not surprising that the boards of Australia's banks concentrated on financial risk. Regulators required it. The Commissioner acknowledges this background. Boards have also focused on financial returns as demanded by institutions including Australia's superannuation funds.
Regulators have had difficulty getting regulatory traction with banks on non-financial risk and customer wellbeing. The interim report makes it clear that boards now have no option but to re-balance the voice of finance and the voice of the customer. Amongst the many questions the Commissioner raises, these are themes bank directors should reflect on.
Do it right and put it right for customers. The report is clear that breaching the law should have consequences, and this is in line with community expectations. Executives have cited complexity, broken processes and absence of resources but these excuses are all within the control of boards and executives.
The report also sees remuneration arrangements as crucial in rebalancing the current prominence of the financial voice in banks. Boards will have to find new ways to incentivise staff because currently much of the misconduct "can be traced to entities preferring pursuit of profit to pursuit of any other purpose". Finding and instilling customer regarding purposes may be the Commissioner's biggest challenge to bank boards.
Banks and their executives should be prepared for more ongoing scrutiny internally and externally on non-financial risk and customer welfare. Senior executives should expect to remain the focus of both boards and regulators. Civil penalty and prosecution actions are not off the agenda.
Internally at banks, legal compliance, internal audit and risk processes need resourcing to have greater authority over business units on non-financial risk. Board scrutiny of performance regarding customer treatment and bank reputation should have consequences for executive remuneration and tenure because existing "governance and risk management practices did not prevent the conduct occurring".
Directors should be prepared for more external regulatory scrutiny. The Commissioner has no time for breaches of the law, concluding that entities "were doing as little as they thought they needed to do" to be compliant.
This will require greater responsiveness to breach notices, expedition for remediation and fixing misleading disclosure or fees for no service. Banks will find it harder to keep enforcement in the lower ranges such as enforceable undertakings. Directors will need new strategies on how to navigate these with parallel prosecutions or civil penalty actions and class actions. They will need to prepare for enforcement against individuals as well as their bank itself.
Prepare to navigate a more regulated environment with fewer opportunities for revenue generation.
The Commissioner's strong view that conflicted remuneration and bank profit targets are at the centre of institutional and individual misconduct and shabby customer treatment suggests directions for future regulation. Although complex to abolish retrospectively, 'grand-fathered' commissions in financial advice and superannuation funds are under scrutiny and so are commissions for mortgage brokers.
Likewise seemingly invulnerable insurance commissions. The Commissioner is reserved about recommendations on regulation. Rather he raises many questions, in a climate of sharpened political will for regulatory reform and better resourcing. Boards, used to their banks influencing the regulatory agenda, will have to respond. They will need to manage the gap between community expectations of customer treatment and the standards set by the law.
The Commissioner holds nothing back in his expectation, shared by the community, that banks should comply with the law. He and counsel assisting have often asked witnesses, did you understand you were breaking the law? And, to regulators, why did you not enforce the law? In his report the Commissioner observes "Compliance appeared to have been relegated to a cost of doing business".
Large-scale businesses like banks see legal compliance in a risk management framework. Those controls permit residual risks to remain, including non-compliance risks, which may result in customer losses. Boards will have to reflect on balancing risk practices with the community expectation that banks comply fully with the law. That is the expectation the legal system sets for car drivers for example, who are also navigating risks. Boards have managed financial risks, but non-financial risks have run a poor second.
The challenge for directors, in the financial sector and beyond in companies with mass customer markets, is how to do better so that corporations' non-financial risks are bought closer to the legal compliance the legal system and the community expects.
By Dimity Kingsford Smith is Professor of Law and Director, Centre for Law Markets and Regulation at UNSW Law, Sydney.
28 September 2018